Adient plc (ADNT) Earnings Call Transcript & Summary

If everybody can get settled in. If we could maybe close that door over there. Just that would be great. Thank you very much. Next up, we're very happy to have Adient. Adient is the largest seat supplier in the world. It's taken some major steps forward after some prior management missteps. It certainly -- really, I think we turned a corner in a major way since Doug Del Grosso, dropped in to save the company about 3 years ago. In concert with that, they've made a number of financial moves led by Jeff Stafeil, who's here, the CFO, including ending its joint venture with Yanfeng, consolidating some of its operations and using the proceeds, I would say a lot of the proceeds, big proceeds to delever and it appears the company is really on track at this point. And we think it's really just the right time because we believe, despite what's going on here in the near term, the cycle will really recover and the company will hit [ PAGR ] in 2023 plus. We're very happy to have Jeff Stafeil, the CFO of Adient; as well as Jerome Dorlack, Executive Vice President of Americas; Mark Oswald, Vice President and Treasurer, is in the audience and always helpful for questions if you're looking for answers. If you can't get us, you can certainly always get Mark. He's a treasure trove of information. So with that, we're going to get into the grill session and kick off. So thanks, guys, for joining us.

Yes. Of course.

Thank you.

So if we can maybe start first from the near-term environment. I think we kind of had some of this discussion last night. If you were to look at all the headwinds that you're facing right now, if you got relief from one of them at the moment, which would be the biggest relief? So if you think about mix, volume, stability of schedules and cost inflation, right? There's a lot going on right now. There's a few more than that. But I mean if you were to think of all of those, which would be the best?

Yes. Volume. I mean it would…

Volume.

Yes. It would. Hands down, it would be volume. I think if we could get the volume, that would be first and foremost. I think behind that would then be stability. So being able to run at kind of a set number of units, we can then size our business accordingly and run at that. And right now, there's just a lot of instability because our customers want to run whenever they can get shipped. So they'll run a Saturday and Sunday, and then call off Tuesday and Wednesday of the next week. So if we can get volume, great. If we even get stability, that would be kind of our next preference down. And then anything with mix is really, I'd say, cream on top of it after that.

Okay. And then relief on inflation. I mean, how do you think about on the input costs as well? I mean, import raws as well as labor?

Yes. On the inflation side of it, I think for the commodities, last time we talked, we had kind of framed up like a 70% number with a lag on steel and we've really worked over the last 8 months, 12 months in renegotiating some of those contracts, whether it be putting on index or adjusting some of the lags that are out there in order to kind of increase that coverage. And our -- some of our other mechanisms are efficient when it comes to foam and things like that. I think now there's -- the next wave that we've got to go to work on around European energy and what's happened there and then also some of the supply chain and logistics. So ocean freight going from $2,000 a container to $20,000 a container to move diesel fuel at $5.50 a gallon and what that's doing to some of the over-the-road trucking. So I'd say that's the next frontier. I think we've demonstrated on the steel side, the foam side, we can break through some of those barriers and now it's just the next tranche that we have to navigate our way through.

Got it. And with all of this, I mean, instability, I mean that's coming from the top down from your automaker customers, I mean how is the current relationship and discussion on potential recoveries, repricing what the future really is going to be as things hopefully normalize and how do you claw back from where you are to there?

I mean I think the relationships with our customers are I mean really kind of across the board, extremely strong. And that's from the top of their house to the top of our house, and really driven from a foundation of execution. So we talked a lot about early on in the turnaround kind of this relentless laser focus on execution, so executing launches, not disrupting our customers. And because of the nature of our business, with a large portion of it being just in time, I mean we're directly connected to the vehicle assembly plant. And so as we run is how that vehicle assembly plant runs. And as long as we have that laser focus on execution, we do develop these really strong relationships. And then I think you layer upon that the activities we've done around our ES3 activity, focusing on VA/VE, sustainability of new products, bringing new products to the market for our customers, and that's really helped to strengthen our relationships. Now that when we start to have the discussions around whether it's renegotiation of steel or things like ocean freight, we are seeing traction. It's not easy. I mean, to be clear, these aren't easy discussions, but they're also not discussions where we're laying kind of a burned path in our way. I mean we are making headway without completely destroying customer relationships kind of on this backbone of really strong execution.

But I mean, is anything changing sort of in the contract terms or how you're -- I mean, how you're laying out new contracts or working existing contracts in light of this?

Yes. I mean, yes, I mean we've been on pieces of the business in the last 6 months where we've included things around ocean freight as an example, where a year ago, we would have never even thought about that, and so we've worked in things like ocean freight. We're now working -- we have a customer where we have an agreement on craft labor, and we're now working on spreading that across the multiple customer groups. And so it is as new contracts come up, taking these kind of unknowns and now working them to the newer agreements. And the best example I can give is if you go back to '07, no one really had a mechanism for scrap steel or for a #1 busheling as it came to cast products and things like that or steel production. And then we all -- through that period of hyperinflation, we all went through and worked in mechanisms around steel recovery; same thing for aluminum. And it's just now this is kind of the next wave of coming through, okay, we know ocean freight is now volatile. It's going to be volatile going forward. We need to work through it. We know there's going to be trapped labor elements going forward. So we need to be including those in the way we contract or at least getting recovery for them.

Got you. And there's a lot going on in China right now. I mean, there's some of the stuff that you guys have done with Yanfeng over time. So you've cleaned up your -- or streamlined your footprint to some degree and raised capital as a result of it. But I mean, the operating environment over there right now is pretty challenging. Can you talk about what's going on over there right now as far as your operations, as much as you can, in the near term, how you're handling that, how it's impacting volumes?

Yes. The situation in China is, I'd say, in particular, parts of China, the North and Changchun area has generally been shut down for a month. If you look in the Shanghai area, where there's less production, but a lot of overall leadership and certainly as some element of supply has been shut down the last couple of weeks, I believe publicized, so you have a smattering of production stoppages. I would say the people in the region have been going above and beyond to keep production going where possible. An example, we have a facility in a location that's shut down or is in quarantine. But our customer is in a slightly different area that's still running. And our team has voluntarily elected to go in and continue to run the plant and supply through this whole time. So they've been living in the plant for like a month. And so you've seen the resiliency of the workforce. You've seen resiliency of the industry. It's unclear exactly how long the current lockdowns will last, but I would say my expectation is when they do return to a steady state, there's going to be a desire. And I think the capability of the work -- workforce in the industry to make up some lost volume. So I would expect it to come out strong, but I think it's going to be fairly weak for a little bit as we work through some of these supply challenges.

And when you look at what's going on around the globe, I mean, obviously, Europe's, I mean, a relative mess for obvious reasons, China is going through these issues. I mean do you get the sense that there's any sort of light here in North America where there's an increased focus basically human capital and parts and raws that are flowing into the North American market where this is really a market where there could be significant recovery sooner rather than later rather than -- relative to those markets? Or is there just not that level of fungibility in the supply chain, particularly for your seats? Or the automakers at large?

I mean we've seen it with multiple customers where if they have a challenge in Europe because of wire harnesses from Ukraine, as an example, they're able to take silicon and redeploy it into North American production. So there is that kind of fungibility in the supply chain. We've seen in the month of March, a couple of shifts going from a 1-shift operation to a 2-shift operation even at some of our customer plants were added in because they are able to say, redeploy some of those components across multiple operations, and it varies by customer depending on the amount of standardization they have in their vehicle architectures, but those that have the ability to do it are very adept at doing so. I mean that's one of the great things about auto. I mean we're really good at dealing with a crisis.

And I'd say, fundamentally, the industry wants to produce they want to build vehicles. This is the first time we've been in this industry that we've been supply constrained versus demand constrained. And there's a number of challenges that have kind of 1, 2, 3 punched us as an industry over the course of the last couple of years. I suspect a lot of those -- there's tons of progress being made in silicon. There's tons of progress being made across each component of difficulty. Some of the Ukraine things exacerbated. Some of the things in China will have some reverberations outside of China and even in North America on the supply chain. But it's a matter of time. It's not really an if; it's just a win. And -- but it's going to be a little bit of time before we get back to normal production and being able to really meet the demand.

And amidst all demand, I mean, you guys really are turning the corner in the last couple of years in quality and delivery and everything with a customer. You're back in, I would say, very good graces, I would imagine with most of your customers at this point. How is new -- how are new bookings going and the bidding process? I mean, it seems like there's a lot of crowding out of a lot of issues that are obviously just kind of talked about. But I mean, are you seeing your backlog builds maybe at a greater rate than it has in the past or is some of what's going on right now tamping down or delaying some of that -- those new business wins or even product launches, right, for that matter? I mean, just simply product you know what I mean, on the product launch side?

I can start and Jerome can jump in. But in general, we've been winning what we want to win. I think we've had -- Jerome talked about it, the relationship with our customers, we got through all the delivery quality, all those issues on execution. I think there's a huge amount of comfort. But what they've also seen with us is when we talk about ES3 or we talk about ESG, we've sat down and given them a full portfolio review. We can sit there and say, we've ripped down your seat and we can compare it to all your competitors and show you exactly where you're spending too much, where your part proliferation is causing you challenges, where you have opportunities to save, where you could do things to help on an ESG. We have all those things, I think, in spades. So they're actually starting to see not only the execution side, but all this value add that we can put to it, that there's more of a pull from our customers to source Adient. We've seen it in new business. I would emphasize our focus. We have a big portion of the market. And our focus has not been so much growth. I think there's opportunity for growth and I think there's still content per vehicle growth for us, and I think a lot of the trends are positive for seating. But we're winning the business we really want to and need to win. And we've been encouraged by that. But anything you want to add?

Yes. No, I mean, I think that's a very good summary. And in addition to some of the business that I would call kind of replacement target or things that we enjoy today, we have notched what I would call conquest wins across all 3 regions that we operate in. So taking share from competitors. And really, again, on the back of being a supplier of choice to them, based on not just always fighting the war on cost, but really on cost, quality and delivery, and in some cases, being awarded at a premium because of the track record of execution because we're able to bring things forward on a complete vertical integration scale that some of our competitors can. I think you look at our ability to supply not only the just in time, but the foam, the trim, the metals and then do that against this backdrop of ESG and some of the things we can bring forward there. It is a differentiator for us against some of our peers.

I have a kind of big picture question. As we migrate to the EV platforms, a lot of investors are trying to kind of pick winners and losers and who is in the right position. Given that you guys make seats and EV will need seats, can you just shape a little bit of the concept around what does the EV migration mean to seats and margins? And how could those seats be different then?

Yes. Do you want me to go?

Go ahead.

Yes, I can -- I'll start it. I think you have to maybe break it down into kind of near-term EVs. So and I'll say the next 3 to 5 year of launches and then after that. I think if you look at the next 3 to 5 years, the contracts that we're working on now for EVs are all what I would call very richly contented. So you've got 8-way adjustment or 26-way adjustment. You've got 4-way headrests. You've got very high-end vegan leathers that are in them, a lot of kind of 2- and 3-row midsize to large-size SUVs. And so the content per vehicle for us on an EV compared to a standardized is generally much greater. And that's kind of the…

So the mix is going [indiscernible].

Yes, and then that would then roll through to kind of the mix end of it. And that's, I would say, the next 3 to 5 years and what we see in that launch window. And then I think as customers then pivot towards getting to kind of that magical $30,000 EV, we'll see what content ultimately ends up in them. But I think what's important for us is that then presents an opportunity for kind of additional vehicle integration and control. Because our customers need to redeploy their finite resources towards the battery or the actual drivetrain unit or autonomous and even the further kind of way out. We have a group of really talented seating engineers as do they. And what they're seeing is I benefit from giving more of this content, more of this control over to my seating supplier, being Adient. And then even though that, call it, $30,000 EV may not have an 8-way standard, we're getting more control of the sourcing. We're getting more control over the vertical integration. And so as we look at that transition to EV, it's great because we don't have to grapple with the ICE to EV conversion. And we kind of see content increasing for us as that continues through. So generally, I'd say very, very positive. Yes. And just one other thing is the seat takes up valuable real estate in the vehicle. And so anything we can do to keep the comfort levels where they're at while freeing up some of that real estate where they can put batteries or other types of propulsion is another benefit that we bring forward. And so we're doing a lot of work with our customers on packaging of the seat packaging of comfort in order to allow for more power density in the vehicle as well.

Makes sense. Yes. Perfect.

When you think of the economics of the new contracts versus your own contracts, I mean, there's been a story for a long time of making this transition to working off your olds uneconomic contracts and working on to contracts that make a lot of sense. I mean, where are we in that process? And given what's going on right now, is there greater latitude to rework some of those older contracts and get them more economic faster?

Yes. I mean I think we've done a number of things on some of those old contracts that were really problematic. And some of the programs that were really ailing us, we've been able to make improvements throughout, just operational floor-type stuff or sometimes commercially, VA/VE or what have you, that we've been able to put forward in changes. As you look at the new business, I'd say that's an area where I've been encouraged and it's a lot of the execution on the development side, where we've -- there's -- after a seat is awarded, there's enormous number of changes typically that go into it. It's a complex product. And we've been able to walk up the margin while still keeping our cost. The customers' cost control, very positive, but walk up the margin from our standpoint in a meaningful way such that I'm encouraged as the portfolio continues to turn. Remember, just less than let's say, 15% to 20% per year of our business turns over. So I'd say we're on where we need to be from the path. It's just the market has so much turmoil right now with everything, it's hard to see it with lower volume and all the inefficiencies around production. But knock on wood; I think we're on the transition we talked about in turning over new business and some of those old contracts into the new.

So if you were to fast-forward the clock to 2023, presuming the world is somewhat normalized, certainly not perfect, I mean, what portion of the portfolio do you think would be sort of still in the underperforming legacy camp versus stuff that's been reasonably reworked to the new world order or new contract wins since then?

It's a good question. I think you're largely sort of through a normalized transition. Even in a great scenario where we get to after, there's going to be a great diversity of program returns. We have thousands of different programs. And sometimes volume really turns out positive on a vehicle, sometimes it doesn't turn out positive. But that overall range within the portfolio is going to have programs that still are well below our average margin to well above the average margin. I don't see ever getting to that super tight range there. We'll obviously work to continue to bring up margin portfolio. But a lot of the real bleeders and those things that were really driving our portfolio down, in a normalized environment, I think are going to find their way through or find their way out in the next year or 2. The real question is where does volume come through? As we look at margin, the things to watch for us is going to be volume and making sure our production schedules are more normalized like they were before, let's say, COVID in the last couple of years. It's going to be these inflationary pressures, and this is going to be something in the whole industry, is making sure that we have -- we're priced to be a value-add supplier. We're not priced to take the risk on commodity pricing increasing or labor pricing all over or shipping containers going up 10x. All those things are things we're working to navigate with our customer right now and are going to be much more key to the margin success next year than necessarily the old core product profile.

So I mean, if you can remind us, I mean, I think the range you kind of talked about is "normal" seating margins is in the 7% to 8% on operating margin, give or take. You can confirm or deny that or maybe it's slightly different? But I think it's in that range. But I mean, is there an opportunity as we go through an actual recovery, right, whenever that comes, where you could -- those margins because of everything that's going on at the moment, the way that you've kind of reset contracts, the way that you've kind of leaned everything out, that there could be a period of margin potential that's significantly higher than that?

Yes. And you can paint scenarios, I think, that go a little higher and lower. What we've specifically said is there's no reason why we should have a different margin profile than our peers. Today, that 8% has been roughly around where some of our peers have operated. And when we've looked at ourselves, we've said there's nothing structurally disadvantaging the Adient business model or the Adient business versus the competitors, and we're working to sort of bridge that. But I can see scenarios where we generally benefit, for example, on downward trends in commodity prices because we have a lag with our customers. So we'd theoretically be paying less for material and getting a higher recovery from our customers in those scenarios. Those are areas where we could have outsized margin. And I think as we've been extremely diligent on our cost structure, as I know others have, as we start to have a rebound in volume, this is a business where the variable margin is a lot higher than our overall margin. So if we benefit on that volume, as people build back their inventory, yes, we could definitely have a positive margin impact.

And when you get -- also when you get into an environment of stability and the cash flow generation should be pretty damn strong.

Yes.

What are priorities for like when we get into that world of not having to worry about distress of the macro, not the industry or you? I mean, where does that cash go? What are the priorities?

Yes. No, the distress of the macro has been a big part of the last couple of years. But if you look overall, we've tried to give some definition around that. We've said, one, if you just think about cash in total for us, we think if we operate with -- end of the quarter, $600 million-ish of cash is a very comfortable amount for us and access we can start to use for other things. We've said as well that somewhere around a 1.5 to 2x leverage is something that makes sense to us. On a normalized earnings, and we have to -- it's been really hard to normalize earnings right now. It's really been hard to figure out exactly what's going to happen in the world economy. So we've left ourselves a little bit more flexibility. But in a more normalized time frame, look for us to be in that 1.5 to 2x, $600 million of cash, and we can start to use the excess. And yes, we said we don't have a lot to buy. We don't have holes in our portfolio really. We could be opportunistic, but with our share price, if it remains at a low level, that's clearly a target where we would look to do some share buybacks and take advantage of that price.

But ultimately, in the footprint of the business where it stands right now, I mean, there's not a whole lot to go after, I mean, other than our organic wins or portfolio rebalancing in any way you really need to do.

I mean, we could be opportunistic, but there's nothing we like have to have.

Yes. I mean, when you look at our portfolio and when we look out 10, 15 years forward to autonomous vehicles, there's nothing, to Jeff's point, that we think will be required that we don't have today or that we can't develop given the assets that we have around us. So if something, as you just pointed, is opportunistic, yes, I think that's different. But in terms of actively having to seek out some type of a new technology on long tracks or something that we either have it in our portfolio or we've got a path to develop it with what we have around us.

Okay. So I mean cash goes to buybacks or ultimately a dividend over time?

Yes, because it's something we could start to -- as the share price gets more in line and stability, there's more certain, dividend's definitely on the table.

I don't know if there are any questions in the audience.

There's a question here in the right. Please.

I have just 2 really quick ones. One is a follow-up. You talked about nothing very exciting in terms of organic acquisitions that you guys are looking at today. One of the things that Lear's been talking about is taking comfort seating into the rear seats. And obviously, with Kongsberg, they're now aggressively trying to pursue that. And very simply, if you have comfort in the front seat, you take it to the rear seats, that could double the CPV on a car. Is that something that you guys are considering as a potential future growth avenue for yourselves? And then on the cost side, you talked about a $95 million net commodity headwind over the course of this year. Are there any restructuring initiatives in the business today from winding down the SS&M business or European restructuring? Things that you've talked about in the past, maybe just an update on the restructuring initiatives in the business, what's sort of left. So between those 2, that would be great.

Sure. I mean, I'll start a little bit and let Jerome finish on that first part of your question. But one thing to think through is we have a big market, and we always have had a big market share in China. And China, especially in the premium vehicles but kind of throughout, has much more of a rear seat focus because so many people have drivers. So there's a lot of focus around all the creature comforts and rear seat comfort. And we've been part of a lot of those programs, so have a lot of expertise on those and certainly have made a number of investments and innovation around there. But...

Yes. I mean, I think the way Lear is going about it is one path to get there. And to Jeff's point, when it comes to rear seat comfort, we are able to deliver the same quality, the same comfort via some of our supplier partners and some of our vertical integration in other areas, whether that be through some of our foaming technologies or through some additional technologies we're actively developing with integrated lumbar and high support and we're in a -- call it, a joint development agreement with one of our customers right now on that. So we see it as an area of potential growth. And we have avenues in order to capitalize on that growth. They may be different, they may be the same, but we recognize the same potential there.

As it relates to the commodity exposure, we started last year talking about we had effectively $200 million of net exposure, a lot higher increase in overall steel and chemical content, but net of what we were getting back from the customers, around $200 million. I think in November, we narrowed that down to $125 million. In February, we narrowed that to $95 million, through a couple of things. We did that through -- we actually started to see a little bit of relief in the commodity markets themselves, but more importantly and more structurally important, having success with renegotiating contracts with our customers. And that's something we continue to work on. We'll update you. I'll give you -- we'll give you another update on where that sits when we talk to the market on the 5th of May. But I would say our focus there is back to the concept of we're a value-added supplier. We're not price compensated to take on the risk of all these commodities, but it has historically been and traded in a very narrow band. We've taken the opportunity here with them trading in very wide bands and much more volatility to go back to our customers and rework a lot of those relationships. And that's something we still have to do, and we'll continue to report on our progress. Separately, you asked about restructuring. We had a bow wave of restructuring the last few years, but we've said this business will never be at 0. Expect it to be somewhere 0 to 100, but probably on average, but I'd say probably closer to 50 to 100 on a normalized year. And that's mostly related to footprint decisions from our customers. But overall, we are still absolutely focused on keeping an incredibly lean cost structure. And through this time period, that's been paramount. I think we'll benefit from that once volume recovers, and I don't think we have to add all the fixed income -- or fixed expense that we've had in the past. So I think we should benefit, back to your margin comment, on recovering volume and not necessarily replacing the fixed cost.

One last quick question. I mean Tesla is doing its own seats, right? What does that mean? What does that mean? I mean, is that an opportunity? Is that an issue? I mean, why do they view it as something that needs to be vertically integrated in the company where everybody else is outsourcing it?

Yes. I mean, I think, first, Tesla doesn't do their own seats everywhere. So in...

China they don't.

Right. In China, they don't. So in China, they have a just-in-time supplier.

Who's that just-in-time supplier?

It was us. It was YF seating, but then we split that, went with YF.

Okay. Okay.

Okay. And I think one of the things that maybe enables Tesla to do it is their seating model or their overall vehicle architecture. So if you try to spec out a Model 3 or Model S, you get a black interior or a white interior. And that's pretty much it. So they really -- and all of them have power content, there is no difference. If you want heated seats, it's subscription services. And so their seating build is extremely simple and very limited complexity, which allows them, if they want to go in-house, to do it. But I think what's important is those -- we know the margin profile of our business, know that [ jet ], from a margin standpoint isn't the highest merchant that's out there. But I mean, specific to the Americas and Europe, I mean, we are, I think, still Tesla's largest seating supplier through components. So we have a very large portion of their foam, we're their largest foaming supplier. We have trim operations for them, and then we have some metals operations for them. So while it may not be that headline of kind of that top level revenue on [ jet ], we're generating returns through the components that we supply them, and that model won't change. I mean to set up a trim operation, I mean you're talking 3,000, 4,000 people in Mexico, very highly specialized or in Morocco, same thing with metals. There's a lot of capital that goes into that. They don't necessarily want full exposure to. So they have a mix. And foaming operations, to set up a dedicated foaming operation is pretty cost prohibitive for them. So they've kind of tried to find that sweet spot that works for them based on their complexity, but there's still plenty of content per vehicle for the seating side of the auto supplier area.

So the economics on all those subcomponents or sub parts, if you will, I mean, are they similar to what you would get on a fully assembled seat or in some ways better?

A lot of those components have higher average margin than what we have. It's just a question of really grabbing more content there. And I think Tesla had made a big investment in automating their seating facility more so than most, and it's because they have low level of complexity. Most customers provide more options and features. And we really come in managing that complexity for our customer to where we really add a ton of value. And then I think as you start to just develop new products and I think that's why most people turn to an Adient or a Tier 1 to do it.

Great. With that, thank you very much, guys, for joining us. We really appreciate the time. Jeff and Jerome, we really appreciate it. Thank you.

Thank you very much.

Thank you. Really appreciate it.

And we're going to have lunch in this room, so it should be outside of box lunches. We're going to be back here at 12:10, so if you guys can kind of hustle, get food and get settled, we'll start the EV panel. Thank you, guys. Thank you so much.

Thank you so much.

Thank you.