Aptiv PLC (APTV) Earnings Call Transcript & Summary

[Audio Gap] With Aptiv. So as you know, no supplier in this industry is more associated with growth and this industry's megatrends than Aptiv. And we've seen this pretty clearly. Over the past 3 years alone, this company has achieved growth over market averaging around 12%. And that was driven largely by growth in technologies for active safety, high-voltage architectures for electric vehicles. And then yesterday's Investor Day, the company sent a pretty clear message. That is that impressive growth is going to continue, and they talked about 8 to 10 points of growth over market through 2025 and then even higher than that beyond 2025. The next few years, it will be driven by 30% annual growth from high-voltage architectures for EVs, 25% annual growth from active safety, and then there are new drivers of growth from smart vehicle architecture software and growth into adjacent markets. The company targeted revenue growth from about $17.5 billion in 2022 to somewhere between $23 billion and $24 billion by 2025. And then more importantly, they suggest -- at least for me, more importantly, they suggested that the margins for the business will expand from 9.1% last year, mid 10% this year, 14% to 14.5% by 2025. That means that the margin growth is actually accelerating. This year, it will be about 140, 150 basis points. And then you would average something like almost 200 basis points per year to get to the high end of that by 2025. Obviously, the market liked it, the market -- the stock was up 7% yesterday. And with that as background, very thrilled to have Joe Massaro, Aptiv's CFO, joining us for meetings on the heels of that. I've got a bunch of questions for Joe. And then as we've done before, I'd love to get your questions after that. So Joe, thank you very much for joining.

Well, thanks for having me. The timing worked out perfectly. So...

So I think I'd like to start, maybe just talking about rewinding the clock a little bit first.

Sure.

Because the company's margins were in that 13%, 14% range back in, 3 or 4 years ago?

Yes.

Then they went down to 8%, 9% and now 10.5% and coming back. So now that you're back on your forefront, or your front foot, and you're expecting 500 to 550 basis points of margin expansion between 2022 and 2025, how is that turning around so dramatically? .

Yes. I think to some extent, it's really what we've been talking about over the last few years, right? We're in a very difficult environment, really beginning in early 2020 with COVID, followed up by -- which became expensive for us. We sent the teams back to the manufacturing plant, 170,000 workers. So the team back to manufacturing plant in May of '20. And obviously, to get things up and running. And from that point on, occurred a fair amount of COVID cost, right, just cost of personal protection and back in those days, social distancing. That then got followed up by a fair amount of what we were referring to is as supply chain disruption costs. Either due to COVID or due to shortfalls in the -- in some of the supply base, either from our own -- what we needed to manufacture our own products, or customers being disrupted by other suppliers, we incurred an incredibly hectic production schedule over the course of 2021 and 2022. And as we've talked about a lot, those and I know other suppliers have and I think some of the OEs have as well, that is really the worst thing that can happen to the industry, right? If you're closing on a Monday, Tuesday, Wednesday and opening back up and trying to make up production on Thursday, Friday, Saturday and Sunday, that becomes a very expensive way to operate. And as I mentioned yesterday, in 2022 alone, we had about $835 million of costs associated with material inflation, COVID and supply chain disruption costs. So you have these enormous costs coming in the P&L. At the same time, we remain very focused on executing for our customers. And we knew it was expensive to operate. We knew we obviously had a significant amount of impact on the margin rates, but the focus really was around -- and Kevin started this very early on in 2020 through COVID, stay focused on the longer-term picture, keeping customers connected. Meaning don't be the what for in any of their shutdowns, and really stay focused on the new business awards and growing the top line. And we will work our way through these -- sort of these transitory problems around supply chain disruption and material inflation. And I think what you saw in the back half of 2022, and then in the guidance for 2023 and then the extension of that yesterday, is really getting those costs behind us. In 2022, we passed on $0.5 billion of direct material inflation to our customers, increasing the prices of our products. We'll get the full year benefit of that in 2023. And we've started to work through sequentially the supply chains getting better. We occasionally have some disruptions. We had -- as we talked about in the Q4 earnings call, 90% of our workforce in China got COVID between October and the end of the year. That was a very choppy operating environment, obviously, as you were trying to deal with the loading of the plants and when you had workforce. But as we get through those, those costs are coming out. And I think that's a big part of us getting back. They're coming out at a time where we've continued to grow the business, to your opening comments, very significantly. In 2019, our high-voltage product line was about $350 million of revenue. 2023, it will be north of $1.5 billion. So as we clear those costs, we're -- because of our focus on keeping customers connected, because of our focus on new product development and the new business wins, we actually are not only getting the benefit of coming out from those costs, but we're coming out in a much stronger position. So the product line profitability is a lot higher. And you're starting to see us with the supply base and to some extent, the manufacturing footprint. Not only are we getting rid of the disruptions of the inflation, but we're actually returning to our historical norms of annual manufacturing production, annual material performance, right? So we're -- not only are we eliminating some of sort of the bad guys that were in there, but we're also sort of back on a good footing. If you have less disruption from supply chains in the plants, you can then start to get back on how do you lean out those production processes, right? How do you make your processes more efficient? So it's really the combination of all those sort of happening over the '23 to '25 time frame. That's giving you that -- really that return to what we were capable of doing in the business in 2019 before everything went upside down.

So for a period of time, it looked like you actually were giving your customers the price deflation, but you weren't able to extract the normal productivity from your organization and from your suppliers. It looks like that was a part of that. .

That was a part of it. When we talked about this intermittent production shutdowns being disruptive, it's not only the cost of a plant closed down or it's a temporary -- effectively, we've got to pay our workers even though there's no productivity, right? You can't send them home on a Monday, Tuesday, Wednesday and expect them all to come back on Thursday. You might be able to do that for a week, but if you try to do it for a second time, you're going to wind up with fewer people coming back. So not only would we wind up with the inefficiency of having them out for 2 or 3 days, but the processes that they normally do in those plants to operate better week in, week out, month in, month out, those obviously get stopped because you're focused on just how do you get back up and running and how do you make -- how do you catch up on schedules.

So you're now looking forward and basically doubling earnings. You had $1.6 billion of earnings in 2022. You're looking for $3.2 billion to $3.5 billion by 2025. What's interesting is that's despite $1.6 billion of assumed inflation in pricing when you have the 2 together. So you're offsetting that now with $1.7 billion of performance, which then allows your operating leverage to drop to the bottom line from your volume. So why are you now -- we're still in an inflationary environment, right? We had 6%, whatever it is. Why you now able to mitigate inflation with performance?

In part because the plants start running better with less disruption. Again, there was a compounding effect when the plants were heavily disrupted of the cost of the disruption plus the lost opportunity to gain efficiencies, right? Because, again, you're focused on sort of getting things out. So you've got an element of that compounding. We've also taken, as I mentioned earlier, a significant amount of those direct material costs and every price for them and repriced to the customer base. So that benefit, again, came in back half of last year at about $0.5 billion. We'll get the -- those agreements tended to get cut around the June or July time frame, not many of them were retroactive. So we'll catch up to the first half benefit of '23 and that's helped a lot. But really, the disruption the industry has faced, and this just isn't Aptiv. Here like I said, a lot of other suppliers, and I think the OEs both experience it themselves and then I think, to some extent, acknowledge the impact it has on the supply base. Being able to clear that disruption, sequentially get better on that disruption, which we're seeing, allows us to get back to, again not only being disrupted, but how to operate better on a regular basis and sort of that continuous improvement process.

Is there anything that you could tell us about the trajectory of the improvement that you're expecting over the next couple of years? So this year will be 140, 150 basis points of improvement, but that includes the benefit pretty easy comps, right, versus the first half last year?

Relatively easy comps, yes.

And then as I look out to 2024 and 2025, is it, in your mind, linear at this point? Or does it sort of move around? .

So it jumps around a little bit. I think 2024, you'll see sort of another step up. Because right now within the 2023 guide, we're assuming $180 million of disruption costs, which is our estimate. In 2022, it was $315 million, 3-1-5. So we're getting the benefit of that $135 million coming out this year. Our assumption is over the course of very early next year, that $180 million goes away, right? So that's in 2023. So I think you'll have a bit of a step-up there, and then I think you get -- you return to the normal -- sort of return to the normal cadence. The other thing I would point out as you think about profitability. And for a long time, and Rod you know this, we've -- we focused on making sure Aptiv has the ability to expand margins without a lot of help from global vehicle production, right? Even in 2019 at our Capital Markets Day, we had effectively flat vehicle production growth. Here, we have it up 2%. But we're still well below the levels we were operating at in 2019 from total vehicle production, right? We're still talking about whether it's an 85 million or 86 million units per production, versus what was at 94 million, 95 million. So we are leaned out. We're going to continue to lean out. We're very well positioned to flow growth at whether it's our growth over market or increases in vehicle production growth. We're set up very well to flow that as well. I mean our gross margin flow-through on incremental volume is right around. We've assumed 30% in the model, right around 30% you've seen. We've actually been trending a little bit better than that over the past year or so. So that's going to be another, I think, to the extent vehicle production can come back and we think by 2025, we're back to 89 million units. If you can see growth above that either in the next 2 years or right after 2025, we'll flow strongly as well for that, too.

Let's talk about the growth. So it looks like you're projecting a little bit over $6 billion of revenue growth. I'm talking about net of the pricing. So it was like $6.3 billion net of pricing. About $2 billion of that comes from electrification because that's growing from $1.2 billion to $3 billion. And then $2 billion comes from active safety, from $2 billion to $4 billion. You've got $1.3 billion from adjacent markets. Can you talk about some of the drivers here? Maybe just starting with EV, what have you assumed for electric vehicle content and penetration? And can you talk about why you're winning this business with EV?

Yes, absolutely. So our EV portfolio typically is around the -- what we'll call the high-voltage electrical distribution system. So the connectors, the cabling, the wiring, to provide sort of a whole system from battery to the various other parts of the vehicle, whether it's the power electronics or things like the motor. We did an acquisition at the end of last year called Intercable Automotive, which actually puts us on top of the battery now with modular bus bars. We estimate that content opportunity over the next couple of years to grow to right around $1,700. We're then introducing our power electronics and our battery management portfolio, which we think is another roughly $600 to get you to the $2,300 we've presented yesterday. So very strong. Like I said, we've -- we'll be -- finished last year at about $1.2 billion of revenue in high-voltage ex Intercable. Intercable is about EUR 250 million of revenue. So you add that to -- add on to that business beginning this year. So we've got a fairly significant business with the margins that are accretive to the overall SPS segment. So it's a strong revenue growth, growing at about 30% and strong margin profile accretive to the segment. I think there's a couple of reasons why we win, right? There's -- certainly, as the legacy OEs started to sort of over the past 4 years plus, make the decision to produce EVs at volume. They quickly needed to go to places within the supply chain that could operate at volume. And operate complexity at volume -- complex systems, complex delivery, complex designs. And we're very well positioned for that. We have historically been a leader in sort of the very complex electrical architecture in the industry, whether it's on the larger SUVs or some of the larger performance vehicles. And that skill set was there, from an engineering perspective, allowed us to work quickly with the customers. Also, given the footprint and the scale of SPS overall, we were able to get to volumes pretty quickly with -- by leveraging existing infrastructures. The plants are in all the right locations. And we have grown up really over the past 6 or 7 years with Tesla, who's now a top 5 customer. So there was also an element of know-how within Signal and Power that I think a lot of customers found very helpful.

Tesla has got to be at least a $1 billion customer for you at this point, just based on the disclosures you've made in the past in your 10-Ks. That growth, obviously -- even Tesla alone is a couple of hundred basis points. We just talked to a consultant, who was talking about a mile of wiring that's going to come out of legacy OEMs and significantly reduce costs as other companies are emulating Tesla. Is that a good thing or a bad thing for Aptiv? .

That is a good thing. We've talked about that for a while. We've watched it. That then takes you into -- it goes a number of different directions, but all building up to what we call smart vehicle architecture, which is our, sort of, architecture of the future, where you've taken more complex systems, whether it's on the nervous system, the SPS side of the house where the high power requirements, signal fidelity become very important in the vehicle, power management, battery management becomes very important. [Technical Difficulty] It's back on. Can everybody hear me? Okay. So I think that's good news, and we're starting to see it. So we've had on both the brain and the nervous system side of the house, tremendous amount of interest in our SVA over the last couple of years. Smart Vehicle Architecture is a concept we introduced in 2017. We went into 12 advanced development programs with customers on how they would design that. To date, we've booked business with 7 of those. We have SVA bookings on the compute side that total over $5 billion, and we'll start to see our first SVA revenue in 2024. So the benefits are both on the architecture side where you tend to -- what you tend to see happen when you're consolidating, and I didn't hear that presentation, but we've certainly done a lot of work on this ourselves, you tend to take out round copper cable. Round copper cable for us is a pass-through. We don't make money on round copper cable. We pass that cost through to our customers. It's sort of a direct -- we pay $3 for a pound of copper, we charge the customer at $3. The materials that -- to take that mass out, you tend to replace that with different materials, things like the modular bus bars that we bought -- that Intercable Automotive does, right? Or other types of material for high fidelity signal transmission instead of copper, right? So you're thinking ribbon cable or flex circuitry. All those become part of the system. And those materials, although they're more expensive on a -- as compared to the equivalent of copper, the overall system is saving the OEs a significant amount of money. So that you sort of take cost out while Aptiv content goes up. And we talked a lot about that yesterday, how in several areas, we're able to reduce the overall cost out to our customers, which is very important, particularly when you think about things like the EV profitability over time, but the content that Aptiv is able to provide actually goes up.

What's -- on this SVA, I'd like to ask you who are your competitors that are the alternatives to Aptiv's SVA offering? And can you talk a little bit about what your typical content per vehicle is on an SVA vehicle versus a non-SVA vehicle? .

Content is going to go up significantly. So it depends on sort of where you want to take it, right? Let's start with a competitor. From a competitor perspective, single delivery of an SVA system, there really is no one that can sort of match up to Aptiv. Typically, if customers are not talking to us, they end up talking to 3, 4 or 5 competitors, right? Because you got to bring a compute person in, you bring an architecture person in. And a lot of times, you'll need to bring a separate connection systems person in, an interconnect provider, possibly some software providers. So we, I think, have a very good -- have really established ourselves as sort of the single SVA. SVA is an Aptiv term. That is not something others use, right? It's -- that is something we defined and created like I said over 5 years ago. So I think we're very well positioned from a competitive standpoint. Content growth can be significant. I mean, we took -- in some of the Investor Day materials, there's specifics as to where we think the SVA content can grow. But you're talking our average content -- sort of addressable average content per vehicle with the inclusion of SVA and high voltage going from around [ $1,200 ] per vehicle to over [ $2,300 ] as you get to full SVAs. And we now estimate about 25% of the vehicles manufactured in 2030 will have an SVA architecture. So the opportunity is fairly significant.

How does this affect the competitive landscape for you? Just this SVA concept, does it make it very difficult if you're a competitor that focuses on ADAS only or airbag controllers only, or infotainment only? Like does that kind of change the game competitive?

It certainly impacts them from a hardware perspective. So right now, we're working through an SVA opportunity with a global OEM. And this is -- this was the spec that came to us from the OEM. This isn't in Aptiv. The OEM's request was to eliminate 75% of the domain controllers in the vehicle and replace them with a centralized compute of SVA. So if you're an individual domain controller provider, you're providing a brake control or a chassis controller, an infotainment controller, at some point there's no box that you're going to be providing, right? The software -- we use the term as up-integrated. The software is going to be up-integrated into these larger central computes that we're providing. So I think there's certainly an opportunity to certain suppliers to move from a partner model to a software model, maybe and provide, their -- to participate in that up integration maybe as a software provider, but really the up integration opportunities we're seeing are very significant. Like I said, that was a customer number that was 75%, which we think is about right. But the fact that you already have global OEs at, "Hey, we need to make -- to get to where we need to from a cost perspective and to make these cars run the way we want to, we need to eliminate 75% of the individual domains is a big, big first step."

I want to ask you about Wind River, because that was really interesting what -- you said about how this fits into the company strategically. So who are the competitors to Wind River in the marketplace? And what I'm talking about is some of these tools that you've got for developing the software that's going to run the vehicle. And practically, how do you think this is going to play out in the market? Will Volkswagen tell Continental and Bosch hey, Magna, we want you to use Aptiv's development kit for you to write code for your product, so it fits in the Aptiv's system? Or how does that actually work?

Sure. So Wind River, we completed the deal at the end of last year. It was obviously -- it took a little bit longer than normal to close, but we're excited to have it close behind us. Wind River, for those who aren't familiar with it, is a software provider that's been around for a while. It's about a 40-year-old company. It has been providing what the industry refers to as intelligent edge software. So middleware, real-time operating systems to what they call the intelligent edge. So think of edge devices, that require a fair amount of compute to operate successfully so aircraft, 5G, big market now is 5G telecommunications or the towers, right? There's tremendous amount of signal and transaction processing that the devices there have to do on the edge, industrial automation. And we started partnering with Wind River in 2021 to develop an automotive software stack, because we didn't see the traditional software providers to the industry providing the software necessary to make SVA a reality, right? The hardware consolidation, the infrastructure consolidation around SVA was actually moving a lot quicker than the software, right? And typically, software moves a little faster. And through a couple of customer projects Wind River was working on, we got to know them, entered into a collaboration deal in 2021, and that ultimately led to an acquisition opportunity in 2022. Wind River, it not only provides the actual software that sits on the edge device, so the plane or now the automobile, but also provides a development suite and a deployment suite called Wind River Studios and Wind River Conductor, which is ultimately what we thought was the highest value in terms of what they offer. So not only can you put software in a controller, but you have the ability through Wind River Studio to effectively containerize the software. So think of apps on your iPhone working as part of iOS. You now have an environment where you can update those, develop those sort of real time, which doesn't exist in the industry today. So I think Wind River -- we spent a lot of time talking about how that's working. We've got a lot of interest from customers. We announced our first post-acquisition deal with Wind River for Geely in China, where they'll be providing the operating system for Geely's Level 2 active safety system, which will also be our active safety system, but moving to the Wind River operating system and development environment. How we see it working with other competitors, Wind River is remaining stand-alone within Aptiv. And yes, typically, what happens in the software programs today, we're currently working on over 60 software development programs with various customers. The OE does -- based on the program that's being developed, the OE will choose a tool set, right, of how they want -- or an environment that they want the software to be compatible with. And you typically go out and get -- as the developer, you'll typically go out and get licenses for that development software. And your engineers will work for that customer, will work within those tool sets. So that is something we do and what Aptiv does now, the industry does now. Certainly, folks like QNX and others participate in that space. Wind River has historically been very small. They, to date, have their software in about 50 million vehicles pre-acquisition. So somewhat smaller but have been in the space with select OEs. So yes, that would be the expectation that's developed within Wind River Studio. And then that gives the full benefit. And we spent a lot of time yesterday. I'll never do it justice, so a lot of time yesterday, and it's available on our Investor Relations site just of how the new deployment tools work and how Wind River is additive to that process.

Let's see if we have time for one question from the audience. Anybody? Let me ask you one more, then we haven't asked about Motional. It's going to cost Aptiv about $300 million in equity loss, I guess, for your portion. I don't think that many investors at this point are looking at Aptiv on a sum of the parts basis. They're applying some multiple, maybe 17, 18x. It means that people are applying a negative $5 billion impact on Aptiv. And I'm curious if you can maybe just address how we should think about this? Is this efficient R&D? Or is this something that you think investors' perception is going to change on that at some point?

Yes. Listen, it's obviously more than R&D. I mean we have always approached -- even before the Motional transaction with Hyundai, we've always approached Level 4, Level 5 as sort of on the spectrum of active safety and automation. At the moment, we're heavily involved with Motional as both providing them technology for their Robotaxi products, which they continue to make strong commercial progress. We're also working with them on some Level 3 solutions. We're actually able to take some of their technology, if you will, a step down from Level 4 into the Level 3. We're working to push our sort of Level 2 plus up. So there is certainly a collaborative environment. Hyundai is using them for very much the same, while they continue to develop their commercial model. So it's certainly a stand-alone business. It's a business that, as Kevin mentioned yesterday in 2019, we thought their automated driving revenues would be approaching $0.5 billion in 2025. They are behind, and we think it will be closer to $250 million to $300 million now, breakeven a couple of years after that, but continue to do well from a providing technology. And just to remind folks, we never viewed Motional as a competitor to Lyft or Uber. We're not deploying capital to be a ride-hail network. It's really around this automated technology provision. And this year, they'll start -- Uber will be using their technology for both passenger services as well as Uber Eats. They've expanded their relationship with Lyft. We always talked about them sort of getting through their technology development in late 2022, early '23 and then the commercial activity ramping, and they're on track with that now.

Yes. Awesome. And even with that investment, it looks like you'll be heading towards the 6s and then 8s in terms of earnings as you look at that...

Yes. No, I mean the 30% EPS growth we talked about yesterday includes that Motional, right? We don't exclude it. We don't back it out. The 30% EPS growth that we're talking about includes the impact for Motional.

Right. well, we're out of time. But I want to thank you, Joe, for coming after this Investor Day.

No, it's a great timing. Thanks for having us.

Thank you.

Thank you, everybody.