Cooper-Standard Holdings Inc. (CPS) Earnings Call Transcript & Summary

With Cooper-Standard as part of Deutsche Bank's Global Automotive Conference. My name is Emmanuel Rosner, and I'm the senior U.S. autos and technology analyst at Deutsche Bank. Cooper-Standard is the [ normative ] supplier, focusing primarily on sealing, fuel and brake delivery and fluid transfer system. Recently, the company has been getting very good traction to electric vehicle content and nonautos end markets, particularly leveraging its material science expertise. We're extremely pleased to be joined today by Jeff Edwards, who is Chairman and CEO of the company, as well as by Jonathan Banas, who's EVP and CFO. So the format for today will be fireside chat using some of my questions that I've prepared as well as from audience on the line. [Operator Instructions] So with that, Jeff and Jonathan, thank you so much for being with us.

Thanks, Emmanuel. Good afternoon.

Good afternoon, Emmanuel. Thank you.

Let's get it started. Jeff, you spend virtually your entire career in the automotive industry in the last 8 plus years as the Chairman and CEO of Cooper-Standard. Specifically thinking about this past 8 years have been pretty volatile for the industry overall. How has this played out as you expected compared to what you expected when you took on as the CEO? What would you consider to be the most impactful changes in this industry?

Well, obviously, the different events over the last 8 or 9 years for us of, in some cases, were more about self-help, so early on in the assignments starting in 2013, the business was struggling for a number of reasons. So it was more about rebuilding the company so that from an execution point of view, we can deliver for our customers. And certainly, from a financial standpoint, so we can deliver for our stakeholders. And then when you think about fast forwarding to what we have experienced here with the global pandemic. I certainly don't think anyone could say they've ever been through anything like this. Obviously, we haven't and I don't think anybody was prepared in terms of the magnitude. But like most companies that have strong cultures and have strong leadership, you put plans in place and you adapt and you make sure that you're directly connected to your customers so that the information that you're receiving is the best it can be, and then you take that and you do what you need to. Prior to the pandemic, we'd actually started a restructuring or rebuild of the company to make it smaller and more profitable. And so we were well on our way to making that happen. The plan had been communicated internally and externally. So the fact that we had to go to a Zoom approach to managing the company across the world, I think for us was a bit simpler because we had already done a lot of the planning and development of that driving value plan. So when we had to execute it virtually, it made it doable. I guess if we hadn't built that plan, and we found ourselves Zooming from our kitchens, and it probably would have been a little bit more difficult. So our timing was good in that regard. And then as we've come through the crisis and now we're into supply chain issues that our customers are dealing with, and that's presented additional challenges. But I think the good news for us is that we're prepared for the second half of this year to be much better than the first half. Our customers, I think, have a very good handle on the scheduling issues that we were dealing with during the first and second quarter. And then as far as Cooper-Standard is concerned, the ability to deliver double-digit EBITDA and double-digit ROIC is now within our site. And I think the market conditions in the second half of this year, all of '22, all of '23 and probably in through '24, are very favorable. So we look very positive towards the future.

That's good to hear. Some might consider this the products that Cooper-Standard produces to be more traditional technology or maybe in some cases, commoditized. What would you say to that? Do you need to develop new technologies or expand into new product lines to be reaching some of these targets?

Well, we don't think so. I -- we've been in the process of developing the portfolio that we have today. We have made a lot of changes to that portfolio over the last 8 years, both in terms of the innovation that we now offer our customers in our fuel business and in our sealing business. And so we think we're well positioned with the right technology to service ICE to service hybrid and to service eventually the EV transition that's occurring as we speak. We also have exited some businesses over the last couple of years as part of the get smaller, more profitable Cooper-Standard strategy. And so while we aren't geographically in India, and we don't have our EPDM rubber hose business in Europe, and we exited the global AVS business, we find ourselves in a much stronger position with sealing and with fluid to manage this transition. And our content per vehicle actually is higher than it is on the ICE engine. So you look at hybrid, our fluid business almost doubles in content. If you look at the EV business in relationship to ICE, or sealing business with new technology is probably about 8% content per vehicle up if we look at the high end of the market that we serve. And then the fluid business can be anywhere from 10% to 20% higher in content, simply because of the heating and cooling requirement of these EVs versus what we see today in the ICE powertrain. So I think we're well positioned, both from a customer, geography and product point of view to be successful going forward. And the amount of business that we've booked here in the last 1.5 years in EV is really encouraging. We're on 16 of the top 25 global platforms related to EV and half of the new business that we've booked this year is on EV. So I think that says that our customers trust us, and we're really happy to hear that.

And I guess specifically on the fluid, I think you were mentioning the upside to content was on the hybrid vehicles. I guess the -- what's the -- if you move to a full battery electric vehicle world, like what would be sort of like the net effect on some of the -- it feels like some of your components or some of your products would probably not be there, but then others would have like higher content. I guess what does the profile look like on the just pure EV?

Yes, pure EV, we obviously are minus a fuel line. That's it, but the content per vehicle on the fluid side of the business. So the heating and cooling requirement of these EVs, that's where our content goes up significantly. So it more -- well more than offsets the lost fuel line. And then related to sealing, there's a lot of new technology that's going to actually drive value in the sealing side of the business, whether that's frameless, sealing technology or whether that's lighter weight, newer materials to make sure that the acoustic performance of the interior of the vehicle is acceptable to the customer as well as the overall performance of the sealing system. Both of those transitions are resulting in higher content per vehicle for both sealing and in our fluid business. I'm sure as we go forward, we'll learn a lot more customers. We'll learn a lot more about the details of that. But so far, that's what we're seeing.

Understood. Inflation is beginning to impact several sectors and throughout multiple fireside chats earlier today. I think some companies that sought maybe things would moderate in the back half of this year on the -- your materials or commodity side are now thinking it could continue to be a headwind into 2022. Is this a concern for your business and business model? What are the main commodities that Cooper uses in their product and how do you usually offset any increases in those costs?

Yes. Well, it's not unexpected, first of all, going into the 2021 year. We did expect some inflation related to raw material, about $15 million is what we thought our headwind would be as we started the year. And I would say that it's probably double that as we sit here today. So it's a challenge, but it's something that we're prepared to deal with, both on the cost side of the equation because, obviously, we don't just walk in and hand off-price increases for 100% of that. But fortunately, our customer relationships and the indexing that we have in place with most of our customers related to, especially the EPDM inflation we're seeing in our business that helps us offset some of it. The real question, I think Emmanuel on this inflation issue is going to be, how long? Are we talking about a sustained inflationary period. If we are, then obviously, our customers have to help us absorb the majority of that. And then that would result, obviously, probably in higher vehicle prices. This is something in the short term that many people think it will be then it's manageable, and it's part of the normal negotiation that takes place on an annual basis, both with our suppliers as well with our customers. But as we sit here today, I think the indexing that we have in place will help us offset some of this. And then we'll have to determine how long it's going to be here as to how we go forward and deal with that issue with our customers. But the good news for us is we've taken $80 million to $85 million of cost out of our business last year versus this year. So we're well positioned to continue to run the company and hit the financial targets and assuming that inflation is here, our customers will help us offset that. And that's just how it has to be.

And I guess what proportion of your raw material exposure is typically protected or covered by some of these agreements in next indices?

Yes. So fortunately, for us, the area of our business that has the indexing that I just spoke of is really EPDM. So that doesn't cover all of it by any stretch, but at least it covers some of it. So that helps smooth it a little more than if we didn't have that. But it really depends on how big and how long it lasts in order for us to determine what the action or reaction is. But we're seeing it in steel. We're seeing it in aluminum, we're seeing it in our resin. So it's across the board.

Okay. Focusing on your customer base, historically it has been heavily weighted to the Detroit big 3. How has that changed recently or over the last few years? And in particular, have you had any good success with some of the new entrants, whether it's on the EV side, in China. I guess, traditional automakers versus some of the newer ones.

Yes, sure. As I mentioned, we're on 16 of the top 25 EVs now, so the 16 of the top 25 selling EVs were on and so many of those are not the traditional Detroit 3, as you referred to it. And so we feel positive about that diversification. In addition, from a diversification point of view, we continue to grow our business in China. And so we've established joint ventures there with [ Dongfeng ], with FAW, and we believe that will continue to help diversify our portfolio. But clearly, Ford and General Motors and PSA, Volkswagen, Stellantis, they continue to be our largest customers today. The sealing business is about 51% of the company's revenue and the rest is fluid. So I think we're diversified on the product side. We're becoming better diversified on the customer. To answer your question about new customers and how some new technology has helped us expand there, I'll use our fuel business, fuel and brake business. So with the introduction of our MagAlloy technology a couple of years ago, we were actually able to begin selling that product into the Japanese OEM. We had a product that was going finally meet their specifications. And so that's an example of how innovation and new technology allowed us to enter a market that prior to that, we weren't able to enter. And so if you think about the Japanese customers with 30% of the global automotive volume, that's an important part of a customer base. And in our sealing business, we're partnered there with some of their [indiscernible] companies, but we also are now standalone on the fluid side of the business. So very positive.

Great. Of your 4 geographical business segments, only North America has consistently turned to profits. Why is that? And then -- so GM exited Europe a few years ago, Ford exited Brazil out of this year. Do you need to stay in Asia, Europe, South America? And if so, what could you do to improve profitability there?

Yes. Let me summarize it real simple. 49% of the revenue that we have today is not profitable. And with our driving value plan next year, that number is reduced to 18%. And by 2023, all of our revenue will be profitable in the company. So that's what it's about. And we exited India, we exited the rubber hose business in Europe. We exited our AVS business. So what we have left and what we're doing with it is going to change the overall profitability of the company in a big way. We're going to be back to 10% EBITDA or higher, and we're going to be back to a return on invested capital level of above 10% once we finish executing this plan and simply put by the end of '22, we'll be operating at that level. And so for all of '23, we expect the return on invested capital to be above 10%, and we expect the EBITDA, as a percentage of sales, not to be above 10%.

And so I guess just rewinding back to what the issues are there? Is it -- what are -- I guess, the legacy reasons for the lack of profitability in some of these regions? Is it lack of scale or just poorly priced contracts?

Yes. For us, simply put, we were a $3.6 billion company in 2018. And at that point, unfortunately, the China market really fell. And as you remember, probably, the units were down 14%. But for Cooper-Standard, that resulted in a 33% revenue cut in China. So we went from making almost $100 million in that region to nothing. And then in Europe, at the same time, several programs that really made up almost all of our profit in Europe, also from a volume and mix point of view, went down dramatically. And so we went from making $60 million or $70 million in Europe to basically making nothing. And so at that point, we said, look, we just can't continue to ride that roller coaster, right? So we're going to look at each and every market, in each product, each customer, and we're going to make some long-term decisions in terms of what we're going to be in and what we're not going to be in. So we sold those businesses that I mentioned earlier. So that, obviously, resulted in a smaller company. So what we wanted to do is rightsize our fixed cost. And so that's what we've been doing, especially in Europe, where we're going to free cash flow this year is -- we're spending well over $100 million to restructure and to fix that business. And that certainly comes way down next year, Europe will actually be cash flow positive in '22. And on top of that, we had some commercial things that we had to get corrected in Europe, which we have done that, and we wanted to stop the bleeding in India. And so we did that. And then we needed to rightsize China because, as I mentioned, 33% the revenue went away, so we didn't need all the costs. So what did we do? We took out significant SGA&E across the business, across the company. So that is now below 9%. And now over the next 3 years, we expect a 10% [ compound ] annual growth rate of this new Cooper and so with a much lower cost [indiscernible] that's, in fact, how we're going to return to over $300 million of EBITDA and a return on invested capital of over 10%. So it really was about changing the company that we had built, recognizing that the markets were changing, and we needed to change fast. So that's what we did. We basically, in that 2018 time period, we lost $100 million out of our margin because of the raw material inflation, and we lost about $60 million because we had a couple of percentage points of price that we had to give back to protect some business that we, obviously, didn't want to lose for the future. And so those 2 things, along with the significant volume and mix change in China, in Europe really created what has become this new driving value opportunity, and that's what we're executing.

Understood. And so I guess in terms of your goals to where you want to bring back margins and returns. So is the plan to get back to the historical double-digit margins and return on capital?

It is. And that's what we're in the process of doing, and we're confident that we are on target on all of those plans. The only 2 things right now that are, obviously, a bit challenging is, one, the microchip shortage and some other supply chain issues that our customers have been dealing with. And then potentially going forward as inflation here to stay, and then we'll to address that as a different variable. But in terms of what we can control, we are very pleased to announce and to state here that we are on target to deliver what we've said we're going to deliver and the timing associated with it. So the simple answer to your question is, yes, we'll be above 10% EBITDA and we'll be above 10% return on invested capital for the entire sustained year of 2023, and we will exit 2022 at both of those levels.

Okay. Great. You've spoken in the past about diversifying your business beyond the automotive industry. Is that still part of the strategy going forward?

It is. In fact, our ISG business continues to grow. We expect that business over the course of the next 3 years to grow at a 10% organic -- [ comp ] annual growth rate, that's about $180 million of the company today. And the good news is we can organically grow it. We think that sometime next year, the following year will be poised to bring in potentially a couple of other smaller acquisitions to help tuck under and support the growth there. And in addition, we have the Fortrex material that we're trying to get into that business. Frankly, the pandemic has hurt us there. Now the last 1.5 years has really been a struggle, especially in the state of Ohio, where we're struggling with labor because, frankly, the deal that was made in terms of paying people to stay home and then paying them more to stay home has really hurt manufacturing in the state, and we need to do something about that. We're working through it, obviously, with those governments but that hurt our business there. And so now we're in the process of fixing that, along with some other self-help issues within that business. And I think that it will prove that, that diversification strategy is alive and well. And over the next 3 years, I think it will be important that we try to figure out a way to double that, right? I mean that could be $350 million or $400 million business for us, whether, obviously, that's not all coming organically. But that's really what it needs to be in order to contribute the way we want it to contribute. The other part of your question is related to the Advanced Materials Science business and simply put our Fortrex material getting that into the footwear market. And so as we've stated here recently, that's our primary focus for the AMS business. We're in the process of negotiating commercial deals there. We hope to have some really good news here in the coming weeks and months related to those negotiations. One of the things that's really kind of cool as it relates to the Fortrex technology both in automotive and in the non-automotive applications that I'm talking about. It's not a secret that carbon footprint has become a real priority for customers, both in automotive and the nonautomotive markets that we serve. And what we've been saying since we launched Fortrex is that it really plays favorably to an EPDM extrusion line as an example. And when you look at an EPDM extrusion line, it's about 100 yards long for the American football fans out there. And when you look at a Fortrex line, it's about 30 yards long. The difference is 70 yards of gas-fired ovens. So when you think about the energy use associated with manufacturing EPDM extrusion versus our Fortrex extrusion, it's significantly different. In fact, 52% better carbon footprint with Fortrex versus an EPDM extrusion line and 22% versus APT line. So we're certainly hearing from our customers in automotive, they really like that. In fact, we've received an award recently from innovation, standpoint, we can't talk about that in detail because it's still confidential and the customer hasn't announced it yet. Now but on the footwear side, as you know, in that industry, it's critical that carbon footprint is improved, and they all have gone out with this carbon neutral position for 2025. So that has created even more of a demand for Fortrex. So we will be spending a lot more time marketing that side of it, that aspect of it here in the coming weeks and months, and you'll see more and more about that from Cooper-Standard, but that's relatively new information and something that we're pretty excited about and another example of why innovation matters.

Yes. And then can you just go back over what is special about the Fortrex material, I guess, the [indiscernible]?

Yes. So in addition to the sustainability improvement that I just talked about related to Fortrex versus the EPDM seals that you see on large trucks and SUVs. So as an example, if you took a large SUV, pick whichever manufacturer you want. And if it was EPDM seals and you'd weigh those seals with EPDM rubber. And then if you would replace those seals with our Fortrex product, you'd save over 10 pounds of vehicle in weight. So there aren't very many things that you can change on vehicles today that you can gain that type of weight savings. So in addition to the density improvements, you also have an opportunity when you expose it to severe weather conditions like EPDM rubber, we all know what you do. You run to Walmart and you buy Armor All and you shine up the seals or the tires on your vehicle because it oxidizes when exposed to certain weather conditions. The Fortrex material looks showroom, black or whatever color you want it to be actually from the time you put it on the vehicle. So that certainly, from an aesthetic point of view, is important. The other thing it does in certain formulations, it certainly improves the acoustic performance of the interior of the vehicle. So when you think about electrification, and now all of a sudden, you're dealing with a lot of different noise, road noise, wind noise around the vehicle. The customers are concerned with how the ceiling system can contribute to improving the decibel level of the interior, and Fortrex has been shown through science to do that. So those are a few examples of why customers are really liking it. We sold that to our largest customers, and they're putting it in their vehicles and assembly plants here in the United States as we speak.

Got it. So I guess summing it all up, what do you see as the greatest opportunity for Cooper-Standard over the next few years?

Yes. I think I would characterize it this way. Our company has never been stronger. Our quality, cost, delivery, the overall engineering performance, the way our customers are trusting us to deliver on launch and to deliver on day-to-day has never been better. And so that's a position of strength that we have really everywhere in the world with our manufacturing and engineering teams coming to work, really delivering at a high level. Our safety performance has never been better. So we take care of our folks. It's a great place to work. We're able to recruit the best and the brightest and most importantly, they want to stay. And so I'd start with our culture and tell you that, that's a strength going forward. Then I would tell you that when you look at the markets and the demand associated with the growth in the rest of '21, all of '22, '23 and out through '24. I mean it's a very, very steep curve in terms of market growth. We're going to outpace that growth. So that, obviously, is something to be excited about. But in addition, over 70% of our global revenue is on trucks and crossovers and SUVs, those large vehicles that our customers are producing more of, and will produce more of even as they turn to hybrid and EV. And that's our sweet spot. So I'm very excited about how we're positioned in the market. I'm excited about all of the work that we've done to create a foundation of strength, both from a financial point of view and also a culture point of view. And really to return to a level of financial performance, along with all those other KPIs that we talked about, positions us to be the community leader that we always have been, to give back to make sure that as we work and live in 21 countries around the world and support it with 25,000 employees, we're making the world a better place. We're making the communities a better place. And having a strong company with strong customer relationships is always at the core. And I'm really proud to say that, that's where we find ourselves today. So nothing to be ashamed of there and certainly really proud of the Cooper-Standard team and all the work that's been done through this pandemic and even prior to that. And to come out of it as strong as we are, feels really good. I would also mention one other thing to you. Take a look, and I encourage everyone listening to take a look at the corporate responsibility report we've published, I think, 4 or 5 of those over the last 5 years. And it really talks about all the things we're doing from an ESG point of view, and how we're making sure that all stakeholders in this company benefit from a stronger company going forward. And we're really proud to be in the automotive industry. We're proud to have the customer relationships. We're also proud of the diversification opportunity we have across the business. But we also have responsibility to continue to get better as it relates to our diversity, inclusion and belonging initiatives in addition to the ESG initiatives that we have in place. We had a announcement recently. If you take a look, I also encourage everyone to take a look at our Board of Directors, a diverse group, a very strong group. They represent from finance to automotive and far outside of that scope as well, both technical as well as operating people and we're really, really excited about the leadership we have in the Board room. And like we say, if you can't connect the culture of the Board room to the culture of the lunch room, then we're not doing our job, but we're really excited about how that's coming together for us. And I'll tell you the next 5 years are going to be really, really fun.

And then just maybe finally, what are your greatest concerns? Is it mostly on the macro side?

Yes. I think as we all said here, I guess, if you're lucky enough to be an elected official, you think inflation is going to be here just for a short period of time. If you're a business leader like we are, you kind of worry about that being here for a long time. And so that clearly could be a big challenge for our industry as we go forward. We don't need a level of sustained inflation that could help or that would hurt, I should say, create headwinds for us. So I'm hopeful that, that's not going to be the case. And then clearly, we're still in a pandemic. I mean we talk about microchip shortages and other supply chain issues, those just didn't happen. I mean, it's a result of the pandemic, and it's a result of supply issues and supply chains changing as a result of the pandemic. And so that's still here, and we still have to manage through that, the complexity of that, of the rest of '21. And it's probably here really through '22 and maybe even into '23 before we see all of that subside. So obviously, that complexity gives us something else to worry about in addition to a challenging industry and a challenging competitive base. But I can tell you, we've never been better positioned. Our team is extremely strong and experienced. And as I mentioned, our Board is poised to provide the overall guidance that we need to make all this happen. So I'm excited. Certainly, a lot more to be pleased with than worried about. But you got to balance, of course.

Yes. Well, that's really great to hear. Jeff and Jonathan, thank you so much for your time and insights today. I really appreciate this update on the company and you joining our conference. Thanks for everyone on the line for joining and tuning in today. Have a great rest of your day.

Thanks, Emmanuel. All the best to you. Thanks, again.

Thanks, Emmanuel.

Take care. Thanks.