Aptiv PLC (APTV) Earnings Call Transcript & Summary

Hi. Good afternoon. This is Ryan Brinkman, the automotive equity research analyst at JPMorgan. Thanks for joining us at the 2020 JPMorgan Automotive Conference being held virtually this year. Excited to get going with our next discussion, which is with Aptiv. I'll just remind the investors before we start that there is a way to ask a question of the management by typing it on to the conference website. I'll be happy to ask it on your behalf without naming yourself or your affiliation. So with that, let's get started now. We have Kevin Clark, Aptiv's President and Chief Executive Officer; as well as Joe Massaro, Senior Vice President and Chief Financial Officer; and Elena Rosman, Vice President of Investor Relations. Kevin, Joe, Elena, thanks so much for being here. We really appreciate it.

Thanks for having us.

Absolutely.

I thought we'd start with some questions on coronavirus, starting with what impact do you think the virus may have on the type or pace of technological change in the industry. Do you think that coronavirus speeds up, slows down or has no effect on preexisting trends, such as vehicle electrification, autonomous driving, et cetera?

Yes. Ryan, it's Kevin. I'll start. I -- listen, from a secular growth standpoint, we think the underlying trends and where we're situated from a product portfolio continue post-COVID. Areas like active safety, increasing the safety of the vehicle. We continue to see significant demand from our OEM customers for ADAS solutions. We've probably seen an acceleration of Level 2, Level 2+ sort of active safety solutions. ADAS helps OEMs sell cars. It's something that consumers are certainly pulling for. It's a feature that they're able to sell and sell at a higher price and make incremental margin. We tell you, we've -- over the last 6 months, it's definitely seen an acceleration of high-voltage electrification, both battery electric vehicle as well as plug-in hybrid. A couple of things are driving that: one, consumer demand from a -- from the performance of an electric vehicle; two, probably a stronger sense, certainly after going through this, about -- from a consumer standpoint about being more eco-friendly, more "socially responsible;" and then three, the continued pressure OEM customers are getting from governments as it relates to achieving regulatory standards. And then probably the last by-product related to COVID is given the incremental pressure on costs in a lower-volume scenario, OEMs looking at the costs associated with continuing to invest in technology development for the traditional internal combustion engine, along with electrifying the powertrain, maybe a more conscious decision about you need to choose one path or another and, again, given where government regulations are headed, a decision to more fully invest in high-voltage electrification. I'd say the third item where we're seeing increased focus as well, and it might be I think pre-COVID and probably a bit of an acceleration as it relates to COVID, is on the connectivity side, the data side, more focus on how do we accelerate the connectivity of vehicles, how to identify issues in vehicles sooner rather than later so that we can attack increasing warranty costs, so that we can address potential warranty issues before vehicles go into production or if they're in production, how do you capture a problem in a much smaller vehicle population so that you're not repairing a large number of vehicles, you're addressing an issue earlier.So by and large, we feel as though, again, that the secular trends are continuing to be very, very robust.

Okay. Great. And maybe just a little bit of a similar question but about profitability or margin, just thinking about how many parts suppliers actually increased their margin coming out of the global financial crisis after it obviously first dipped. Just in thinking about the current situation with any sort of extra costs associated with the virus that it might be lasting like, I don't know, supply chain compression or something? And on the other hand, though, everybody is sort of learning how to do more with less and just lean out SG&A, et cetera. What do you think the virus means for the ultimate margin trajectory of your company as you -- as we eventually move past the present situation?

Yes. Ryan, it's Joe. I'll take the first pass. Listen, I think there's a couple of aspects to that. One, clearly, dealing with a lot of disruption from the shutdowns, and we've seen some slightly higher decrementals as a result of that in Q1 and Q2, shutdowns are obviously very costly. As it relates to sort of COVID or operating COVID direct costs, we spent about $40 million on PPE in Q2. At this point, that's a good number to use going forward on a quarterly basis. It could be a little higher or lower depending on what happens with production and overall levels of employees, that's mostly consumables. So as you're manufacturing, as you got folks from the plants, we're spending that money. Longer term, and I would say this is sort of post-2021 because we do think there's going to be a fair amount of disruption in 2021 around us, hopefully not the levels of shutdowns we saw, but still operating with COVID in the environment. But post-2021, we see nothing that takes us off our longer-term margin trajectory, right? If you think about what was driving our margin levels, what was driving our margin expansion, the profitability in key product lines like active safety and high voltage, that we see continuing. Active safety in 2019 hit double-digit margins. We're obviously reinvesting some of that in 2020 into the business. The high-voltage product line, although low, relatively low from a revenue perspective, a little less than $400 million this year, already add SPS segment margins. Our ability to focus on material and manufacturing savings, we think all of that's intact long term. We have a little bit of a knee-jerk reaction to -- and I do know other companies are saying this like due to the global pandemic, they found a way to be -- they found all this waste in their business they hadn't realized existed before. We tended to be much more proactive. Over the last couple of years, we took out almost $400 million of overhead costs, right, to help fund engineering, help drive the margin expansion. So we tend to look at how to be more efficient, how to do things for less continuously. It's not something that we've sort of had a great epiphany over as part of COVID. Certainly, we're expecting lower vehicle production in 2021 and relative to where the vehicle production was in 2018, 2019. And we'll do what's necessary to start to adjust the cost structure as we form -- firm up schedules and such with customers. The muscles within the company to do that are pretty robust, and we're good at getting after the cost. But I think the important takeaway certainly on COVID-related costs the next -- certainly into 2021. But long-term margin trajectory, we think we'll obviously start from a place that's lower once COVID clears. But the fundamentals that were driving that in the business remain intact.

Okay. Great. That's fair. I know you guys have tended to run a tight ship even in the good times. We've also been asking supplier managements at the conference if coronavirus causes them to think any differently about capital allocation. For example, how much capital cushion is appropriate, what the right leverage ratio is, what the right amount or timing of return of capital to shareholders is? And I ask in part, given that most of the other suppliers, including those more levered than Aptiv, they tended to raise debt capital during the crisis rather than equity capital. Maybe they would have liked to have raised equity capital, but their share prices were more depressed than yours was at the time. I'm just -- I'm curious what your latest thoughts are on capital allocation.

Yes. Certainly, we have a very firm view that we did not want to put more leverage in the business. Our view is we come out of this, and we're actually already seeing it now with some M&A opportunities coming back to life. But we wanted to make sure beginning in 2020, even if we were operating with COVID in the environment, we were able to go on the offensive and go on sort of continuing to execute our strategy. And our view was higher levels of leverage would hinder that for a period of time and particularly in a low production environment. And I think there's great opportunities from an M&A perspective to continue with both sort of the auto and nonauto bolt-ons for SPS and to the extent we can identify them, smart technology investments. So that's why we did the equity raise. We've got that cash. We got a great cash business on the balance sheet. Great liquidity perspective.Clearly, we will -- we're going to execute on that M&A. I think as you clear 2021 and look at how the world is, again, just sort of the theme of our longer-term view of things have not changed. We've done a great job through 2020 of returning capital to shareholders if we don't have a use for it investing in the business. And I think over time, we go back to that. When exactly? A little hard to call at the moment. We typically ran the business pre-COVID with somewhere between $350 million and $500 million of cash on the balance sheet. Certainly, in an uncertain time, I would think, just as CFO, I'd probably run with a little bit more on the balance sheet, but not significantly more. It's -- that cash is available to us to do M&A, and we'll be back to cash flow generation here in Q3. Obviously, Q2 was a tough quarter. But again, I think 2021, you're still going to see disruption. But again, thematically, for Aptiv, I think the big takeaway is the long-term strategy is intact, the long-term financial framework's intact. And it will be a period of time until we sort of fully get back to it, but that's our intention.

Yes. Hey, Ryan, if I can. I think one thing I just would add to Joe's comment. And I'm not sure exactly your view, but our view on vehicle production this year is you'll be at 70 million units of global vehicle production. And Joe has given an outlook as it relates to if we were to strike a line for next year, what that looks like. And you look at absolute vehicle production, let's set aside growth rate from a unit standpoint, on a relative basis, it's low versus historical levels. And to Joe's point, our growth over market stays intact. Our margin expansion story stays intact, but you're operating off of a much lower base. And that was one of the reasons where we just wanted to make sure we thought that low vehicle production environment, lower growth overall economic environment was going to present really tremendous M&A opportunities and did not want to be hamstrung by capital structure.

Yes. Absolutely. And I think there's a lot of expectation that M&A may be directed at nonlight-vehicle-exposed companies. You've got that target out there, 25by '25. Maybe just update us on your nonlight vehicle business, how some of the acquisitions have gone and how they're faring now with their various different end markets, including aerospace, which I know has been impacted, HellermannTyton, Winchester Interconnect, you've got gabocom now. What's going on with those firms and those end markets? And which of those end markets are you most attracted to and should we think about you adding to going forward? I see you got telecom in there now as well.

Yes. Listen, I think, Ryan, and so let me back up just real quickly. From our perspective, the bolt-on acquisitions for SPS are very attractive, including the auto deals. And certainly, auto tech, when you think about autonomy and the control tech business. So I don't want to leave more with the impression that it's -- that M&A can strictly be nonauto. We've had great success. And our focus really is around regional customer end-market diversification, and that can come in a lot of forms. And KUM was a good example where we significantly increased the strength of our business in Asia Pacific with auto connectors, really put us in a top 2 position in the region and a very strong position. In Korea, particularly, it actually was one of the early things that really cemented our long-term relationship with Hyundai. So the real focus is how do we take our know-how around those ruggedized electrical components, harsh environment electronics and expand into different markets and look with somebody like a HellermannTyton, which was half auto, half nonauto, really great product portfolio, really great engineering talent around products and around materials. And they're able to apply that to a number of end markets. And that's really very much what Winchester does, too. So it's not particularly a focus on, "Okay. We got to get more of X industry." It's how do we take our know-how engineering capabilities within Aptiv, our footprint, our scale, identifying companies that have maybe channel access or slightly different product know-how and bring those together to address multiple markets. And gabocom, to your point, is a good example. It's -- the HellermannTyton product line really enhanced it in the telecom space. That business has done quite well. There was obviously a pause in some of the projects in March and April, as you'd expect. But they have come back. And quite honestly, we think that business over the next couple of years will probably benefit a bit from some of the build-out around infrastructure related to so much more remote work. And you've seen investments announced in this country and then certainly in Europe around pulling ahead sort of investments in the broader networks to make sure they can facilitate all the increases in remote work. So that business is -- was sort of right in the wheelhouse, if you will, for the strategy. And it's -- and over the last 6 or 7 months, it's proven itself out.

Okay. Great. You announced that the autonomous driving joint venture with Hyundai last September closed in March. It's only been I guess 5 months since the close, but how would you rate the early progress there, including the relationship with your JV partner? What's next for the organization? What are the goals or milestones you're looking for out of the venture over the next year? Any sort of update you can provide on the path to commercialization for fully autonomous systems would be great also.

Yes. It's -- so Ryan, it's Kevin. It's on track. So Joe and I sit on the Board of the joint venture with some -- with an additional colleague here at Aptiv, and then there's 3 Board members from Hyundai. We have regular monthly Board meetings. Obviously, given proximity, Joe and myself are a more regular contact with Karl and his overall team, and there's some technology aspects that the Aptiv ASUX team is working on with the AD team.Hopefully, you saw it yesterday, they announced a new brand, Motional, in and around e-motion. So I'd say that's the biggest news most recently. From a technology development standpoint, they've been seeding. They've been, one, hiring significant amount of technical resources; two, seeding the organization with engineers from Hyundai. They recently opened a office in Seoul, so added to their existing locations; remain on track to have the Gen 1 AD vehicle driver -- driverless vehicle launching in December of this year with Gen 2 being in 2022, which will be on a Hyundai vehicle platform, electric vehicle platform. So things are on track and going extremely well. I would say, from an overall relationship standpoint and hitting our stride standpoint, we're actually probably further along than what we expected at this point in time. So things are going -- Karl and the team are doing a great job.

Great. We've got some questions from investors here. One is on the pace of recovery in Europe. I think there was a perception that Europe was slower to recover from coronavirus than the U.S., even though it kind of went down first. However, this client is saying that expectations for 3Q were that sales would be down high single digits, but the most recent development they're hearing potentially that sales could actually be flat in the third quarter, production is coming back faster. Just curious, they want to know if you're seeing anything on the ground that would confirm that sort of emerging view that Europe might be turning the corner here in the third quarter.

Yes. [ Jokingly ] specific, I think, Ryan, the thing that we all need to make sure we don't lose sight of is in all these regions with slow, steady restart of production, the reality is we're operating and accelerating production, Tier 1s, Tier 2s, Tier 3s and OEMs, in an environment where we're dealing with COVID, whether it's Serbia, North Africa, Eastern Europe, Western Europe,as well as here in the U.S., in places like Mexico. And the certainty that the -- it's a straight line or straight ramp-up of vehicle production, we think is something that you got to be careful not to fall into that trap. So the industry is doing a regional -- reasonable job managing through it. But I will tell you, it's a little bit like the duck swimming on the pond. Everything looks nice and serene above the water, but it's paddling like hell below the water. So we're dealing with a lot of supply chain issues, dealing with them well, but it's not perfectly seamless from an overall global supply chain standpoint.

Yes. I think, Ryan, what we've...

That's...

Sorry. Go ahead.

No. I was just saying that's helpful context. Please go ahead, Joe.

Yes. What we've seen, and it's been very consistent across region, although timing has been a little staggered because China reopened first, then Europe and then North America as you tended to see -- and I think it's a little bit of how we got into this particular part of the cycle, right? We got in -- we started this downturn with a supply shock, which is a little unconventional, right? We shut down production. So upon reopening, in every region, there was a big push by the OEs to fix the supply both in total inventory as well as, what I'll say, mix, like, for instance, in North America, you saw a lot of emphasis on truck and SUV when production restarted because the OEs I think were very focused on making sure they had their bestsellers, the high runners on the dealers' lots. What we saw in China, what we saw in Europe towards the end of Q2 into July was a pullback on some of those production schedules. And we have updated production schedules down through the end of our year with our customers across the globe. And if we look at the ones in North America, they do soften up a bit here in late Q3, Q4, as we talked about. Now that to us is -- and when we talk to our customers, it's -- they're sort of they fixed their supply issue, they're waiting to see what happens with demand. And that's a little bit more of a wait and see. I will say the schedules, although we have them, they're much more fluid and subject to shorter-term changes than they certainly were in recent history, last year, the year before. And they could go both up and down. So I think it's a little bit to Kevin's point, it's not going to be a straight line, and there's still an amount of uncertainty out there that's much more significant than there was in any time in 2019 or prior. Now we're open. We're producing. So again, you're not -- we're not in. So it's a massive step-up to where we were in April and the first half of May. But there's still a lot of ups and downs in those production schedules.

Okay. We got another question from a client here says with regard to smart vehicle architecture, do we need Level 4, Level 5 to see more momentum in the adoption? What needs to happen here -- from here for SVA to have more traction?

It's Kevin. I'll start. Listen, we have a tremendous amount of traction. So no, you don't need Level 4, Level 5. The trend towards battery electric vehicle certainly helped. It certainly helps. It certainly gives you an opportunity to kind of rethink and more dramatically accelerate the redesign of vehicle architecture. Just reminding everybody, the whole trend towards centralized domain controllers is really the path to SVA. We've won 11 of them. We have 2 advanced development programs with 2 OEMs -- actually, 3 advanced development programs with 2 OEMs. So there's one we're doing actually 2 with. And we think end of this year, early next year, we should have a couple more awards as it relates to SVA. So our view is it's on track and is accelerating.

Okay. Great. Next up, I'd like to ask on the outgrowth of your revenue versus light vehicle production. In the first quarter, you really crushed it. You were 13 points better than production. The second quarter, too, you were 11 points better.Firstly, what's the biggest driver of that great outgrowth, which is a lot more than the 6 to 8 points that you typically target? And then secondly, just given that you do continue to target 6% to 8% for the full year despite that stronger first half, it does seem to imply a bit of deceleration in the back half. Is there something specific driving that or could possibly be relative to launches or whatever? But -- or could it possibly relate to conservatism?

On the back half production, it's -- I mean, as I mentioned, we are on schedule. So I mean they are subject to change, but it's not -- we've got schedules, and then there's a haircut from above kind of thing at this point.

Yes, Ryan, I think, listen, you got -- you've heard Joe say this. Quarter-to-quarter, there'll be some element of variability to growth over market. So there are periods of time where we have a higher level of launch impact. And when you get into a situation where you're annualizing that, obviously, there's downward pressure on growth over market. But as you look at that framework of 6 to 8 points over market for 2020 as you think about it for 2021 and beyond, that's something that we remain comfortable, very comfortable with the extent we see accelerated demand for high-voltage electrification and some of the other areas where we're well positioned, obviously, that further -- that gives us further comfort and confidence.

And the launch lumpiness -- and we've talked about this a lot. The launch lumpiness was -- is certainly not COVID related. That number has always been something that has shot straight.I think, Ryan, one other thing we've talked about, and again, just as you look at sort of where customers or what they've scheduled out that's sort of driving that -- our view of that calculation is we've got -- COVID has introduced what I'll call sort of a production miss -- mix aspect to that growth over market calculation. China is a good example, right? China came back when China first started -- and we only intend to do business with the top 10-or-so OEs in China, both the global folks as well as the top locals. They tended to be the companies that were more organized around safe restart, organized around supply chain that restarted more quickly. So they represented a higher percentage of vehicle production mix in a particular month than historically had been the case as the other Chinese OEs come up who we don't have content with. It's not necessarily that we're producing any less with our customers, but the denominator in that growth over market is going to have a -- what is a more traditional mix. And so you're seeing a little bit of lumpiness from 1 quarter to the next. But over longer period of time, to the extent that normalizes, it looks more like it has historically, we'd expect that part of the lumpiness to sort of work its way out. But it's always been a bit of a choppy calculation, and we'd expect it to be a little bit more so over, call it, the next 4 to 6 quarters.

Okay. That's helpful. Maybe just a quick answer to a final question from an investor here as we're running out of time. He writes, can you talk about how you are approaching share repurchases? Is it fair to say that M&A is the preferred use of capital at this stage of the cycle even as conditions normalize?

Yes.

Yes. I think that's fair to say. And I'll go back to our -- our capital allocation always was investment in the business first, whether organic or inorganic. And as we talked about on the equity offering and other on this earnings call, we do think there's going to be some meaningful opportunities here to -- from an inorganic perspective over the course of 2021, maybe a little bit in the back half of 2020, but we really need to see the world loosen up a little bit from a travel and meeting perspective, but we do think there's opportunities there.

Okay. Great. With that, Kevin, Joe and Elena, thanks so much for your time today. Great insights. Appreciate it.

Thanks, Ryan.

Take care. Be safe.

You, too.