Adient plc (ADNT) Earnings Call Transcript & Summary

I'm Ryan Brinkman, the automotive equity research analyst here at JPMorgan. Thanks for joining us for the 2020 JPMorgan Auto Conference Virtual this year. Before we get going with our next presentation, which is from Adient, which is going to be audio, I just wanted to remind the investors that you can ask a question of management by typing it into the conference website, and I'd be happy to relay that to them without identifying your name or firm. So with that, I do want to get going. I'm going to turn it over to Doug Del Grosso, Adient's President and CEO; as well as Jeff Stafeil, Executive Vice President, for some prepared remarks, and then we'll get into Q&A. Doug, Jeff, thank you.

Okay. Thanks, Ryan, and thanks for giving us the opportunity to spend a little time talk and update where Adient is on their business. We're, like many others, on the heels of an earnings call, so the information that we'll discuss today is relatively fresh. Before we went into -- go into Q&A, I wanted to spend just a couple of minutes setting up the discussion. We sent out a presentation earlier today. It's not our intent to walk through that, but I did want to provide some comments. The takeaway or the -- one of the key messages that we were trying to communicate in our earnings call was, as COVID associated with the production environment changed and production came back online, we were steadily focused on our plan and really didn't feel that we had lost any ground in the turnaround plan that we had in place prior to COVID, and that was reflected in most recently, our Q2 earnings, where we felt we had made great traction in that plan. And as volume comes back on, we're continuing that pace. We successfully restarted our operations not only having the capacity to meet our customers' schedules, but also having an environment that our employees felt safe working in. We did that globally. Pretty proud of that achievement. We're continuing to drive operational improvement has been one of the key elements of our turnaround plan. We spent a little bit of time talking about the way we execute commercial discipline. That's not only resolving commercial issues that historically have hurt the business, but it also is a reflection of new business that we've recently brought on that we think has significantly improved margins over the business that's rolling off, particularly true in the Americas, but really true across all the regions in our business. We're moving into a high level of launch activity. We highlighted the F-Series as being a significant launch. We wanted to communicate a couple of messages. One, that it's a significant launch. But two, we felt pretty good where we're at, and we are going to continue with improved launch activity, which is another key element of the turnaround that we had in place. We spent a bit of time talking about restructuring. We recently announced some incremental activity, in Europe, that is volume-related as a result of pre-COVID or post-COVID levels, anticipated levels. It's fairly significant, but absolutely the right thing for us to be doing. And we're staying focused on strengthening the balance sheet and the strategic actions that we had in place that were previously announced are on schedule to close in Q4. So pandemic has been tough, but we think we've navigated through it well, and we're coming out on the other side of it, ready to continue with the turnaround that we had in place. So with that, I'll turn it to Jeff to let him talk a little bit specifically about the earnings, and then we'll open it up for Q&A.

Thanks, Doug. Good morning, everyone. And just a few comments before I turn it over to Ryan for some Q&A. But on Q3, our -- talking about the quarterly trend, the quarter was one of the most unusual, probably the most unusual we'll ever experience. The month of April was a shutdown month. I've never seen that before. The month of May mostly was a shutdown month and then trying to return to work and get comfortable with post-COVID production environments. And dealing with the stops and starts and absenteeism and other things that was extremely prevalent, especially as we began operations. The quarterly numbers are really hard to make much sense out of. But I will say June, and maybe just focusing on June a little bit, our June 2020 EBITDA was essentially the same or nominally the same as it was in June 2019, despite sales being down 25%. So still with COVID impact, we were able to continue the operating momentum that Doug has talked about into the June period, seeing that in July as well. I will also say that if you adjust out the COVID impact, our June month was pretty comparable to Q2 from a margin perspective. So as volume comes back, we expect that to -- in more normal operating procedures come back, we expect the momentum that we've had to continue. Doug mentioned the transactions that we announced earlier this year are on pace to close before the end of the year. That will bring about $500 million, $509 million of cash into the business with another $60 million that will come in over the course of a couple of years, give or take, with sort of a WiFi earnout feature. As it relates to liquidity, our liquidity was $1.2 billion at the end of the last quarter. We do expect that to be trough liquidity for us. It was highly impacted by working capital swings within the quarter that have a big whipsaw effect. Effectively, we see that reversing in our Q4, and we expect our net debt to be something -- I promise I don't have COVID, but for some reason, I have a cough. Excuse me. We have expectations of something closer to $2 billion by the end of the quarter. Doug, talk through -- somebody just brand me water, thankfully. Excuse me. It's better. From a cost management standpoint, we have, as Doug mentioned, made a lot of efforts around taking cost out of our system. And we have, I'd say, been extremely aggressive in both the U.S. and Asia. Our Europe operations, we're planning to be aggressive there, and we've announced some very aggressive moves. The activity will take shape as it requires a bit more negotiations with our workers' council in 2021. But we're optimistic. That will allow us to bring our breakeven volume down quite a bit as we move into 2021. But as volumes return, that will also improve our future cash flows and allow upward momentum opportunity as we come on the other side of COVID. As it relates to this improving performance, we've continued to see improving performance, especially from our SS&M business, that's been a highlight of some of our historical challenges. The SS&M business had a negative free cash flow in 2019 of something closer to $400 million. Despite COVID, we've cut that in half in 2020 and are still on pace to exit 2021 with positive cash flow and obviously, significant improvement to margins and operating performance. But as Doug said, we're seeing that improvement continue throughout really all parts of the business. As it relates to a couple of final comments on our forward outlook, we gave a Q4 outlook of roughly 13% down in sales with EBITDA at or slightly lower than 2019 levels. Our free cash flow is expected to be $300 million to $400 million positive as that working capital reverses from the previous quarter. So with that, Ryan, you can turn it over to Q&A.

Great. Thanks. I'm asking several of the suppliers really to comment on coronavirus from a couple of different angles. The first one is about profitability and profit margin because during the global financial crisis, margins for suppliers, first fell very sharply; but then in subsequent years, as the industry recovered, rebounded to levels actually much higher than prior to the downturn. So this time around, as you think about the extra costs associated with coronavirus, including potentially possible changes with the supply chain, et cetera. But on the other hand, maybe the leaning out of other expenses to SG&A, et cetera. I'm just curious what you think it means for the trajectory of margin for the industry in Adient, in particular, as we eventually do move past the present situation?

Sure. Well, I'll start out, and then Jeff can provide additional comments. I think there is elements similar to what happened in 2009, where a sharp downturn forces everyone to be very cost focused. And then as volume comes back on, you see the benefit of being slightly more lean in both the fixed and variable side. That certainly was the case. And I think we formally commented on that in our operations in Asia, where -- particularly China where I think we're more mature on what the new norm looks like. It's still a fairly fragile environment in Europe. And I would say, to a greater degree, in the Americas when you have regions like Mexico or even some of the issues we're experiencing in the U.S. with regard to, I'll say, employment levels, absentee levels that are driving a little bit of near-term inefficiency in our business. I guess my comment really is, I think it's more of a volume story from our perspective is what the business will look like coming out of COVID. I think you go through this first few months as we restart, and there's some volatility in volumes. As that stabilizes, supply basis stabilize, people work through the working capital bubble, et cetera. What we're anticipating is that next year, our next fiscal year, volumes are going to be down. And as a result, we need to, particularly on an SG&A side, continue to flex our SG&A down associated with that volume. That's a heavy emphasis. That's what we signaled in our third quarter earnings call. A lot of that activity takes place in Europe -- or I'll say, it takes place across the board. Europe takes a little bit longer because of the complexity of the negotiations associated with it. And then what's not completely clear is what our customers intend to do from a, say, mid-cycle enhancement, new volume introduction. I think that's not completely determined. I know they're all looking at their product plans and seeing if they're going to change the way they cascade those product plans. That will have an impact from a cost standpoint. So if launches go down, if we've seen some levels of products being extended or what was going to be a complete refresh of vehicles, now becoming a mid-cycle enhancement, that obviously would, in my opinion, be a positive sign for Adient. But that -- it's still too early, and we haven't completely seen that picture.

Okay. Great. And then also on capital allocation, does coronavirus cause you to think any differently about that, about how much capital cushion you should run with, what the right debt-to-equity level is or the right amount or timing of return of capital, et cetera, to shareholders?

Well, it certainly makes us a bit more cautious about separating ourselves from liquidity. During the -- until a vaccine is developed. But we mentioned we'll end the quarter with something over $2 billion, about $1.5 billion is what we would think to give or take on normalized course of what we need to handle the trials and tribulations of the auto industry. So as COVID starts to come into the rearview mirror when that comes in, we can start to address the balance sheet more meaningfully, use some of that excess liquidity to pay down debt. From a leverage ratio standpoint, I would say, as we look at it, we've operated pretty well through this. It's important we have liquidity. We think that $1.5 billion is about the right number on a normalized basis. So getting ourselves inside of a 2x leverage is, I think, the goal, maybe a bit more inside it, but I would say, at least inside of a 2, and that's what we're really trending towards. As far as capital allocation, I think we've been cautious. We've brought down CapEx quite a bit, but we brought it down for the right reasons. We've been able to bring it down for focusing on the best business that we can target with high returns and great comfort that we can deliver, and reusing equipment and the like. So as we look at capital allocation for CapEx, I think we've been comfortable in bringing that down as it relates to probably the next priority is really just making sure our leverage comes down. So that's improving the operations and also using some of the excess cash flow as we move forward to in excess liquidity to pay down debt.

Okay. And then I wanted to be sure to ask about China, given that you are the company at the conference that derives the greatest percentage of its revenue, at least on a consolidated, nonconsolidated basis from China. Just what do you see happening in the market there? It feels like it really fell a lot further than what a lot of people thought possible, but now has rebounded probably a lot further and faster than investors might have surmised, including -- I saw a headline this morning about July sales were up 16.4% year-over-year. So pretty incredible there. How are you positioning yourself for the rebound in the back half there? What are you seeing?

Yes. So I'll start on a macro level, and we can get into more specifics. So we're pretty excited to see how fast the market has rebounded in China. We saw the same headline July sales look outstanding. We know there is some level of incentive driving that sales rebound. But if our best crystal ball, if we look out into the out years, we fully expect that the China market will continue to grow. Getting out into that '25 time line, back to where it was projected to grow before it went through the downturn and then more significantly impacted by COVID. We like our mix of business there. We have a good customer base and not only with our traditional customers, but as the premium brands have expanded in the market, we think we're positioned well to continue to benefit, whether it's the European premium brands or a strong business with the Japanese. If you look at price points on vehicle, we continue to expect that to grow as we move out into the future. And although not significant at this point, but one thing that we're excited about is some of the success we've had with electric vehicles, namely Tesla in China. That's been so far, a really great program for us, utilizing the business we had in the U.S. to launch into our joint venture in Shanghai. If you believe the projections on that particular platform or the Tesla brand and then some of the other brands that will go along with it. We've got good content there. So we're pretty positive on continued success in the market in China.

Great. And what about specifically on your Seating margins in China. How do you see that trending going forward as volume returns to, hopefully, here, it's pre-COVID levels?

Yes. We've done, I think, a really nice job. The teams have done a really nice job of keeping margins stable in 2019 where we saw depressed volume and in 2020, where we saw the shock of COVID hit, we were able to get back to margins with volume being quite a bit down -- or the actual margin with -- despite volumes being down quite a bit. That should provide us some opportunity on the upside, I think, as we see return of volumes there. There's going to be a mix element, not all of our JVs are same level of profitability. But I would say, overall, I think it gives us some optimism that there could be some margin enhancement here as some of these cost reduction ideas that we generated, will still have some stickiness as volume returns.

Great. And maybe 1, 2 on free cash generation. You mentioned targeting being cash flow positive in a 20% down market. How are you tracking so far relative to that target? And then maybe separately from that, working capital was a help in the third fiscal quarter there. As we look ahead to fiscal '21, presumably, that's going to turn into a headwind as demand picks up, hopefully, right? I mean a high-class problem. You've also highlighted, though, on the other hand, potential opportunities for -- when it comes to capital expenditures. So when you kind of add it all together, working capital headwind, CapEx tailwinds, maybe restructuring in Europe, I don't know, how should we think about cash flows tracking next year, high level?

Yes. So with the caveat that we're still in the middle of our -- in the middle, I'd say, of our 2021 budgeting cycle, let me make some sort of high-level comments around it. You mentioned working capital, so I'll start there. Huge amount of noise for us this year because of COVID. But in general, our working capital tends to swing kind of back and forth a little bit, but over time is generally fairly neutral. We don't have a big investment in working capital. The just-in-time nature of our -- most of our sales keeps inventory pretty low. We tend to collect pretty quickly on AR and have a little bit of lag on the AP timing. So net-net, there's not generally in a normal year that much. So I wouldn't expect it to be a big negative in 2021. As you look at CapEx, we're about $360 million or so this year in that range in 2020. It always depends a bit on volume. We've done a lot to improve our effectiveness and utilization of old equipment and better sourcing of new equipment and just a real focus across the company on capital. I would say, for now, probably just use the 2020 number, and we'll come in with a better estimate as we have things refined. As it relates to cash taxes. Cash taxes were about $100 million this year, probably a reasonable estimate to use for next year. Might be some opportunity there, but there's a couple of things that could go the other way, but $100 million is probably a pretty good guess as you look at it. The biggest variable here, the 2 biggest variables is where is revenue going to come in because that's going to drive our EBITDA quite a bit. So revenue will play a big piece. Remember, our variable margin is in the high teens. So as volume goes up or down, it's quite a bit more impactful than our average EBITDA margin. The other side is restructuring. The restructuring outside of Europe has largely been done. A lot of it has been done. Europe has been announced, but a lot of that will be spent and done in 2021. So we're trying to be quite aggressive. We see a downtick in European volumes. That looks like it's going to stick for a couple of years. It's important for us to take cost out of our structure there. So might have a little bit of elevated restructuring is probably the highlight for us for you as you model out 2021. We'll come back with better estimates on everything, but hopefully, that gave you a few parameters to think about.

Yes. No, it is helpful. And then I wanted to ask to about decremental margins. Really well contained recently, including as low as 13%. Just curious to the degree to which that performance may have been aided by more temporary austerity or furlough measures? And how should we think about that trending going forward?

Yes. No, great question. We were able to benefit quite a bit of the furloughs and salary reductions in that Q2 number where we were able to hit 13%. And if you remember on our Q2 call, we said, "don't expect us to be at 13% decrementals, it will start to get a little bit worse." The magnitude of the shutdowns in our fiscal Q3, the one that just ended, combined with just -- I will say, some of the inefficiencies of coming back to work as it relates to absenteeism and the like, drove the margins to 16% -- or decremental to about 16% in the quarter. If we do nothing, if we kind of stand still with nothing, I would say it's probably closer to an 18%, but the actions and the other things that we've been able to do has been able to limit that. We'll continue to work to bring those numbers down. But meanwhile, we're working to bring our variable margin up. So it's going to be -- as we move forward, we would expect to start to see with some of the changes in the program and the improvements in the SS&M business and improvements elsewhere. Start to ink our -- or eke our variable margin up. But hopefully, as volume in those times where it does come against us, we're able to take our decrementals inside of our variable margin. That's one of the metrics we use as a management team to judge our operating performance in periods of down sales.

Okay. I know it's not a needle mover right now, but just thought you could give us a little bit of an update on Adient Aerospace. It looks like some of these Dreamliners are being delayed, as you might imagine, just given what's going on. Any developments on that front?

Yes. I guess the big development is -- I know you know, but just to remind everyone, the -- we downsized our interest in Adient Aerospace last year. To 19.9%, so -- or maybe 19.99%, but just under 20%. And limited -- or eliminated the need to ever fund that operation against to sort of tied off the funding or it would dilute our ownership, but we don't have any further requirements to continue to fund that. The operation continues to move forward, obviously, with a lot of noise around aircraft and the like. But from -- I would view it as a potential future opportunity, if it ever turns into something, we do own a piece of it. But from an investment and a resource standpoint, I think we've put the tourniquet on that.

Got it. And then just lastly here, a few minutes left, I thought to ask on seat structures and mechanisms, where you all think you are in terms of the turnaround? Maybe what work remains to be done? And if you've got any updated thoughts on the long-term margin potential of that business, whether it is core and beneficial from a go-to-market perspective relative to the remainder of your Seating business.

Sure. So essentially, with, I would say, with the suspension and time for COVID, we're on track with our original plan associated with the metal and mechanism business. That plan consisted of a number of elements. One was to bring revenue down and to reduce the spend on CapEx and then to improve margin. We had targeted to get it to cash flow neutral, at least on a run rate somewhere in the '21 time frame. We still see that as something that we can accomplish. So our plan is in place. We announced recently a change we're making with AYM and how we want to utilize that joint venture in the future to continue to help us extract value out of the metal and mechanism business. But it also continues to be an important part of our business. There is a number of customers where it's an important element with regard to our complete seat business, but it's -- that's particularly true when we can vertically integrate. And so when it creates a vertical integration opportunity where we can get JIT business, we can put additional content, there's a cluster of customers that operate that way, and we continue to market that business to them. What we've moved away from are some of the mega programs that were, in some cases, multiple customers, common hardware that were launched on multiple platforms. That's not proven to be a successful formula in our mind. And that's where we're bringing the revenue down, and particularly when we had to sell across through those multiple platforms to our competitors the kind of directed business is historically underperformed. So the plan is in place. We've made good improvement operationally, both in Europe and in the Americas, so we feel good about where we're trending that business.

Okay. Great. Thanks. Looks like we're out of time here. But thanks so much for joining us and all the great color and insight you provided today. Thanks so much.

Thanks, Ryan.

Thank you, Ryan. Bye-bye.

Thanks, everyone. Have a good day. Thank you.

You, too. Appreciate it.