Adient plc (ADNT) Earnings Call Transcript & Summary

All right. Good morning, everybody, and thank you so much for joining us for this Day 3 at Deutsche Bank Global Automotive Conference. My name is Emmanuel Rosner, and I'm the lead U.S. autos and auto technology here at Deutsche Bank. We're extremely pleased to be welcoming this morning Adient with us, and we have Jeff Stafeil to my right, who's the CFO of the company as well as Jerome Dorlack, who is EVP of the Americas, to talk to us, give us an update about the company, hopefully, about the industry as well. As you probably all know, Adient is the largest supplier of automotive seating with leading market shares in every region. It's been operating a pretty radical transformation to streamline its operation and boost returns and profitability, and we believe there's still large additional opportunity. So we're very happy to have you here. The format of the session will be a short introduction presentation by Jerome, and then we will turn that into a fireside chat. And we'll be happy to also accommodate your questions. So with that, thanks again. And over to you, Jerome.

Yes. Thank you very much. Good morning, everybody. So this is on our website. I won't spend a lot of time going through each slide. You guys can view it at your leisure. There's really kind of 2 areas I wanted to touch on, one of them is what we call our carbon estimation tool, our carbon footprint tool. And really what we're using this for at the moment is we're in active development with some of our customers where we're able to go down to kind of the individual component of the seat and forecast for them, here's an incumbent seat, here's where we can drive the CO2 emissions to for your next-generation seat. So we have one kind of in production running through the process, and we have a number of development activities with them. And how this works is we really look at everything through the process. So we're looking at raw materials, where do we source them from with the logistics or the transport to get into our manufacturing plants, how are we packaging the materials, where are those packaging materials coming from, the manufacturing and assembling of the seat itself. Are we able to reuse the components, both in the seat today, but then also from a recyclability standpoint after the seat of the vehicle has reached its end of life and then the waste that comes out of it. So if we do have scrap, what do we do with that scrap, how do we essentially dispose of that scrap. And what we're able to do then with this is basically go through what are the top vehicles that are then driving the emission. And then if you go through this is kind of a typical vehicle seat where you've got some of the plastics is actually some of the lowest and the steel is really the highest in terms of what drives some of the CO2 emission. And so we had a press release, I want to say 1.5 months ago with one of our partners in Europe, we've actually secured future green steel tonnage. So as the green steel comes on, we've secured some of that tonnage to go into future seating programs to really drive down those CO2 emissions. And then if you look at seat set today is, call it, 187 kilograms through the life of that vehicle and that seat. And then working through these different steps, you've got -- I talked about the green steel, looking at a manual track versus, say, call it, power track, some of the recycling of the material that's in there all the way through to on the trim, looking at going to either recycled fiber, where I'll talk a little bit about natural fibers, we can take that 187 all the way down to 67. And then you've got things that our customers say, "Well, we want to add these back in, such as venter massage or sound and seat and then what does it actually kind of wash through for the end consumer and for our customer?" And so this is something where -- when we were awarded this program and questioned us with the, call it, where the OE had a target that we jointly agreed to, to reach on this seat set and you can see where we're at against that target today. It's actually exceeding that target. And the reason this is important is we're seeing more and more of our customers move towards this type of an analysis. And so we've used this as a pilot. We're now in, as I said, in active discussions in another development, and we're rolling this out where our customers are receptive to it, really in a meaningful way. And so it's not only looking at sustainability from our manufacturing plants, but also sustainability in the products we're designing and selling. And then the other big part of this that I want to talk a little bit about is from a deforestation standpoint. And so if you look at where we sit in the supply chain, although the vast majority of our surfaces are directed to us by our customers, we're still working with our customers to give them alternatives. So what alternatives are there to leather, especially in order to meet deforestation commitments. I've listed out a couple of them there, whether that's an e-leather or there's the natural fibers, such as apple skin, where you get a very leather-like product without all of the deforestation risks that go along with it. I mean so actually, Jeff and I sat in a discussion 2 weeks ago with Global Canopy and Ford 500 and World Wildlife Fund, where we walked them through where do we sit in the supply chain, how can we impact this and what are we doing to impact it. And then really with all of our OEs and we are in very active discussions on what are we doing to kind of drive leather content out of their future vehicles. Certainly, on a lot of the EVs, they've got a mindset of, they want them to be green, and so they're looking at a lot of kind of non-leather alternatives as well. And so that's really it for opening comments. Again, you can see a lot of this out there on our website, you can download. If you have any other questions, you can certainly round them through Mark. But just given kind of the effort around sustainability, we haven't spoken a lot about what we are doing. So we thought it would be a good form to just kind of give a bit of a window into it. And with that, I'll turn it over to Emmanuel.

Sounds good. Yes. Thanks so much for the introduction. It's certainly an angle that we haven't explored today. I'll be honest, more -- my questions are more of the short to midterm type. So you may not tie directly with the slides that you just presented. But maybe just to set the stage first in terms of the environment you're operating in, can you maybe provide an update on the -- what you're seeing in terms of expected impact from the China COVID shutdown on the industry production and also indirect impact from Ukraine war in Europe on industry production in the quarter and I guess for the remaining quarter of your year?

Yes. Great question. Yes, overall, I'd characterize our state of auto is still being supply constrained. In China, which was the first part of your question, I think, we're more optimistic than we were. And certainly, I'd say, I have some optimism around the market in China. Much of it was shut down in the March, April, May time period certainly Shanghai, but lots of production regions. There was still quite a bit of a mix within China itself of where you were producing and where life was generally reasonably normal and where people were locked down, but come on July -- or June 1, Shanghai opened up, and it's opened up a lot quicker than we had expected it to. Life is, I wouldn't say, totally normal yet there, but it's much more normal. And our facilities are back up and running, our people in the office and, I'd say, production is flowing again. And there's optimism as we saw in the north, let's say, FAW area, Changchun area of China, they came out of lockdown earlier and they've jumped back into production, and I think are optimistic that even some of that volume will be made up through the year. I do believe the China government will put in some incentives to stimulate vehicle demand, but that's probably the big question within China. The 2 big questions are probably whatever that stimulus is and how effective it is on getting consumers out in purchasing vehicles. And then the other side is, is there any other COVID lockdown or second shoe to drop as it relates to lockdowns or impacts on people's lives. But right now, I'd say, we feel quite a bit more optimistic than we did a few weeks ago and have seen a lot of positive early signs that the lockdown is over. As it relates to Ukraine, initially, there was quite a few just logistical supply issues. So wire harnesses is the big one. But we saw some of that earlier, and it impacted our customers differently. I'd say we've largely worked through that right now. I'd say the market is still supply constrained but starting to feel a little bit more of -- more questions around where demand will eventually go and how long it will take back to get -- take to get back to 2019 levels. So watching that pretty closely. But overall, production as it relates to Ukraine is back to normal. But what it's done is it's moved other input prices, utilities being the big one. But all the other things of semiconductors and other supply constraint issues. I'll let Jerome hit Americas.

Yes. I mean I think in the Americas, we're seeing some improved stability. So we look a lot at kind of start of month versus end of month. We're -- what our customers release us at. So 8 months ago, we'd see about a 25% drop off. So if they told us at the start of the month, they're going to build 100 cars, they've usually build about 75. Now that's down to, call it, if they say they're going to build 100, they usually build about 80. And so there is more stability coming in. I think the health of how that's showing up could be a bit more disruptive. So a lot of weekend production and then we'll work at Saturday and Sunday, and then they'll call off an entire shift for the next week. So maybe more throughput, but disruption is still there, for sure, in the market for us.

Can you just remind us what's your assumption for LVP growth is for the year and whether that's broadly tracking?

Just vehicle growth?

In -- yes, industry production.

Yes, it's basically roughly flat from 2021. Because our fiscal year-end is end of September. But it's just shy of 80 million units globally.

Got it. Then one last one on the sort of, I guess, on the environment, but how has the semiconductor shortage progressed in the start of the year as far as impact on industry production and revenue are you hearing from your customers that things are improving sequentially?

I mean they -- every month, they say they get better. And every month, they don't actually get better. And it's -- I do think semis are better, but I think you're now starting to see other kind of rocks that are being uncovered in the industry and not just in North America, but North America and Europe, where we've had customers who have struggled because of lack of radiator hoses and for as much smart technology as there is, I don't know of a radiator hose that's got any kind of silicon in it. And so it's as they solve one issue another one kind of creeps up. and I think you'll start to see that until we get to kind of stability in the industry where we just haven't run at 92 million vehicles in a while. And so to get back to 92 million, it's not going to be a light switch that's flipped on. It's not like if semi cons are available, all of a sudden, there's going to be 92 million. I mean you still have port congestion. You still have lack of truck drivers. You still have a tight labor market. You still have energy constraints in Europe. And so I think there will be other things that will challenge the industry to get back to 92 million outside the semi cons even.

So maybe should shift gears to some of the cost drivers and your performance there. So last quarter, when you reported, you cut your '22 EBITDA outlook to a range more than $100 million below the $810 million that you did last year due to lower industry production outlook and higher nonmaterial inflation. At the same time, you assume you would offset nearly all commodities cost pressure at least for this year. Is this still the right framework for this year's outlook? Or are the cost headwinds and volatility playing out differently than you had expected?

Yes. We just gave that update last month. So I'd say it's still pretty much the guiding element. We've done -- I think, we've done pretty well in managing steel and chemicals. If you look at a year ago, we had given some guidance that versus 2020, we were $650 million up in steel and chemical prices and then we would have something over $250 million or what have you of an impact for the year. We've worked that down to roughly $15 million through a lot of negotiation with our customer, but also just working to get better arrangements such that the amount of contractual recovery we have on these commodities are pass-through. We're a value-add supplier. Taking that risk exposure on raw materials is not something our profit margin or business model is really built around. And we've had good success as the market was booming up on those prices to recapture. I think the other side of what we've had nice success on is other inflationary puts have jumped up. We've used the opportunity to renegotiate with our customers on trying to build in mechanisms or at least recovery sometimes just one-off on things like ocean freight or utility costs, et cetera. What -- the reason we brought down our volume, or I should say, we brought down our EBITDA was purely driven by volume. And we would expect as volume improves, that EBITDA will come back. We haven't lived in time other than the last year where we've been supply constrained in auto. I don't expect we'll be supply constrained going into the future. And as some of these from semiconductors to all the variables that Jerome just mentioned, improve, I do expect supply to improve. I expect it to normalize with demand and I think big opportunities for us to roll that through in both EBITDA and free cash flow. But this year has definitely been challenged due to [indiscernible]

So let me take some of these factors in sequence. So the first part is you were able to successfully negotiate with automakers for nearly 4 commodities-related recovery for the year. You also benefited from, I think, some of the timing of when some of these contracts were negotiated. As we look into 2023, how should we think about commodities for you amid the resetting of some of these contracts as well as based on the ongoing commercial negotiations that you're having with automakers?

Yes. I could start and Jerome can jump in. But I'd say, in general, as you think about us with these variables, as prices are increasing, we're always working to catch up a little bit. Our customers -- in areas where we don't have built-in mechanisms and that's going to be many of these particular variables that hit in an inflationary environment, we're working to mechanize more of them. But as they go up or new things go up, it does require us to negotiate with our customers, and there's usually a time lag. As these prices start to stabilize or eventually go down, I think, you could see some stabilizing of that. I won't say necessarily upside, but maybe a little bit, but more stabilization of it. And that's -- as I look in 2023, it's hard to predict where a lot of these prices will go. But everything we're doing right now is working with our customers to mechanize where we can, ocean freight, utilities, steel, [ temps ]. And if we can start to see some price stability around there, I don't think it's going to be a big negative impact for us in 2003 at least at this point.

Yes. I mean I think that's accurate. I think you've got to kind of -- I mean, similar to what happened in the industry in 2006 and '07 when we collectively redefined commodities. I mean back then, each deal was a commodity, but it wasn't a commodity as we talk about it today with indexes and things like that. So when you say commodities, if you mean it in a historic sense around steel and resin and chemical inputs, I think, we've really seized this crisis in order to fix a lot of our contracts, fix a lot of the lags, as Jeff said. And so as we think about '23, that -- all that work we did this year, that good renegotiation will flow through and now to Jeff's point, it's going after the things like ocean freight, diesel fuel surcharge, energy input costs and starting to think of them as commodities now as well and working through and getting those put on indexes. So the historic commodities, I think, as you look at '23, the good work, it will pay off. It's just now going after this next tranche of headwinds that we face.

Understood. Now as part of this year's outlook, you had also identified $475 million in transitory cost headwinds, which were impacting EBITDA. Now heading into 2023, as you mentioned, industry volume would be expected to bounce back. And with this recovery as a backdrop, how do you think about the opportunity to recover some of that $475 million into next year it's going to be that with the higher volume and with more predictable customer schedule, what's your latest thinking on that front?

Yes, that $475 million was a significant portion of it was made up of volume and it's just lost contribution on volume. And predicting volume right now is really difficult. If you look at our customers, they get it wrong every month by 20% on average. If you look forward though, and I'm seeing more optimism around 2023 in semiconductor. So if you're able to get there and then we can just have some stability around the overall COVID environment, I believe. China, for instance, or what's going on in Europe and Ukraine, if you can find any stability around those, I do think your volume can boost up. I don't think it's probably going to go to $92 million next year. I think IHS is in the mid-80s. That can have a huge benefit for us. And a lot of that $475 million can come back. The other side of -- the other big component and Jerome could speak more on this, but we are just in time business, so we have to run at the same line speed as our customers. So when they give us forecast for the current month that are 20% greater than where they build, the impact to that us is pretty significant as we have to hold people and capacity in our plants to produce 20 more percent than we're actually needing to do. So we have more workers, more cost in our system and a lot of times, we're running overtime on weekends and then shut down during the weeks. It doesn't make a lot of sense, and it's caused a very inefficient production environment. So if we see more stability in there, that's the other portion of the $475 million or other big portion, things like ocean freight are in there, too. And Jerome, you can probably mention a little bit of what we're trying to do on that exposure.

Yes. So Jeff touched on the labor. If you take the ocean freight, I think, we've called it out as a gross $60 million headwind year-over-year, and we really went after it in what I'd call kind of 3 buckets. The first bucket being just looking at all of our pack densities. So as we're moving things over, are we getting the absolute most amount that we can? When it was $2,000 a container to go and reissue dunnage, maybe you didn't have a payback to it. Now at $20,000, container spot rates are lower. But if you say $20,000 a container, that dunnage payback has a much higher feature to it. And so we went through all of our pack densities. The other thing we've done is we've looked at West Coast versus East Coast. So we've actually moved quite a bit of our freight out of Long Beach and into Mobile, Savannah and different ports along the East Coast, where you see rates from $20,000 down to $16,000, $14,000, even $12,000 a container. And that just takes time to work through the system because you've got an additional logistics loop that goes through there. And then the third one was really around this customer negotiation. And there's a couple of examples where this year, we've been able to get, say, one-off recovery. So customers haven't been willing to adjust POs because they see spot rates going down and so they'd rather give us one-off recoveries. But then there also are some cases where because of a customer's decision to not industrialize something here locally, we have to bring it in from overseas, where those contracts now have ocean freight baked into them. So it's a true -- I go back to this concept of a true commodity now where it's being adjusted like a true commodity would be. And so as we look at ocean freight, as an example, rolling into '23, net of volume increases, I mean, we'll take a meaningful chunk out of that $60 million. But then as volume goes up, the absolute number goes up. And so it's just -- it's working through those different scenarios. And then the last one on that, that we have talked about is looking at onshoring product again. And that's either onshoring it ourselves, and so making investments ourselves to onshore. We've done that with one of our key back frames or working with actually one of our JVs to where they're going to set up a footprint in Mexico. And so we'll eliminate a significant amount of freight that comes over today from China as they localize into the Mexico footprint that hits kind of in the January time frame of next year. So a lot of activity, a lot of level of regression just taking the time to kind of cycle it through.

But I guess, just to be clear, though, so because the way you frame it for this year, I think, you separated $475 million in transitory costs, which were largely volume-related. And then you had a separate $125 million or so, which you felt could be stickier costs sort of like going into next year, is that -- so the opportunity, if $475 million is volume-related, so as volume recovers, there's an opportunity to get a decent portion of that back on the $125 million, these are the actions that you're working towards and [indiscernible]

Yes. We kind of put them all together as we manage.

Yes. And the sticky ones are there's others in there, right? So there's the freight costs, there's also labor and some of the utilities as well. Labor is -- it's a unique challenge that's really exacerbated by our customer scheduling and ability. So if you look at a really good example, one of our plants in Tennessee during the month of June, we'll run, call it, 7 days a week, 3 shifts a day, and then they run out of chips in July, and they want to go back to like a 3- or 4-day work pattern. Well, it's hard to manage a plant with 800 people in it and say, "I'm going to run you essentially full tilt for a month, save up all your money because then come in July. I'm not -- I'm going to take your shifts back." Well, they just go and work at Costco or Amazon or something like that. And then so you'd say, okay, well, that's okay because you're getting your labor out. That's true. But then when they want to run again, those employees that were at 85% efficiency has to go and hire new employees, they come on at 50% efficiency. And it takes them 6 weeks to get proficient again. And so you've got these kind of costs that run through on labor that are real sticky from just overall inflation in the market, but then our transitory as well as we take heads out and move heads in. We would -- in some of our plants, we're at -- in excess of 100% turnover in the last 9 months. And to give you an idea, that means in an 800-person plan, I've had to hire 900 people, and it's just -- it's difficult to operate in that environment. And a lot of it -- most of it being fueled by our customers and ability to forecast and run.

So you've heard to sum it all up and trying to think of the puts and takes as we move into -- in the next fiscal year. So it would be my volume growth or recovery assumption that traditional contribution margin, which is what? 15%?

Yes, 15% to high teens.

High teens percent on the volume side. On top of that, you would aim to recover a portion of the $475 million, which is volume-related to depending on how normalized volumes goes back. And then that sticky cost part, $125 million, does that then be -- is that then a stable year-over-year? Or is there tailwind or headwind, how do you think about that?

No. I mean I think Doug answered the question on the last call. I mean, generally, it takes about 12 months to work through some of these things. If I use steel, as an example, when we sat with you and we talked about our original '22 guide, we had a very significant number for steel, and we were able to work that and really kind of beat it down to about zero, something like that. But it takes 12 months. It will be the same with these costs, right? And ocean freight has been a real issue now for kind of 8 months, and we've been able to work through it. We're getting contracts. We're onshoring. So 12 to 14 months, we work through it. Labor is relatively new, call it, 6 months. So we've got some lag there. Utilities in Europe, you can just -- whenever the Ukraine war started 87 days ago or whatever the number is, so it will take time to work through that. Diesel fuel surcharge are kind of over the road in the U.S. again, relatively new. It's now up, say, $6. And so that will take time for us to work through as well. There's no acceptance from the management team that, that $125 million is now in our cost structure. I mean the clear objective of management is to work that $125 million out, it's just -- it takes time to work it out through the cost structure.

And then the only part I'm missing, I mean, I don't know if there's other parts are missing, but commodities, obviously, as year-over-year, but you don't seem to be...

Well, I mean I think we've -- one of the things is we did take advantage of the crisis in -- over the last year or so and renegotiated a lot of our contracts with customers. Historically, we had about a 70% contractual recovery at about a 2-quarter lag. And I would characterize it's hard to put an exact percentage on it, but significantly higher overall recapture. And I think we did bring down that lag period a little bit as well. So net-net, I think, we're much better shielded for commodities than we were before, but I think we've also shown the capability to go and recapture those costs when they do hit us from our customer base.

Right. Then maybe 2 more from me and then I'll open it up to you all, if you've questions. So that would get you to a certain level in 2023, probably still not in line with the margin target that you've set yourself to essentially narrow the gap with your peers. What else needs to then take place for that to happen?

Yes. I mean I think the thing we're -- a couple of messages here, that $475 million and the $125 million of sticky costs have been big impediments, obviously, to this year. As we move forward, I don't see all the volume coming back next year. I don't think we get pre-2019 production levels in 2023, but I do think we have an improvement in the situation. And if we can have better stability from our customer standpoint, we'll see better margins, we'll see better capability. We haven't been sitting still through the crisis. So I'd also say that we're continuing to improve our operational floor. A lot of that stuff has been masked by volume. This is a business that lives on volume. So as the market improves, I do think you'll see better margins from us and a lot of the extra margin should really turn into cash flow. Our interest expense is materially down from where it was. We do have a small portion of our capital structure, our term loan that is variable with the rest is fixed rate. As you look at restructuring, we brought that cost down, I think, we brought CapEx down quite a bit. Cash taxes should stay low even as profits increase. We have a number of regions in the world where we have pretty large NOLs that should shield us from some future taxes. So getting back to our margin target, it's [indiscernible] the Cap with Lear. I do think requires us to bring to normalized production levels. But taking big bites out of it or taking big improvements should very much be an opportunity here as soon as volume tries to improve.

And then what are the priorities for free cash flow use?

Yes. Good question. A common question. We have put out a capital allocation target or, I should say, a leverage target of 1.5 to 2x. And that's a number where I think we're very comfortable living in. We can -- as you look at the environment we're in right now, just with all the uncertainty, we've, I'd say, been a little cautious on putting much more than we've already done, but we've done quite a bit. Last year, we took out our $800 million note. This year, we took out 85% of the $600 million 9% note took out a couple of hundred million of the 3.5% European notes, and we took out the EIB loan. So big reductions in our overall debt mix. But as we -- that leverage target, I guess, I would summarize and say it's important from us -- or for us to have visibility that we're going to have a stable operating environment before we would necessarily do something more significant on returning capital, let's say, buying shares. But it doesn't have to be in our LTM. We don't necessarily have to have a 1.5 to 2.0 in our rearview mirror. But if we can have forward visibility that we're giving there, I could see us starting to do more significant things, but we certainly would like to see more stability and our customers getting closer to hitting their release targets and the overall environment being a little bit more stable.

Great. Any questions in the room? Yes.

[indiscernible] And then we have a lot of plants that aren't running anywhere near full capacity. So as the OEM production capacity still like at 100 million, 105 million units. So that -- so they will price to sell that volume at some point down the road, is that how we should be thinking about it?

I think so.

And accordingly, what's that mix implication for you, if any, in terms of selling? What was the average median price in the U.S., $28,000, pre-COVID, now it's like $38,000. I mean it's amazing. So I just want to make sure I got the mix impact right for you in terms of that volume growth.

Yes. I think -- you're right. I mean I think if you look further in the future, I think, given the production capacity theoretically goes up more than that, right? Are they going to be able to hold the discipline on inventory levels, are they going to be able to hold the discipline on price? And I guess I would be -- I have some skepticism. But I think from our business model, it should work okay. We didn't -- we benefit much more on volume than we do on the mix side. And you've seen that through the last 12 months for certain. So as volume jumps back up and whoever the winners are, I think, our tentacles are spread well enough that I think we're going to benefit from it. But I do have some skepticism on whether or not the overall industry's we'll probably have some capacity adjustments as we move forward.

Yes. I think the other thing that's key for us, we've been extremely disciplined on is, I mean, we see the phenomenon where if you add up all the EV sales in the U.S., you end up at like 25 million units with the ICIS ones combined. So when we've won contracts, we've really focused on how can we sweat our existing manufacturing footprint and not put up new brick-and-mortar in order to bet on volumes that may or may not come. So as an example, we've got 2 GM EV platforms that we've won that we're putting into an existing site and we'll do what we call long distance jet, we'll move those seats 100 miles to a sequence center in an existing metals plant actually and then into the customer footprint. And so -- and we've done that not just here. I mean we've done that globally to really say, if we're going to make bets on some of these EVs because we know the capacity play that's out there, let's make sure that we're not putting in a bunch of brick-and-mortar and fixed asset in the event that they don't hit, we're not sitting on all of this capital that's not being utilized. So we've spend a lot of time going through that as a management team.

Great. I think we're out of time. So Jerome and Jeff, thank you so much for all the insights and for being here with us.

Thank you. Thank you, everyone. Appreciate it.