Aptiv PLC (APTV) Earnings Call Transcript & Summary

Welcome to our next presentation. From Aptiv, we have Chairman and CEO, Kevin Clark; and CFO and Senior Vice President of Business Operations, Joe Massaro; and the Investor Relations team representing the company. Thank you so much for being here. This presentation, please, before we can kick off, go to morganstanley.com/researchdisclosures, for important disclosures and any questions, reach out to your Morgan Stanley salesperson or contact. Kevin and Joe, thanks for being here.

Well, thanks for inviting us. It's great to see everyone face-to-face in a while.

It's good to be back. It's good to be back. Exciting things going on in your industry. We're going to try to tap into it and please I encourage our audience participation, but I just want to give you an opportunity at the top for some key messages. You had a pretty tiny little acquisition that you have announced that I think fits very well in the portfolio. But if you want to touch on that? And then any key developments since 2Q results that you want to highlight?

Sure. So maybe taking a step back, I would say myself, Joe, the management team, as you think about Aptiv and you think about how we're situated from a portfolio standpoint, market standpoint, safe, green, connected. We'd say we've never felt better about how the business is positioned. And it's reflected in our recent bookings over the last couple of years, in our revenue growth, in our growth over market. So in terms of how we're competitively positioned, very excited about the opportunities. Obviously, the industry and Aptiv -- industry broadly and Aptiv specifically is dealing with supply chain challenges, inflation challenges, COVID challenges. So I'm sure we'll have a question or 2 about that. We're working through that extremely, extremely well. There's a lot of progress that we've made. There's more progress that we need to make. You'll see a lot of that reflected in the back half of this year and how that plays out from a margin standpoint in both segments and then how that positions us for 2023 and beyond.

You are one of the few companies in 2Q earnings season that really called out European production and alluding to more than just supply constraints that were affecting Europe. Is that panned out so far in line with your expectations? It seems like just talking to my European colleagues there, like every 3 weeks, they could buy, it's kind of like pick a number like it's not even cutting numbers because it's just -- its pointless, it takes too much work. But -- where, how that particular situation goes?

So we operate off of vehicle production schedule. So what we reflect in our guidance reflects the information that were provided by our customers. So we don't use third-party sources as it relates to our forecast or developing our business plan. We use that as a -- to provide some sort of conceptual framework relative to what we're experiencing with customers. So I would say the market, Europe as well as North America and China are playing out exactly as we thought they would play out. And nothing new to update anyone on at this point in time. Joe, if you want to add anything to that?

No. I think from early August earnings release, again, as Kevin said, very consistent with what we've seen.

In terms of supply chain, if I were to give you a scale, bear with me here, 1 being pre-COVID normal just-in-time working more or less like in orchestra and everything is great. 5 being the worst that the production bottlenecks were, the worst of the chip crisis, the worst of the logistics from the COVID related, where are we today?

2, 2.5, so it's better -- it's certainly better. It continues to get better. There remain constraints, and we're operating through them in the back half of this year that certainly is impacting vehicle production. So that's where we sit today. As we look into 2023 and 2024, it will continue to get better. But there will be certain areas, certain nodes, certain semiconductor suppliers that are -- that will continue to have some constraints that will impact the industry.

Very few companies that I've been talking to have really wanted to -- whether they're seeing it or not as one thing, maybe they don't see it yet, but no one's really ringing in any bell on demand concern. It's all -- I'm kind of broad brushing this. So just supply is still an issue getting better. Demand looks great sold out to the end of the year, everything's fine. Europe watching situation carefully. Kevin, between supply and demand right now, looking 12 months out, what kind of -- and again, you don't know when you don't know, but what would you do a bit more concerned contingency planning?

In terms of...

Supply or demand? Is there anything on demand that you're seeing that's outside [indiscernible] what you got right here with the schedule?

So we'd say a little bit of both. So we watch -- we would watch Europe very closely. We think there is some demand-driven impact on current schedules that we're seeing for the back half of this year. It's tough to completely bifurcate how much of that is specific demand versus supply, but we think there's some. We're watching Europe very closely as we head into 2023. Again, supply chain remains tight. The issue you have, if you have a COVID issue in parts of the globe or you have a supply chain issue, you tend to have a compounding effect on the overall supply chain and availability so that can have an outsized impact. So that's something that we're watching closely. So I think we would say it's a little bit of both to be very transparent.

And I was going to ask about bolt-on M&A and then you announced just yesterday, Intercable. It gets you closer to the battery, it gets you closer to certain parts of electric vehicle architecture where you were adjacent but kind of built some capability, obviously. It seems like there's not only revenue synergies and know-how, but also some cost synergies over time. But want you to give us a bit of sense of when that develops and what it means to business.

Sure. So we announced yesterday the acquisition of 85% of a company called Intercable Automotive Solutions. They are a high-voltage interconnect connector business from Italy. They're up in Northern Italy right along the German and Austrian border up. It's very nice. It's a nice part of the world.

It's not a cheap place to me.

It's a very nice part of the world. They actually manufacture in Slovakia. So they are headquartered in. It makes sense. Their engineering is really there. But I'd say it's a business we've known for a while. We've bought some products from them for a couple of advanced development agreements. We've seen them displace much larger interconnect companies on some key German OEM high-voltage platform. So we had a good sense of what they are capable of, but I got to know them over the course of the summer, there are about $250 million of revenue, traditional sort of interconnect margins in sort of that 20% range. Growing 30% per year, and we expect that to continue for the next couple of years. Very consistent expected growth rate with our high-voltage business, which this year will be about $1.2 billion. And Adam is absolutely right. If you think about where our high-voltage portfolio places us, we really distribute power from the battery throughout the vehicle's high-voltage system. So connecting to the power electronics, the motor, the safety disconnect systems, those type of systems that are on high-voltage vehicles. That's traditionally where we've been, and we've done a great job of growing that business. This places us on the battery. So they've got great, what I'd call a modular busbar technology, so interconnect combined with busbar, very efficient at managing power off the battery, great thermal profile as I said, have won a lot of work with some large sophisticated European OEs. So it's a very complementary product portfolio. They've got a small operation in China. They started up right before COVID. We're going to be able to help them grow that and accelerate that growth. And then we'll be helping them move into North America, where we obviously got a very large presence from an electrical architecture perspective. They have yet to get there just given the size of the business and sort of what they were managing. So a lot of synergies and a great fit from a portfolio perspective.

So just on M&A, I mean, your team has really a stellar proven track record on M&A. You're very selective when you make decisions, you're very decisive and strategic about it, not just bringing a business where you have the confidence and line of sight of expressing synergies, but something that kind of leads the industry. It almost suggests like, I'd like to use the example, over a decade ago when people were like cash flow, what a joke. And you guys and Glen were like we're going to do business with it, really, whatever. You just have that foresight, right? Then it was the Wind River. Now before we go in further on Wind River, what's the timing update? When does this thing close.

We're going through the regulatory process. We're targeting this year. So...

Okay, all right. We'll move on that. But like investors are split on this one. And it's easy to kind of pick on finding in hindsight where the market was. For the skeptics who think that you mistimed it or that say that it contributed to some margin -- sorry, multiple contraction. Remind us the examples of the strategic importance of this business, what it enables you to do with OTA and connect the business that just would have -- if you didn't do it would have -- can you either longer or cut me out.

Yes. So listen, when you think about the big opportunity within automotive, it's clearly in and around software being one of the big pieces. And obviously -- and some of these are very public, as an industry, our industry struggled with software on the OEM side and in some circumstances on the supply side. What does Wind River give us? They've operated for 40-plus years. They're on millions of different units in and around operating systems -- real-time operating systems for mission-critical solutions for things like telecom, like aerospace and defense where the operating system needs to be secure. It needs to be regularly secured, and it needs to perform at very, very high levels. So problems in those industries that Wind River has addressed from a software development standpoint, a new management team that came in and really focused on how do they take that position within the operating system? How do they add to it a tool chain so that buyers of the Wind River operating solution can develop software much more efficiently, can operate the unit that has the software in a much more productive way so that it can enable life cycle management, like you see on a Tesla sort of vehicle? And then there's a regular opportunity to upgrade, enhance and generate recurring revenues. A big piece of the solution that we provide, whether it's ADAS user experience is clearly -- is clearly software. And we see firsthand the challenges that our customers have, and a lot of that is in and around and starts with -- you look at middleware, middleware across multiple domains and then building the software stack above that. And given the fact that Wind River has addressed those challenges, in other industries that had mission-critical systems where systems have to perform. Given the fact that they've developed a tool chain that makes software development much easier and allows customers to operate those systems real-time and provide life cycle management, which every one of our OEMs is looking for, not installing software on a vehicle today and then it rolls off the assembly line, and you never see it or touch it again. The fact that they've solved that in other industries, we thought it's -- we strongly believe it's perfectly positioned to bring a tremendous amount of value into the automotive space. And on top of that, in the spaces they operate today, telecom, aerospace and defense, they've made a lot of progress and captured a lot of revenue growth in those spaces as well. So those are areas of opportunity for growth, and those are technologies that we can bring into the automotive industry.

Thanks, Kevin. I'm just going to give the audience a chance here. Please think about it. Okay. I'll come back to you. EV sales are up about 70% year-to-date globally and in most markets. Remind us the margin differential. I mean, these things are starting to scale now. So like if we're having this conversation kind of pre-COVID you would ask -- you can get the question all the time, you still do. Is there a margin sacrifice in your high-voltage or even in your ASUX stuff on EVs versus ICE to getting -- because of the timing of the development costs, et cetera, or lack of scale or ability to scale later. Now we're starting to get into scale, particularly with some of your customers like a Tesla, really, really high scale for SKU. What's the kind of latest in terms of parity or premium of the EV exposed business versus ICE.

Yes. No. Our high-voltage business in part because we're leveraging a very substantive low-voltage business on the electrical architecture, where we have content calling on 1 out of every 3.5 vehicles manufactured globally. So big business, big base to build off of from a manufacturing footprint, engineering supply chain. So that business got out to a very good start from a margin perspective, right? We typically say our product lines have broken even between sort of that $500 million and $1 billion of revenue. This business was effectively profitable from day 1, just given the ability to leverage the infrastructure. We're going to finish this year at about $1.2 billion. It's growing above 30%. Life to date, we've booked over $4 billion of high-voltage business. So we've got a nice trajectory to continue to see that 30% growth. This is before the acquisition of Intercable and the high-voltage business is now accretive to the SBS margins. So it's accretive on a growth basis as well as a margin basis. Again, part of that is being able to leverage the infrastructure. The other part for us, particularly when we're able to deliver a full system, a high-voltage electrical distribution system has about 50% cabling content, 50% connector, low voltage by comparison, 70% cable, 30% connector. Connector margins, interconnect margins are roughly 2x what we have on the cable business. So it's an inherently more margin-accretive product just given how it's designed. You tend to have lower or shorter cable runs, you get a lot more connectors because of things like the safety disconnect systems that I mentioned earlier. So high growth and accretive from a margin perspective.

Moving to ASUX. In 2018, business was doing about 14% margins, and this is adjusted for like amortization impairment. It was 11% in 2019. I think mid-single -- now we're talking mid-single digits thereabouts. So we had on much, much higher revenue. So what's going on in that business? And if we're getting higher scale. We're in many billions of dollars of revenue. What's the plan? Because it seems like that the -- there is the huge opportunity, not only to contribute to growth, but I think also to maybe get some of the multiple back if you can show that that's turning around.

We'd agree with you. Joe do you want to walk through...

Yes, I'll start and then Kevin can jump in. So if you look at that sort of '18 to '20 time period, early '18, '19. And we were very overly disclosed this. We put some investment back into that business. It was growing very fast. It had reached, to Adam's point, sort of a low teens profitability range. And we looked out and saw our opportunity to accelerate growth. We saw some really big bookings opportunities in sort of that 12- to 24-month period. And the business, we needed to reinvest some of the profits in that business to continue to -- to be able to capture that growth. And that's worked out very well. If you look at this year, we've had some very large bookings for our SVA, our centralized architecture, whether it's a central computer, the zonal computer. And last quarter, we secured nearly a $3 billion lifetime revenue booking for the next-generation active safety system for a global OE. So that was some investment we made sort of eyes wide open to go after that business and it's worked out. More recently, really for that business, what we're dealing with is significant impact of material cost inflation, right? So we're dealing as total Aptiv about $500 million of direct material inflation that we're in the process of passing through to customers, obviously, a very significant number. About 70%, 75% of that is related to semiconductors. And the ASUX segment, it takes about 90% of the semiconductor spend in the business. There's some semis that go into connectors, but the bulk of that spend. So we're pushing those prices through. As of the time of the earnings call of the $500 million, we had $400 million agreed to with our customers. We're in the process of contracting that. Some of that this year is retroactive from the first half, recoveries of things that were shipped. But as we move into next year, our expectation is that's priced in as piece part and you start to see the recovery. You'll start to see margin recovery in that segment in the back half of this year, but you'll start -- you'll see it next year as well.

If I ask another version of the question the 1 through 5, 5 being the worst of the supply chain tightness, 1 being normal or free the madness and specifically for semiconductors. Is that -- where would that rank from semiconductor supply constraints.

Specifically -- roughly 2.

Okay. I mean, is there a potential to get some relief there if that market could be sufficiently if not oversupplied.

We'll continue to see improvement. We think it's a few years before it's oversupplied to be very transparent, especially on the automotive side.

Got it. Kevin, Joe, what your thoughts on IRA, even just tangentially your initial thoughts on what this might mean for either EV adoption or obviously, it's designed to create onshoring, but I'm wondering if that onshoring could drive moves that could be temporarily inflationary for EVs and maybe early adoption because you now put China in play.

Our view is medium to long term extremely positive. Very, very positive. So we think it will drive more demand near term. There could be some constraints for few of the OEMs who operate here today.

Would you buy into the hypothesis, unprove them that it could drive pull forward of internal combustion sales, and particularly with the states that they're outlying in? Or is that kind of...

I don't know.

For your portfolio, it may not matter so much. So capital allocation, minus key priorities there, any changes in -- given current environment or interest rate environment. Obviously, we're seeing where you are in M&A now kind of post assuming Wind River closes and you do Intercable kind of tell us what your targets are in terms of credit rating and leverage and kind of use of cash.

Yes. No. We -- obviously, we've done a very good job over the last couple of years, I think, of taking advantage of the credit markets sort of prior to the end of the first quarter of this year. Over the last couple of years, we've moved the average tenure of the debt from 7 years out to almost 18, that are a number of 30-year debt offerings as part of M&A as well as normal refinancing. So we've gotten ourselves capital search, I think, in a really good place. We went to market very early. We went to market in February when things were still relatively very good for the Wind River funding. So that is in place and that combination of 10- and 30-year debt on that deal. So we feel like we're in a very good place. We'll obviously our intention is to remain investment grade. We have a very good relationship with the rating agencies and a good track record of ticking up a bit related to M&A and then sharing with them our plans to work that down back to that, call it, 2 to 1 level where they'd expect us to be. So very confident we can continue to demonstrate the ability to do that. And like I said, they've been very accommodating in terms of how they view us and how they view the track record.

Yes. I mean, to be clear, our focus is on investing in profitable growth opportunities, whether that's organic or inorganic, obviously, within the framework that Joe talked about.

Emotional -- I mean at the time you've created -- contributed your assets and nuTonomy and working with Hyundai, I mean this has made a lot of sense culturally to kind of -- for transparency and just for the maturation cycle that technology being potentially very, very long dated. It seems to me that that type of problem solving that type of issue of fully autonomous in a business that it can actually scale. I mean it is one thing putting some investors in our city and saying, "Hey, look, it works through blunt force the way Tesla describes versus saying here that really can scale. Give us a progress report on kind of when we could really see this any appreciable scale. And when can we experience it -- when are our next experiences? You've obviously done a number of experiences and kind of what's the outlook? Because it does seem like there's some clock and they ask you all the time, when is it going to need more money and it doesn't need it right now. But in a year, it might be a different discussion.

So I'd start with the joint venture. So we would tell you we picked a perfect partner in Hyundai absolutely perfect partner and I agree. And we had discussions with multiple folks out there that are -- that have a lot of notoriety from an OEM standpoint. They bring forward a very forward-looking view on the automobile, specifically transportation more broadly in the role of autonomy. They're very, very supportive of the joint venture, not only from the cash they put in, but in an ongoing support of how do we mature the technology? And how do we use their capability and how that goes on the car, how we do it the most cost effectively possible. And then lastly, they're very focused on value. So our business model is about the -- having the software stack, the AD software stack for sale to OEMs or to other providers in maximizing the revenues and the customer breadth there. They're very aligned. This is not about how do we keep it within the Hyundai family. It's about how do we drive value. From a tech road map standpoint, the team is doing extremely well. You'll see a fully driverless vehicle on the -- in the Lyft network in Las Vegas in 2023. You saw the announcement with Uber and Uber Eats in Santa Monica. There are several other commercial initiatives that they're working on that we'd expect to see announcements in the coming months. So a tremendous amount of progress. The vehicle -- the Gen 2 vehicle that's being developed and launched now is the Hyundai IONIQ 5 and the team is focused on at this point in time, bringing that up and then the Gen 3 vehicle, which is kind of a 2026, 2027 time frame. Fully driverless.

Fully driverless like the Cruise, what Cruise is demonstrating 2023 in Las Vegas. Do you think ready for CES. Is that too soon?

We'll see. Well, I look forward to that.

Some of the major semi guys are talking about working directly with OEMs and it's raising questions about whether this can disintermediate some of the Tier 1s. Can you get this question a lot, but just for this audience, that might not be familiar with how you see that risk go? What do you think?

Listen, there's a lot of dialogue in and around a lot of different business models. We feel given our capabilities from a technology standpoint, from a systems -- knowledge of systems from an integration standpoint that we have a very strong position.

Some parts of your business are extremely labor intensive and you've worked very carefully over many, many years, if not decades in predecessor companies to kind of locate and match the labor costs with some of the more labor-intensive products, particularly in wiring harnesses. Maybe at one point, you were maybe not now the largest private employer -- one of the largest private employers in Mexico?

Yes, we bounce between #1 and number #2. Pretty consistent up there.

Yes. Okay. So material cost inflation, you could chart on a Bloomberg screen to some degree with raw materials abating and I think maybe some relief but labor. When we talk about rail strike, we're talking about all sorts of interesting socioeconomic concerns and inflation and other areas that are driving this labor concerns. So what's the posture there? Remind us how much of your business is labor, if you could tell us what even if it's a...

Total labor, it's [ $3.9 ] of total kind of compensation, [ $1.8 ] is total labor expenses. Yes, you're talking about our wire harness business from an overall labor intensity standpoint. I would say historically, the business model was where can you find the cheapest labor, the trade-off was what does it cost in time from a supply chain standpoint. Over the last 5 years, there's been a lot of activity around not how do we near term automate the wire harness right? So how do we automate that whole process. It's how do we automate parts of the wire harness and then how do we bring it to a central point where it's assembled. So a lot of activity and progress really in Mexico, in Eastern Europe, North Africa and China in terms of that. The next stage is smart vehicle architecture and how do we drive zone control and consolidation there, which is a much more automated process. It's taking a lot of the labor out. It's higher content for us from a value standpoint. And it's certainly easier for our OEM customers to install in an assembly plant in a much more automated way. So we've made progress in the traditional model as we're booking business from a smart vehicle architecture standpoint, that's a whole new approach to vehicle architecture. So I think over the coming years, you'll continue to see the amount of labor in that particular business actually declined pretty dramatically.

A couple of minutes left in case there's questions from the audience for the Aptiv team. Kevin, Joe, you guys are too good, just too clear.

Had a lot of good meetings over the course of the day.

If you recognize a few of the questions. Is ADAS a commodity?

No, absolutely not.

Will it be a commodity?

We don't think so. Our -- it's certainly from a consumer standpoint, if you've purchased a vehicle with an advanced ADAS solution, you're never going to purchase a vehicle without it. There are significant developments that can be made from where ADAS sits today from a penetration standpoint, the levels to where it can be. So fastest-growing space in our -- and our particular business is the L2, L2+. We have customers that were working on L3 solutions with. When you combine that sort of capability, there's more in-cabin sensing that needs to come into play, right? So we think it's a long, long way from becoming a commodity. Now having said that, we work in an industry that tries to drive commoditization. We recognize that, but that's why we work so hard to stay out in front from a technology standpoint and from a cost standpoint for our customers.

So just wrapping up, Kevin and Joe, just kind of these are odd hypothetical. I mean you guys have seen so many cycles. Your business is such safe, green and connected. So it's all the mega trends, all the issues that sustainability and life-saving technology. If you -- let's say there's a world where, I don't know, Elon Musk is like Energy Secretary or Energy Czar or I don't know what. -- if you could grab the microphone to the administration, the Department of Energy, the Department of Defense, Treasury and give them this message saying, "Hey, look, just we're a company here, just dial in from Boston. You really -- if you're going to really rearchitect and get the arsenal democracy to really behind industrializing a new energy architecture, just consider this. Will it be go kind of mind?

Yes. I would -- listen, to the extent we can more standardize kind of safety outcomes as you think about end cap and other things and drive that behavior to the extent you can push more high-voltage electrification and support the supply base in growing and enabling that. Those would be the 2 areas.

You think IRA is just a first step of what's...

That's the first step. Okay. Well, let's see how it turns out.

Kevin and Joe, thanks for your time. Thank you. That concludes the presentation.

Thank you Adam. Thank you everybody.

Thank you.