Aptiv PLC (APTV) Earnings Call Transcript & Summary

Good afternoon, everyone. Very pleased to have with us in an audio segment, Joe Massaro, CFO and SVP, Business Operations of Aptiv. Once again. You can click on something on your screen that send me e-mail messages for questions. You can also get me up on Bloomberg, B. Johnson 487 if you have questions as we go along. Joe, I want to start with a couple of questions we've been asking most suppliers, which is just -- can you give us the latest thoughts on the timing of chip shortage as seen easing the volumes for any kind of within that kind of 4Q versus 3Q in terms of both volumes and in particular, choppiness in the schedules? Is that improving? And then kind of your latest thoughts on the timing of semiconductor shortages easing.

Sure. Thanks, Brian. Yes, listen, I think Q4 is certainly from what we've seen, and we even talked about this on the earnings call, we had some visibility into it. It's certainly better than it was at the end of Q3. From what we saw August, late September, in particular, became very choppy. A lot of disruption in production schedules, primarily attributed to COVID lockdowns in Southeast Asia, which particularly for the semiconductor and electronics part of the supply chain, is a big area for some of the back-end testing, some of the final assembly and packaging. So that was very disruptive. We're still obviously operating in a constrained environment. But I think Q2 or Q4 is more like sort of what we saw in Q2, that May time frame than what we were seeing in September. So relative improvement from Q3, but still a constrained environment. We -- if you look at sort of -- what the midpoint of our guide, we're assuming vehicle production for the fourth quarter of around 19.7. So a sequential improvement over Q3. And that's very consistent with where we were on the -- where basically where we were from -- on the earnings call as well. No real change there.

Okay. And in terms of the broader -- beyond chips, are there other parts of the supply chain that are a risk for you?

I think I'd probably put risk into 2 different categories. One, the inflation or the cost side of things as a risk versus the constraints. The majority of our constraints have been on the semiconductor and to some extent, the passive electronics that go with semiconductor, but primarily on the chips themselves. That has been the most constrained part. There were some intermittent constraints around things like resin and copper strips associated with the flooding in Germany and Belgium. But that was -- that sort of came and went almost as a normal supply chain disruption. There was some bumpiness for a couple of weeks. We readjusted sources. We pulled from some distribution and got through that. So the systemic shortage has really been around semiconductors. On the inflation side, same cost increases in a couple of areas but primarily semiconductors and resins. And those are really the 2 big areas for us. Our metal spend outside of copper, which we obviously buy a lot of, but have a pretty effective pass-through mechanism from a price perspective, are -- our other metal spend is fairly small, less than $100 million for things like steel, magnesium, aluminum, just given the shift we've done in the product lines over the last couple of years in the portfolio, don't have a lot of exposure to that. So exposure to something like magnesium or aluminum for us would be much more indirect, meaning if it impacts our customers' ability to produce, we could certainly be impacted, but it's not a direct impact where we're not able to procure something we need in those particular commodities.

And as you think about -- well, a couple of things, a couple of the smaller electric truck suppliers flagged wiring and connector shortages as an issue in the last quarter. Is that something you saw? Or is that something kind of unique to maybe other suppliers in the CV connector marketplace?

Given the size of our connector business, we obviously supply a lot of our own connectors in addition to selling to third parties. So we may have some insulation from that. There have been periods of time where connectors from other providers have been tight. Some of that, I think, came from the weather event in Belgium and Germany that I mentioned that really impacted the connector supply chain, things like copper stripping, copper strips that go into connectors. So certainly not at the level that we've seen in the supply -- the semiconductor disruption, but there have been periods of time. We've actually been able to offer some of our key customers are our own solutions where we had availability to displace other connector providers. That's something that we -- what to do as part of our normal sales and sourcing activity, but there were a couple of instances over the past 4 or 5 months where we were able to help customers out by bringing in our own product that we had availability to. And the team did a really good job of responding to the -- to that constraint. So I think we were able to get ahead of it pretty quickly.

And I guess on the bigger picture side, and then I kind of want to go into chips and software in more detail. But as we think about just the broader inflationary pressures that appear to be out there, whether it's energy costs, shipping costs, wage rates, just general inflation other than just the index commodities like copper, where there, you're well indexed. How are you thinking about the broader inflation that might not be tied to mechanical pass-through cost. How much room do you have to offset those? And at what point do you have to sit down with OEMs? And how receptive will they be to the idea that the old 2% to 4% priced down formula in an environment where general deflationary over the last couple of decades, combined with lots of lean manufacturing opportunities across suppliers and OEMs, that we may be kind of at the tail end of the cost saves and inflation picking up. So how receptive are OEMs going to be to kind of broader inflationary pressures that are right now being felt by the suppliers?

Yes. Listen, I don't think we'll ever be in a situation where people are overly receptive to cost going up obviously. I think there's going to be a lot of pressure throughout the supply chain, including ourselves down and obviously, from our customers to figure out ways to offset where, as Kevin has mentioned, I think on the last earnings call, we're well into over 100 redesign initiatives. We're either looking to take costs out of BOM or identify alternative sources for products to give ourselves a little bit of additional leverage from a supply base perspective, particularly around chips where the industry, not just Aptiv, but the industry over a number of years has found itself concentrate -- with a concentrated position where maybe a particular type of chip or a particular technology comes from 1 supplier. So obviously, you don't have a tremendous amount of leverage when it comes to price negotiations. So I think there'll be a lot of engineering activity that the customers are generally very supportive of. But we are going to wind up in commercial discussions where some of these cost increases are going to have to be put on the table. But it's still early days for those discussions. Kevin has obviously talked about it as well. But there is going to have to be a look at overall -- the overall sort of commercial balance. And I do think price downs at some point will get factored into that conversation, particularly for situations where the OEs have a directed buy where they're telling the tier ones to buy a certain number of products from a supplier where we don't necessarily have the flexibility to design out. We'll start to get after those. And then we're going to have to figure out as well a lot of folks in the industry, how to have continuing operating improvements to help offset those or other cost offsets. So it's -- I think to your opening question, it's getting harder. There's a lot of work to do on it, but it is something the industry is going to have to -- including Aptiv is going to have to work through.

Okay. So let's go on to kind of 2 developments, both relate to the role of you as a very value-added Tier 1 in terms of software and in terms of electronics. So let's begin with the software and then I want to kind of also talk about the chips. The software is turnkey to both ADAS and AV. It's key through the electrical architecture, recurring revenue opportunities, which does require your software-defined vehicle architecture. So I don't think there's a big debate that software is important in the next generation of light vehicles. The real question is between the new entrants who largely want to be vertically integrated,around their software, the legacy Tier 1s who, to varying extent, want to write the software themselves. If you think about Volkswagen and GM in that category. And at the other end of the spectrum, sensor companies like Luminar and others we're hosting today kind of moving up, and chip companies like NVIDIA, Qualcomm, moving up from chipsets or sensors into big Luminar sensor fusions in software. So how does Aptiv fit into that? What's your view on how this dynamic plays out? And how do you preserve that kind of very real value-added role versus as you have OEMs trying to come into software and sensor and chip companies coming up in the software?

Sure. One, I think it's, first and foremost, reflective of just the view on how big the opportunity is in software over the next, call it, 5 to 10 years in automotive, right? It's going to be an expanding TAM. There's going to be a lot of opportunities to monetize, what I'll say, across the -- across that software stack. We think we're very well positioned. We're obviously, to your point, when you think it's something like active safety or the big domain controllers, eventually SBA, we're well positioned as obviously the starting point being the integrator with a strong legacy of integrating complex systems and bringing the SoCs into the vehicle in a way that's efficient, in a way that's certainly auto grade, and that role will continue. But that's really just the starting point, I think, for us over the next few years. And there's a number of opportunities we see where we can play in and be successful in monetizing parts of the stack. Certainly, when you think about some of the feature set, things like sensor perception, radar algorithms, the ability to fuse radar and vision. Those are strong software capabilities that we've had in place for years. They're well understood by our customers. They've been integrated into a number of systems. They're very efficient from a capability and a cost perspective. And we obviously see opportunities to not only continue that but expand it. And that's part of -- whether that's part of our full Aptiv safety system or on sort of one-off opportunities to capitalize there. I think we'll be growing opportunities in other parts of the software stack, whether it's the cloud enablement through OTA, whether it's the ability to go down from the feature set to what I'll call sort of that middleware and operating system. So as we look out on both our organic road map as well as where we think we could get through some inorganic opportunities, we think it's a big TAM. We understand there's going to be a lot of people playing for it, but we think we're very well positioned to continue to capitalize on what we do. I think from a customer perspective, you're absolutely right, you're going to see some customers want to do more on software, they'll invest. They'll spend money there. Some of them will be successful. I think we're also going to be in a situation where you have other OEs who know they need a more software-enabled vehicle aren't in a position to invest and rely more on the supply base. And I think we're very well positioned to provide them the type of software and capabilities that they'll need over the next 5 to 10 years. So it's certainly a growing area. It's one we're very focused on. But have a really good -- are in a really strong position to continue to leverage those capabilities.

Well, let's drill down on a few of those. So GM, we just had Mark Reuss on the line. He described GM's -- 1 way they're going to deal with chip shortages move to 3 large domain controllers. So it's obviously an OEM, and I'm just making them as example, who has adopted the thesis, the fundamental thesis you have around smart vehicle architecture, the one we hear about CES related activities every year. But the question is because -- the question I get from clients is, if they're doing that, how -- whether it's GM or another company going down that route, how can we get comfortable that Aptiv hasn't just educated them, provided a lot of thought leadership, but ultimately doesn't come away with real content coming out of those very large-scale transformations at very large OEMs towards exactly the kind of vision you've been outlining for years.

Well, listen, it's an understandable question. I mean, clearly, I think there is a -- and currently have 9 advanced development agreements with OEs on their -- helping design their smart vehicle architecture, their next moves into architecture. We actually have a commercial award with a Chinese OE on building the first big -- and designing and building the first big central processing unit that's going into their version of smart vehicle architecture. So there's clearly an element of, from an industry perspective, needing to help advance the technology to a point where it is commercializable and deployable. And for something that is as significant a change as smart vehicle architecture, there is collaboration and education that needs to take place. I don't necessarily think that becomes a block to helping execute and deliver on that technology, right? And typically, what we've seen, and this has worked for active safety, it's certainly working for high voltage. The customers that become the most comfortable with technology, advanced technology including developing some capabilities on their own tend to be the customers that are first to deploy it. And so I think we've -- if you look at what we're strong at, particularly from a brain, nervous system perspective, our capabilities to take the customers' desired architecture, design it, help them develop it and then commercialize it in such a way that it is scalable across their platforms, it is scalable at high volumes, that integrates with the existing systems in the vehicle, some of which will come into the SBA fold slower than others. That's really a key strength of Aptiv's. And so I do think there's an element of the industry needing to get comfortable with the technology before it gets deployed. OEs aren't going to put black boxes, if you will, in their vehicles that they don't completely understand and get comfortable with. So I think that evolution is a natural part of the path to commercialization. And they're very complicated systems. If you look even right now in our Level 2+ active safety systems, we'll have that type of content out with 20 global OEs by the end of 2022, right? So clearly well credentialed and the ability to just not envision it and just not design it, but then go and implement it effectively and develop it effectively is a core strength of ours that I think applies to SBA.

Okay. Well, let's talk about ASUX where really we have 2 trends going on that -- well, 3 trends talked about. So one, first question is with your focus on sensor fusion, there, where do you see adoption going in Level 2 plus and Level 3? There have been some delays in Level 3, but now we're seeing whether it's a Nissan ProPILOT or Hyundai pilot assist. A lot of Level 2+ systems going on. Where do you see penetration going? And then I want to get into the software and hardware volume to play there.

Yes. For us, I think you're right. We have seen -- and we talked about this last year, certainly, Level 3, in any meaningful way, sort of get pushed in from that sort of 2024, 2025 time frame to sort of 2026 and beyond. With that said, we've got a very strong position within Level 2, particularly in our satellite architecture awards. Our view is that Level 2, 2+ penetration in 2022 is only about 20% of vehicle production. So there's a lot of room to run there. So the pushback of Level 3, obviously, gives us more opportunity to not only deploy additional Level 2+ systems, but gives our systems that are in the field today, are being launched today and early next year, a longer run time. So we feel very well positioned there and I think you're going to see -- continue to see the outgrowth coming from a Level 2 penetration that not only starts to take up the Level 1 penetration that we view as at about 40% for 2022. But also that 40% of the market that at this point really has no ADAS, right? So we see that as a continuing strong trend for the next number of years. There's a couple of things driving that. Active safety is sought after by end users, by the drivers of the vehicles. It tends to be very sticky, meaning people expect the car they buy today to have as much, if not more active safety content than the vehicle they may have purchased or leased a few years back. The other thing that we're seeing that we think provides additional tailwind to the Level 2 business is the battery electric vehicles that are coming out are highly contented from a technology perspective. They tend to be targeting, Tesla tends to be the benchmark, whether it's the S or the 3 depending on the nature of the vehicle. That tends to be the benchmark. Those cars are obviously very highly contented from a digital cockpit perspective, from an active safety perspective. So the BEVs themselves tend to bring with them a fair amount of additional technologies. So don't view the pushback of Level 3 by a couple of years as something that's going to meaningfully slow down the growth of Level 2 or the penetration of Web 2 into platforms that today don't have ADAS or that just simply have a Level 1 type system.

And again, kind of how, in particular, in Level 2+, Level 3, how is the interplay between OEMs wanting to do sensor? And chip makers, whether it's Mobileye or now going forward perhaps Veoneer, Qualcomm combination moving up? And where does that leave Aptiv?

Listen, certainly, from an existing system perspective, what's getting deployed over the next couple of years, we've won that work. That is our -- those are our systems on a -- with the Mobileye vision system. So obviously, in the -- the rollout of the bookings over the next couple of years, we obviously feel very well positioned with the technology we have. You're certainly going to see others come in from a vision perspective and look to take share as you go into Level 2 and Level 3. We're certainly looking at and remain -- and continue to have the ability to work with others from that perspective, using our radar, taking our sensor fusion technology to others. So again, certainly from a nearer-term revenue perspective, let's -- feel very comfortable obviously with what we've booked and the technology that's underlying that. And as we go forward into more advanced systems and ultimately, Level 3, have the ability to integrate really the customers' desire their choice of SOC and their choice of vision solutions.

Okay. And then the other thing is the OEMs are -- one thing they will say they've learned from the chip shortage crisis is the need to understand their supply chain and to build direct relationships, including sourcing and pricing relationships with semiconductor manufacturers. So if they're doing that, it essentially becomes kind of a directed buy. What threat or opportunity does that pose to particularly your ASUX margins?

Listen, I think there's a lot of discussion there, and there's a lot of view on what types of chips or semiconductors would fall into that relationship. I mean certainly, if you -- and so I think it's a bit more of a specific answer. Certainly, if an OE is looking at designing, developing, investing in a dedicated SoC and wants to work with a chip manufacturer or a foundry provider or a wafer provider, there may be an opportunity for them there. When you think of the types of chips we're buying, the imaging chips, the video serializers, the types of things that go into the radars, into the cameras, into that technology we're deploying today. We obviously have a tremendous amount of buying leverage, right? We're buying -- as I mentioned earlier, we're buying product for -- across 20 OEs, that type of technology. So it remains to be seen the nature of the chips that the OEs would source on themselves. Obviously, we're under contract to get our volume from our semiconductor providers and again, leveraging our global spend. So I'm not sure if you're really looking at an OE who has a better value proposition to take their portion of that buy and leverage that across 1 particular semiconductor player. And certainly, there will be -- you've seen Tesla do it with their SoCs. Certainly, if it's a dedicated type chip and they want an individual relationship, then you could see that happening in certain cases. But obviously, from a cost, from a leverage, from a quantity perspective, I think the Tier 1s remain very well placed to provide a lot of volume to the semiconductor suppliers and leverage that volume across -- really across the industry, just not across 1 OE.

So kind of boiling that all together, what's the implications for ASUX margins. They've been doing 12% mid-decade. It's hard to sort out investment, cost pressure, price pressures. But what's the midterm margin outlook for ASUX?

Yes. In 2019 at the Capital Markets Day, we talked about sort of 2023 and beyond being in that mid-teens level. I would tell you the product line performance, the growth in active safety, the new technologies that are coming out in user experience, those continue to be on track. Certainly, what has developed since then is the inflation in some of those underlying commodities that I talked about earlier, that $195 million. And I think to be able to reach those sort of mid-decade margin targets we talked about, we obviously have some work to do to work through that inflation. But certainly, the growth, the bookings, the customer diversity that sort of underwrote that margin thesis back in 2019, all of that remains very much intact. And quite honestly, on the high-voltage side from a product line perspective, obviously running well ahead of -- that was on SPS, but running well ahead of where we were in 2019. So it's continuing to balance the growth, the attractiveness of our product offering to the customers. Continue to see strong bookings in ASUX and then working to offset at inflation over the coming -- what Kevin talked about on the earnings call being sort of over the coming 4 to 6 quarters.

Okay. And I know you're not really doing '22 guidance at this part. But I think the key question, midterm continues to be the growth over market framework. The 6 to 8 points is your longer-term multiyear guide. Is that a reasonable baseline to think about '22, especially because you're coming off about 1,700 basis points year-to-date.

Yes. Growth over market has certainly been choppy in the past 2 years with the COVID stuff starts and then with the impact on production of the supply chain constraints. Obviously, it's been strong. I think part of that is the model mix that's coming from customers' decisions and what to build when there is a constraint. We remain highly confident in the 6% to 8%. The question we often get for 2022, and we evaluate this on obviously, as you'd expect, on a regular basis. Certainly, as we look at it for 2022, what we're working through right now and the question we often get is, could you be above the 6% to 8% in 2022? Or what would it take to be above the 8% in 2022? And I think for next year, it really comes down to continue to see incredibly strong growth in high voltage. Do we see strong growth or very strong growth in high voltage? We obviously you're seeing very strong growth now. We've got almost $1 billion in high-voltage revenue. We expect to grow at about 40% next year. 40% to 50% really over the next couple of years. And then to what extent does this model mix continue? And that's really where we are from a planning perspective. As we talked about in the earnings call, typically, this time of year, we have a view on vehicle production for next year. But just given the level of disruption and lingering impacts of these supply chain constraints into 2022. We're not as far along with the planning process with our customers. So hard to go into detail in 2022, but still remain very confident in the 6% to 8%. And have not seen any elasticity in terms of that outgrowth contracting as vehicle productions come down. So it's really a question of how strong does the model mix remain into next year and to what extent we continue to see high voltage. And the only other thing, Brian, I'd comment on there is where -- even if you were to see that sort of plus 10% come back down closer to that 6% to 8% or within that 6% to 8% range, we don't see anything that's slowing the growth of active safety or high voltage at the product line level, right? There'll be more cars with active safety next year than this year. Always continue to put that technology into vehicles for the reasons I talked about earlier. What you may see that will sort of impact the math on that growth over market is more lower contented vehicles produced overall in 2022 versus 2021. So even if we talk -- even as we talk about that number potentially coming back to within that range, it's not reflective of a slowdown necessarily in those product lines. It's more reflective of those lower contented vehicles, the 40% of the vehicles I mentioned earlier that don't have an ADAS solution. Those vehicles being a greater percentage of the vehicle build, not necessarily impacting what our customers are taking from us.

Interesting. So it could go -- so we shouldn't extrapolate because there's a lot of mix in the 1,700 basis points year-to-date. Moving on to kind of close it out in the last few minutes on capital allocation. Our model has you ending net leverage ratio of 04x. Clearly some room to make -- move up. And first, I want to talk about the M&A opportunities then, of course, share repurchase and dividend. With M&A, how is the pipeline looking? In particular, a few things around that, would you be looking at automotive only or are you looking at assets that continue the multi-industry expansion? And related to multi-industry, some of the multi-industry peers is not necessarily competitors, but companies you like to benchmark, the Rockwells, for example, have been -- most of the M&A budget we're seeing in multi-industries going towards software and IoT-related things. So is there something along those lines around software that you could be looking at?

Yes, absolutely. I think from a cash on the balance sheet perspective and the sort of a balance sheet capacity perspective, clearly, targeting M&A, our long-term view of capital allocation, which we have a great track record on hasn't changed. But certainly, the immediate use of the cash in the balance sheet will be to augment our existing capabilities, our existing technologies through M&A. I think you'll see us very much do what you've seen us do in the past, sort of pre-COVID, which was a balanced approach, investing in both businesses, the SPS and the ASUX. In SPS, you'll see bolt-on transactions like HellermannTyton, like KUM, like Winchester that bolstered the interconnect business, gave us end market diversification, to your point, into CV, other harsh environment, industrial applications, geography or sort of product line expansion. And we've gotten very good at those types of transactions. We've been able to drive the synergies as appropriate and the revenue diversification, which has been accretive to our growth and to our margin over the last couple of years. And we'll end this year at closing 15% of our revenues being not tied to light passenger vehicle sales, which if you go back 10 years or so, that number was in the mid- to high 90s, right? So just -- we love the automotive business. We're obviously very good at growing above vehicle production, but some diversification, we think, just provides for a healthier overall business. Certainly, on the software side, we think there's a lot of opportunities. We've got a very good organic technology road map in our key product lines. But we think there are opportunities out there where we could significantly enhance our time to market or our overall product offering and particularly around software capabilities. Those are certainly opportunities that we're looking at. From an overall funnel and activity perspective, I would say we're back to pre-COVID levels. That world really shut down in February of 2020, as we've talked about. But we think there are a lot of opportunities there, and the processes have certainly started back up. Travel has become a lot easier to most places of the world, the least and certainly the places that we're interested in being and talking to folks. So we remain on track with that. Obviously, it's hard to call the exact timing for some of those opportunities. But from a strategy and intent perspective, nothing has changed there.

Okay. Great. And then finally, just to close it out, share repurchases and/or dividend. Any kind of preliminary views on when either of those capital allocation activities could restart?

Nothing to update. We're certainly -- like I said, we've got a great long-term track record, no long-term philosophy change there, but very much focused from a capital allocation and deployment perspective on investing back in the business, both organically and inorganically, and in part driven by what we spend a lot of time talking about, just the success of those product lines and driving that above-market growth. And we certainly think that investment in the business along those lines is very much warranted at this point.

Okay. Great. Well, thank you very much, Joe. I appreciate the conversation and look forward to keeping the dialogue going, perhaps in-person in Florida, where we usually host Aptiv in February.

Yes, we will be there.

Okay. Great. And thank you very much. Have a great close to the year.

Great. Thanks, Brian. Appreciate everybody's time. Thank you.