Adient plc (ADNT) Earnings Call Transcript & Summary

Great, and I think we are live. I'm very pleased to have all of you join with us as we continue the CS Global Industrials Conference in the auto track. I'm very pleased to have Adient, a global Tier 1 supplier in seating solutions, and pleased to have on the line with us Jeff Stafeil, CFO; and Mark Oswald, who leads -- who's Treasurer and leads the Investor Relations efforts. Jeff, I think, is going to open it up, and then we're going to go to some questions/ To the extent you have any questions, please e-mail me at [email protected], D-A-N dot L-E-V-Y at credit-suisse.com, and I'll be sure to ask. But Jeff, thank you very much. And why don't you go ahead?

Great. Thanks, Dan. Thanks, everyone, for joining and spending a little time with us today. We just did our earnings call on Monday, so lot of messages I know are fresh in folks' minds. So I'll just maybe start with a couple of comments and then let you ask away. But our quarter and our year just ended back in September, and I would say 2020 was one of those years that makes you scratch your head for a lot of reasons. We started our fiscal year off with the GM strike. We then experienced this virus that was rolling through China and started to shut down production. And then obviously, that continued, and we saw the virus impact and especially our fiscal Q3 where we were shut down more than we were operating in that quarter. But despite all that, I'd say, Adient and the turnaround plan that we started a couple of years ago gained actually momentum, didn't lose it in 2020. We had started a process of going back to basics, focusing on the knitting. We are the largest global seating supplier, and I'd say the focus has been on launch management, on operational improvement, cost reduction, commercial discipline. All those things started to pay dividends, and -- but for COVID, I think we would have had a really terrific year, but we had a good year despite it in many regards. Our fourth quarter, you can see some of the metrics, but we were down about 8% in sales, but our EBITDA was up around 33%. If you exclude the income that we had in 2019 relating to YFAI, which is an entity we sold, and I'll talk more about it in a moment, we would have been up closer -- a little over 40% on an EBITDA basis, despite the lower sales. Our cash ended strong. We had roughly $1.7 billion in cash, over $2.5 billion in liquidity. And we chose to be a little proactive on one of our core objectives, which is debt reduction, and we paid down over -- a little bit over $100 million of principal on our debt during the quarter. We have a lot of opportunity to continue on that, but given where COVID is right now, we said we'd kind of watch and wait and see a little bit as we get a better feel of making sure we don't have any shutdowns or things that would be shocks to the system. But we've been pleased -- certainly pleased within the things that we control from a company standpoint. During the quarter, we also completed 2 strategic divestitures that we have talked about or announced earlier in the year. One was the YFAI investment I mentioned a moment ago. The other was our fabrics business. We sold both, completed sales of both in the last quarter, gave us a little over $500 million in cash. And then as we look forward, I'd say we continue to focus on where we've -- what's helped us along the way here, strong commercial discipline, strong launch management, continuing to drive our SS&M portfolio into first breakeven and then -- from a cash flow standpoint and then getting that business up to margins and profitability and returns that we would expect from that business. But I'd say we've been pleased with the progress, and thank you for letting us speak here today. So maybe, Dan, if you want to start rolling into some questions.

Great. And let's just start, I think -- let's kick off with a couple of questions on the guidance. So maybe we could just talk about the '21 guidance. And you just -- if we look at the margin ex equity income, you just put up 5.5% in the fourth quarter. The midpoint of your new guidance, though, for '21 is 5.4%, so actually a little -- a hair weaker than what you just did in the fourth quarter. And -- but you're going to have all of these benefits from restructuring and all of the improvement initiatives that you talk about in 2021. So maybe help us understand what should not be extrapolated from the fourth quarter. Is it simply just elevated mix? Is it some reversal of those temporary benefits? Is it the commodity headwinds? Help us understand the bridge from annualizing 4Q on the margin and EBITDA to '21 ex equity income.

Yes. Well, it's a great question. I'd probably answer -- so piece of the answer in all the different parts of what you just phrased. But one thing is auto is really hard to annualize. It's really hard to take any quarter and multiply it times 4. We do have seasonal differences that do make a difference for us. I would also say that if you look at commodities, we called those out on the call, those are -- we estimated about $50 million of net headwind for the year. We've seen both steel and chemical prices start to shoot up, not just because of demand, although demand has obviously shot up, but a lot of supply came offline during the shutdown that has been slow to bring back up. That has had a big impact and has given us a bit of a supply shock in a few areas that is material. We've also seen just operating patterns being a little bit more spotty, especially as we're in COVID times. They're heavy, we'll say -- I don't want to say lockdown, it's not like it was in April, but we have seen challenges from an operating environment, where we're seeing higher absenteeism, maybe where we can operate on a weekend and parts of Mexico, we've experienced -- we've seen supply disruptions or some less than fully efficient overtime runs because of not just how we're operating -- or really not how we're operating, but how the system is operating around us. So some of those inefficiencies have given us some pause. You mentioned vehicle mix. We obviously saw a nice rich vehicle mix in our fiscal Q4. We don't see that going through the whole year. We have some launches. Obviously, the F-150 is a big launch. It's in the process now, going well, but it does have an impact. We have some other launches -- a couple of launches that were supposed to happen in 2020 that got pushed to 2021. That has some impact. And I'd say that, finally, during the year, we took a number of aggressive actions on cost structure. We took down salaries. We took lots of furloughing, lots of cost where we could, on a temporary basis, take them out of the system. Some of those costs will come back in. Some of them are permanent reductions, some of them are temporary reductions. Those temporary ones will impact our 2021 results. So that's all a bit of a mix, but that kind of gets you back to that 5.4% or so at the mid-range, excluding equity income.

And maybe you could just comment on the inefficiencies. Maybe help us understand on a regional basis, are you seeing more pronounced supply chain or production, launch schedule or production inefficiencies in Europe or Mexico, anything in Asia?

There's -- I'd say what we've generally seen are things that by themselves aren't terribly material, but you get sort of lots of little pinpricks, I would describe them as. We've seen areas where -- Mexico in the Juárez region, for instance, for a time, wasn't allowing weekend production. That creates a challenge for us. It creates a challenge for some of our suppliers at times. So you figure out workaround solutions. Some of those workaround solutions where you move some production to other facilities, you maybe buy it from -- have another supplier produce parts for you or what have you or move locations from some of the -- versus some of the regions that were impacted. So those are some examples of this. We've also seen from an absenteeism, I'd say, is a big element of just getting people to come to work. Sometimes, as a result, we fight that by overstaffing, allowing for a certain amount of absenteeism, but by that overstaffing itself is a bit of an inefficiency. So all those things are parts of it. Nothing huge, nothing necessarily to call out by itself, but these little things sort of add up, and that's what we're talking about with some of these inefficiencies.

Got it. And then -- and I just got a question here. Maybe you could just comment any assumptions on the commodity headwind. What's in that?

Well, we gave $50 million as a net number for our commodity headwind in 2021.

And Dan, that's both on the steel side and chemical side.

Correct.

Great. Okay. And then continuing that line of questions, the equity income itself. Obviously, we're seeing very strong China volumes into 2021. I mean, our forecast is up 10% on your fiscal year basis. And you just had a very strong equity income margin in the fourth quarter. I think that outpaces your historical pace in the seating business. So why forecasting flat? Is it again just the commodity headwinds that you're assuming in the JVs?

That's a part of it. I wouldn't say it's the whole equation, but we are seeing commodity headwinds there, and we thought it was prudent to make some sort of adjustment to the margin we expected in the business as a result. There's a couple of other things, though. Similar to the rest of the world, the Chinese government did offer some temporary incentives in 2020, essentially reducing some of the Social Security payments companies had to pay. That was -- we mentioned in total, that was $30-or-so million for the year, I think. Some of that is obviously impacting us from a China standpoint. As we look at the 2020 results as well, we did have -- we called out, I think, a year ago in the first quarter, we had a $10 million benefit that was somewhat onetime in nature. We called out, I think, on our first quarter earnings call, we wouldn't expect that to repeat. So it's flat year-over-year. But hopefully, we'll obviously work to do better than that. But given the commodity situation, given some of the headwind as it relates to the loss of some of those incentives, we thought it was prudent to put in what we did, around $250 million.

Great. Why don't we pivot more broadly to your profit improvement initiatives and let's just zoom out? First of all, if I look over the years, 2018, '19, those were the pain points for you. And if you add up all those business performance headwinds, it was in excess of $600 million. You just did in excess of $300 million recovery in 2020. And with some assumptions on your guidance for '21, you're talking maybe another $100 million, $150 million. So basically, you've recovered -- you will have recovered almost the vast majority of these headwinds by the end of 2021. So what's the opportunity for incremental profit improvement beyond? Is it just once we clean up all of those headwinds from the past, then there's not as much runway? Or do you see more significant runway and ease or attainability of incremental profit beyond that or incremental recovery beyond that?

Yes. Great question. I guess, I'd characterize it, as while the company might have turned in some of those results 3, 4 years ago that we're making or getting back somewhere around the same level, I would argue the company right now is operating and is positioned to operate far better than any time, at least that I've been here. The team that's in place, the sort of the commercial discipline that we've put in place, the purchasing discipline that we've put in place, the relative leanness of how we think through kind of all aspects of our business, I would say, is dramatically better than any time in our past, such that I don't think we have the limit of just getting back to where we were from a margin standpoint and correcting some of the stumbles. Where are the opportunities? We talked about it, but -- we've talked about it a lot in different pieces, but just kind of highlighting a few. SS&M, obviously, that progression on getting that business, not just to free cash flow positive, which we think we'll exit '21 with, but getting that business to something where it's really making an attractive return on capital, there's a lot of opportunity there. There's a lot of distance to travel still for us. If you look over at vertical integration for us, we have a very large and profitable foam and trim business. Having business where we just have the JIT business, the example I'd like to provide is, if we sell $1,000 seat set, we might make $30 or $40 on the seat itself for that final JIT assembly. But if we do the foam and we do the trim and we do the seat structures in a profitable way, we might turn that $30 or $40 into $100. And that's on that same -- we eliminate intercompany sales. That gives us a 10% margin on that by having that vertical integration. That gives us more of a, I'd say, platform with a customer to go in with the VA/VE ideas, go in with a larger real estate to go and make a difference for the customers, too, on taking cost reduction, and that's why we've invested so much in that cost reduction effort. I'd say as we go -- every day as we continue to improve from a commercial standpoint, we continue to improve with the relationship we have with the customers as they look to drive cost out, so they can invest in EVs and the things that they want to put money in and not so much in a seat. By us taking a bit more of that real estate over, we not only help ourselves, we can help the customers, and we think that can feed upon itself. And I'd say the commercial execution, the back-to-basics execution and that real focus on cost reduction and supporting the customers for what they really need to do allows us to go quite a bit past where we were just a few years ago. And that's why we've really set our sights at really first getting to our peer set margin, and we think we might -- could even have some opportunity beyond that. But that is really the goal here that we've set, and we do think it's not just getting through 2021. We think there's going to be more to go.

And Dan, one other comment on that. And if I compare us today versus where we were a couple of years ago, clearly, there's more efforts today underway within the purchasing area, too, making sure that purchasing is aligned with each of the regions in terms of our buy rates. So there's other drivers today that basically will improve that profitability where we weren't even tapping those levers a few years ago.

Great. Help us understand, as we're looking, I think you have 4 key pillars: launch, operations, cost and then the customer management. Is it fair to say that the way that the progression has gone, you sort of cleared out a lot of the low-hanging fruit on the launch side, so maybe not as much incremental opportunity. Now you're focused more on the operations and cost. And then really, the leg beyond operations cost, that's the customer improvement initiatives. And then within the operations and cost, help us understand what's the lowest hanging fruit between footprint, utilization, purchasing, et cetera? What's easier? What's harder?

Yes. Well, nothing, I suppose, is easy. The commercial discipline is probably where I'd focus the most, but -- and I say that -- you look at -- it wasn't just about repricing bad contracts. We did a little bit of that. That's not the big piece of the driver in our performance. But when we say commercial discipline, it's -- we talked about on a call a little bit ago of us not winning $700 million of business where we were incumbent upon. That was strategically done. We didn't want to meet the price. This was business that not only was 0 to negative EBITDA. It was costing us money. It was essentially negative capital -- return on capital employed, made no sense for us to continue business like that. And we replaced it with $700 million, give or take, of profitable business, exactly what we should be doing. So that discipline around which programs do we need to be on, which customers, which platforms, et cetera, do we need to be on because we can provide an advantage, it kind of starts there and managing that relationship. But in order to do that well, we need to do the other stuff well. We need to launch well. We need to control costs. We need to give the best product we can to the customers or we're not going to win on the customer side, and we won't have as much opportunity to really drive the business forward. So it all -- we put it in that circle because they're all interrelated. But cost reduction, Mark mentioned it, but purchasing is a huge part. We have 65% of what we sell, we buy. We have revamped the purchasing organization almost top to bottom, and we're seeing results in that. To say it's harder or not, I'd say, getting the right infrastructure in place, getting the right set of buyers, getting the right set of metrics are all things that feed upon each other, and I think we're headed in the right direction. As it relates to operational improvement, it's more than just SS&M. This is making sure we've staffed as leanly as possible. We're making really wise choices on when we buy new capital, when we can reuse capital and how -- and which capital we're going to go and spend money on. So those are all kind of pieces, but it's all difficult. It all works together. But hopefully, that gives you a little bit of color, not exactly the answer to your question.

Great. And then as we think about the customers themselves, maybe you can help us frame -- you said there were $700 million of business that you passed on. Within your book of business right now, can you maybe give us a sense -- you said you cleared out all the bleeders. Now you're addressing the leakers. What percent of your book of business would you classify as leakers, so to speak? How large is the opportunity that just needs to -- is more pressing that needs to be cleared out?

Well, it's actually just a mathematical equation of leakers, which is kind of the fun way to manage it, and I really like the concept that we've put in place because all leakers are things that are below your average margin. So you can think of almost half your portfolio is below your average. I mean, it doesn't work exactly that way. But mathematically, and as you improve, so as we go this year and we increase our average margin, things that were above the waterline before all of a sudden become under the average margin and become leakers in our system. So we're constantly redoing, and those things that were leakers are actually more -- the group of leakers that exist today are more profitable than the leakers that were around last year, and that's sort of this opportunity for us in the focus. So I would say we found great progress, and it puts our commercial managers on the spot when their programs start to enter that leaker list. Nothing's changed. Maybe they even got more profitable. But if the average margin shoots up 100 or 200 basis points, new programs fall into that leaker list, and we start to manage on them. But a lot less bleeders today. Those were the things that were negative. I don't see -- there's still a couple of examples or a few examples, but certainly nowhere near the magnitude of what we saw before. But we have a rich opportunity, less to continue to drive improvement as we go forward.

And then as far as commercial recoveries you had, I think you -- and refresh us on what you had in 2020. Is that an opportunity in 2021 and beyond? How easily can those recoveries be achieved? Or is this really more when you talk about the commercial side, just VA/VE where you're executing those benefits?

Yes. I'd say, VA/VE is a big piece of it. I wouldn't think of commercial. We had sort of a separate element of commercial when we first kicked off our turnaround plan that was addressing some really negative programs. Those are behind us. The commercial elements here are making sure we respond when a customer's volumes are half of what they were supposed to be and make sure we get recovery or the customer changes something that costs us more money that we get recovery in price or if there's a claim that we manage it appropriately and professionally, and that we're laser-focused on winning the awards that we really believe we need to win and should win. So that's more of the commercial side here. The VA/VE side, by us continuing to push ideas to customers, that just brings the pull-in for customers to choose us on next-generation programs as well. If we can save them money, that's a big deal right now.

Great. Let's ask on the backlog piece. Can you just maybe give us a sense, based on your program wins today, what your market share in the seating universe is today. And based on all of these program awards, what does that dictate about your market share in the future? We've obviously heard rumblings from some of your competitors about incumbent wins. Just trying to understand the overall market share trends for you and what's in the pipe.

Yes. It's a great question. We're in the low 30s, I think, from a market share standpoint, low 30% range globally. Each region, it's a little bit different. I'd say it's relatively stable. Might tick down a couple of points in Europe as we made some decisions to exit some business that was really not profitable or had negative profitability around us. But we see pretty stable market share as we move forward, but with a better, richer mix from a margin perspective.

Great. And then as far as your SS&M business, I believe you talked about that rolling off. And it's interesting because you're still going to outpace the market, or at least, that's what you guided to for '21. So when do we start to see some of that SS&M business more materially rolling off? And I would assume that would allow -- that would make your revenue in -- more in line -- or your growth more in line with the market.

Yes. So remember, in the SS&M portfolio, that business, we generally win 2 to 3 years before we launch it. So when we took our foot off the gas on some of the growth efforts there, that doesn't even change -- it's just starting to change our launch schedule because that was a couple of years ago. Stuff won't really start to roll off from that business for several years. So we'll have less launch load in that business than we did historically, I think, the next several years, but the actual business is really only moving up and down more due to the market. And the market has been a bit slower, so -- obviously, in 2020, especially. So some of that business has gone down in terms of revenue, but the real impact of us taking our foot off the gas on some of the programs are still a few years down the road being felt.

Great. Let's wrap up here. I know we have a few minutes left. I want to talk about the balance sheet and cash flows. First, could you just refresh us on your ultimate leverage target? Are you still looking to get to 2x net debt to EBITDA? And then I would ask as a follow-up. Look, I mean, we all have our own assumptions in the model, but we could make some assumptions that you could potentially be below 2x leverage by the end of next year. So how do things change from a capital allocation standpoint once you get to below 2x? Is a dividend potential? What would you need to see to put in a dividend?

Yes. No, it's a great question. It's something we talk about a lot, and we start -- maybe for a little bit, we weren't talking about it because we were very focused on capital preservation and just making sure we got the turnaround kicking in the right direction. As we sit here today, deleveraging is a primary goal, but getting to something below 2, I think it changes the tone of our discussion from a Board standpoint externally, and we can start to do things that are more shareholder friendly. We do think getting inside that 2x leverage ratio makes sense. We don't see that to be terribly far. We're not going to give an exact prediction on the time line of that, but we don't see it terribly far in the future from a possibility standpoint. And then I think, yes, dividend, share buybacks or other things kind of can come into the discussion here, for sure.

And then as far as -- and then how would you prioritize dividend versus share buyback? Any views on that?

It's sort of -- it will depend on the share price when we get to that spot, right? If we think we're undervalued and if we think it's a great opportunity, that's an area where we certainly want to put some attention towards. But we also think that having a dividend is something we'd like to reconstitute as well. So I can't necessarily give you the priorities of both, but they both will be on our radar for sure once we get down to sort of the target leverage ratio.

And then just to close more broadly on free cash. We know about your efforts in SS&M. Obviously, you're targeting breakeven by the end of next year. You actually just did it fourth quarter free cash flow. Help us understand outside of SS&M though, is this purely an EBITDA opportunity? Or is there any low-hanging fruit as far as incremental CapEx or working capital actions on the free cash side?

Yes. I mean, it's going to be much more -- we always tell people, think of working capital as something that's fairly neutral over time. We've done a big -- we've made a big improvement on CapEx over the last couple of years. Maybe there's a little bit more, but I wouldn't necessarily count that as a being a step change in our free cash flow due to CapEx. The big drivers are going to be margin EBITDA growth and making sure we -- getting our restructuring -- the restructuring one is unfortunate. We saw -- and that's -- we've talked about an elevated level of restructuring in 2021, and that's primarily due to the European volume situation. It's dropped and it's really dropped through the whole projection time frame from pre-COVID levels, which has necessitated us doing some more significant levels of restructuring, some of which has a great payback, some of which is really just volume-related and stuff we would have rather not had done. But restructuring is a piece for us, and getting it somewhere inside of $50 million to $100 million is a much better number and will allow us to accelerate. But EBITDA margin will be the big driver, and the good news is we have a lot of tax attributes in a lot of locations. So I think our cash taxes won't necessarily be there. If we can delever, we can also take down interest expense. So those are all pieces that I think can drive that free cash flow equation.

Great. And with that, we'll leave it there. Mark and Jeff and to the entire Adient team, thank you so much. Very helpful, very insightful.

Thank you. Thanks, everyone, for your time today.

Thanks, again. Appreciate it.

Yes. Take care.