Adient plc (ADNT) Earnings Call Transcript & Summary

All right. Good morning, everybody. Thank you so much for joining us for this 2023 edition of Deutsche Bank's Global Automotive Conference. My name is Emmanuel Rosner, and I'm the lead U.S. autos and auto technology analyst at Deutsche Bank. I'm very pleased to be spending the next 2 days with you. We have lined up an exciting roster of 50 participating corporates doing fireside chats today and tomorrow in addition to yesterday's virtual sessions. I would like to bring to your attention some of the next 2-days highlights. We'll have keynotes from Aptiv at lunch today. We'll have 3 keynote sessions tomorrow with the CFOs of Ford, GM and Rivian. Also, do not miss this afternoon the reception from 3:45 on the spectacular rooftop terrace of this Deutsche Bank Center overlooking Central Park. And finally, we also have a whole roster of exciting electric vehicles in the lobby available for test drives, including the not-yet-released Chevrolet Blazer, the HUMMER SUV, Rivian SUV and then Polestar 2 and the not-yet-released 3. So let the meeting desk know if you'd like to add a ride to your schedule. Now with this out of the way, I would like to warmly welcome our opening presenter of the day, Adient. Adient is the largest global supplier of automotive seating with leading market share in every region. It has been operating a radical transformation to streamline its operations and boost returns and profitability. And management believes there is a still large additional opportunity. So to represent the company, I'm very pleased to host Jerome Dorlack, the CFO, and very much look forward to the conversation. So the format for this session will be a fireside chat around some of my prepared questions, but certainly happy to open up also to the room if you have any questions. And maybe to kick it off, Jerome, thanks again.

Yes. Thank you very much for having us.

Maybe just to kick it off. How are things playing out so far for Adient in the third quarter, I guess, your fiscal first -- third quarter? And how do you feel about the rest of the year?

Yes. I think as far as the third quarter goes, for us, it's playing out largely as we would have expected it to. There's been, I'd say, puts and takes, as you would expect from that standpoint. I'd say there's been, from a vehicle production standpoint, generally in line with where we thought it would be, green shoots here and there. Europe, I think coming off of what was a depressed level, has been a little bit better than some would have thought it would be. China has been coming in about where we would expect it to be. North America, about where we would expect it to be. And then Asia, surprisingly, still has some production disruption due to chip supply, but generally in line with expectations from that standpoint. And then for kind of -- you asked a little bit about rest of the year, I think rest of the year continues to really come in, again, where we expect it to be from that standpoint. We're battling through kind of the puts and takes, again, on whether it be we see softening of some of the input factors on ocean freight and some of the over-the-road freight. Some of the other input costs still remain stubbornly high, whether it be labor. We still see labor issues or labor input costs remaining sticky. We still see some of the energy costs in Europe remaining elevated, and the commercial teams continue to pedal through and really fight hard on the recovery front. But I mean, all in all, it remains where we expect it to be from that standpoint. So it's trending where we thought it would be from that side.

That's good to hear. So maybe just honing in on a few more on this point you mentioned around the environment. First of all, customer schedule volatility, which I think has been a big part of the inefficiencies, but also a big upside potential in the longer term. How has that volatility been progressing? Any notable changes?

Yes. I think on the volatility side, I mean it's interesting, if we go back, what would have been a -- there's a really good dialogue, I think, we had with the analysts around -- we always said, as things began to slow down in the economy overall, we really thought the OEs would have to get more disciplined in the way they released us just because as ATPs began to either set or normalize, they would just have to become more disciplined in the way they ran their operation. And that's really started to now play itself out. As chip supply or other inputs to them have become more normalized, as they've seen some of their margins now become compressed, as ATP acceleration has slowed and you've seen now incentives start to increase, we have seen them become more disciplined in the way they've scheduled. And so that's really translated, to us, in schedule stability. And to put some figures around it -- and this is really an Americas phenomenon. Europe generally had schedule stability or a higher level of schedule stability, I would say. And so in the Americas, 18 months ago, we were at 70% schedule attainment, and that is to say from -- at the beginning of the month to what we saw at the end of the month, 70% of the widgets they asked for, they would actually order. If you look at this month we just ended at, we were closer to the 90%, 91% level. So it's really helped us unwind some of those costs. And to put figures to it, and we've been transparent on this, we had $100 million of costs last year in this category. We've unwound about $50 million of that this year already -- or we expect to unwind, I should say, $50 million of that this year. So we're seeing already this progression of, in our Americas business, really of this stability playing into our schedule. So it's been very helpful as our customers have gotten more disciplined.

Yes, that's encouraging. And then I guess on the production volume, what's your outlook by region? What do you view as the biggest risk factors or opportunities for the sector over the rest of the calendar year, maybe?

Yes. I think on the production volume, you've got to kind of view it as 4 regions. That's how we look at it. I think in the Americas, I mean, generally, we're in line with IHS or S&P. I think we really follow it from that standpoint. We don't see anything outside or anything different than what S&P sees in the Americas region. I think it's generally trending in line with that. We've got, obviously, as everyone does, some amount of hesitation or caution around what will happen in the back half of the year with the UAW negotiations in Europe. Coming from what was really a very bleak outlook, what S&P would have called for, I think the region as a whole has kind of outperformed what S&P would have had and it somewhat continues to do so. We'll see how that trends in the back half of the year. From a China standpoint, the latest S&P now shows China flat year-over-year. So we mirror S&P from that standpoint. I think the big question is, now with the recently announced incentive plan from the Chinese government going into the local provinces, what does that mean in calendar year Q4? For us, that will flow into our fiscal year Q1 of next year. And how does that then play itself out with the new ICE emissions regulations? And that, I think, is yet to be seen. S&P doesn't really forecast any impact from that. And so we'll -- I'd say we're watching and observing what will that mean, what will the manufacturers do with inventories. We don't anticipate any big shift, but we're obviously watching that and seeing what it does to dealer stocks and as much data as we can get. And then as I already touched on, Asia, in particular, is where we see really, surprisingly so, interruptions coming from chip supply still flowing into that region. And so there's been some disruption even as recently as this month in our production schedules. But customers are saying they're going to make that up. And what would be our Q4? It's not massive disruption, but there is still some disruption there, but generally strong demand, in line with S&P, but still some minor disruption from that standpoint.

And then maybe finally, just around the environment, what kind of visibility do you have into the commodity and other input costs, progression over the balance of the year? I have some of these customer recovery conversations in progress.

Yes. I think on the input cost side, and then I'll touch on the customer recovery side, I talked a little bit about it. On the input cost side, there's been puts and takes. I think on the ocean freight side, it will come down markedly, and we're starting to see the benefit of that now. Over the road freight, it has come down also markedly, especially in the Americas region. Europe, it's remained, I'd say, stubbornly high. We're starting this [ now in product ] diesel surcharge as well. I think on the negative side -- or another positive, obviously, European energy has come down from the 2023 highs. It's still above the 2021 levels. I'd say those are all what I would call positives. I think on some of the headwinds that the industry is facing, if you look at Mexican labor, I mean Mexican labor is certainly a challenge. And it's going to be a challenge for anyone with a significant Mexican labor footprint. We're the only one who operates cut and sew operations, harness operations in that region. And there's always been a natural arbitrage in that region against the peso devaluation. Now with all of the FDI going into Mexico, you actually see the opposite. So you see the peso significantly strengthening coming from what would have been a 21:1 level. Now it's, I think today, it's all the way almost at 17:1. And so you don't have this natural arbitrage that would have occurred in that region. So I think that's an area that we're watching pretty closely. In Europe, you've had this, I'd say, this level of labor inflation as well that we're actively managing now with our customers. And then I'll get to the customer recovery. And then outside of that, China is managing -- we're managing that with our customers, no significant labor or input cost issues, and I'd say similar in Asia. Then if you get to the customer recovery front, and we've talked about this in the past, this is a business model for us that because we're a seating pure play, we need to be aggressive, and we need to be quick in terms of our management of our input cost and how we manage that margin profile with our customers because we don't have other businesses that are out there that kind of, I'd say, masks the margin from that standpoint. And so when we see these moves in the market, we're very quick to address them with our customers. And so we've been in with our customers now addressing the European energy, addressing the European labor, on the Mexican labor piece. And certainly, we were in there on ocean freight and things like that. And we've shown in the past, it takes us 12, 16 months to work through these types of issues. And certainly, in Europe, we're in the process of closing out some of these topics now with our customers. I think we'll get through some of them in this quarter. Some will close out in Q4, but some will linger into our fiscal year '24. And same thing in the Americas, I think we've got a -- some will close out this quarter, some will linger into our fiscal Q4 and maybe into fiscal year '24. But in general, as we've demonstrated, somewhere in that 12- to 16-month window, we're able to work through these inflationary pressures. And that assumes that we don't have new ones that kind of then pop their head into the network and we're able to get some stabilization on to the input cost is generally how we view those types of inflationary pressures working their way through the system.

Okay. Great. So maybe focusing a little bit more on the -- on your margin drivers and some of the outlook for that. You have outlined expectations for about $200 million in sticky inflation for this year to be offset by about $100 million in the recoveries. Is this the right way to think about it? You've obviously commented on how the recoveries are going. But I guess, numerically, are we still talking about this kind of magnitude? And then for 2024, what would be the implication?

Yes, I think that's what we've said kind of historically is that's how to frame it up, $200 million offset with $100 million. I still think that's how you should frame it up. We're not here, obviously, to discuss kind of a 2024 guide. It's too early for that. What I would say for 2024 is there's going to be puts and takes when we get to 2024. And it's too early to say what will ocean freight be because that $200 million assumed some level of ocean freight. It assumes some level of energy. It assumes some level of labor. And it's too early to say how much of that hangs over. And it's also too early to say of that $100 million, how much of that parlays itself into ongoing recoveries versus lump sums. And then as we build our sustainability model, what does that look like in terms of VA/VE offsets and other things? What I would say is as we think about our business model for Adient, there's a couple of key things. One is this business should really have an incremental margin of 16%. That's somewhere between 15% and 17%, so just call it 16% is what the incremental margins on this business should be. So for every dollar of revenue, 16% should flow to the bottom line. Anything outside of that is really business performance, good or bad. And so as we think about moving into 2024 and we see the volume, we should be flowing that at 16%. Anything outside of that is business performance, and that's really our goal. And the other part is we expanded margins this year by 100 basis points. Our objective next year, really as a management team, I mean we'd be disappointed, I think, if we didn't see kind of another 100 basis points of margin expansion. We've been kind of public about that. That's what we've been saying for the last 3 or 4 of these investor conferences. And that's what we want to -- the management team continue to see kind of that natural margin progression. And so how much of that sticky cost sticks around? How much of that inflation sticks around? I don't know. But I know what our incremental should box at, and I know how we want to see this margin progression occur. Whether that comes through as margin recovery, sticky cost recovery, incremental volume or business performance, I don't know how it will box yet. I just know how our margin progression should occur as a management team and as a business, and that's really our objective.

And just to be clear, so you want your 16% incremental in volume and then an additional -- targeting an additional 100 basis points of performance?

No. I mean I think for us, it's the 16% on margin and then whatever we don't get towards that 100 basis points, that to me then has to come from business performance. Whether it's through customer recoveries, VA/VE or that mix of sustainability, that's really what we, as a management team, then ultimately have to solve for. I mean that's our objective.

Understood. Okay. So I guess a lot of -- a couple of my next questions were actually going to be around some of these opportunities for cost performance. So maybe just give us some confidence around it. And in 2023, I think your guidance includes $125 million benefit from cost performance. What are the main drivers of this? What are you accomplishing this year to reap this benefit? And is that still sort of like the right framework?

Yes. I think the $125 million, $135 million of what I would call business performance is that really comes from, I'd say, a multitude of buckets. And it's CI in our plant, so it's kind of ongoing, just operational improvement in our plants over and above kind of normal labor inflation that we see. It's that VA/VE bucket that I talked about where we're outstripping just normal, what I'd call, engineering activity, but really driving in value and value-added activity to our products. It comes from commercial negotiations above and beyond what we would normally have to give back to our customers. We're -- we've got positive sustainability in that negotiation equation with our customers. And it's really that business performance that I talked about that allows us to expand that margin. And that's where -- when we get to this kind of what I would call sticky cost topic that you brought up, the $200 million, the $100 million and then you say we've got $100 million of trapped sticky costs, but in the end, we're still expanding that margin by 100 basis points year-on-year. So there is that business performance in there of $135 million. And that to me is when I step back and look at the business, that's what's really critical at the end of the day. And that's where I know the team underlying is outpacing the headwinds that we see coming in.

So longer term, you've set a goal to improve your margins towards 8.5% EBITDA, up from 5-plus percent guided basically for this year. What else needs to take place for this to happen? And I guess, what part of it is in your control?

Yes. So I mean we've kind of given this bridge. And I -- for those who haven't, I'd say, seen the bridge, last week out in China, we actually, I think, published it, put it down in hard paper for the first time versus me just standing here kind of waving my hands. It's actually now kind of written down from that standpoint. And we've really broken it into 3 buckets. The first bucket that's not necessarily in our control is really around volume. And so we've said kind of 100 basis points comes from volume, just getting back to 90 million units of light vehicle production. Now what I would say that's in there that's really important is there is a component of positive mix because our China operation or our Asia Pacific operation is really favorable for us if you look at the way that region prints. And so depending on where that volume comes from, that comes back sooner for us. If we get more volume in Asia sooner, if more of that 90 million comes from Asia, obviously, we get that 100 basis points quicker. But it's 100 basis points of it. You then have 100 basis points that comes from really as we see some of these macros returning back to kind of what I'd call pre-COVID levels. So as you see ocean freight come down, as you see some of the steel input costs come down, over-the-road come down, that's a portion of it. And whatever doesn't come down, so things like European energy or Mexican labor or European labor, those obviously don't return, and so we then have to go and negotiate those recoveries with our customer. And so it's either in that second bullet -- bucket, sorry, in that second bucket, it's either as macros come down or if they don't come down, our ability to negotiate is that second 100 basis points of recovery or margin capture. And then the third bucket is really around what I'd call roll-on, roll-off, which is we've been transparent around there's still contracts in our network, really a lot in our metals network still that are decremental to us. We've talked about the IBK2 platform. We've talked about some of these contracts that we have in our North America metals business, a few in our European metals business that really start to roll off back half of '24 and a lot in the '25 time frame. And then as those roll off, along with some amount of business performance we still have to get, that's really that last 100 basis points that then gets us to that 8.5% margin target. And that bridges this gap for us to get us to that long-term margin objective in the business.

And since, in an earlier question, you were saying maybe 100 basis points, so it's what you would be targeting sort of like in any given year, is it fair to say that the time line for this margin normalization is about 3 years?

Yes. I mean we haven't put a time line out there. I think the biggest -- if you look at IHS, I mean they've got 90 million light vehicle build. I think the latest one was '26, I think, was the number I saw. So you'd say, okay, that's about in that time frame. I just commented on kind of that roll-on, roll-off is in the '25 -- really end of '25 is when all that comes out, so '25, '26. And then I commented earlier on, it takes us kind of 12 to 16 months to work through the macro. So I mean you build kind of that 2- to 3-year time line and somewhere in that range, I think, is a fair statement.

Now let me ask you the -- you mentioned the company is evaluating restructuring options, in particular, in Europe. Is there an opportunity and/or need to accelerate these with the potential view that in the end, we don't really know when the industry goes back to 90 million units? And I think this would have been sort of like a theoretical question that we had. But then more recently, sort of had like Autoliv announcing like 11% of their global workforce headcount reduction. Is this something that would be applicable for you?

Yes. I think the way we view our European operation, and we talked about it on our last earnings call, is really I think we're at a point in our European operation where I think we're sized today at a level where we feel is appropriate for today's light vehicle build at a level of restructuring that we're at today. So we spent this year, I think we've guided to about $70 million in restructuring. We think that's a normal sustainable level of restructuring for our business at today's level of European vehicle build. And so that is to say we don't see us going towards a $200 million restructuring level. We don't see that need with today's level of the European vehicle build. And instead, what we have the ability to do is if we see a JIT plant closing, we can avoid some of that restructuring via our long-distance JIT models and via repurposing some of our plants. And what we were able to articulate or what we tried to articulate in our earnings call with our Bor example, we made a conscious decision to walk away from some BMW business. We're very transparent about that. And via long-distance JIT, we were actually able to repurpose that plant, put other business into it, ship completed seats over a distance of 500 kilometers at a very competitive level and avoid what would have been a EUR 30-plus million restructuring bill. And I think that's really what we look to do in our European footprint is that type of activity and still maintain somewhere in that global $70 million, $80 million restructuring amount. And so we don't see this need to really balloon our restructuring dollars up beyond that kind of sustainable run rate we're at today, at today's level of the European build. And that's really what we were trying to articulate on that call. So I don't think we see that need today. Now if there's a massive change in European production, then obviously we'll have to reevaluate it. But I think where we're at today, I think we're at a comfortable level of restructuring dollars globally.

And of utilization.

And of utilization, yes. I mean those 2, I think, go hand in hand. I mean we're not -- we don't want to drive our MUs down and that they're with half-utilized plants either. And I think there's -- so a really good example, not to go into too much of the weeds, but because we have this global footprint, we've got the ability to shift assets around. And so within the U.S. right now, there's this dynamic where the U.S. stampers are really taking advantage of capacity tightening on heavy tonnage presses. And so we have presses in our Polish plant that are vastly underutilized. And so actually, we took a 1,600-ton Fagor press out of Poland, shipped it down to our Ramos, Mexico plant and are setting it up down there and pulling business out of the pressers in Mexico because, I mean, they're just like raking us over the coals on pricing. And because we have this global footprint of common Fagors, like we're just able to do that kind of stuff. So yes, that's the kind of stuff we're interested in doing, not in like closing and sitting there with half-utilized presses in Poland and paying higher prices in Mexico. I mean we'll move capacity around.

Maybe shifting gears to some of the growth outlook, some of your product launches. So this year's guidance contemplates fairly large growth above market. Can you remind us what is driving this? And how should we think about this going forward? Is 1 to 2 points the right framework going forward for growth above market? Or is there incremental upside there?

Yes, I think -- well, first of all, so you said you have the Blazer EV downstairs?

Yes. Maybe...

Yes. And maybe if you get a chance, so that's a conquest win for Adient. So go and look at the seats, hopefully, they're really nice seats. Maybe I'll actually go and look at it first just to make sure. But yes, now that I said that, hopefully, they're good-looking...

I'm sure they've put the nicest version here. Yes.

Yes, I'm optimistic. So that's -- I still think when you think about us, you should think about 1 to 2 points of growth. I mean that's generally how we think about the business as a whole. It's -- we've always said, I mean, we value profitable business over growth. I mean it's really how we think about this business as a whole. I mean that's how we think about it. That's how we run it as a management team. It's -- this is a business that is cash. I mean that's how we think about this business. It's a business that we want to run for cash. We're a very disciplined management team from that standpoint, and we drive it through the entire company. And so it's not growth for growth, it's growth for cash from that standpoint. And so, yes, you should think about it from a 1% to 2% type of level, CAGR type of position. This year in China, we've done really well in the first 2 quarters. We've expected that because of some of our new product launches and our new product launches coming on board. But I mean we're going to be very, very disciplined from a capital allocation standpoint. We're not going to put up greenfield sites if we don't have to. And the Chevy Blazer is actually a really good example of that. So we're launching that product out of a brownfield site in our Derramadero facility. We're going to ship those seats via long-distance JIT, leveraging existing capacity, existing capital to support General Motors with kind of minimal investment in order to minimize their launch risk, minimize our launch risk and then get the best utilization of capital for both of us. And that's -- it's a win for them, it's a win for us, and it's just how you like make good use of capital in this industry. And that's really how we think about it. And if that means 1% to 2% growth, I think that's a good outcome.

So I guess another way to think about it is what -- how is your market share trending in aspiration?

Yes. I mean our market share continues to, I mean, be -- well, first, there's a lot of different ways to think about market share. I mean you can calculate market share a lot of different ways. I mean the way we think about market share is how many of our business wins have content beyond just JIT in them. So when we win something, does it have JIT, does it have trim, does it have foam. Because if I win the JIT, I get the top line revenue number, but am I getting the content that's below it as well? So do I have the JIT, do I have the trim, do I have the foam as well? Because that's where I get some of that vertical integration that's in my sweet spot where I've got existing assets today that I can really make good utilization of my entire network where I'm not having to reinvest within there. And so for me, that's what really matters. And if you look at my conquest -- or not my conquest, my incumbent win rate, I'm still well in excess of 98%, 99% on my incumbent win rate. So my market share around the globe is holding extremely, extremely high. Again, you can calculate it in a lot of different ways. You'll hear from [ Jason ] and [ Ray ] later, they'll calculate it one way. They're really smart guys. So I wouldn't discount the way they calculate it. You may calculate it in different ways.

Yes. Are you satisfied with your current level of vertical integration in the seats? Or are you looking to do more or less?

I think when we look at our portfolio that we have today, I mean we're very satisfied with our level of vertical integration. We have everything in our portfolio today that we need to bid and win. There's nothing that we have today that we see as a white spot. We have access to all of the latest technology via our partners through people like Leggett & Platt and Gentherm, [ New Development ], [ Conduct ], Ficosa. Especially in a market like comfort systems where it's changing so fast and you don't want to be locked in necessarily to one partner or one individual, you can go and you can really shop from anyone out there from -- that has all the different arrays of technology and you don't have to be isolated into one option, yes, I think it's really proven to be successful for us.

And maybe finally, what are your priorities for capital allocation in the current environment between the CapEx, M&A, buyback, debt repayment? How would you prioritize that?

Yes, I think it -- I mean I think it varies. I mean we've said our leverage ratio, we want to be somewhere in that 1.75% to 2%. By the end of this year, we'll be within that target ratio. And then we still have our, call it, our TLB that is going to be trading based on the current rates at a fairly attractive level. And so between that and the share buybacks, we'll continue to execute somewhere opportunistically between the 2 of them is what we'll look at. We have the authorization. We've executed against that. I think we'll continue to look to opportunistically execute that against that and weigh it between that and where the Term Loan B is at.

Perfect. I think we have 1 minute left. So any final questions? Absolutely. Please pass the mic.

Curious, you mentioned that Asia is a richer mix for you. Wondering if you could dive into that a little bit more, just curious why. Is it the wafer side? Is it...

No, it's -- I mean it really comes down to this vertical integration piece of it. If you look at -- a very high percentage of our programs in Asia have JIT, trim and foam and some of our more profitable metals businesses in Asia, where we've got that entire full suite. So the majority of our programs in Asia have all of that vertical integration compared with our programs elsewhere in the world. And so that really is why we just have a richer mix in Asia as a result of it.

Yes, on the front?

Just around this concept of production normalizing, and I think a common view is that should be maybe a mixed headwind for some of the seating players. Just how do you think about that? And is that contemplated in your long-term framework?

Yes. Well, I mean I think some of the seating players is the guys who will talk to you at 9:35 today. And that really comes down to the -- I mean we don't have T1XX down in Arlington, they do. So I mean they've been really public about that, so I'm not telling you anything that they don't. And so we don't have that tailwind. So for us, we don't have one program that as production normalizes, that's run all through COVID at a very high volume. So they won't get that uplift. I don't have that tailwind, but I didn't have -- or headwind, but I didn't have that massive tailwind through COVID like they did. I offered at the Bank of America Conference, if Jason wanted to call me, and he didn't call me, so I didn't pick up T1XX in the meantime. So such is life. But yes, I don't have that tailwind like -- or headwind this time like they did, so yes.

Awesome. It looks like we're quite right fresh out of time. So Jerome, thank you so much.

Yes, thank you.

Thank you, everyone.