Aptiv PLC (APTV) Earnings Call Transcript & Summary

Hey, everybody, and welcome to the Aptiv session, featuring Joe Massaro, Chief Financial Officer and Senior Vice President, Business Operations; and Elena Rosman, Vice President, Investor Relations for Aptiv. This webcast is for Morgan Stanley clients and approved observers only, no press, no media, get the hell out. Questions will be conducted electronically through the webcast. Don't wait, initiate. Get involved early. I got a good group of you on now. We want to hear from you. Your questions are better than mine. And for important disclosures, please go to the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. Joe, a lot to get through, but I just want to give you a couple of minutes at the top to emphasize key messages for investors this afternoon.

Sure, Adam. Thanks. Let me start off and then look forward to getting into the Q&A. Hello, everybody. Good afternoon. Really key messages here, continue to work through a difficult production environment, particularly around some of the supply chain constraints, particularly around semiconductor chips. But when you really look at the business sort of in 2 pieces, sort of that transactional difficulty that we're working through versus really the strategic tailwinds that we have, we continue to do very well from a growth over market perspective. Continuing to see a lot of strength in our high-voltage portfolio as well as our active safety product lines. And really, the macro trends that we've now talked about for years, and Kevin talked a lot in our last earnings call, remain very much intact. And despite the -- some of the day-to-day challenges around supply chain constraints and where, obviously, folks are seeing now around some continued customer plant shutdowns around COVID-related delays coming out of Southeast Asia, the business continues to do well. And the mid- to long term remains very much intact. And in some cases, like high voltage, we're actually seeing some strength in it. So with that, Adam, I'm happy to turn it over to Q&A.

Great. And look, Joe, we really appreciate you being here today during this time. Because Aptiv's incredible portfolio is so close, so central to every tech aspect of the car, right, so you see a lot of things other suppliers don't see, and you see earlier. So on the supply chain chip shortage, obviously, you've never seen anything like it in your career, I'm not going to ask that. But what's the latest you're seeing real time? The semiconductor -- our semiconductor sources say that coming from the foundries, chips are really flowing and back to like pre-COVID levels and new territory of records. Why is the auto industry having so much of a problem when, at an aggregate level, the industry is recovering? Where is the bottleneck from what you're seeing?

Sure. So let me start off with -- you really got to -- in a lot of times, in sort of the broader coverage, it get lumps -- it gets lumped together as the semiconductor supply constraint, right? But it really has a couple of very distinct pieces that I think help answer your question. First and foremost, when we started to see this very late last year, what I'll call the original supply constraint, where really demand was just outpacing supply, the key was that maybe the semiconductor guys were expecting maybe a U-shaped recovery in auto had shifted some capacity to other industries. And as auto came back in, in what was much more of a V recovery, we started to see some tightness. That's the original, what I'll call, COVID demand-supply constraint. Very impactful in Q1. Our estimate is it cost about 1.5 million units of production for the industry in Q1 of this year. But there has been some sequential improvement. It was maybe 500,000 to 700,000 units of production in Q2 and still impacting the back half of the year. And we expect, in some cases, that you'll be hearing about this demand-supply imbalance even into 2022, particularly around certain types of chips and technologies. And I think that's when people hear about wafer supply coming back and those types of things. That's sort of the constraint that was related to what you might be hearing from the semiconductor folks. Unfortunately, in both Q2 and Q3, the auto industry was also hit with, what I'll call, 2 very discrete events that, from a units of production perspective, are just as impactful. It's not a little bit more impactful than the original supply constraint. The first was a fire at the Naka facility, a fab run by Renesas in Japan. That fab produces a lot of auto semiconductors. And particularly in late May, June of Q2, probably cost the industry about 2.2 million units of production. Just as there was a damaged inventory, there was obviously downtime at that fab. And the fire happened in March. But given the lead times, we really felt the impact in May or June. Now Naka has returned to production. I'd say, in most cases, they're getting very close to pre-fire levels. So we've sort of come out of that discrete event. But unfortunately, and I know people in the industry have been talking about this for a couple of weeks now, we're really seeing a second discrete event, which is COVID-related shutdowns in Southeast Asia, particularly Malaysia, where there's a lot of back-end test assembly packaging for semiconductors that has impacted the industry. And I would tell you, it's been more impactful than some of the initial estimates when we sort of -- at the end of July, I think folks would have told you maybe it cost the industry 1 million to 1.5 million units of production in Q3. Estimates now are that's going to be closer to about 2.5 million, 3 million units of production. So it has been more impactful. So I think, as it relates to auto, you've got sort of that original constraint that impacted a number of industries, compounded by those 2 discrete events.

So it gives the impression, Joe, without being -- issuing formal new guidance here, of course, I'm not going to do that. But the Q3 might just be this could be crunch time where you just don't have the volume offsets that you did in the velocity maybe earlier in the year. And you also have some inflation and premium freight and things as well. And then you don't benefit in real time for the pricing, the way other parts of the auto chain can, like dealers or OEMs. So is that fair for expectations to be kind of managed, that we're kind of through the narrowest part of this tunnel in Q3 in terms of financial results?

Yes, listen, I think we obviously don't have a Q3 guide out there, just given some of these expected volatility in production. We do have our full year guide that we maintain through and actually increased in the second quarter earnings call. And I think it's fair. We talked about, for a full year basis, having a $400 million of costs, additional cost in the P&L, $250 million of which are really COVID and supply chain-related costs. The remaining $150 million were input costs. You're definitely seeing the impact from a financial perspective of these constraints. I think it's going to be important here as you think about -- and I mentioned sort of the incremental lost units of production from the Southeast Asia, yes, the question is really going to be how much of that lost production can be made up in Q4? Or how much of that flops into 2022? End markets continue to be very strong. Our customers, when they want to build vehicles, when they have the -- they want to build the vehicles. When they have the chips, they are building the vehicles. They tend to be -- we're continuing to see a very strong mix impact, where the -- for instance, in North America, about the higher content of trucks and SUVs are being favored. And actually, in Europe, we continue to see a bias for TV production. So the mix is favorable, a lot of end demand to build vehicles, and our customers are building as many as they can once the parts come in.

Okay. So just to draw a line under this, your guidance at the end -- at 2Q did not include the impact of the fire and the COVID shutdowns. But it also didn't impact -- include some of potential positive offsets, like mix and recovery, in the fourth quarter, right? I just want to -- is that fair?

Yes, it's balanced. Yes. And I think the question is going to be how much? We had an impact for Southeast Malaysia in there. Like I said, it's been running a little harder. There is, in theory, room for OEs to make up that lost production in Q4. I think, obviously, there's going to be a time on it in terms of how many weeks they actually have to do it. But I would tell you, one of the things that is maybe a silver lining as it relates to the Southeast Malaysia issue, those are physical government-mandated shutdowns of facilities, right? The facility is shut down for 2 weeks. They're shut down in an orderly way. When the employees get back to the plants, they tend to ramp up pretty quickly. It's not like Naka fire where we saw an extended period of downtime. And in a lot of cases, it's actually finished goods in those fabs, and it's just a matter of getting them shipped out once the staff comes back to the plants.

Got it. So one question on this top -- on the issue of premium airfreight. What portion of your current supply chain is being air-freighted out of China to the U.S.? Is that in the margin outlook? Is that getting better or worse? Specific question on the supply chain.

Yes, very specific. So for the most part, it's semiconductor chips. They're mostly coming out of Southeast Asia. So Singapore tends to be a hub, where they're saying -- a lot of those chips go to Singapore from the various countries, get consolidated there and come out. At this point, just given the issues in Southeast Asia, I'd say we're running as much premium freight as probably we were around the time of Naka fire. And that is included when I talked about that $250 million impact for the full year around supply -- COVID and supply chain disruption costs. And that did include our best estimate of premium freight at the time.

Okay. We're going to go around the horn here. I'm going to take another -- there's a few questions here from the audience I want to just kind of throw in now. Kind of 3, in quick succession, are you ready? What is the advantage that Aptiv has in high-voltage connector products versus the competition?

Yes. From that perspective, Aptiv, we have a very large automotive connector business, #1, #2 in markets, depending on exactly where in the world you're talking about. Our real advantage, though, is we're actually a Tier 1, right? Most connector suppliers are Tier 2. We're able to bring together a complete system solution when we bring together our electrical architecture business, our cable management business with HellermannTyton and really offer customers a complete Aptiv-designed solution.

The second was, which products might you see an application of silicon carbide that you produce?

Not sure at all.

Not applicable?

Not applicable, yes, I meant.

Didn't think so. And then the last one is many OEMs are teaming up and developing their own electrification plan together. Does this represent a potential encroachment or loss of customers to those OEM-formed JVs?

Yes. From -- the short answer, no. From an Aptiv perspective, our high-voltage product line really constitutes an electrical architecture system, the distribution system, if you will, of both high-voltage and low-voltage power and signal throughout the vehicle. And those tend to be the electric architecture, the connectors, cable management, not something the OEs are doing on their own. So even to the extent you see a joint venture form, say, with a motor provider or a battery provider, our systems that bring all those together, that connect all of those, remain relevant to that JV. That is not something that is being in-sourced in any real way.

All right, Joe. Loads of big talk from the internal combustion companies or the legacy OEMs who are targeting the end of ICE and decommissioning the tech and moving to 30% and then 50% EV penetration really, really fast, like even this side of 2030, in some cases. Does your forward order activity actually resemble and reflect those types of targets that they're talking about?

At this point, and I'll let Elena go into the specifics of how much we've booked. Obviously, we don't have visibility out towards sort of that 2030 time frame yet, right? But I will tell you -- or the activity that we're seeing from both a shipment perspective, a revenue perspective, we'll do almost $1 billion in high-voltage product this year. We expect that to grow at about 50% to 60% CAGR over the next few years. Over the next coming years, we're at about -- we have content at about 50% of the EVs that are being launched globally. And we're seeing a continued increases in demand. And we've seen some significant -- we booked almost $1 billion of high-voltage business in Q1 alone this year. So hard to say does it reflect everything that folks are talking about from 2030 to 2035 at this point, just given that length of time. But the business is off to a very strong start, and we see -- we've got a -- what we think will be about $1 billion product line by the end of this year, growing at 50% for the next couple of years. So certainly signaling a lot of strength in that space.

So Joe...

Yes, and if I could...

Yes, Elena, please.

And just to chime in, Adam, on that point. So looking at the IHS estimates, at least through 2025, right, the high-voltage market is growing at about a 30% CAGR, right? We're signaling north of that through our 2025. We've talked about $2.5 billion plus of high-voltage revenues. And then when you layer on our low-voltage revenues that are also supplying into battery electric vehicles, that backlog mix, at least when you look at today versus 2025, almost doubles in terms of the absolute percentage of revenues coming from some type of high-voltage battery electric vehicle in 2025.

So remind us why BEVs make better autonomous cars? And why autonomous cars are better when they're BEVs? I get this question a lot because you do both -- because you approach from both sides, your answer matters.

Yes. No, absolutely. And as some may be aware, our joint venture with Hyundai, Motional, we'll be launching a second-generation, fully automated robotaxi, a true Level 4 vehicle. And they will be using a BEV platform, the IONIQ 5 from Hyundai. Listen, there's a couple of benefits there. One, right, there's the practical that as you get further down the road, have large robotaxi fleets of BEVs. There is a thought there that you'll, at some point, have that wireless charging technology, which will essentially allow the car to go someplace and charge itself, right? So there's some efficiencies there from in terms of fleet utilization. Two, another reason, there's -- as you think about the first applications for robotaxis, a lot of those are going to be in urban environments, dense urban environments within geo-fenced areas within cities, where, even today, there's some requirements around commissions on those public fleets, right? And this is a way of jumping ahead of that and making sure we're offering a sustainable solution for those ride-hailing fleets. On the flip side of that, why does a BEV make a good autonomous vehicle? You're starting to see BEVs today that have a very simplified architecture or a more simplified architecture. We think there's a lot of room to continue to optimize that. But as you think about needing to integrate the Level 4, Level 5 system, including the additional sensors, obviously, it's a big compute platform that goes in there. On a newly designed BEV from the ground up, you tend to find a lot more room and a lot more ease of integration of that system into that vehicle.

I mean, as that architecture gets simpler, is it possible for us to have fewer chips? And that as you have a truly software-defined vehicle, you could have a much more elegantly designed product that isn't this monstrosity of complexity that we have that's -- that might be contributing to some of the issues the auto industry has with supply constraint.

Yes. No, so a couple of thoughts there. We -- certainly, we believe so. I think one of the nuances there, though, as well, as you get into what we refer to as Smart Vehicle Architecture, where you've taken what are now up to 100 or more very small compute platforms that are distributed throughout a traditional internal combustion vehicle today that, maybe to your point, include a lot of legacy automotive A6 that are -- have been around for a while, are not necessarily current tech. As you pull those in and pull that functionality into what will be in a Smart Vehicle Architecture setting to larger compute platforms, those large compute platform will run on newer silica or state-of-the-art silica, right, smaller chips that are sort of produced with -- from a -- smaller from a nanometer perspective. And a more aligned with the current state of semiconductor just not technology, but where the investment is going, which should allow us to help assure supply. So it's an actual reduction of controllers and a move to sort of larger -- fewer larger GPUs that are much more of the mainstream of what's being invested in and produced today.

Joe, does -- tell us where Aptiv is on, let's say, designing its own silicon. Any thoughts there? And could you partially vertically integrate to do more of your own system-on-chip in-house instead of relying on that part in the supply chain, somewhere halfway around the world.

Yes. Listen, I think it's -- we'd obviously be fabless, if you will, right?

Yes, of course, fab.

We wouldn't have our own fab. So we'd still be relying on some element of the supply chain. But -- we've got a number of engineering projects. Kevin referenced over 100 currently ongoing around semis in the company that do include both sort of redesigning or finding multiple sources for something that may be single-sourced at the moment. But also, looking at opportunities, whether it's around perception or with SPA, where we could have a more control over the design of the chip and more control around contracting for supply and ensuring supply. So certainly something we are taking a look at.

So I'd love your thoughts on the capital markets here in SPAC mania capital formation. I mean you have this flood, proliferation of potential new customers. There may be opportunities for you, but what criteria do you use when you assess whether to engage seriously in quoting for companies and systems that have never made a car before? How do you allocate the resources?

Yes. And well, listen, it's an evaluation that we go through both with some of the newer entrants. And quite honestly -- and Kevin has mentioned this a couple of times on high voltage, even with some of the legacy OEs, right, we want to make sure we're on platforms, where there's a commitment to manufacture those and a commitment to manufacture at volume. Certainly, as some of these companies have been able to raise capital and are well funded, that's helpful, because in the early stages, we do -- we are willing to make some investment in the future of a platform or in the future of a product. But obviously, also rely on the OE to provide some of that funding. We're not doing it all completely with sweat equity. So the fact that some of these have raised capital and have funding allows us to then evaluate the strength of their portfolio, the strength of their ideas and their -- our view on their ultimate success. So certainly, their ability to raise capital helps open that door. And then we go through a process that we quite honestly apply to a number of OEs and platforms.

So a question, Joe, for you and Elena, on disclosure. I mean, so I'm starting to talk to some investors, increasingly tech investors, nonauto, who are wondering whether the industry and the opportunities and the markets that you're addressing have changed enough in the past year or 2 to maybe warrant a re-examination of your reporting structure in terms of the divisions, right? What would you tell them?

Yes, listen, we get this question a lot around would you split out between maybe electric vehicle or internal combustion or that ...

For example? Yes.

Any type of walk-in. Really, from our perspective, 2 things to think about. One, we report how we run the business, how we go to market, right? Because we think that's -- that provides the best visibility and it's the most consistent with what we, as management, are seeing happening in the business. And at this point, we continue to run the business, go to market and enjoy a lot of success with sort of -- based on that brain nervous system. We'll always have product line discussions around things like active safety and high voltage. But I actually think one of the most exciting is, we probably don't talk about this enough, with what we've done with both positioning the portfolio itself, the businesses that are part of Aptiv, but also the product lines, with something like EEV versus ICE, we really have very minimal internal combustion content. There is really no big decremental content for Aptiv as internal combustions go away. Our active safety systems, obviously, are very portable to BEV. As a matter of fact, one of our initial Level 2 systems, the zFAS that we released for the Audi A8, that's actually been picked up on the Porsche Taycan. So again, that doesn't matter if it's an internal combustion or electric. And even in the Electrical Architecture business, we're getting a great lift from the addition of the high-voltage electrical architecture center. But even BEVs continues to have a low-voltage system, right? And we're maintaining our share, growing our share actually on the low voltage side of BEV. And our ICE-specific content at this point, as total Aptiv, is really limited to less than a couple of hundred dollars on what is known as an engine harness, which is effectively the electrical connections from the engine to the rest of the vehicle. And when you think about just the amount of content opportunity from high voltage and increased levels of technology, a sub-$200 decremental, and we've netted that out and all the content numbers we share with folks, it's just not an impactful amount.

So just a few questions left here, Joe and Elena. Any milestones or timing of first volume commercial introduction of SVA you want to share? Just kind of those milestones on SVA, and I'll follow up with a similar question on Motional, the Motional time line.

Sure. Yes, let me start, and Elena can go through a couple of the specifics. But we've actually seen a tremendous amount of SVA activity in the first 9 months of the year. We're up to 9 advanced development agreements with various OEs. And we actually had -- and Kevin spoke to it during our earnings call in August, we actually had a 1 OE that sort of skipped the advanced development process and went right to a commercial agreement with us for a central compute platform. Elena, do you want to give a bit of those details?

Yes, sure. So that central vehicle controller win, that obviously will go into production in the next couple of years. Where we are? You talked about domain centralization as sort of the first phase. The next evolutionary step is really breaking the vehicle up into zones. We'll launch our first zone controller. It was a commercial win we had in 2019. We'll launch that next year in 2022. We have a pursuit pipeline that's growing as a result of that significant increase in advanced development program work that we've done this year on SVA. And then we'll see further adds into the commercial pipeline for more up integration of the compute cluster as part of that central vehicle controller.

Thanks, Elena. And any -- you mentioned Motional and the IONIQ. Anything else on Motional in terms of a milestone or upcoming event you want to share?

Yes. No, absolutely. They continue to -- Karl's team continue to do a great job. They continue to hit their milestones from a technology road map perspective. They are -- they have the IONIQ 5 on the road on a test basis today. That will be the platform that launches in 2023 with Lyft. They'll take 150 of those units for a second city. And they continue to make great progress on both the commercial side as well as preparing to move into multiple cities. So I'm often asked, what's a reasonable expectation of Motional over the coming sort of 12 to 15 months and certainly expect that generation 2 of the IONIQ platform, to see that on the roads operating in true Level 4 mode. And then it's a very reasonable expectation for additional commercial agreements that expand both maybe with existing customers, expanding into more cities or certainly adding more customers to the fold.

And kind of going back to the question about what OEMs could do. There clearly seems to be some opportunity for them to in-source. A lot of what you do makes it -- it doesn't make sense for them to do it. And that's part of with the value proposition that you have. But what -- but I'm curious of individual pieces. What would you say in the -- as we move to electric and autonomous cars, what would be vulnerable to in-sourcing. Just for this audience to think about, to be able to compare other portfolios of other suppliers versus yours.

Yes. No, I think you're right. For us, don't see them in-sourcing really electrical architecture, connectors, those types of things. Don't see them in-sourcing big compute platforms or integration. Do expect, over the coming years, that the software delivery, the type of software that a particular OE may take from a supplier, may change. Not all OEs will do the same. But there are certainly OEs that are going to do more of their own software. And much like -- and there's been presence for this in the past, you had a lot of OEs that focused on their own powertrains in the past and used the supply base differently than others. But with OEs that do a lot of their own software, they tend to focus in 2 areas. One, sort of broadly speaking, the entire vehicle software architecture. OEs are the only ones that are actually aware of all the software that comes together in a vehicle and how to manage that and how to maintain that falls to the OE. You have some of the more tech-savvy OEs that like to play a role or like to do software or functionality that they believe is important to their brand. So you may have an OE that wants to do their own highway pilot because they believe how the vehicle behaves on highways supported their brand. They're still relying on us for an active safety system, still relying on us doing something like Traffic Jam Assist, but we'll use their own software for highway pilot. So I do think that's an area that will evolve over the coming years. And like all things -- like a lot of things in the industry, you'll have OEs that need -- don't do their own software and continue to rely on the supply base for much more. But I think, for us, that's really where you'll see sort of an evolving model. But we believe there's -- just given the opportunity for software in the vehicle, given our expertise and systems integration, we believe there's plenty of room for that model and for us to continue to be successful.

Joe, I'm going to squeeze one more in from the audience, and then I got an odd ball question for you.

Sure.

How do you think of a potential Veoneer-Qualcomm combination could change the active safety competitive landscape?

Yes. No, that's a fair question, obviously. I think you've seen a number of semiconductor folks talk about doing more from a software perspective. There are cases where that makes sense. But I don't think you'll see a situation where the semiconductor provider becomes a Tier 1 provider of active safety systems. But I think they are -- Qualcomm's focus has been, as they've said themselves, very much more the Arriver software than those other types of active safety products that Veoneer was working on. So they become a more robust Tier 2. There's a software solution that may come with their chip. And much like I said around the software coming around the OE, we'll work to see how best that's integrated. But we don't see them becoming a Tier 1 providing full active safety systems, full Level 2, Level 3 systems.

All right. You're from Boston.

Yes, sir.

I could -- your accent, it's pretty. It's a beautiful thing.

Hopefully it's not too fast.

What is your favorite Boston rock band?

Favorite? Probably The Cars, going back a little bit. Big fan of The Cars.

Ric Ocasek. Rest in peace. I thought I was about -- I thought you were going to say J. Geils Band. I was going to fall out of my damn chair.

No, no, probably The Cars.

Okay. Awesome. All right. Maybe Marky Mark, Funky Bunch, whatever.

Maybe.

Joe, Elena, thank you so much for joining. A lot more to talk about, and thanks for your questions. So we're going to end it there. This concludes the Aptiv session of the conference. Thanks, everybody. Thanks, Joe. Thanks, Elena.

Thanks a lot, Adam. Take care. Appreciate it.

Good luck. Speak soon.

Yes.