Good morning, and thank you for attending today's Constellium Q3 2022 Results Conference Call. My name is Austin, and I will be your moderator for today. All lines will be muted during the presentation portion of the call, with an opportunity for questions and answers at the end. If you'd like to ask a question, please press star one on your telephone keypad. I would now like to pass the conference over to our host, Jason Hershiser, Director of Investor Relations. Jason, please go ahead.
Thank you, Austin. I would like to welcome everyone to our Q3 2022 earnings call. On the call today, we have our Chief Executive Officer, Jean-Marc Germain, and our Chief Financial Officer, Peter Matt. After the presentation, we will have a Q&A session. A copy of the slide presentation for today's call is available on our website at constellium.com, and today's call is being recorded. Before we begin, I'd like to encourage everyone to visit the company's website and take a look at our recent filings. Today's call may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include statements regarding the company's anticipated financial and operating performance, future events and expectations, and may involve known and unknown risks and uncertainties.
For a summary of specific risk factors that could cause results to differ from statement, please refer to the factors presented under the heading Risk Factors in our annual report on Form 20-F. All information in this presentation is as of the date of the presentation. We undertake no obligation to update or revise any forward-looking statement as a result of new information, future events, or otherwise, except as required by law. In addition, today's presentation includes information regarding certain non-GAAP financial measures. Please see the reconciliations of non-GAAP financial measures attached in today's slide presentation, which supplement our IFRS disclosures. Without further ado, I would now like to turn the call over to Jean-Marc.
Thank you, Jason, and good morning. Good afternoon, everyone. Thank you for your interest in Constellium. Let's turn to slide five and discuss the highlights from our Q3 results. I'd like to start with safety, our number one priority and a key pillar of our sustainability strategy. I am pleased to report that we delivered best-in-class safety performance in the Q3, with reducing our year-to-date recordable case rate to 1.8 per million hours worked. In the Q3, several of our sites achieved safety milestones. Our research center, C-TEC in France, achieved a one-year milestone without a recordable case. Nanjing, China, achieved two years, and both Vigo, Spain, and Astrex in Canada achieved three years.
I want to congratulate all of our employees on this excellent performance, but the safety journey is never complete, and we all need to remain focused on this critical priority every day. Turning to our financial results, shipments were 387,000 tons, down 2% compared to the Q3 of 2021, as higher shipments in A&T and AS&I were more than offset by lower shipments in P&ARP. Revenue increased 27% to EUR 2 billion as a result of higher metal prices and improved price and mix. As we have said previously, while our revenues are affected by changes in metal prices, we operate a pass-through business model, which minimizes our exposure to metal price risk. Our value-added revenue, which reflects our sales, excluding the cost of metal, was EUR 673 million, up 21% compared to the Q3 last year.
Our net income of EUR 131 million in the quarter compares to the net income of EUR 99 million in the Q3 of 2021. The increase in net income is primarily related to the recognition of deferred tax assets that were previously unrecognized. As you can see in the bridge on the top right, adjusted EBITDA was EUR 160 million, 12% above the Q3 of 2021. This is a record for the company in the Q3 and includes record Q3 results in both A&T and AS&I. Holdings and corporate was a tailwind of EUR 5 million in the quarter. Looking across our end markets, aerospace demand was very strong, with shipments up around 50% compared to last year for the Q2 in a row.
Automotive shipments were up double digits in the quarter versus last year, with new platform launches driving our growth, but we continue to be impacted by the semiconductor shortage and other supply chain challenges. Packaging demand continues to be resilient, though our shipments were down in the quarter due to operating challenges at our Muscle Shoals facility, in large part due to a shortage of experienced engineers and operators. While we are seeing signs of weakness across certain industrial markets, we like our overall end market positioning. The combination of solid demand, pricing power, and good execution by our team and a stronger US dollar drove better results despite the significant cost pressures, which Peter will discuss later in more detail. Moving now to cash flow. We extended our track record of consistent free cash flow generation with EUR 74 million in the quarter.
As you can see on the bottom right of the slide, we demonstrated our continuing commitment to deleveraging, ending the Q3 at three times or down 0.6 times from the end of the Q3 last year. We remain committed to achieving our leverage target of 2.5 times and maintaining our long-term leverage target range of 1.5-2.5 times. Overall, I am very proud of our Q3 performance. Looking at the balance of 2022, macroeconomic and geopolitical risks remain elevated, and we expect inflationary pressures to continue, especially for inputs like energy and in regions more directly affected by the ongoing war in Ukraine. Despite seeing signs of weakness across certain industrial markets, we have not experienced a material reduction in demand in our core end markets.
As I mentioned, we are dealing with some operating challenges at our Muscle Shoals facility, but overall, our business has continued to perform well. We expect to finish 2022 with adjusted EBITDA landing at the low end of our guidance range of EUR 670 million-EUR 690 million, which would be a new record year for the company. We continue to expect free cash flow in excess of EUR 170 million in 2022. Turning to slide 6, before handing it over to Peter, I want to give an overview of the environment we are currently facing in Europe. European energy markets are in disarray today, largely as a result of the war in Ukraine and Russia's significant reduction of its gas flow to Europe.
Both gas and electricity prices have been significantly above historical levels, at some points more than ten times higher since the start of the war. To date, our operations have not been affected from an availability standpoint, and we feel comfortable that gas will continue to be available in the near term. There is, though, still some risk on availability of gas in Europe, especially if Europe experiences a colder than normal winter. The current energy situation also has knock-on effects in other markets. As a result of substantially higher energy costs, several smelters have curtailed operations, which is impacting aluminum and alloy availability. Higher energy costs are also creating certain inflationary pressures across a wide range of inputs to our business. Further, the risk of lower demand due to the impact of slowing markets has increased compared to where we were three months ago.
As you should expect, given the performance track record of the Constellium team, we are working hard to manage the company through this current environment. On the energy front, we have a company-wide effort to reduce our energy consumption across our operations. Underway, as we speak here today, are active discussions with customers to pass through these higher energy costs. We are making very good progress on this front, and Peter will go into more details on this and on inflationary pressures in general. Finally, thanks to the great efforts of our procurement and operations team, we have thus far been able to successfully manage a number of supply chain challenges. Overall, our plants are running well without interruption and keenly focused on controlling costs. We are obviously monitoring the situation very closely and will continue to update you on developments.
With that, I will now hand the call over to Peter for further details on our financial performance. Peter?
Thank you, Jean-Marc, and thank you everyone for joining the call today. Please turn now to slide 8. Value-added revenue, or VAR, was EUR 673 million in the Q3 of 2022, up 21% compared to the same quarter last year. EUR 109 million of this increase was due to improved price and mix in each of our segments. EUR 44 million of this increase was due to favorable FX translation tied to a stronger US dollar. Volume was a headwind of EUR 11 million as higher shipments in A&T and AS&I were more than offset by lower shipments in P&ARP. Finally, metal impacts were a headwind of EUR 27 million as inflation on input costs, such as hardeners and alloying elements, more than offset our scrap performance in the quarter. There are three important takeaways from this slide.
First, we grew our value-added revenue by 21% in the quarter versus last year. Second, we continue to have pricing power. Price and mix, and price specifically, is the biggest increment of our year-over-year variance and is helping us combat inflationary pressures. Third, with adjusted EBITDA of EUR 160 million in the quarter, our margin on value-added revenue in the quarter was 23.7%, which is better than our 2019 VAR margin. Now, turn to slide nine and let's focus on our P&ARP segment performance. Adjusted EBITDA of EUR 78 million decreased 17% compared to the Q3 of 2021. Volume was a headwind of EUR 9 million, with higher shipments in automotive more than offset by lower shipments in packaging and specialty rolled product.
Automotive shipments increased 16% in the quarter versus last year as new platforms began to ramp up, though we continue to be impacted by the semiconductor shortage and other supply chain challenges. Packaging shipments decreased 9% versus last year, while demand in packaging continued to be resilient, our shipments were lower in the quarter, mainly due to the operating challenges at our Muscle Shoals facility that Jean-Marc mentioned earlier. Our Muscle Shoals team is highly dedicated and is working hard to recruit and train new hires, but this will take some time.
Price and mix was a tailwind of EUR 22 million, primarily on improved contract pricing, including inflation-related pass-throughs. Costs were a headwind of EUR 35 million as a result of higher operating costs due to inflation across P&ARP and higher maintenance and supply costs at Muscle Shoals related to the people shortages that I just noted. FX translation, which is non-cash, was a tailwind of EUR 6 million in the quarter due to a stronger US dollar. Now turn to slide 10 and let's focus on the A&T segment. Adjusted EBITDA of EUR 45 million increased 136% compared to the Q3 of 2021. Volume was a tailwind of EUR 4 million with higher aerospace shipments more than offsetting lower TID shipments. Aerospace shipments were up 46% versus last year as the recovery in aerospace markets continues.
Shipments in TID were down 8% versus last year, reflecting a slowdown in certain industrial markets. Price and mix was a tailwind of EUR 47 million on improved contract pricing, including inflation-related pass-throughs and a stronger mix with more aerospace. Costs were a headwind of EUR 30 million on higher operating costs due to inflation and the production ramp up in aerospace. FX translation was a tailwind of EUR 4 million in the quarter due to a stronger US dollar. Now turn to slide 11 and let's focus on the AS&I segment. Adjusted EBITDA of EUR 35 million increased by 7% compared to the Q3 of 2021. Volume was a EUR 4 million tailwind with higher shipments in automotive. Automotive shipments increased 12% in the quarter versus last year as we experienced some improvement in activity levels.
However, the business continues to be impacted by the semiconductor shortage and other supply chain challenges. Industry shipments were stable in the quarter versus last year. Price and mix was a EUR 22 million tailwind, primarily due to improved contract pricing, including inflation-related pass-throughs. Costs were a headwind of EUR 23 million on higher operating costs, mainly due to inflation. It is not on the slide, but I want to conclude with a quick comment on holdings in corporate. In the quarter, holdings in corporate was a tailwind of EUR 5 million, as Jean-Marc noted. The positive result was related to a number of one-off adjustments in the quarter. We continue to expect holdings in corporate costs to run at approximately EUR 20 million per annum.
Now turn to slide 12, and I want to give an update on the current inflationary environment we are facing and our focus on pricing and cost control to offset these pressures. In the Q3, as expected, we continued to experience significant inflationary pressures across our business, many of which are exacerbated by the war in Ukraine. As you know, we operate a pass-through business model, so we are not materially exposed to changes in the price of aluminum, our most significant cost input. That said, metal supply remains tight today, with high energy prices in Europe increasingly forcing smelters to reduce or eliminate capacity. Aluminum smelter capacity today in Europe is down approximately 1.4 million tons compared to previous levels. We currently expect to be able to source our needs, but in certain cases, at an incremental cost.
The cost of alloying elements like magnesium and lithium are significantly higher this year due to supply disruptions and to the actions we took previously to secure our 2022 supply. Alloy supply is not currently a major concern for us. However, supply disruptions in certain cases are forcing us to resource alloy inputs at elevated market prices and will add significant incremental costs to the second half of 2022. Non-metal costs are also higher this year, particularly European energy. As previously noted, we purchase energy on a multi-year rolling forward basis, which has helped us to mitigate some of the current cost pressures. However, our energy costs will run significantly higher this year, particularly in Europe. Our total energy costs over the 2019-2021 period averaged around EUR 150 million per annum.
Currently, we expect total energy costs to be around EUR 250 million in 2022, and we expect total energy costs to be materially higher in 2023. As Jean-Marc noted, we are in active dialogue with our customers on passing through these costs and are making very good progress across all of our end markets. We will continue to update as we progress these discussions. While not to the same extent, we are also experiencing significant cost pressures across most other categories, which we expect to continue through the balance of 2022 and into 2023. Given these cost pressures, we are working across a number of fronts to mitigate their impact on our results. Our businesses continue to deliver strong cost performance in the quarter, and our recently announced Vision 2025 initiative is helping.
Across the company, we are working to increase our efficiency, reduce our consumption of expensive inputs, and lower our fixed costs. On the commercial side, many of our existing contracts have inflationary protections such as PPI inflators or surcharge mechanisms, where, and where they do not, we are working with our customers to include them. We have now, for example, been successful in incorporating magnesium and lithium price protections in most of our existing contracts in response to the extraordinary changes in these markets. The extraordinary increases in European energy prices support the need for some type of energy surcharge mechanism, and we have already been successful in adding one in a number of existing contracts. Where we are signing new contracts, they are coming with better pricing and a range of inflationary protections.
As you can see in the bridge on the right, year to date, we have been very successful with price and mix, the largest increment being price in offsetting inflationary pressures. While inflation continues to be significant in 2022, we believe it's manageable and that it will be largely offset by improved pricing and our relentless focus on cost control. The net impact of inflation and other cost increases and the actions we are taking to offset them are included in our guidance for 2022. 2022 has been a challenging year from the standpoint of inflationary cost pressures that have run north of EUR 200 million. Looking forward to 2023, with energy prices at current levels and inflation generally remaining stubbornly elevated, we expect the inflationary pressures in 2023 to be greater than in 2022.
We continue to believe that we will be able to offset most of this cost pressure in 2023 or in future periods with a combination of the tools that we have noted. Consistent with our past practice, it is too early to provide any specific guidance for 2023, especially this year, given the current environment and the number of open initiatives. However, based on our current view of 2023 costs and business conditions and the potential lag between when costs materialize and when they can be passed through, we believe that our 2023 adjusted EBITDA will be moderately lower than our 2022 adjusted EBITDA. Now, let's turn to slide 13 and discuss our free cash flow. We generated EUR 74 million of free cash flow in the Q3, bringing our year-to-date total to EUR 160 million.
As you can see on the bottom left of the slide, we have continued to deliver on our commitment to generate consistent, strong free cash flow. Since the beginning of 2019, we have generated over EUR 625 million of free cash flow. Looking at 2022, we expect to generate free cash flow in excess of EUR 170 million. This includes a number of strategic inventories we have built to ensure that we can meet our customer needs. Given the shifting market conditions, we will continue to evaluate this need over the Q4. We expect CapEx to be between EUR 265 million and EUR 275 million this year. We expect cash interest to be approximately EUR 110 million. We expect cash taxes of approximately EUR 20 million.
Now let's turn to slide 14 and discuss our balance sheet and liquidity position. At the end of the Q3, our net debt was EUR 2 billion. This was roughly flat compared to the end of 2021, as EUR 160 million of free cash flow generated in the first nine months of this year was offset by unfavorable non-cash FX translation of EUR 160 million with the strengthening of the US dollar. Our leverage remained at a multi-year low of 3x at the end of the Q3, or down 0.6x versus the end of the Q3 last year. Given our 2022 guidance for adjusted EBITDA and free cash flow and the impact of the stronger US dollar, we expect leverage to end the year around 3x.
We remain committed to achieving our leverage target of 2.5 times and to maintaining our long-term leverage target range of 1.5 to 2.5 times. As you can see in our debt summary, we have no bond maturities until 2026. Our liquidity remains strong at EUR 819 million at the end of the Q3. We are very proud of the progress we have made on our capital structure and of the flexibility we are building. I will now hand the call back to Jean-Marc. Jean-Marc?
Thank you, Peter. Let's turn to slide 16, please, and discuss our current end market outlooks. The packaging market continues to be strong in both North America and Europe, and domestic supply remains tight. In North America, we have seen some short-term inventory adjustments at the can makers, but we believe this will be short-lived. The focus on sustainability is driving increased demand for infinitely recyclable aluminum cans, and we are confident in the long-term outlook for these end markets. We've announced can maker capacity additions in both regions, as well as recent announcements of greenfield investments here in North America. We'll participate in this growth in both North America and Europe through a series of projects to unlock 200,000 tons of capacity by 2025, as announced at our Analyst Day earlier this year.
Turning to automotive, near term, the demand continues to be hindered by the semiconductor shortage and other supply chain challenges, and the industry is already operating at a low utilization rate. However, we remain very positive on this market. Inventories are low, consumer demand remains high, and vehicle electrification and sustainability trends will continue to increase the demand for lightweighting and low CO2 recycled content. Let's turn now to aerospace. Aerospace shipments were up around 50% in the Q3 versus last year, but are still only back to approximately two-thirds of pre-COVID levels. Major OEMs have announced build rate increases. We remain confident that the fundamentals driving aerospace demand remain intact, including growing passenger traffic and greater demand for new, more fuel-efficient aircraft. As the chart on the left side of the page highlights, these three core end markets represent 76% of our LTM revenue.
We like the fundamentals in each, and hence my consistent comment, we like our hand even in these uncertain times. Turning lastly to other specialties. In general, these markets are dependent on the health of the industrial economies in Europe and North America, and we are seeing signs of weakness in a number of end markets across both continents. It is also of note, though, that many of the sustainability trends supporting growth in our core markets are very much at play here as well in markets like those for semiconductors, rail, and solar. Defense applications, of course, remain in high demand in the current environment. On balance, even across our specialties portfolio, we like our hand, too. Let's turn now to slide 17 to wrap up before we open the line for Q&A.
Constellium delivered strong performance in the quarter, including record Q3 adjusted EBITDA of EUR 160 million. We extended our track record of free cash flow generation, and our net debt to adjusted EBITDA of three times remains a multiyear low. We continue to expect a strong 2022 and are targeting the low end of our adjusted EBITDA guidance range of EUR 670 million-EUR 690 million and free cash flow in excess of EUR 170 million. The low end of our guidance reflects adjusted EBITDA growth of around 15% compared to 2021 and a very strong free cash flow yield. Achieving this will be a strong result, particularly given the significant number of unforeseeable challenges we have faced this year.
Looking forward, 2023 will be another challenging year given the extraordinary inflationary pressures we are facing, particularly on European energy costs and given the recent slowdown in certain industrial markets. As Peter noted, we are currently expecting higher inflationary pressures in 2023 than in 2022, but we remain confident in our ability to pass through most of these costs in 2023 or in future periods. As inflationary pressures subside, we believe we will emerge an even stronger company. Our business model provides a strong foundation for long-term success, and we believe we have an exciting future ahead with opportunities to grow our business and enhance profitability and returns.
We have a diversified portfolio, and our end market positioning will enable us to take advantage of sustainability-driven secular growth trends, such as consumer preference for infinitely recyclable aluminum cans, lightweighting in transportation, and the electrification of the automotive fleet. The Constellium team has demonstrated its resilience and ability to execute across a range of different market conditions, and I am confident we'll continue to do so. As a result, we are reiterating our long-term guidance of adjusted EBITDA in excess of EUR 800 million by 2025 and target leverage range of 1.5-2.5x. We remain focused on operational performance, cost control, free cash flow generation, the achievement of our ESG objectives, and shareholder value creation. In conclusion, I remain very optimistic about our future. With that, operator, we'll now open the Q&A session.
Thank you. If you'd like to ask a question, please press star followed by one on your telephone keypad. If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, press star one. If you're using a speakerphone, please remember to pick up your handset before asking your question. We will pause here briefly as questions are registered. Our first question is with Emily Chang from Goldman Sachs. Emily, your line is open.
Good morning, Jean-Marc and Peter, and thank you for the update this morning. My first question is just around.
Good morning.
Thank you. The first question is just around the power hedging strategy that you have, and understandably that, you know, the 2023 outlook probably has a few moving pieces there. Wanted to understand if you can share any color around how that hedge book looks for 2023, and if you've been able to take advantage of some of the recent lowered European power prices right now.
Yeah. Thanks, Emily. We hedge, as we've said in the past, on a multiyear rolling forward basis, and we layer in our hedges over time. If you take kind of a three-year horizon, that's typically what we're working with. We aim to be approximately, you know, kind of 75%-80% hedged before the beginning of the year. Without saying exactly kind of what our
What our kind of hedge position is for 2023, you can kind of figure it out in rough order of magnitude from that. Then with respect to your second question, we are watching energy prices very closely. You know, what you've seen in the spot market has not really translated itself fully into the forward market, but we are watching that carefully and, you know, hopefully it will create some opportunities for us.
Great. Thanks, Peter. Then a second question, if I may. I know you mentioned there's a fairly tight metal supply landscape out there right now. In the past, I believe you've mentioned that you're no longer consuming Russian metal across your portfolio as well. To the extent that we do get an announcement from either the White House or the LME around further sanctioning Russian metal, how do you foresee that impacting your ability to purchase primary aluminum?
We still purchase some Russian metal just for the record, and we've got contracts which we honor. I mean, as you know, Rusal is not sanctioned. I think, you know, it's very difficult to ascertain what would happen if there was a, if there were sanctions and what kind of sanctions there would be against Rusal and whether they would apply to Europe or to America or both. I think we went through that a little bit in 2018, and what happened was obviously the cessation of purchases from Rusal and a big spike in LME and premiums.
Which means on one hand, it gets a little bit more difficult in the short term to find the metal we need, but on the other hand, our scrap profits are increasing because the LME goes up. In terms of impact on EBITDA, which ultimately is what matters, I think you've got an offsetting mechanism here. I think, you know, we'll be monitoring the situation, complying with all the laws, regulations, the sanctions, obviously. In terms of what it means, we'll see when it happens. I think from an EBITDA standpoint, that shouldn't be a catastrophe, far from it.
Just one thing to jump in to enhance what Jean-Marc said, we buy less than 5% of our metal from Rusal.
Thanks.
I'll add as well, you will have noted that our inventories are quite high, and deliberately so, and we plan to continue to maintain some high inventories going into the end of the year so that we are insulated from, you know, the vicissitudes of what may happen in terms of what we source from where.
Great. That's very helpful. Thank you both.
Thank you.
Our next question is from Curt Woodworth from Credit Suisse. Kurt, your line is open.
Yeah, thank you. Good morning, Jean-Marc and Peter.
Morning, Curt.
I guess with respect to the guide for 2023, I mean, if we look at year to date this year based on your bridge, it seems like you're roughly EUR 30 million ahead on price versus cost. And obviously you're outlining, you know, materially higher energy and continued inflation next year. You know, the 210 bucket year to date, you know, can you kind of give us a little bit of idea that, you know, if you're ahead this year, then are you kind of thinking that you're gonna see a reversal of maybe the same magnitude. Theoretically, you know, it's kinda like what you're saying, the operating leverage is gonna be negated by price cost. If you can give any more, you know, granularity on how we should be thinking about that'd be helpful.
Yeah, sure, Curt. Well, first, I mean, we're not giving guidance yet. I mean, we're trying to give you some color as to how we look at the future given the pressures we are feeling on the, you know, cost side with inflation. You're absolutely right. I mean, if you look at page 12, we're ahead this year. We're able to improve our price, our mix of products more than we suffer from inflation. However, there is a lag in terms of what we can, you know, how we can push through the cost pressures.
We are seeing more inflation on energy in the second half of this year than we have seen in the first half compared to 2021. Our judgment at this point in time is, you know, if I look at the big buckets from a volume standpoint, we've got 76% of our business, as Peter was saying, in markets that we like, I mean, that we like very much. Our key strategic markets, packaging should continue to be a resilient arrow. There are no signs of weakening whatsoever, and it's gonna continue to grow quite significantly next year.
In automotive, we've been down, you know, in 2020, in 2021, in 2022, kind of 20% below the trend rate in terms of auto builds so far. We think the fundamentals on the volumes are quite good. In our specialties, you know, there's more than half of them which are going to be very good going into next year. We think on the volume side, it's not too bad, and with the weakness we're seeing, you know, may continue into next year. Overall, as I said in the prepared remarks, we like our hands. In terms of pricing, we've been very strong and very good at pushing through price increases.
There's more price increases coming, but there's also more costs coming next year with the very significant spikes we've seen in energy prices in Europe. It's all a matter of how fast do we get to a resolution, how fast do we push that through energy surcharges? We've got PPI protection. Typically, a PPI would apply to the prior period. You compute the PPI on the prior period inflation and then push it into the next period. There may be a lag here, typically of one year, between when you get the higher prices compared to when you get the higher costs into your P&L. I think that's what we're trying to describe with our best view, kind of, under the current conditions.
We think that lag is gonna penalize us going into next year. To us, it's a temporary squeeze, and that's why we are reiterating very firmly our 2025 guidance. If you look in the forward markets in 2025 for energy, these are costs that will have been passed through given our business model. Once we factor that in, we still feel very comfortable with the 2025 guidance. We just think there's gonna be kind of a pinch next year as you know the slope of the increase has been so tremendous. Does that help?
Okay, that's helpful. Yeah, I mean, I know that I think I believe you have PPI escalators for a fair amount of your business as well in Europe. I mean, German PPI was up, I think, 45% in September. You know, I assume that will be a meaningful help, coupled with the fact that you're trying to implement surcharges. It seems like what you're saying is it's just the contractual nature of these contracts. It just takes time, potentially, to show the cost coming in, and then you can recoup price.
Correct.
Is it just the fact that energy is up so dramatically that the PPI is not gonna be enough to help offset it? I know it's still early to talk about next year as well, because energy is.
It's really too early.
Moving around a lot, but.
Both factors come into play. I mean, we're in such an extraordinary environment that the PPI mechanism in itself has not been tested with energy prices that go up by 500%, 600%, 700%, right? We have to see how it comes out. You know, also, we're pushing through energy surcharges with success with some customers. You know, if you get it three months sooner or three months later, that does make a difference.
Okay. Thank you very much. That's all.
Yep.
Our next question is with Corinne Blanchard from Deutsche Bank. Corinne, your line is open.
Hey, good morning, Jean-Marc and Peter. Thank you for the time this morning. I have two question. Maybe the first one, you mentioned the operational setback at the Muscle Shoals facility. Can you just provide a little bit more commentary around how they're going to transition into 4Q in 2023? And then I think the second question was trying to understand better the packaging market and the volume. I think volume went down 14%-15% this quarter. I understand there is some seasonality, but I think that was not, like, most of the decline. Just trying to understand maybe what happened this quarter and how to think about the next six to nine months for packaging.
Yeah. Good morning, Corinne. Thanks for the question. In terms of the operational issue that's at Muscle Shoals, they essentially boil down to the key factor, which is finding and retaining talent. I mean, I saw a stat recently that turnover, staff turnover in the US in manufacturing is around 40%. We're not at that level. We're in the 20s. But that's painful in terms of bringing in new people, training them. We have jobs that need pretty solid qualification and experience. So if it takes one year to two years to bring somebody to the top of their game, obviously, as you have more new people, the more tenured people spend time training them, that has an impact on productivity.
That's really the key challenge we've faced in Muscle Shoals. That translates into less volume that we're able to produce. We still meet our contractual commitments, but there's always a band around them. We tend to be at the lower end of the band right now. In addition, there's been you know some inventory adjustments in the North American system. As you know, the market is growing very fast and you know that's never linear when the market grows so fast. That's on the volume side, I mean, the root cause and also on the cost side, the lack of you know experienced, trained operators, engineers is costing us a little bit in volume and a little bit in costs.
We've got another factor, too, which is with the decrease in LME and Midwest premium price, our recycling operations are a little bit less profitable. We used to say that we had something around EUR 5 million of benefit through scrap spreads in the past. They are not here anymore. It's a combination of these, you know, two factors. I mean, training experienced people, leading to higher costs and lower volumes, and the scrap spreads that are creating the situation. Now, in terms of how that projects forward, I will not make a prediction on scrap spreads. In FX terms, they continue to be very favorable. It's just that the LME is lower.
I think, you know, getting the situation back to a target productivity at Muscle Shoals will take a few quarters. We have stabilized the situation. We used to have 150 open positions. We have around 30, 40 now. So we're making progress, but it's gonna take, you know, six months, nine months to get back on track. In terms of the packaging market, I continue to see it as pretty strong and solid, and I've got a pretty good outlook for, you know, the rest of the year and next year. You're right to point out that there is seasonality and typically Q4 is going to be lower than Q3, and the best quarter for can sheet is really Q2.
That's kind of my answer to your question.
Thank you. Just to follow up hopefully in the sense. This quarter, when we see volume down like let's say 15% or so, was it like purely like a seasonal move or was there anything else coming from demand?
No. There is a portion of it which comes from the fact that lacking enough staff, trained staff, we have not been able to run at the rates of productivity that we wished we would have. There is some of it which is inventory adjustments in the market, and there is some of it which is us not reaching the productivity levels we should have in under normal circumstances.
Okay. Great. Thank you.
Thank you.
Our next question is with Timna Tanners from Wolfe Research. Timna, your line is open.
Yeah. Hey, guys. Thanks a lot. Wanted to just touch again on the inventory situation with lower prices. We've been kind of watchful of inventory work down, and I know you mentioned that there's a reason to keep strategic inventories of certain alloys and so on, but it's still been a pretty, you know, sticky inventory level. So I guess to ask the question a different way, what do you think it takes to see an unwind there and an improvement in working capital release there?
Yeah. Thanks, Timna. I think... Well, first of all, remember that, you know, we hedge our inventory. So from a, you know, kind of a metal price variability, there might be some translation impacts, but there shouldn't be material cash impacts on us. But in terms of the, you know, what we're seeing, we still see a decent amount of uncertainty in the market, in terms of metal supply, in terms of end market demand and so forth, and all that's leading us to make sure that we wanna be sure that we have the materials to, you know, kind of serve our customers.
As we see more stability and, you know, I think more stability would probably mean that, just to paint the picture, that we've got a little bit clearer guide on the direction of the economy. That number two, we have a little bit clearer guide on, you know, kind of where energy prices are going, and therefore, you know, kind of the output from various smelters on metals and alloys is clear, then we'd be prepared to bring that down. But it's definitely an opportunity for us. I'll remind everyone on the call that, you know, it's a significant source of cash for us when we do eventually unwind it.
Right. Okay. That's why we're so watchful of it. I guess along the same lines, this quarter, you talked about end of year leverage on the call, you said at three times and then the prior earnings last quarter, you had said below three times end of year leverage expectations. Is that purely the slower inventory release and the low end of the EBITDA guide, or is there anything else there? Is there, you know, is this just a question of timing and greater visibility that you can get to the targets you've laid out? Thanks.
Yeah, sure. I guess there are a couple things. Number one, moving to the low end of the EBITDA guide definitely impacts it, but the big headwind that we have had is on FX, right? We're generating all this free cash flow, but the FX is offsetting it. If you know, kind of do the math on this, the incremental EBITDA that we get from, you know, kind of an FX tailwind does not offset the negative that we get from the FX translation on the dollar debt, right? As a consequence, you know, our leverage ends up being a little bit higher than what we expected it to be. Of course, you know, when FX moderates, then this will go the other way.
Got it. Okay, that makes sense. Thanks very much.
Yeah. Maybe just one other point. You know, given some of the uncertainties in the market, we've probably been a little bit more conservative with our capital structure than we might have otherwise been. You know, for example, our debt's trading at a pretty significant discount, and so some might say, "Why don't you know, kind of buy back some debt?" But we wanna make sure we know what we're heading for or heading through before we start making those decisions.
Okay. Thank you.
Our next question is with Josh Sullivan from The Benchmark Company. Josh, your line is open.
Hey, good morning.
Morning, Josh.
Just, is there any arbitrage you're able to coordinate between the European and North American operations or inventories? How fungible, you know, is the production in Europe? You know, could you shift anything to North America or are the friction costs just too high? I think we can do it on a very marginal basis, but typically we like to avoid it. The markets are still good for us in Europe. I mean, we're running at pretty high utilization rates, so there's not that much even if there were economical advantages which they are really not so much. We are pretty booked in Europe.
In the US, right?
In the US.
We don't have the spare capacity to do that in a big way.
Just on the aerospace side, you know, what are you seeing relative to OEM inventory stocking ahead of upcoming production increases? You know, historically, we would see pulsing the lines to prepare for these increases. You know, clearly it's a unique cycle. Do you think that the current demand that you're seeing, you know, reflects any pulsing on the inventory or do you think there's been any long-term structural changes to more, you know, kind of a just-in-time environment going forward?
I think it's too early to tell. Everybody's scrambling to rebuild inventories because they were really depleted. I mean, as I think I mentioned, I mean, for two years, markets were down by 30%. We were shipping at 50% of what we used to be shipping. I think everybody's trying to rebuild. How that settles, I think is too early to tell.
Okay. Thank you for the time.
Thank you.
Thank you.
Our next question is with Karl Blunden from Goldman Sachs. Karl, your line is open.
Thanks so much for the time. Peter, you kind of preempted one of my questions there as to why not buy back some debt given where it's trading now. I guess just to build on that comment that you were making in the prior question, when you think about the market maybe normalizing or becoming more just visibility improving, is the next step on the balance sheet to pay down debt or is it to extend the maturity runway? In other words, would the world need to be really unclear as to where it was heading for you to look to extend versus just to pay down and get towards that leverage target that you're looking to get to by 2025?
Well, again, you know, if you think about what we've said consistently, we want a lower gross debt. That kind of points us in the direction of kind of paying down debt as opposed to just extending. The other thing I'd say is that, you know, despite some of these headwinds that we have, and as Jean-Marc said, you know, we're kind of going through this blip of energy prices in Europe, but when we look at the overall kind of horizon, we see a lot of opportunities for the company. You know, internal opportunities that we can do, you know, take advantage of to be better, projects that we can do. Markets that really want our projects so or want our products.
that leads us to more forcefully direct ourselves towards getting that balance sheet to a place where, you know, regardless of what the environment is, we can pursue these 'cause we really believe that there are some opportunities to really enhance the returns of the company by some of these initiatives.
Mm-hmm. That's helpful context.
Sorry, Karl.
Sorry, Jean-Marc.
We really do not feel it. Yeah, we really do not feel any need to refinance anything at this stage. If you look at the quantum of what becomes due in 2026, and you compare it to the free cash flow generation of the company and to the level of inventory we have now that we will not have by that time, you know, we should be paying that down quite handsomely. I think we're in a very good place from a, you know, capital structure standpoint, and we'll just be patient, chipping away at the gross debt.
Mm-hmm. That's helpful. There were some comments earlier around forward purchases of energy and doing that on a rolling basis. Understand that exact details might be hard to disclose, but how much flexibility do you have there to do more in a given month versus another month, or should we expect it to be fairly consistent over the course of the year?
Well, I think you should expect it to be fairly linear. I mean, we have a policy that we follow, right? However, you know, within the context of the policy, we also have the ability to get the team together and decide there's a good opportunity here, or we should, you know, on the other hand, wait a little bit. We have some flexibility within it, but generally speaking, we're following the policy.
Thanks for all the time. Appreciate it.
Thank you.
Our next question is with Sean Wondrack from Deutsche Bank. Sean, your line is open.
Hey there. Just a couple from me. I guess just going back to the aerospace question, I think you said you're roughly two-thirds of pre-COVID levels. Is that sort of where utilization? Should we assume utilization sort of in the two-thirds level?
Yes.
That's the right statement, Sean.
Is it fair to think that you guys get greater economies of scale as that ramps up moving forward?
Somewhat, but at the same time you got threshold effects, and we need to hire more staff and all that. That's there is some economies of scale, yes. It's not like everything.
No
every additional ton is pure gravy.
I mean, it's
Right.
It is definitely our best margin product, right? You'll see it fall through, and you're seeing it fall through on the EBITDA line for A&T.
Right. Absolutely. I guess just switching to CapEx a little bit. Obviously you haven't given guidance. I respect that. I think in the past, Peter, you've sort of talked about the flexibility to adjust CapEx to market conditions. I was curious if you can comment on that. Can you just remind us of what is sort of sustaining or maintenance versus growth?
Yep. Well, first on the second question, maintenance is about EUR 200, so that's a good number to use on that front. You know, we've been on this journey to improve our capital structure, and I think you know, the frustrating thing for us is that we're really almost there. You know, we're hitting this bit of a speed bump here. The one thing is that when we look at this, and this goes a little bit to the response that we gave to Karl's question, you know, we think we've gotten to a place where we need to run the company for the long-term benefit of our stakeholders, right?
Therefore, we think that we can continue with our CapEx plan, the plan that we outlined in the Analyst Day, and put some of those projects in place to deliver returns, even though we might be a little bit lower on the adjusted EBITDA side. For the time being, I mean, again, never say never, but for the time being, our plan is to stick to the CapEx plan that we had outlined at the Analyst Day and build the company for the future, taking advantage of the opportunities we see.
Fair enough.
Okay.
Um, and-
Actually, Sean.
Sorry, go ahead.
Just wanted to compliment. Actually on some of these projects that we have in the pipeline that we highlighted at the April Analyst Day, their profitability, their returns are improving. I mean, the higher energy costs are making quite a few of these projects around recycling and efficiencies very attractive to us. Yes, I mean, the plan would be to plow ahead in 2023 and onward because we think these are very good projects in the short and long run for shareholders.
Understood.
Back to you, Sean.
All right. Thank you very much. I appreciate all your help.
Thank you.
That concludes our Q&A session, so I will pass the conference back over to our host, Jean-Marc Germain, CEO of Constellium.
Thank you, Austin, and thank you everyone for listening in today. As we said, we've got some challenges ahead, but we faced up to worse challenges in the past, and I'm sure the company will prevail again. I'm very optimistic about our future and our ability to make this temporary squeeze a very temporary one. Thank you so much.
That concludes today's call. Thank you for your participation. You may now disconnect your line.