Howmet Aerospace - Earnings Call - Q4 2020
February 3, 2021
Transcript
Operator (participant)
Good morning, ladies and gentlemen, and welcome to the Howmet Aerospace Fourth Quarter 2020 Results conference call. My name is Sia, and I will be the operator for today. As a reminder, today's conference is being recorded for replay purposes. I would now like to turn the conference call over to your host for today, Paul Luther, Vice President of Investor Relations. Please proceed.
Paul Luther (VP of Investor Relations)
Thank you, Sia. Good morning and welcome to the Howmet Aerospace Fourth Quarter 2020 and Full Year 2020 Results conference call. I'm joined by John Plant, Executive Chairman and Co-Chief Executive Officer, Tolga Oal, Co-Chief Executive Officer, and Ken Giacobbe, Executive Vice President and Chief Financial Officer. After comments by John, Tolga, and Ken, we will have a question-and-answer session. I would like to remind you that today's discussion will contain forward-looking statements relating to future events and expectations. You can find factors that could cause the company's actual results to differ materially from these projections listed in today's presentation and earnings press release and in our most recent SEC filings. In addition, we've included some non-GAAP financial measures in our discussion. Reconciliation to the most directly comparable GAAP financial measures can be found in today's press release and in the appendix in today's presentation.
With that, I'd like to turn the call over to John.
John Plant (Executive Chairman and Co-CEO)
Thanks, PT, and welcome everyone to our fourth quarter call. Following the same format as last quarter's earnings call, I plan to give an overview of the fourth quarter Howmet performance. Tolga will then speak to segment information, and Ken will provide further financial detail. I'll return to talk to the outlook for the 2021 financial year, so please move to slide number four, and first, let me provide some qualitative commentary regarding the fourth quarter before moving on to specific numbers. The fourth quarter played out as expected and guided. In fact, the results were above both consensus and the improved outlook that we provided in November. Revenues rose compared to the third quarter due to the lesser impact of commercial aerospace inventory corrections.
Performance improved again, and the decremental margin year-over-year was 24%, which was an improvement from the decremental margin in the third quarter, which was 37%. The incremental margin on the revenues benefited from the utilization of labor that were held onto in the third quarter in order to meet the expected increase in fourth quarter revenues, which were 9%, as approximately forecast. Furthermore, the third quarter included the $8 million write-down of a long-term contract that we bought out. Moving to specific numbers, revenues improved over the third quarter by 9% and were 29% lower than the fourth quarter of 2019 due to the reductions in commercial aerospace. The fourth quarter EBITDA margin was 22.8% and ahead of outlook. The fourth quarter EBITDA margin in 2020 was, in fact, the same as the fourth quarter of 2019 while mitigating the market reductions and commercial aerospace adverse mix.
Performance was driven by permanent cost reductions and price increases. Lastly, the fourth quarter earnings per share was 21%, again ahead of consensus and at the top end of our outlook range. Moving to cash, free cash flow for the fourth quarter was positive at $268 million, which is the third consecutive quarter of positive free cash flow since separation. As you know, we define free cash flow very conservatively as the net cash after everything, i.e., after pension, after AR securitization, paydown, etc. Q2 through Q4 free cash flow was $487 million and above the outlook. The $487 million includes an $80 million reduction in accounts receivable securitization, a $70 million of cash flow to pay down in incremental voluntary pension contributions, $47 million of severance costs, and we did receive a $45 million tax refund. Without these one-time items, free cash flow would indeed have been $638 million.
Full year free cash flow as a percentage of net income was 115%, well above our guide of approximately 90%, and would have been approximately 160% excluding the one-time items mentioned. Year-end cash balance was also ahead of outlook at $1.6 billion after repurchasing $73 million of common stock throughout the year at an average price of $18.98. Now let me turn it over to Tolga to highlight segment performance.
Tolga Oal (Co-CEO)
Thank you, John. So let's move to slide number five, please. Safety of our people is a top priority as the COVID cases continue to increase worldwide in the fourth quarter. Our operations stick with continuity and customer demand with no major events. Our segments remain focused on the cost containment and cash preservation targets in the fourth quarter. Structural cost reductions exceeded the outlook. Effective variable cost flexing and furloughs continued in specific locations to manage the sales fluctuations in different segments. Cash management actions continue with clock speed. Strict capital expenditure control, strong accounts receivable collections, and effective inventory management with the key customer-stranded inventory discussions in the background contributed to Howmet's fourth quarter cash performance. Let's move to slide six, please. I will start with Engine Products.
Commercial aerospace revenue showed quarterly improvement with the third quarter seasonal shutdown impacts not repeating and inventory adjustments slowing in line with our expectations. Defense aerospace and industrial gas turbine growth continued in the fourth quarter. Effective variable cost flexing and driving permanent cost out ahead of the plan have contributed to our incremental margins from the engine side in the fourth quarter. We are expecting the stranded inventory discussion with our key customers to continue. Fastening Systems industrial business continued to grow, balancing the timing of commercial aerospace distribution business in the fourth quarter. I mentioned in our last earnings release that the fasteners business had the highest number of locations, and permanent cost reductions gained traction across these locations in the fourth quarter.
We continued to bridge the timing of pending reductions with targeted furloughs and successful variable cost flexing, improving our operating margins with relatively flat revenue in the fourth quarter versus third quarter. The Engineered Structures segment revenue showed a small increase in the fourth quarter versus third quarter while we continue level loading our operations for an optimized operating model for long lead time orders. We are ahead of our cost out plans as we implemented additional headcount reductions to get ready for the latest announcements in the 787 build rates. Cost out plans are running ahead of plan and contributed to incremental margins also on the structures side. Commercial vehicle market recovery in the fourth quarter led to a record quarterly profit margin for the wheel segment.
While the Boeing market continued to recover, increasing our low-cost country content, keeping fixed costs compressed, and increasing the share of our revolutionary 39 lb Wheels led to very healthy incremental margins in the fourth quarter. Let me now turn it over to Ken to provide more details on the financials.
Ken Giacobbe (EVP and CFO)
Thank you, Tolga. Now let's move to slide seven. For additional details on the fourth quarter, let's start with revenue. As expected, revenue was down 29% year-over-year, driven by a 51% reduction in commercial aerospace and a 10% reduction in commercial transportation. These markets were partially offset by continued growth in defense aerospace and industrial gas turbine markets. On a sequential basis, although commercial aerospace grew 5%, we do not expect a meaningful recovery in commercial aerospace in the first quarter of 2021 due to lingering customer inventory corrections. Regarding the defense aerospace, commercial transportation, and IGT markets, they all had double-digit sequential growth. Operating income excluding special items was down 28% year-over-year, with commercial aerospace representing 40% of total revenue compared to 60% in 2019. Permanent cost reductions and price increases continued in the quarter.
Permanent cost reductions were $60 million in the quarter and $197 million for the year, which were ahead of our outlook. Price increases were $11 million for the quarter and $39 million for the year, which were in line with our expectations. Decremental margins improved to 24% in the fourth quarter compared to 37% in the third quarter. Fourth quarter earnings per share was $0.21, which was ahead of consensus and at the top end of the outlook range. Moving to the balance sheet and cash flow, John covered the full year and post-separation numbers, which were ahead of the outlook. I would add that in the fourth quarter, we finished the year with $1.6 billion of cash after repurchasing an additional $22 million of common stock in the quarter at an average price of $23.99. Remaining common stock repurchase authority from the board of directors is $277 million.
Lastly, net debt to EBITDA was 3.2x, and a revolving credit facility of $1 billion remains undrawn. Please move to slide eight. Slide eight is a summary of EBITDA margin performance. The fourth quarter EBITDA margin of 22.8% was ahead of the outlook and at the same level as the fourth quarter of 2019, despite a 29% revenue decline in an unfavorable commercial aerospace mix. The improvement in EBITDA margin was driven by price increases, variable cost flexing, and permanent cost reductions. Now let's move to slide nine. Before moving into the revenue and segment profitability, I would point out that the fourth quarter revenue was in line with the outlook at $1.238 billion, while profit was more than 10% or $27 million better than the outlook. Now for more detail on fourth quarter year-over-year revenue performance.
Revenue was down 29%, driven by commercial aerospace, which continues to represent approximately 40% of total revenue in the quarter. As previously mentioned, commercial aerospace was down 51% year-over-year, which showed a 5% sequential increase. Our second largest market, defense aerospace, continued to show growth and was up 24% in the quarter and 10% sequentially, driven by demand for the Joint Strike Fighter on both new airplane builds and engine spares. Our next largest market, commercial transportation, which impacts both the Forged Wheels and the Fastening Systems segments, was down 10% year-over-year. We continue to see favorable trends for increased demand, and this market improved 15% sequentially. Finally, industrial and other markets, which is comprised of IGT, oil and gas, and general industrial, was flat but up 12% sequentially.
IGT, which makes up 45% of this market, continues to be strong and was up 38% year-over-year and up 3% sequentially. Moving to slide 10, we'll quickly cover full year revenue performance. For the full year, revenue was down 29%, driven by commercial aerospace, which was down 38%. Commercial aerospace represented approximately 50% of revenue, which was down from approximately 60% in 2019. Defense aerospace was strong throughout the year and was up 14%. Defense aerospace represents almost 20% of total revenue. Commercial transportation was down 31% for the year but showed a strong recovery trend in the third and fourth quarters. Finally, the industrial and other markets were up 1%, with IGT up 28% as the IGT market rebounds from a weak level in 2019. Now let's move to slide 11 for the segment results.
As expected, Engine Products year-over-year revenue was down 33% in the fourth quarter. Commercial aerospace in the segment was down 58%, driven by customer inventory corrections. Commercial aerospace was partially offset by a 30% year-over-year increase in defense aerospace and a 38% increase in IGT as IGT benefits from continued favorable natural gas prices. Decremental margins for engines improved to 18% for the quarter compared to 34% in the third quarter. In the appendix of the presentation, we provided a schedule which shows how all of the segments' decremental margins improved from the third quarter to the fourth quarter. Now let's move to Fastening Systems on slide 12. Also, as expected, Fastening Systems year-over-year revenue was down 30% in the fourth quarter. Commercial aerospace in the segment was down 38%, and commercial transportation was down 21%.
Like the engine segment, we continue to experience inventory corrections in the commercial aerospace market. Decremental margins for Fastening Systems improved to 45% for the quarter compared to 58% in the third quarter. Now let's move to Engineered Structures on slide 13. Engineered Structures year-over-year revenue was down 30% in the fourth quarter. Commercial aerospace in the segment was down 52%, driven by customer inventory corrections and production declines for both the 787 and 737 MAX platforms. Commercial aerospace was partially offset by a 40% year-over-year increase in defense aerospace. Decremental margins for Engineered Structures improved to 24% for the quarter compared to 27% in the third quarter. Lastly, let's please move to slide 14 for Forged Wheels. Forged Wheels revenue was down 6% year-over-year but increased 18% sequentially as expected.
Despite the lower revenues, the wheel segment's operating profit was higher than last year, and operating profit margin was at a record high of 30%. The improved margin was driven by continued cost reductions. Moreover, with the reduced volumes, we were able to shift production temporarily to low-cost countries, including Hungary and Mexico, which improved our margins. Lastly, we've been increasing market share with a new innovative 39 lb wheel. Now let's move to slide 15 for special items. Special items for the quarter were a benefit of approximately $14 million after tax, primarily due to insurance proceeds received for fires at two of our plants. Additionally, a favorable outcome of a Spanish tax assessment primarily offset our severance cost. I'd like to comment and provide further perspective on Howmet's post-separation special items.
For the past two years, we've undertook a major restructuring and performance improvement program, including the separation of Arconic Corporation. Post-separation, the after-tax charges in 2020 were approximately $100 million, driven by two items. First, a voluntary U.K. pension settlement charge of $55 million in the second quarter, which reduced our gross pension liability by $320 million, and then second, in April, we paid down and refinanced our debt at an after-tax cost of $50 million. The refinancing added $420 million of cash to the balance sheet and refinanced a portion of the 2021 and 2022 bonds to a maturity in May of 2025. Regarding the balance, the other special items, they've pretty much all meted out, so now let's move to the capital structure and liquidity on slide 16. We continue to focus on improving our capital structure and liquidity.
All debt is unsecured, and our next significant maturity is October 2024. Gross debt at the end of 2020 was $1.5 billion, and net debt was $3.5 million. Strong cash generation in the year has reduced our net debt by approximately $370 million since separation. Moreover, as we previously mentioned, we decreased our U.K. gross pension liability by $320 million. A few additional items of note. First, our $1 billion five-year revolving credit facility remains undrawn. Second, we have reduced our AR securitization by $100 million in 2020. This reduction in AR sold was effectively a repayment of debt, which increases working capital and reduced our 2020 adjusted free cash flow, as John mentioned. Lastly, on January 15th of 2021, we used cash on hand to complete the redemption at par of our 2021 bonds that were due in April.
By paying down the bonds three months early at no additional cost, we saved $5 million of interest costs. On an annual basis, interest costs are reduced by approximately $19 million. Now let me turn it back over to John.
John Plant (Executive Chairman and Co-CEO)
Thank you, Ken, and please move to slide 17 for closing remarks on the fourth quarter and 2020 before talking about the 2021 outlook. Revenue was in line with the outlook while profit and margin exceeded. Differentiated products and ability to scale resulted in price increases in line with expectations. Permanent cost reductions continued and accelerated throughout the year, which also exceeded our outlook. Fourth quarter EBITDA margin rate of 22.8% exceeded the outlook and was at the same level as the fourth quarter of 2019, despite some 29% less revenue and an unfavorable commercial aerospace mix. Regarding liquidity, adjusted free cash flow and cash balance exceeded our outlook. Full year accounts receivable securitization was reduced by $100 million, and voluntary pension contributions were made of $70 million, while severance costs of $51 million were incurred, albeit we had tax refunds of some $78 million.
Full year CapEx was favorable to the outlook at 3% of revenue. The $155 million spend was over $100 million less than the depreciation of $269 million. Adjusted free cash flow was ahead of outlook at $487 million for the second through fourth quarters and $387 million for the full year. Net debt was reduced by $370 million since separation. Additionally, the gross pension liability was reduced by some $320 million. Cash increased to $1.6 billion, a $100 million beat to guide after the repurchasing of $73 million of common stock throughout the year at an average price of $18.98. 2020 was another year of heavy lifting. After separation, we refinanced the balance sheet, faced into the COVID pandemic and the impact on operations and our sales demand, and further improved our balance sheet. Now let's move on to slide 18. First, let me comment on the 2021 outlook qualitatively.
Our end markets of defense aerospace, commercial transportation, and industrial gas turbines continue to be healthy and growing. Commercial aerospace has less visibility and reflects our view regarding the global vaccine rollout, its acceptance, and potential impact on travel. Airline travel should improve, especially for short-haul routes, which may help dissipate narrowbody inventories, especially for Boeing. We expect improved clarity on these factors as we move through 2021. Regarding commercial aerospace, we expect increased aircraft build, especially as we move forward into 2022 and beyond. This will help both inventory clearance and shift to an inventory build situation, which will help rebuild the pipeline of aircraft parts. Now let's move to the specific numbers. Revenue for the first quarter is expected to be $1.2 billion ±$50 million.
For EBITDA, we provided you with a baseline figure with a range of -$5 million to +$15 million, so between $245 million and $265 million. Our EBITDA margin is ranged from 20.8%-21.3%. Earnings per share is at a $0.16 baseline with a range of $0.15-$0.19. In Q1 2021, we expect commercial aerospace to be down a little from Q4 due to lingering inventory corrections. Please note that for the second quarter, third quarter, and fourth quarter, average was $1.208 million, and the baseline guide is in line with the average of the last three quarters. For the year, we expect revenues of $5.1 billion at baseline with a range of $5.05 billion-$5.25 billion. In other words, -$50 million +$150 million. EBITDA baseline of $1.1 billion with a range of $1.07 billion-$1.15 billion, again, -$30 million to +$50 million.
EBITDA margin 21.6% for the year with a range of 21.2%-21.9%. Earnings per share baseline at $0.80 with a range of $0.75-$0.89 and free cash flow at $400 million ±$50 million. Let me provide you with a few assumptions. The cost reduction carryover into 2021 will be $100 million. Price increases are expected to be above the 2020 increases. Pension OPEB cash contributions are expected to be about $160 million compared to last year's $236 million. The operational tax rate is in the range of 26.5%-28.5%, similar to the average rate for 2020 of 27.5%. Adjusted free cash flow conversion is expected to be 115%, again above our long-term outlook of 90%. The cash tax rate will increase to about 15%, and CapEx we put in the range of $200 million-$220 million.
Maybe a couple of further comments to put 2021 into perspective. You can see by the revenue guide at $1.2 billion for the first quarter versus $5.1 billion for the year at baseline that there is an expectation that quarterly revenue begins to accelerate during the year. Margins are respectable and above 2020 year and in our baseline versus the normal outlook word we use, we have a smaller lower bandwidth to the downside and a higher bandwidth to the upside. That concludes my commentary before we move to question and answer. Thank you.
Operator (participant)
Thank you, and we will now begin the question and answer session. As a reminder, press star one to be placed in the Q&A queue. Press the pound key if you would like to be removed from the queue. We request that you limit yourself to one question. We'll pause for just a moment to compile the Q&A roster. And the first question will come from Gautam Khanna with Cowen. Please go ahead.
Gautam Khanna (Analyst)
Yeah, thanks. Good morning, guys.
John Plant (Executive Chairman and Co-CEO)
Hey, good morning, Gautam.
Gautam Khanna (Analyst)
John and Ken, I was wondering if you could give us a little bit more of your assumptions on Q1 and 2021 guidance because it looks like it's sequentially lower in Q1. The implied EBITDA margin for the year is below that of Q4. And I'm just wondering if mix worsens sequentially, if the 787 situation has gotten worse from what you last updated us on in November. What kind of explains the sequential and then if I could have a follow-up after that. Thank you.
John Plant (Executive Chairman and Co-CEO)
Let me have a go at that, Gautam. And I mean, I'll give you a round number. So last year, our second quarter revenues were $1,250 million, Q3 $1,130 million, Q4 $1,240 million, give or take a million or so. And that averages at $1,208 million. So what we've placed what we call baseline at $1,200 million with a bandwidth around it ±$50 million. So our view is that Q1 is essentially the same as the average of the last three quarters. With my feeling or statement is that Q2, we were not seeing much by way of customer inventory reductions, although we had the impact of certain customer plants being closed as we went into April last year. And then significant inventory corrections in the third quarter in particular and a lower correction in the first quarter. Right now, it just feels as though things are pretty opaque.
And essentially, the rollout of the vaccine, the airline load factors, in fact, if anything, airline load factors have reduced substantially in Europe with the almost closing down of travel in certain countries, particularly into the U.K. And international air travel has actually become, if anything, a little bit more problematic rather than improving. And so right now, there's little to observe and celebrate. And then you look at the rollout of the vaccine in particular, and that feels also below that which we could have or maybe should have expected. And indeed, some of the process to actually get that into people's arms is also being, I'll say, underwhelming.
I can talk from personal experience having got my first shot a couple of weeks ago and just the whole process, even trying to register and get the vaccine, never mind, is it going to be available for the second shot? That whole rollout has been, let's say, underwhelming. When you think about travel at the moment and therefore what's the impact on build, there's little to the upside and celebrate. We just say first quarter is roughly in line with the average of the last three quarters. That's the best we can see. I mean, there's a bandwidth of variability around it.
So it could be as we put what we call baseline rather than outlook to try to say, "This is what we think is that which you can rely upon with a relatively small downside and with a relatively higher upside." So we've given you an asymmetrical picture compared to what we normally do of just giving you a midpoint and a plus or minus around it. And we did that for the EBITDA margin in the first quarter. And then for the year, we also gave you an asymmetrical picture calling one baseline and then a lesser reduction and a higher upside. And it really is, it's the degree of opaqueness regarding the future demand. I mean, we've had the courage again to provide not just guidance for the quarter, but guidance for the year.
Just don't want to get ahead of ourselves, ahead of our skis at the moment and say, "Do we really have the absolute foresight to see the full year?" I think any reasonable person would say it's difficult when there's so many factors that you don't yet understand. I mean, while commercial transportation feels pretty solid, the defense and the industrial markets for us feel pretty solid. The oil and gas market is looking better with the improvement in oil prices, and natural gas is still sort of being the prevalent fossil fuel used in power stations. All of that's to the good. Then there's the commercial aerospace. Commercial aero, while we did see a lower inventory takeout in the fourth quarter. It was still 51% down year-on-year.
And at the moment, we don't yet have the courage to say it's going to get significantly better either in the first quarter or in the first half of this year. I mean, the bright news on the horizon appears to be that Airbus has indicated an increasing build rate for the A320, which is great. And that will mop up inventory within the next in the course of the year and maybe give us a build situation. Whereas on the 737, we haven't had any significant news one way or the other. And on 787, it's a little bit reduced from what we thought. So again, take it in the context of it's a baseline, it's a view, and we're hoping that the view of the incremental revenues, we do see that as we move through the year. And that's why I commented $1.2 billion for the first quarter.
Let's say $5.1 billion with that asymmetrical bandwidth around it should give us, hopefully, I'll say a higher run rate into the back half of the year. Does that cover it out, Gautam?
Gautam Khanna (Analyst)
It does. And maybe you can give us, based on what you know as of now, late in Q1, middle of Q1, what segments do you expect to be sequentially up or sequentially down if you have that visibility at this point?
John Plant (Executive Chairman and Co-CEO)
I probably have good thoughts around the commercial transportation business being slightly up, and just find myself cautious around commercial aerospace. With the others, I'm going to call it roughly in line. I recognize I didn't really talk much to the margin question you answered. Let me cover that out as well. So my thoughts around the first quarter is we've guided in that, I think, give or take 21% or possibly even if we had higher numbers over 21%. And conceivably, because I feel stronger about the margin than I do the revenue side, it could even be at the full end of that. But what do I think? First of all, it's higher than 2020. So I think that's good to say that we are confident that our first quarter is going to be at a run rate higher than 2020.
And I do recognize that at the moment, we are saying that it's probably not quite as good as the fourth quarter. And put that, you can assume that's within the bandwidth of all of the uncertainty around the commercial aerospace market at the moment, which we choose to be cautious about because we just don't feel as though we know enough and don't feel on solid ground enough at this point in time. While we hope for better, we're just planning to be in the zone where we think we feel confident at this point. So hopefully that covers out the margin side of it as well for you.
Gautam Khanna (Analyst)
Thank you.
Operator (participant)
The next question will come from Carter Copeland with Melius Research. Please go ahead.
Carter Copeland (Founding Partner, Global Aerospace, and Defense Analyst)
Hey, good morning. Just a quick follow-up to that. On the variable cost flexing and furloughs, can you give us a sense of how much of that is a headwind to the profit in 2021 that's built into your plan?
John Plant (Executive Chairman and Co-CEO)
At the moment, we've just said to ourselves, there is the potential that we may need, and we hope to bring people back from furlough. There may be some, let's call it, let's say, required retraining just to make sure we're on top of our game because we treat both our quality promises and our delivery promises as very serious. Despite all the, I'll say, pandemic disruption last year, both our quality indices and delivery indices were actually improved again, and we do want to maintain that track record, so we have assumed that there may be a little bit of drag from bringing people back earlier than immediately for the demand profile and just to make sure that they're in the fully trained, fully ready to go. Just the same as in our third quarter, we did hold on for some labor ready for the fourth quarter.
And you saw that was good. And so again, it's just a planning assumption. We're not brought anybody back just yet, but we're hopeful that we have that problem to deal with because that will lead to better days ahead for us because that's what I call a high-quality problem. And it's just a matter of then the efficiency with which we do that process, Carter.
Carter Copeland (Founding Partner, Global Aerospace, and Defense Analyst)
Okay, and then just another little quick one on the Forged Wheels, low-cost sourcing, and the Hungary move. Can you give us a sense of how much of that transition has now taken place? Is it substantially complete? And when did it all get transferred over? Just, is there any additional benefit that we should think is still rolling its way in 2021? Thanks.
John Plant (Executive Chairman and Co-CEO)
Yeah. So first of all, for the investment we made in 2019, we have been utilizing that, and we have been increasingly staffing that and there is still more to come in that regard from where we were in the third and fourth quarters last year. So in terms of utilization of that new plant, because we've tended to try to use the new rather than say necessarily some of the old because of the efficiency we can gain from it and therefore the margin, there is still some to come in the first half of 2021. We also have been adjusting our manufacturing footprint, which again, to the benefits, and chosen to invest some more money into Hungary for our Wheels business.
And that basically will come on stream during the fourth quarter of 2021, all leading to, I think, a healthy towards the run rate as we exit the year, but really leading us to 2022. So my previous commentary is that we'd seen, as you know, 2022 to be at similar levels to 2019 and then 2023 above. All of that still holds. And at the moment, you've seen what I think shows a really strong incremental margin in the fourth quarter. So as volume has come back into one of our divisions, then that incremental margin was tremendous. I'll hesitate to give you the number because it just sounds so good. I mean, you can give it later if he needs to.
But basically, I'll call a fabulous incremental margin on that, which if everything works out as planned, we hope to replicate that in our commercial aerospace businesses when we begin to see some volume recovery. And that's why we feel confident we're going to see recovery in the future. It's still a matter of what will it be and when?
Carter Copeland (Founding Partner, Global Aerospace, and Defense Analyst)
Great. Thanks for the color, John.
John Plant (Executive Chairman and Co-CEO)
Thank you.
Operator (participant)
The next question will come from Robert Stallard with Vertical Research. Please go ahead.
Robert Stallard (Partner)
Thanks so much. Good morning.
John Plant (Executive Chairman and Co-CEO)
Hey, Rob.
Robert Stallard (Partner)
John, I just had to follow up on what you said earlier on Airbus and the A320 and also Boeing on the MAX. And the bottom line of this is how much inventory do you think there is still in the chain as it relates to your product? And when can we see this point where we go from sort of destocking to restocking? And what sort of forecast have you built for that into your 2021 numbers?
John Plant (Executive Chairman and Co-CEO)
Okay. So when we originally built our plan for 2021, we just assumed the 40 A320s flew out through the year. We also recognized that we had not been supplying parts at the 40 rate. So we were, let's say, 32-38, sorry, 32-35 build sets. We guesstimate. It's always difficult both when you're at the first tier and through second tier levels of the supply chain. And as you know, through our Engine Products business, we operate through both GE Aviation and also Pratt & Whitney for the two engine variants for the A320. My expectation is that destocking will. I'm going to take a swag at this now. We think that will have completely dried up by the end of the second quarter.
We're going to have to start building some product ahead, particularly as it goes to the 45 rate in the fourth quarter of this year. That's why I call them. We all want bright spots. We've got two commercial transportation, and now this Airbus Lift. That gives us, that brings a little bit of a smile to our face. On the other hand, for Boeing at the moment, they state they've been building at seven per month in the back end of 2020, whereas we know we've been supplying at less than half of that rate. So small numbers. We just expect that to continue certainly through the first half of this year. Then when they raise it to, is it 10 and 20?
Then hopefully into the 30s by the second quarter of 2022, then well before then, we'll have start matching the run rate of part shipments to the build rate of aircraft. Now, the question is, when does that occur? And I don't have a lot of information regarding the clearance of the Boeing inventory at this point. I note the [Ryanair order]. I note that there were 27 deliveries of the 737 out of the 450 aircraft parked up in the fourth quarter for Boeing, which is great. But we know there's, given the fact that they built 20 aircraft in the fourth quarter, that just a little bit below the build rate, more than the build rate, sorry. So there's still a lot to go.
And so once we see that inventory dissipating as the information begins to flow this year, I think we'll become increasingly confident in the Boeing stated build rates. Bear in mind, to date, in actual terms, all we've seen is reductions sequentially for the last 18 months. And we obviously note the planned increases. But for us to feel confident, we've got to see that aircraft park dissipated and those increasing build rates reconfirmed to us. And so we tend to be a little bit cautious at this point in time.
Robert Stallard (Partner)
That's great. Thanks, John.
John Plant (Executive Chairman and Co-CEO)
Thank you.
Operator (participant)
The next question will come from David Strauss with Barclays. Please go ahead.
David Strauss (Managing Director)
Hey. Good morning, guys.
John Plant (Executive Chairman and Co-CEO)
Hey. Hi, David.
David Strauss (Managing Director)
Probably for Ken, a lot of moving pieces here on the free cash flow walk 2020 to 2021. Looks like you're at the midpoint forecasting about flat. Could you walk us through, Ken, just net working capital, kind of what you're thinking? I guess pensions down a little. I assume cash taxes are up, CapEx is down, severance is down. And then what you're assuming for the securitization program, is that a headwind this year as well?
Ken Giacobbe (EVP and CFO)
Yeah. Hey, David. So a couple of things on the free cash flow that we've provided. We've got a nice improvement there on the pension cash contributions and OPEB contributions on a year-over-year basis. As you know, as we exited 2020, the discount rate didn't work favorably for us. It was about 80 basis points unfavorable. That cost us around $200 million on the liability side. Asset returns were very strong for the business, over 14%. So that kind of netted out. But when you look at the work that we've done on the pension and OPEB program, especially over the last 12 months, we're going to see a favorability there. The other things I would look at, tax rate pretty much the same as what we've had before. You can see interest expense. That's most likely going to be, as you do the walk, around $290 million for the year.
And the big question, David, and I know you're focused on it like we are, is the working capital, right? As we looked at 2020, working capital was not a source or a use of cash in 2020, right? We took down the AR securitization program, which was a $100 million burn in that number. So that's all embedded there. So it wasn't a source or use even when we consider the bring down to the AR securitization program. So as we move into 2021, we think working capital, and this is all going to depend on, as John talked about, the revenue ramp as we go to the second half of the year, as well as some of the stranded inventory as we clear that out of the channel.
I expect working capital to be a modest source of cash embedded in that $400 million guide that we gave you.
David Strauss (Managing Director)
Okay. And,
John Plant (Executive Chairman and Co-CEO)
The one thing we didn't cover, Ken, was that we don't plan on any change in AR. The $100 million is done. We think we'll just leave that alone in 2021 at this point in time.
Ken Giacobbe (EVP and CFO)
Right. Yeah, right. Sorry, John, I missed that. $250 million there. David, no change.
David Strauss (Managing Director)
All right. Thanks. And John, obviously sitting with a pretty big cash balance, nothing on the debt side, I guess, to do. How are you thinking about share repurchase? And does your EPS guidance reflect any sort of capital deployment benefit or not? Thanks.
John Plant (Executive Chairman and Co-CEO)
No, we haven't assumed anything in our EPS regarding that. In my feelings on the cash balances, the thing I'm focused on more than anything at the moment is our 2022 bond maturities. And let's say, if we wanted to, should we just roll them off on the due date or should we move early? That's a consideration, which we're sort of thinking about. And so that's in the, I'll call it, in the in basket. In terms of further share repurchase of any note, my thoughts there are the trigger, I think, for us to be more aggressive in that regard would be seeing solidification of the, I'm going to call it, commercial aerospace build rate. And so the way I think about it is we've done some modest picking off of the shares over the last couple of quarters.
In terms of, would I want to be bolder than that in any significant way? Then it would be once I'm convinced that the aircraft build skylines solidify, become more certain from a fluid state, is it this or is it that? What's the wide-body rate really going to be? That's the trigger for me to be more aggressive on that side. So taking cash and deploying into the share buyback of any major note is the trigger for that is all centered on. If the skyline solidifies to a build I feel confident in, I see those skylines begin to lift. If these would go in the back half into 2022, I see inventory being put into the system because those builds are scheduled rather than just talked about.
And the good news is that we're told that we're going to see those Airbus increases actually scheduled in February. So we haven't seen them in the first two or three days, but we said by the end of the month, we'll see those in production releases. And then when you see that, you get more of a confidence than just a new skyline number. Because as you know, that skyline, even on the more confident Airbus side, move from maybe it's going from 40 to 47 to, let's see, a 43, then a 45 before moving maybe to a 48 in 2022. So I like to see it in schedule form rather than just news media form. And we need to just see what's wide body doing and then that clearance of the inventory for Boeing. And I think that's the point where I'll say, yep, we're good.
We'll have a pretty good view of what our incremental margins will be as we see that demand increase. And then it's off to the races maybe in terms of any cash deployment for share buyback.
David Strauss (Managing Director)
All right. Makes sense. Good luck. Thanks.
Ken Giacobbe (EVP and CFO)
Okay. Thank you.
Operator (participant)
The next question will come from Robert Spingarn with Credit Suisse. Please go ahead.
Robert Spingarn (Managing Director)
Hi. Good morning. John, just getting maybe a little more specific, are there any kind of one-off opportunities that might drive commercial aerospace up in 2021? One I'm thinking of is that MTU talked about a 20%-30% increase in MRO for them on the GTF, on some incoming GTF work, low pressure turbine upgrades, normal first-time shop visits, hot section upgrades, those sorts of things. Are there some things there that can drive 2021 up?
John Plant (Executive Chairman and Co-CEO)
Right now, we've said to ourselves, our spares profile is not going to change over the first two quarters of 2021 compared to the last two quarters in 2020 in any regard. So when you think about last year compared to the $400 million normal revenues we'd have, for example, in our engine business for commercial aerospace, the effective run rate for the last couple of quarters has been like 75%, 80%, even 85% down if you look at certain months. So we've just assumed that that just continues and we're not seeing anything and not choosing to believe at the moment that there could be an increase just because what's still out there, what could be cannibalized and moved off. We note that a couple of our customers are providing commentary around solidification of that into the back half of the year.
And I think we're willing to accept that, albeit at the moment, again, it's difficult to plan for it. I've always thought that we'd see some narrowbody build rate increases necessarily before we'd see a large increase in MRO. But when it does come back, then clearly that's going to be a benefit for us because striding along at, let's call it, only 25% of normalized levels or less is pretty tough. And we've just assumed that's the case for the next two quarters.
Robert Spingarn (Managing Director)
Okay. And then I know it's a delicate topic, but I thought I'd revisit just the idea of Pratt & Whitney and their new airfoils facility and if there's any more insight into what's happening there, and if that's going to be work that might share in your markets or if it's separate and separate content from what you do.
John Plant (Executive Chairman and Co-CEO)
First of all, it's not a delicate topic. It's pretty straightforward, really. Pratt & Whitney decided back in 2017, in the year after they'd sold their previous business in airfoils, to make selective reinvestments. They felt the need, first of all, to acquire some business to be able to provide more accurate coring for those castings because previously, they'd never been able to achieve, I believe, the yields which are necessary to be cost-effective in that regard and have the quality performance that comes out. The investment is exactly the same as previously stated, $650 million, as we think. It covers both the casting, coring, hole drilling, machining, coatings. There's a lot of stuff in there, and our view is that the increase in spares demand in the, let's call it in that 2023, 2025, 2027 timeframe, the spares demand is slated to grow very significantly.
Then all of that capacity could be used for that. What we also note is that we have renewed our LTA with Pratt & Whitney in this area. And so all's good. Nothing to comment further, really. No information that we've had.
Robert Spingarn (Managing Director)
Okay. Thank you very much.
John Plant (Executive Chairman and Co-CEO)
Thank you.
Operator (participant)
The next question will come from Seth Seifman with JPMorgan. Please go ahead.
Seth Seifman (Executive Director)
Hey. Thanks very much, and good morning. It's awesome. Some nice growth in the defense end market, and you talked about further growth going forward. Main customer, I guess, Pratt & Whitney had some good growth in 2020, talked about things sort of flattening out. Lockheed's talked about the F-35 production rate sort of nearing a run rate. So do we think about defense growth this year, sort of the year-end run rate sort of normalizing and that driving the growth? Or have there been share gains or maybe places outside the F-35 that might be able to continue to drive growth there?
John Plant (Executive Chairman and Co-CEO)
Yeah. Again, let me put it in perspective for you, Seth. The F-35 is about 40% of our defense sales, so it's less than half. So we do have a lot of significant defense business elsewhere. We supply GE Aviation with a lot of military airfoil applications and other structural casting applications as well as Pratt & Whitney. So I just wanted to baseline that for you. Military budgets, even in the course of a year, they don't necessarily move all in a similar percentage. It's often a little bit of a hike towards the end of the year. Money is spent. Budgets are when they're still replete with money. And so my thought is that maybe the fourth quarter is a little bit higher just because we have seen that in previous years as well.
Having said all of that, we believe our defense sales will be solid and increasing in 2021. The F-35 may be a more modest part of that in terms of OE build, maybe slightly more in spares build, but nothing of great note at this point. And we just see generally the military budget for 2021 remains healthy. And it wouldn't surprise us if we see the similar cadence through the year of, again, slightly lower in the early part of the year and slightly higher in the second half of the year when any remaining budget money is all spent.
Seth Seifman (Executive Director)
Great. Thanks. And then as a follow-up, the idea of inflation has come onto people's radar screens a little bit more recently. I think back at Arconic days occasionally in the TCS segment, there would occasionally be some aluminum impacts. Is that something we should be aware at all for the Forged Wheels business? And then in the rest, on the aerospace side, it's been striking to me the degree to which raw materials have not at all been part of the discussion. And so should we expect that to kind of remain the case with the past three years working fairly effectively and not being really a consideration?
John Plant (Executive Chairman and Co-CEO)
Yeah. I feel as though if I ever call out materials as a massive issue, I feel like maybe I should shoot myself. Maybe that's a bit extreme. But when you're in that 90%-95%, let's call it 95% pass-through situation, then in the course of the year, there may be a quarter where in terms of a lag as if metals move massively. But in the normal course of, let's say, metals corridors and our back-to-back agreements with our customer base, including Wheels. So it doesn't really matter whether it's an aerospace product or a commercial aluminum wheel, but whether it's cobalt or whether it's nickel or vanadium or aluminum, those are pretty much covered, Seth.
Seth Seifman (Executive Director)
Great. Thank you very much.
Ken Giacobbe (EVP and CFO)
Thank you. Yeah. I'd just add to that, Seth, as John mentioned, 95%+ pass-through. And for the remaining piece, we have hedging agreements in place too. So that whole volatility piece from the old Arconic Inc days, that goes away.
Seth Seifman (Executive Director)
Great. No, that clarifies things. Thank you.
Ken Giacobbe (EVP and CFO)
Maybe I should also just remind you that we had covered that back for a lot of what's now Arconic Corporation in terms of aluminum pass-through and spent a lot of time correcting that in 2019 as well. So it was a diminished feature of that business and not a feature of a problem for Howmet at all.
Operator (participant)
The final question is from Noah Poponak with Goldman Sachs. Please go ahead.
Noah Poponak (Managing Director)
Hi. Good morning, everyone.
John Plant (Executive Chairman and Co-CEO)
Hey, Noah.
Noah Poponak (Managing Director)
John, everything I'm hearing from you on this call, I think, translates to this forged wheel margin a little bit over 30% being sustainable. Is that accurate? And then I wanted to circle back to the incremental margin you mentioned in the piece of the business that had better volume. Can you quantify it for us? And then it sounded like you were saying you think of that number as translating to the aerospace business kind of back half of 2021 or into 2022 as you have better volume. Is that literally the case?
John Plant (Executive Chairman and Co-CEO)
Obviously, when I say it's improved, let me use the back end of your question first. It was more of a directional comment. So as volume returns, I'm hopeful that incremental margins are healthy. I'm going to ask Ken just to give you the specific Wheels incremental, but because I thought it was rather good. And in terms of the, I think, the Wheels margin, which I think was 30%, the EBITDA margin in the fourth quarter, and is it sustainable at the volumes we're seeing and had? Yes, I do. I mean, I have no intentions of that business going backwards in its EBITDA margin. So Ken, do you have to comment on that incremental?
Ken Giacobbe (EVP and CFO)
Hey, Noah. Yeah. Hey, Noah. So we've put a slide in the appendix that has the details for Wheels in the other businesses as well. But as John mentioned, from an EBITDA perspective, Q4 at 35.5%, right? That's as we've adjusted the production footprint and leveraged some of the low-cost country areas. We've also invested in them as well. So we've got the benefit of the geography, the global footprint. The team has done a terrific job in Wheels this year in terms of taking costs out of the business quickly. And then as the volume started to come back, it was very surgical in terms of how we brought people back in. But the expansions that we have are going to help as we move forward. And the last thing I would mention is just the improved yields in that business as well.
The production of the Wheels business has improved over the last several years. So a real testament to that team. And I'll give you one data point from a quality perspective. PPMs in our Wheels business is less than 10, so 10, right? So very good production process there as well.
Noah Poponak (Managing Director)
Okay, and if I could just ask one.
John Plant (Executive Chairman and Co-CEO)
The incremental from Q3 to Q4 was off the charts.
Noah Poponak (Managing Director)
Right. Okay. Just one follow-up on the revenue, the sort of sequential walk for the revenue and the 2020 revenue guidance discussion. Given it would seem like most of the businesses outside of aerospace original equipment have some visibility into improving or already improving. And then within aerospace original equipment, there's just a lot of moving pieces given the unique situation with the MAX. The A320 is going higher. The 787 is coming down. We're never exactly sure where you are. Can you just tell us in the 2021 revenue guidance you provided today, what are aggregate total aerospace original equipment revenues doing as you move through the year? Are those higher or lower exiting 2021 compared to exiting 2020?
John Plant (Executive Chairman and Co-CEO)
Higher. If we exit 2021, then 2022, that's pretty straightforward. There's a lot of moving pieces complicated by inventory adjustments, but basically rising as we exit the year is what we strongly believe.
Noah Poponak (Managing Director)
Okay. Great. So the lift on the narrowbody side is more than the incremental step down on the 787?
John Plant (Executive Chairman and Co-CEO)
Yeah.
Noah Poponak (Managing Director)
Okay. Thanks very much.
John Plant (Executive Chairman and Co-CEO)
Okay. Thank you.
Operator (participant)
We have reached the end of the allotted time for the Q&A session. Ladies and gentlemen, thank you for participating in today's conference call. You may all disconnect.