Adient plc (ADNT) Earnings Call Transcript & Summary

Okay, I think we can get going with the next presentation. Once again, I'm Ryan Brinkman, the U.S. automotive equity research analyst at JPMorgan. Thanks for joining us for our next presentation, which is seating supplier and only seating supplier Adient. We are happy to have with us here Doug Del Grosso, President and Chief Executive Officer; as well as Jerome Dorlack, Chief Financial Officer; and on the end, Mark Oswald, Vice President, Corporate Treasurer. I'm going to turn it over to Doug to make some remarks on the podium. And we'll engage in a chat. Thanks so much. Thanks.

Great. Good morning and thank you for participating in the session today. We have just a few slides kind of to set the stage. Some of the themes, I think we'll be discussing as we go through the Q&A. So on the heels of our third quarter earnings call, just a quick summary, a pretty strong quarter for us, stronger than expected. That's primarily a result of volume that was higher than expected. And I would say, overall performance within the company better than we had expected. We returned $65 million to the shareholders, strong cash liquidity position. And we anticipate a positive trend as we move through the balance of the year. We hit on a couple themes, I'm sure we'll be talking about it, that are relevant to seating systems in the automotive space. There's kind of 5 themes that have emerged that are really shaping the way the industry is transforming as we move forward. I think everyone has talked about what happened in the Shanghai Auto Show, the emergence of the domestic Chinese EV players and how they're changing the interior of the vehicle. This is just kind of a summary slide of what we see developing in content per vehicle, that's dramatically different than what we've seen in the past. We're seeing a lot of safety, comfort, integration into seating systems, if we just simplify it, particularly as automakers are moving to level 3 autonomy as the seat is being reconfigured in different locations in the vehicle as resolved, they're focused on comfort, but they're also focused on safety, as it's not in the traditional forward facing. We see a lot of technology being integrated into seating, which we think is very positive for the company as we move forward. Our approach is maybe different than some of our competitors. We think, from a vertical integration standpoint, we're well positioned. Historically we've been vertically integrated on the hardware side, trim, foam, in addition to just-in-time delivery of our product, but as these new technologies and new demands of our customers and the consumer evolve, we're also looking towards partnerships to develop next-generation technology. So as I mentioned, we're looking for strategic partners in safety, in ADAS, connectivity, thermal comfort and lumbar and massage comfort systems. We've been executing the strategy for a while. This isn't something we just created most recently. We've been working on this for the last few years. We have products in the market right now. Probably the best example is our zero gravity seat we jointly developed with Autoliv. That's in the market as we speak. One of the emerging developments we have is with Gentherm for comfort systems. It's utilizing some new technology in Ultrathins. This is a combination of urethane foam and suspension systems with Gentherm's next-generation ClimateSense, which is thermal and lumbar and massage systems. And we're working together with them to jointly develop that, integrate that in a very cost-effective way for seating systems. This is a preferred approach for us in this particular example. And we'll talk in the Q&A if questions come up about vertical integration. It's a bit of a slippery slope. Too much vertical integration, drives a lot of capital on engineering and investment, which we don't think is necessarily healthy for our business. So the pillars of our strategy going forward. We're very focused on automotive seating. That's what we do. It's a homogeneous product that we think about in our portfolio. Driving operational excellence has been a hallmark of our back-to-basics approach to business. We think these two elements are leading us to diversify our customer base and continue to be a leader in seating systems. And we won't spend much time today talking about it, but we have in the past, about the direction we're taking the company from a sustainability standpoint. And with that, that concludes the formal presentation, so we'll open it up for Q&A.

We're asking all suppliers at the conference a few questions and one of which is on demand. After demand has tracked quite a bit stronger than it was expected, so far, this year, particularly in the United States, how would you rate currently the strength of the different economies and end markets that are most important for your company? And what is your outlook going forward?

I'll start out and Jerome and Mark can add into it. I think, generally speaking, the market is much improved, but that's from a pretty low base. It's probably the best answer just quickly going around the map. If we start in the U.S., we think that's probably our most stable market right now. Stability to us is not just gross volume. Certainly that's good, but what we experienced during supply chain disruption as a just-in-time manufacturer was a lot of start and stop. That was very disruptive to our work pattern in our plants and very costly, if you -- but supply chains are more normalized. Demand is relatively high, and that translates into a relatively good environment. Right now, assuming there's no external disruption to that, we anticipate that market continuing to be relatively stable for us. I would say similar in Europe, a bit of a surprise. We entered our fiscal year and it's going to be roughly disrupted because of the war in the Ukraine. It was, but as things tended to, again, normalize, energy prices came down, still a highly inflationary market. Demand did start to modestly increase and production schedules became normal, so again I think, with the exception of external disruption to the market, we anticipate Europe being relatively stable in the near term. A big portion of our business is in China. That's probably the most, I'll say, disrupted market right now. I don't think I really need to go into the economic environment in China, but it's relatively -- I would say the automotive market is bit more stable than the rest of the Chinese market, and that is largely influenced by the number of vehicles that are being exported out into Europe, so I think it's going to be interesting to see that trade-off between exports in China, the recovery of the domestic market and its impact on Europe, but longer term, we're relatively confident in the China market being a strong growth market for the company.

Interesting. And second question is really more around supply. Where would you say that we stand here in the middle of '23 in terms of the semiconductor chip shortage, port delays and the various other supply chain bottlenecks that impacted the level and stability of customer production in recent years? And what is your outlook going forward?

Yes. So I can take that one. I mean, in terms of supply, it's -- I mean it's greatly improved versus where it was sitting here last year. I mean, if you go through kind of port delays, they're I mean generally nonexistent at this point. If you look at what we would call kind of freight [indiscernible] around the world on some of the ocean freight containers and things like that, they've generally reverted to where they were kind of pre-COVID levels. So those are all positive indicators. And those are generally all the freight lanes that we see whether they're transatlantic or transpacific. On the semiconductor side, there is still some prioritization that takes place with some customers. So there's some rationing where they're directing some of the higher-end chips, some of the higher-end memory chips still towards higher-content vehicles. We see that with a few customers in particular, but generally that condition, I would say, has greatly improved as well, nowhere near what it was in the peak, so I -- probably in the 90-plus-percent range of attainment. I think the biggest kind of bottleneck -- if we do enter into a what I'd call fully unconstrained, if we wanted to run -- if I take the U.S. as an example. If we really wanted to run that, a healthy environment of a 17 million build, what would be the constraint? It'd probably get back to labor again. We talked a lot about that a year ago being -- that being kind of the [ topping ] constraint. I still think that would be the constraint here, but at the moment, I don't think that's really popping up because we're teetering between kind of demand versus supply in the U.S. at the moment. You look at the vehicle park kind of going up. We're somewhere in a healthy level, I think, so generally in a good condition, I'd say.

That sounds much improved versus the answer last year, though -- or the year before, sorry. Next, I wanted to ask on sort of the backdrop for operating margin for suppliers generally. EBITDA margin for the suppliers we cover averaged 11% last year. Maybe it'll hit 12% this year, but prepandemic, it was more like 13%, 14%, so considering all of the different macro and industry factors that roll up into the backdrop for supplier margins [indiscernible] mentioned [indiscernible] but also timing of commodity and non-commodity inflation related recoveries, needed spending on R&D, et cetera to support industry change, where do you think we are on the path to the normalization of the general backdrop for supplier margin? Or given structurally higher input costs and related recoveries, are we maybe looking at a new normal of supplier margin where maybe performance metrics like return on invested capital, et cetera might be more useful to gauge performance?

Yes. I mean I think supplier -- I mean I can't speak for the broader supplier margin. I think, if you look at Adient's road map for supplier margin, I think, we've been very kind of transparent in terms of where we see our trajectory heading towards. And this year, we started off at kind of, call it, a 5.2% EBITDA guide. We've recently taken that up to -- in the 5.3 range, somewhere in there. We've always said we think we can get that and we have confidence we can get that kind of in the 8% to 8.5% range, so for us there's still room to expand our margins, really driven by a couple of factors. One is industry volume is still well below kind of that normalized 90 million light vehicle build level. And as that water rises across the industry, I mean not only for us, that should be something that benefits all suppliers. So as you think about industry margins, that should be something that I would think would benefit all suppliers across the industry. So for us, and again I think this would benefit the broader supply base, there is still costs that need to be worked through the system. There's still energy in Europe. While it's retreated, it's still nowhere near what would have been, call it, kind of the 2021 levels. And we've worked through a lot of some of the contractual topics for the pricing topics, but there's still some work to be done there. There's still kind of timing associated with some of the metal prices and the stability that's in there. And so just I'd say some hangover from what are some of the COVID-level dynamics that are in there. And then -- and again I think those are things that all suppliers are still dealing with. And then in particular to Adient, on our road map, there are some of these kind of what I would call metal contracts that we've talked about before that really roll off in the '25, '26 time frame. That's the last piece to kind of bridge our margin gap. That gets us to kind of that 8%, 8.5% range. And so that's not necessarily industry specific but more what I would call on our road map.

Very helpful. I noted that you recently reported much stronger-than-expected fiscal third quarter earnings. And while those earnings were helped by an insurance settlement, even after backing that out, we calculated that your adjusted EBITDA beat consensus by 19% versus the average supplier, which you beat by -- still strong, 11% this quarter. And it comes too despite your sort of disproportionate exposure, right, to China and where production tracked only slightly better than expected in comparison to North America and Europe where it tracked much better. So while you still benefited from the same macro and industry improvements, and other suppliers maybe a little bit less, perhaps in combination with that bigger beat, does that maybe suggest that more of the beat was driven by maybe some of these company-specific self-help factors that are under your control? How much of that beat and raise would you say was driven by the macro versus actions that you specifically are taking and which might carry forward into future periods regardless of which way the industry or macro goes?

Yes. I can start. If you just bifurcate the issues, I would just say volume and stability is a real catalyst for our business. It allows us to drive a lot of productivity in our business that, without it, we can't achieve. We can't drive productivity in our plants if we have instable or unstable volume scenarios, so volume helps. And it's particularly painful, as a just-in-time supplier, and we pointed this out in the past, when we had these disrupted schedules where our customers were running Monday, Tuesday. They ran out of semiconductors on Wednesday, Thursday, restarted Friday and then worked into the weekend and then we had to incur premium costs. So in that environment, self-help is very difficult, other than negotiating with our customers to get some sort of relief on that disruption. When that stabilizes, that creates the opportunity for us to do a lot of things internally separate from commercial discussions with our customers to improve the profitability. That's really, I think, what was reflected in the third quarter. It's that environment was a healthy environment for us and it was reflected in our results.

That's helpful. One element of the full year guide that tracked better was free cash flow, right, improved to $275 million versus the early outlook for $215 million. And the preceding 2 years kind of rounded to 0, right, so a nice improvement there. I wanted to ask if the improvement might have any impact on the pace or cadence of share repurchases given that, when the program was first announced, it seems to be funded more by cash on hand received in conjunction with the China JV reorg but now is supported by ongoing cash flows.

Yes. Great question, Ryan. And when you look at it, you're absolutely right. Clearly, the more earnings we make, obviously that converts into free cash flow. We're going to have the opportunity to return that to shareholders. We've been very -- working very hard over the last couple of years just in terms of stabilizing the calls for cash. So if you recall, a couple of years ago, the focus on capital allocation at that time was really deleveraging the balance sheet. And so we had a target leverage ratio of, call it, 1.5 to 2x. We took actions to make sure that we prepaid the debt. We paid that down. As we did a China transformation, we took some cash off the balance sheet for that. Now that we're within that range and if you look at the guide, if you look at the trailing 12 months, we're at 1.75x. Yes, I do think that, as I look into the future, we're going to continue to grow our earnings. That's going to convert into free cash flow, with the calls for cash stabilized, right? We've got $535 million left on our repurchase program. It's going to have an impact on the pace. That said, we always indicated, when we initiated the program, we're going to take a measured approach. And we're going to look at both what happens within Adient's 4 walls in terms of how we're running the business, where we see the business progressing as well as what's happening from a macro perspective. And if you think about the immediate near term, there's a lot of uncertainty now with production stoppages that could result from UAW strikes, right? So we'll take that into consideration, obviously, in the near term, but once we get past that, yes, I think, with the earnings trajectory that we're on, with the calls for cash stabilized, definitely there's an opportunity to increase the pace.

Maybe just to follow up on one of those comments there about the UAW and maybe holding back some of the -- some dry powder, et cetera. What are your thoughts, headed into the negotiations this year? It does seem -- or I've seen some headlines last couple of days sort of pretty interesting besides seeing kind of far apart. And it does seem to suggest maybe a little bit of increased risk for the supply sector. Or what do you think?

Yes. Well, it's a bit hard to anticipate how serious the UAW is with some of the demands that they've initially outlined. It obviously would have a huge impact to the cost structure of our customers if they were to somehow try to meet those demands. It's not completely clear what the UAW's strategy is. If they pursue a strike, are they going to go and target an OE, which they've traditionally done? Or are they going to take the approach of going after component plants? That would be more disruptive and impact all of the customers, at least the UAW-based customers. I personally don't think a strike is particularly healthy for the economy, so I think the Biden administration probably has some interest in making sure it's not too disruptive. And as they intervene in the rail strike and influence the UPS, they could involve themselves. They've already appointed a point person on the UAW strike, so there's a level of cautious optimism. If there is a strike, it won't be a prolonged strike. For us personally, it's going to be impactful. We commented what we thought from a quantitative standpoint what the impact would look like. We benefit, compared to our competitors, in that we have a rich business with not the traditional Detroit 3. So we have a strong Toyota business, a Honda business, a Nissan business, so it's less impactful on us but certainly not good from a macro perspective, so we hope it's relatively short-lived if there is a strike.

And to follow up on a comment there about striking a component plant. I mean historically my conception of that would be you strike -- I think they struck one time like GM's Mansfield, Ohio stamping plant, something that's wholly owned, a transmission plant that's owned by Ford or Stellantis or GM. Could they strike one of your facilities? Is that even an option?

No. I think it would be a stretch for them to go after one of our facilities because we have separate contracts in our facilities that they would have to really come up with some sort of work rules violation. I don't really see that as a reasonable outcome. And if they did, it would only target one assembly plant typically, so I'm thinking more it's their components, their engine plants, for example, which would, to your example going back in time a bit to the GM strike, that cascaded across a broader production platform.

Very helpful. And maybe to follow up on some of the cash flow comments too. And Mark had mentioned CapEx being a focus. Say you do get to the 8% to 8.5% EBITDA margin. What does cash flow look like in that environment? Jerome has used the words cash flow machine a few times, which it certainly pricks up investor ears. Can you elaborate on that? And what does the walk between EBITDA and free cash flow look like?

Yes. So again if I look at what the calls for cash are, right? So you mentioned CapEx. And we've been very transparent indicating that we think the current $300 million, $320 million is appropriate for us, right, especially if we look at where production is heading, the launch is, right? If I look at our interest expense, right, the cash piece of that, it's pretty stable right now. If I look at restructuring, we've done a lot of heavy lifting, so call it $60 million, $75 million in terms of a run rate there going forward. And our cash taxes, the cash team has -- tax team has put a lot of work around the plumbing of that, so even as earnings improve, our cash tax is, I should say, stable in that, call it, $95 million to $110 million range. So really then the equation becomes EBITDA, right? And as long as EBITDA continues to improve, the pull-through on that should convert into cash which we could then return to shareholders.

We were chatting before the session about how I had a chance to meet with your management team in China during the quarter. And one thing that struck me was just how levered you still are to China even after the monetization of the JV stakes. In fact, you're the most levered to China, 24% of your combined consolidated and nonconsolidated revenue, versus all the other suppliers we cover. I think the average might be like 14% or 15%, so quite a bit. Can you speak to the importance of China to Adient? What trends are you seeing in the market there currently and going forward? And how is Adient positioned or positioning itself in light of those trends, maybe, for example, along the lines of the rise of the domestic Chinese manufacturers or electrification, et cetera?

Sure. There's a lot to pack into that answer, but from our perspective, we think China is still a growth market for us. We think the Chinese government is committed to automotive production and the development of the automotive industry. Now it's focused on electrification, so that provides at a macro level a good environment for us to operate. We see the customers that we have in China being very interested in working with us because we have probably the broadest capability in the market from manufacturing, engineering, development. We provide a global technology portfolio for our customers to think about as they think about their next-generation products, so there's just tremendous capability that we have. And that's why our business has historically performed well in China, continues even in tough market. And when we look out into the future, we see it as a platform that we can align with the way that market is developing and expanding into EV product lines, looking at the domestic Chinese as our major customers. We've done a lot to rebalance our portfolio from a customer standpoint to be focused on them. They're exciting to work with. They are unconventional in the way they do product development. They move very quickly. We've got a dedicated team there that's been adopting -- or adapting to their style of business. So far, it's been extremely successful for us. And really what's happening, from a seating technology standpoint, what's being developed in China is really what we see really reverting back into our traditional markets, so being a leader there is particularly important not just to grow with the market but also to be on the forefront of developing that technology that we can back leverage into our traditional market. Certainly we're always aware of geopolitical influences on the business. We don't really see, being an automotive seating producer, as us being a target by governments from any kind of restriction standpoint, as compared to people who are in perhaps more advanced electronic development. So from a risk standpoint, we see risk, but we also see it being somewhat moderate. Our business in China is for China. We're not exporting into other regions, so we don't have that exposure. Even in our supply base, we've done a lot over the last couple of years to decouple and reshore that business into the appropriate markets that are near our home base, Mexico, for example, for the U.S. So we're not naive. We're cautious, but we're confident in our business in China.

That's helpful. I wanted to ask on what the right degree of vertical integration is for Adient. We've seen some competitors make more of a play to get into the seat heating, ventilation, lumbar, massage elements or even textile or leather operations. I think you've suggested that maybe you could be every bit as competitive by partnering with others. For example, you mentioned Gentherm I heard in your opening remarks there. Although, in other areas, you've also spoken about your margin being higher when you're providing more system solutions versus components and when you have more control over sourcing, et cetera. You do talk about the merits of vertically integrating foam, trim and metal components, so why those parts of the seat and potentially not others? And what's the right way do you think for Adient and for investors in Adient and other seating suppliers to think about vertical integration?

Sure. I'll start out, and I'm sure Jerome and Mark can add to it, all right? If I just take a step back and I think about the seating business as it originally evolved. It was always a relatively low-margin business with relatively low capital, relatively low engineering, the ability to control the supply chain, manage working capital. And what resulted was the business generated a lot of cash. That's again at a very high level how we think about how the business should operate. As we've made vertical integration plays in attempt to improve profitability or grab market share, in our particular case, it hasn't really played out that way. Our customers tend to balance markets where, B2B business, they tend to look for a wide range of technologies, so it -- there's pitfalls associated being with too vertically integrated. Some of that, we've experienced in our metal and mechanisms business. We haven't experience in our trim business. We haven't experienced in our foam business, but those businesses are fundamentally different than our metal and mechanisms. They don't require a tremendous amount of engineering. We've got a manufacturing footprint that we can utilize. We don't have to spend a tremendous amount of capital in that business. And we like being positioned there because they remain very profitable and they kick off a lot of cash. As we look to some of these emerging trends in the seating business where there's opportunities to vertically integrate, I think our message is we're going to approach that with a bit more caution and learning from our past experience. We may ultimately get there, but we're not going to jump into a strong commitment because that's counter to how we think about the points Mark made, how we're managing capital and how we look really to, first and foremost, generate cash in our business. Clearly margins are an important part of that, but we have to think capturing market share as it's been traditionally thought about. Enhancing margins, if it comes with a lot of investment, is something that we're not particularly interested in doing right now, particularly when we have partners that are out there like Gentherm, like Leggett & Platt, like Autoliv, like Joyson, who are happy to engage with us because the seating business model is a bit unique. It's a large module with a lot of components that have to be integrated together in an efficient way. We want to be experts at the integration piece. And so we can pick and choose how we play in that integration and develop that kind of a stand-alone module that we can deliver to our customer. So we understand what the other folks are doing. We think the approach we have, the amount of vertical integration that we have and, I would just say, our overall technical competency -- we feel pretty good that we can continue to be effective and a leader in this business.

That's helpful -- yes, go ahead.

Maybe just to add to that a little bit because you asked the question trim and foam and why does that work. And a lot of it comes down to what I'd call kind of this territory discussion with the customer and where are they willing to really cede territory and sourcing. And so they're generally willing to cede territory and their sourcing activity where they're happy to bundle the just in time and trim and foam together. They're willing to let those be sourced together, metals not so much. They view metals as a separate sourcing activity, which is why, when we went through kind of our own vertical integration with the acquisition of KEIPER and Hammerstein and CRH and all that, it didn't really play out the way we thought it would. We thought we'd get all these synergies and it didn't work out that way. And it's the same thing with comfort systems. They don't really source comfort systems together. It's its own separate sourcing activity because they want that flexibility. They want access to the latest technology that's on the market, whereas trim and foam, they want that to be bundled with the JIT supplier. And we see a lot of benefits with that, so I think that's why trim and foam are really different than metals and mechs and different than comfort system.

Yes. And maybe just a little bit of clarification to Jerome's point, which is when we talk about that vertical integration, we're primarily talking about trim and foam. We do have examples where we get that in metals, but with those customers, and it's usually to a very specific group of customers that allow that to happen, there's aspects of how they behave that make that an attractive vertical integration, specifically the Japanese automakers. They'll get life out of a metal and mechanism investment that's 8 to 10 years, versus our European customers who want to reinvent every 4 years. So just the return on capital is a much better scenario for us in those situations. Similarly, we're seeing the same thing with some of the Chinese customers that are allowing us to really scale up and bring our metal and mechanisms capability in. And their expectation is that, that foundation stays, where they differentiate and refresh products is what we call the top hat. It's the aesthetic aspect of the vehicle, not necessarily the mechanical aspect.

That's very helpful. As I was flipping through some of your recent slide decks to help myself think of questions to ask, one thing that stood out to me was how often you used the word a focus and describing in your strategy or driving forward with focus, focused on executing your strategy, focused on innovation. You have an extreme focus on containing costs. You're focused on customer profitability. And most of all, you are focused on automotive seating, so maybe talk about -- because you also allude to pursuing a back-to-basics approach sometimes. What was Adient maybe more distracted or unfocused by in the past? Or is there maybe -- in addition, maybe an implication, for example, because you're focused on automotive seating, that -- maybe competitors trying to at the same time compete with Aptiv and the electrical architecture space, for example, might not be as capable of focusing on the seating business and their customers as you are with your strategy?

Yes. Perhaps we need to break out the thesaurus and be a little bit more diversified. I -- back-to-basics was something we instituted 5 years ago, 4 years ago-plus to really turn the company around and get us back to the execution side of our business. And your examples of where we're focused are really the pillars associated with that. It's being excellent at product development, managing our supply chain, executing on launches and nurturing our relationships with our customers. So these are just the major pillars, so when we say we're focused there, we'd just add, if we can manage the short list of things and execute at a very high level, the business will perform. And that's really what we were trying to message. So they're all interconnected, but we could be a bit more creative.

Interesting. Let me check to see if there are any questions here in the room. There is one...

[indiscernible] technology [indiscernible] [ any pricing issues ]...

The short answer is, yes, we believe so. Simply because, if we can master some of that integration, we should be able to price some of that into our product. Because that completely -- these are relatively new developments. We're just seeing it unfold in China. We're now in the phase with most of our customers who are now building that into their next-generation product, but like everything that we do, we believe, if we execute well, we should be able to enhance the margin of our business as a result.

One more question...

One is about stabilizing demand or ensuring demand. The other one is that you wanted to partner with an ADAS provider as well too. Is there some correlation between the two? Or is there some better partnership in the interior of the vehicle that better correlates to seats?

I'm not sure achieving one is at the expense of the other, I guess. So if I understood stabilization versus this content opportunity, to me, stabilizing the market just gives us the ability to run our business on a daily basis more effectively. The technology opportunities and the content we see are just what's emerging. And then how we play into that is what we're really trying to redefine for ourselves right now, so -- and maybe I can follow up with you directly, but I don't see the two being opposed to each other.

Okay. And with that, we are out of time, so please join me in thanking Doug and Jerome and Mark for the great insight they shared today.

Okay. Thanks.