Aptiv PLC (APTV) Earnings Call Transcript & Summary

Hello, everyone. This is Joe Spak, auto analyst here at RBC Capital Markets. And we're very pleased to, next up, have in our track, Aptiv. From Aptiv, we have CFO, Joe Massaro; and Elena Rosman from Investor Relations. The format for today is fireside chat. So we'll get right into the Q&A. But first, Joe and Elena, welcome, and thanks for joining us here today.

No, thanks for hosting, Joe.

Thanks, Joe.

So I guess just to get started, obviously, when you came out with second quarter results, you had sort of a view on the global production environment. We've seen obviously a flurry of production downtimes as some of the semi shortages issues seem to have gotten a little bit worse than expected and certainly even at some of your key customers. So can you just give us sort of a mark-to-market here or an update on what you're seeing in the schedules and how that sort of trended versus what you originally expected for the balance of the year?

Yes, sure. And let me start with a couple of things. One, we didn't provide a guide for third quarter, particularly because we were seeing a lot of volatility in customer schedules. Visibility is incredibly low at this point in terms of forward visibility of schedule. So from a schedule perspective, we've got between sort of what I'll call 1 in 3 weeks of schedules where typically, as we've talked, we've had a solid quarter, sort of a rolling quarterly outlook from our customers within a little 3-week period, so very limited visibility. With that said, I think Q3, and I think you've heard others say it as well, it is obviously not just an Aptiv issue, it's an industry issue, there has been more disruption in Q3 than I think folks had anticipated and mainly related to supply chain constraints primarily. And as we've talked in the past, there's been this underlying semiconductor constraint just around sort of supply exceeding demand, and that really originated, as we've talked about before, with just I think some assumption on the part of semiconductor providers back in late 2020 around sort of the U-shaped recovery in auto versus a V. That was that original constraint. Q2, we had the Naka fire situation, the fire at the Renesas plant in Japan that significantly hindered production and constrained supply. What we've seen in Q3 is another sort of a new event. There's still that underlying constraint, the original constraint and why Naka supply has gotten much better than it was in Q2, we are seeing significant constraints from COVID-related impacts in Southeast Asia on semiconductor supply. There's a lot of semiconductor production, particularly back-end final assembly test that's done in places like Malaysia and Thailand. And given the COVID outbreaks there around the Delta variant, governments are taking a pretty meaningful stance on production closures. So we've had semiconductor suppliers who, again, industry-wide, have been closed for a couple of weeks at a time. We had one that was closed for a couple of weeks, opened for a period of time and then reclosed. That's really been the big sort of novel constraint issue around semiconductor supply in Q3. And it is impactful. I mean I think at the time of earnings, we had sort of estimated Southeast Asia COVID could cost the industry about 1.5 million units in Q3. That number, depending on who you talk to, is anywhere from 2 million to 3 million now. So it's been more impactful, I think, Joe, than the industry was expecting.

Yes. Thanks for that update. I guess, Joe, we just had GM earlier today, and they echoed a lot of what you're just saying, especially in the Southeast Asia and Malaysia. And I know we saw another lockdown earlier this week in Malaysia. And it does seem like that is, as you said, final assembly or sort of more packaging versus earlier on in the year, it was more at the wafer level. And it sounds like packaging is maybe more labor intensive. And if the plants are not operating at sort of full capacity, that obviously adds constraints. But I guess what I'm thinking about and what sort of GM was sort of hinting at, I'm wondering if you agree, is that as those constraints are eased or as better procedures are put in place or maybe vaccination in some of those countries come, is it possible to get somewhat of a faster recovery? Because it's really not the wafering issue, it's really sort of more just a labor availability issue.

Yes. I would think this is more like -- if you remember, we described the Renesas fire situation as an air pocket, and supply went away and needed to be backfilled. I think this is more a version of that than a long-term capacity concern, right? There's not enough wafer manufacturing and it takes 18 months to put in more wafer capacity. That's that underlying constraint, which is getting better. As time goes on, I think it will still -- that underlying constraint will still be tight in some areas even into 2022. But this is much more of a -- the plant's closed. In some cases -- and we've seen this happen -- there's actually WIP or finished goods in the plant. They physically can't get in the warehouse to ship it. So when the workforce gets back, one of the first things they do is start shipping finished goods. And that's a much quicker recovery, obviously, than, hey, we need to add more wafer capacity over the next 1.5 years. So I didn't hear GM's comments, but I would say, based on what you've described, we have a similar view.

Yes. I mean I think there's obviously 2 issues. I think that it seems like maybe overall, the industry does need some more wafer capacity and that could take a couple of years. And I think when we've spoken in the past, you've mentioned that because of demand, not only from the automotive industry but from really globally from many industries for sort of semi capacity, you could sort of expect some inflation there or that's sort of your planning assumption as you sort of think about '22 and beyond.

Yes.

I guess I'm wondering, as you are planning for that, how is that working with your conversations with your customers in terms of either negotiations or pricing for new programs, considering that chips just might cost more for a little bit. And you may need more of them in the vehicle as well.

Yes. I think where it's -- those discussions right now tend to be around some of the reengineering activities. Some of those reengineer activities are to address constraints. We've designed in a specific chip, in some cases, at the customer's request. That chip's constrained. There's another chip from another supplier that could work, but it needs to be validated. Those types of things. I think those reengineering activities are also now moving into how do you deal with price. A less constrained chip doesn't necessarily have the same inflation and/or you get some leverage on chip suppliers when talking on price. So that's really where the bulk of the activities are happening now. Certainly, as we get into what I'll call sort of the annual economic discussions with customers that tend to happen late Q4 and into the beginning of the year, that's where I think we'll start to have some of these discussions that will be familiar to us. We have them every year. Now that the chip inflation will obviously be a new topic on the agenda. But they're looking for annual productivity obviously, right? This industry does that every year. We put things on the table that are costing us more money. And that tends to get, I think -- particularly for the auto customers, that will be where that discussion really happens, so sort of a balance of trade in what we're seeing and what we're doing. And obviously, we're incurring a lot of cost to idle plants. Most of the cases where we're idling plants, particularly on the SPS side, we're not the what floor in terms of who's closing production. It's not our parts or chips for our parts that are constraint. We're, in a lot of times, hand-to-mouth. But SPS, just given its size, tends to have an impact from others having chip constraints, right? So there's cost there. I think that will be thrown into the economic discussion. But that's really -- I think there's an element of that that's still to come. And I think the industry at the moment is really focused on getting the chips than making cars. And our sense, and I know Kevin sort of referenced this on our earnings call, you really have sort of those annual economic discussions where most of these things will be sort of brought forward and put on the table for discussions with customers.

I guess, Joe, within SPS, and I'm particularly thinking about wire harnessing, which I know is also pretty manual labor intensive and I think a good chunk of that also gets done in some Southeast Asian countries, are those lockdowns having an impact on the wire harness business as well, separate from the semi -- I mean not all separate but some of it relate, I guess, to the semi issue?

Not significant for us. Our Southeast Asia footprint is fairly small for the wire harness business. We do have a facility in Malaysia that's in a state that's under lockdown. But that's not a big disruption for us. The bulk of our -- just to your point, given the size, the complexity, the logistics around wire harnesses, those plants tend to be located within a reasonable proximity to the actual vehicle assembly plant. So we tend to be more in China than you would sort of a Vietnam or Thailand or Malaysia. So a little impact at our Malaysian facility but not something, Joe, that's overly significant for us.

Right. And look, a lot of the volume stuff here is obviously sort of out of your control. It does sound like maybe -- I know you didn't give, as you mentioned, third quarter guidance, but it sounds like it's probably tougher than planned. Again, that's an industry issue. But there is also a lot of positive things going on at Aptiv. We've certainly seen that in the first half where you've been able to meaningfully outperform the business. So is there any reason to believe -- like obviously, we can make assumptions about volume. But are there other things going on that are sort of more Aptiv specific in some of the content you're adding that may allow you to help to overcome some of the potentially lighter volume numbers.

Yes. No, thanks for the question. I was actually going to add that in. We took our growth over market target up to 10% for the year. We continue to have confidence in that number. I think even as vehicle production moves around, our content, what I'll call sort of our macro trends around electrification, around active safety, more software in the car, all of those remain very much intact. And I think even through the really difficult COVID times during 2020, that sort of Q1, Q2 period, our growth over market held up really well. We saw no real sort of elasticity with vehicle production. It did not move down with vehicle production. And customers continue to want to build vehicles. When we get supply, they run full out, which again creates disruptions in operations. But from a market perspective, it's a very good sign. The minute they can, they build the cars, end demand remains very strong, inventories remain very low. And when they're choosing what cars to build, there continues to be a bias -- and this is really in all 3 big regions that we play in, there is a bias to build a more highly contented vehicles to put as much active safety in as possible. It's the larger trucks, the larger SUVs. And in Europe, we still see a bias towards manufacturing of EVs. So those underlying trends that we spent a lot of time on the last earnings call talking about it, Kevin discussed them for a bit, continue to remain very strong. And we see no indication that, that will change. There's really no discussions around decontenting and that type of stuff. They're really focused on making sure the cars have the technology that the end consumers are interested in.

Yes. I mean I guess that's good to hear. And I guess while we're sort of on that topic, I mean I know you raised that sort of growth over market for this year. I think the more midterm target is still that 6 to 8 points. It does seem like -- and I know you've been sort of talking about this forever, sort of these mega trends, but it seems like things have, certainly on a high-voltage side or even on an active safety side, probably accelerated, connectivity side as well, a little bit faster than maybe even people thought a number of years ago. So I know you're not a management team that sort of wants to go in and overpromise and under deliver. But at what point is sort of a -- is it valid to sort of take another look at what the growth algorithm for the company is?

Yes. Listen, it's a fair question, and we've been running at the higher end of that range, right? And to your point, we put that 6% to 8% out for multiple years. So we want to make sure it's a range that covers sort of all the things that happened over a multiple year period in the industry, right? Some programs go away. We exited the display business, and that sort of all fit between the 6% to 8%. But it's certainly a reasonable question. We're taking a look at it now. I think the real challenge is just the lack of visibility, right? As we get towards the end of the year and start to see the 2022 schedules, make sure we understand -- and I think we've been open on this when we took it up. I mean, we're obviously getting a bit of a mix benefit versus market at the moment, right, because there is a bias towards truck and SUVs. There aren't as many sort of lower-end cars being made. So some of it's just the math. The trends are very strong. And I think as we go through the planning process over the next 4 or 5 months, the question for us with our customers really is, do they expect these trends to continue. And to the extent we do, we're obviously highly confident in that 6% to 8%. And to the extent it, with electrification stuff, looks better than that, we'll revise as appropriate. But very confident in the 6% to 8%. 10% is a good number for this year. Even in the current quarter, we continue to be confident in that number despite the production disruptions.

Maybe a little bit on the cost side, I mean I think you were very open and transparent about some of the input costs and commodities and COVID and sort of supply chain issues that could sort of impact you -- or that have been impacting you and sort of continue to impact you this year. You mentioned earlier, it sounds like maybe this is some of the lowest visibility we've ever sort of seen in the industry. We've definitely heard about a couple of days notice in terms of production schedules sort of being brought down. To me, it sounds like some of that scheduled volatility, if anything, has increased versus maybe what you saw last quarter. And as we all know, and this is not again an Aptiv-specific issue but just an automotive industry, like schedule volatility is somewhat of a killer. So is that a fair comment? Is that something that maybe -- versus what we've seen in the second quarter, some of this schedule volatility might weigh even a little bit more? Or because you've been operating in this uncertain environment for a while, have you gotten better at certain things in terms of loading up the plants to meet schedules?

No, I think it's a fair comment that greater volatility -- if it plays out for the balance of the year, greater volatility generally means greater operating inefficiencies, so I think that's a fair comment. Again, with the lack of visibility, we obviously don't have -- hard to estimate at this point. But I think the correlation for short periods of time is the right one, Joe. A lot of it has to do, which is really basic plant and efficiencies, right, absorption. And you're absolutely right. It's a couple of days' notice. You go down for a couple of days. You find out on Saturday, you'll be down from Monday and Tuesday, but they want to ramp back up on Wednesday. There's not a lot you can do from a cost perspective. And quite [ interesting ] to have. And we did this during -- even the 8-week shutdown with COVID, you have to keep the employees engaged. You have to keep them coming back. You have to pay them, right? You can't take them off the payroll for 3 days and assume they'll all come back on day 4 when you need them. So it becomes an expensive environment to operate in. I think that's the right way to think about it. Our view is it's important to be ready to serve our customers. It's a commitment we've made, so we'll incur those costs. It's not a structural change. It really is related to the schedule disruption. Our plants are not becoming more expensive to run in a normalized environment. So you're really dealing with sort of this sort of episodic event here. And it's important as we get hopefully into 2022, even if there are sort of constraints on some semiconductor products from the original COVID constraint, hopefully, we get to an environment where we can schedule better, right? And a tight supply chain, you can still schedule around. What's really disruptive, are things like the Naka fire or the Malaysia, Southeast Asia shutdowns, right, because they come quickly. And like I said, and we talked about it, I think the right way to think about it, when a government rolls in and closes a plant in Southeast Asia, they're closing the warehouse and a shipment that you'd expected to get at the end of the week just never comes. And that's why you see this very volatile scheduling situation because the finished goods are there, but you can't get anybody into the supplier to ship them to the Tier 1 to make the product to ship to the OE. So it's a very sort of violent series of disruptions that take place to something that isn't the same as, hey, we're only going to have 85% of what we want for the next 2 months, right, because of the original constraint. That you can plan around. You can just figure out how to operate at the 85% efficiently when you told them on a Saturday, there will be no production on Monday and Tuesday. And in a lot of our cases, like I said, it's indirect, we don't even see the visibility because it's not our chips that are constrained on our active safety products. What we're seeing now, I think, out of Southeast Asia is a lot of the chips that go into the smaller control units in the vehicle, the brake controllers, the inter-controllers, it's just very hard to make cars without those, obviously.

Yes. I think some of that content is a good segue into maybe thinking about some of the large puts and takes for 2022 because maybe some of these numbers have changed a little bit with some of the more recent industry updates. But as of last quarter, you sort of identified, call it, $400 million of additional costs in your system right now between I think it was like $150 million on FX and commodities and then $250 million on the COVID and the supply chain issue. So how should we think about what elements of each of those 2 buckets can come back? It sounds like the bigger opportunity is maybe on that supply chain cost based on your sort of prior commentary there. So just some more stability in schedules allows you to operate more efficiently.

Yes. Listen, obviously, it's a question we get a lot, and I understand it's relevant. It's hard to call just given the lack of visibility. Part of the reason we sort of bucketed the costs, and I can go through those buckets quickly, the way we did was to at least provide folks a sense of what's driving those costs and what would have to happen for them to go away. Now the timing of what would have to happen is very hard at the moment. So it's not something I can speak to, but we can certainly give you a nature of them. And you're right, it's about $400 million of costs that we had identified through August based on what we thought would happen with production. $250 million of those costs, we've bucketed as COVID and supply chain disruption. About $80 million of that is COVID personal protection for our staff. We have 140,000 folks in manufacturing facilities. We opened those facilities back up in May of 2020 and are spending money to make sure those employees are safe. And to date, we've been very successful. We've had no reported in-plant transmissions. We obviously have COVID cases with our employees, but they're identified quickly. We're still maintaining social distancing. We're maintaining masking in the manufacturing facilities. And where we can, if we're able to help local governments with vaccinations, we're doing that as well. In some cases, it's as simple as providing a large facility for those to take place. So that's about $80 million of the $250 million. The remainder is really costs around just the supply chain disruptions. A lot of premium freight. It's a very big number. Everything is going air at this point. Chips get finished in Southeast Asia. We put them on a plane. They're flown to our assembly plant in Eastern Europe or in Mexico. We make the parts, and we're typically flying the parts to the vehicle assembly plant. So it's very expensive. So I think that bucket, that $250 million, I think the $80 million stays until we're really comfortable around vaccination rates and employee safety in various places. The remaining $170 million is really going to be tied to how quickly the supply chain normalizes, but it's directly related to that. So it should normalize out as things get better. I don't have an estimate on timing, unfortunately, at this point. The remaining of the $400 million, that $150 million, yes, we've really identified that as component cost inflation, some chips, some resin. We're assuming inflation's not transitory. And we have been working on ways to offset that. In some cases, we have some nonautomotive, obviously, business where we can pass price along, particularly in the resins, in the connector business, HellermannTyton, those price increases get passed along sort of right away, if you will. Copper, we're able to pass along on a quarterly basis. But the $150 million, we're assuming we need to work on. And to address over the course of the coming what I'll call sort of 4 to 6 quarters. And that speaks a little bit to the reengineering activities I had mentioned earlier as well.

Yes. I mean it's obviously sort of all related. But it seems like if the supply chain issues begin to resolve themselves, right, then you can start to get some of that visibility. It doesn't seem like there's an underlying demand issue. So if production starts to move back higher, you're able to sort of convert on that. And at the same time, if supplies constraint issues resolved, then maybe some of the logistical costs, premium freight, et cetera, starts to ease the well. So it's not necessarily binary, but it seems like it's maybe a little bit juiced to the upside once you get past some of the supply chain issues. Is that a fair interpretation of -- and again, I'm not saying that happens in early '22. But it seems that, at some point, we should start to get past some of these supply chain issues.

Yes, I'll say it a little differently than sort of juiced to the upside. The way we think about it, what Kevin and I are looking at, is really separating out structural issues. Has something structurally changed in the business as it relates to the COVID, as it relates to supply chain constraints, those are the things we got to make sure we're focused on. We don't want to fool ourselves by saying, okay, something's COVID related or something's disruption related but it's an underlying structural change. That's why we've called out that inflation bucket. To me, in our world, that, we need to assume, does not go away. It would be great if it does. It would be great if the world got to some level and prices came down, but we can't wait for that. But I think the nonstructural elements are just that. They're transaction. They're somewhat more transitory. And to the extent what's driving them, the faster the situation corrects itself, the faster those costs will go away. It's just very hard to call timing at the moment.

Yes. No, I think that you probably said it more eloquently than I did. I guess just because we're coming up on the 0.5 hour, I know we have much to talk about and not enough time. But I think one thing I did want to touch on, which we hadn't had an opportunity to talk about last time, is M&A. So you're obviously sitting on still quite a large cash balance. I know you raised some capital last time. And the thinking was that it would allow you to sort of potentially be more aggressive or opportunistic with some deals. And I think COVID probably delayed that somewhat because it became a little bit difficult to get out and see stuff. We have seen M&A open up, at least more broadly, in some of the component spaces. And so it would sort of fall more traditionally in your SPS segment. So be curious to sort of get the latest sort of lay of the land there on the M&A side, if that's opening up for you as well, and when investors can expect some of that cash to potentially be put to work.

Yes. So no, good question. So the plan continues to be to put that cash to work from an M&A perspective. Processes have opened up. I would describe our current as we're back to sort of certainly pre-COVID levels, sort of back to sort of 2019 levels of funnel and activity, which is good to see. It did take a little bit to build up. There's still some challenges around logistic, particularly on international type deals around diligence meetings and management meetings and those types of things. But broadly speaking, I think people are finding smart workarounds for those types of things and still able to get a feel for management teams, to get to know management teams and to get the adequate diligence done. So those processes are up and running. In terms of what we're looking at, I think it will be very consistent with what you've seen us do in the past. The bolt-on transactions within SPS to expand product line capabilities, to expand end market capabilities in the connector space, in the engineered component space. And then on the ASUX side, I think there's an opportunity to not only continue to develop product lines but certainly enhance capabilities around things like software and those types of things. And from a size perspective, you could certainly see things that are within the range of our sort of historical deals, which have tended to be between $0.5 billion and $2 billion for HellermannTyton back in 2015, and possibly higher for the right asset. That's really one of the reasons we, in late 2020, did do the capital raise and did make sure that the balance sheet exited sort of the really difficult COVID time in the best possible condition because we did want to be able to ensure we were on offense the minute the opportunities presented themselves. And I think we've done a good job of making sure that happened. And a number of team members in the company are fully engaged in what is, again, a return to a robust M&A process from a funnel perspective.

Great. Well, as I mentioned, always a lot to talk about with you, but unfortunately, we are at the 30 minutes. So Joe and Elena, thanks for joining and participating in the conference today. Thanks to all the investors on the line as well and look forward to hearing more about the Aptiv story in the future. Thanks again for joining us.

All right. Thanks, Joe. Thanks, everybody, for the time. I appreciate it.

All right. Take care.