Dana Incorporated (DAN) Earnings Call Transcript & Summary

Hi. I'm Ryan Brinkman, the automotive equity research analyst here at JPMorgan. Thanks for joining us for the 2020 JPMorgan Automotive Conference being held virtually this year. We're going to get going with our next presentation from Dana. [Operator Instructions] And I'll read it there and be happy to ask it on your behalf without naming you or your firm. And with that, I do want to welcome Jim Kamsickas, Chairman and CEO of Dana; as well as Jonathan Collins, Executive Vice President and CFO. Jim and Jonathan, thanks so much for joining us.

Thank you, Ryan. Good afternoon to you and everyone else out there. Thank you.

Thanks, Ryan.

Absolutely. I want to turn it over to you for introductory remarks. I think you got a slide that you're going to walk us through, and then we can get into the conversation.

Great. Thank you for the opportunity. We'll keep it short. Pretty similar to what we presented at the most recent earnings update. But if we can go to maybe the next slide, that would be great. Okay. All right. So just for -- most folks probably are aware of this about Dana, but just as a quick slide to give you a background on the company. A little bit different than most in that we are -- we like to call ourselves a mobility supply company because we support all mobility end markets, anywhere from, as you can see in here, light vehicle and traditional customers there to heavy vehicle or Class 8, medium-duty vocational, and then of course, off-highway, it could be agriculture, construction, underground mining, material handling, so on and so forth. And I won't go through each one of the markets, but the one thing we've done strategically over the last 5 years is we've really felt it would be important to put balance to our portfolio. And so we pivoted the business. We grouped in a different way of thinking about it. Our light vehicle group is one and then heavy would be the other, 2 together. And that is now approximately a 50-50 split, and it's not by accident. It sets up well for our synergies operationally, our synergies technology, so on and so forth, and we balance to that. Across the page, of course, you can see the regional breakup. Obviously, larger in North America. But over the course of the same period of time, we have definitely grown our participation and balanced our participation around the world in numerous markets. Technologies, you can see them all on there. And the thing that we find a little bit interesting is the word motion. Motion is, largely speaking, it's going to be tied into our off-highway group. And that could be in the slew drives and winches and multiple other things that actually propel or move products on the vehicle. But we also use that in our commercial vehicle segment, and we can kind of come back to that in a minute when we talk about a lot of things, especially in electrification. A quick slide on return to growth or really return to operations. Everyone out there had to go through the same process that we did. Obviously, we shut down facilities in -- pre-COVID or as we entered COVID to coming back out in a more recent time frame. Focusing on the upper left, a big part of that was just getting the operations back up and going again. Obviously, Dana has approximately 150 major manufacturing operation facilities around the globe. That's no small feat to get your furnaces up and going again, getting your operators back in place, making sure you got all the safety protocols, et cetera. Just touching on a few others. The supply chain, this is one I definitely want to reinforce. People often think about it. Well, good for you. You can control 150 plants, get it up and going. But it's obviously much bigger than that. The integrated supply chain to be competitive, to have the best technology, you have to have a supply chain that supports from all parts of the world. And it's one thing to have that. It's another one to make sure that they can come up and be operational coming out of COVID with various protocols and safety requirements and issues as it relates to not just by a country-by-country basis but certainly, providence by providence, state by state, et cetera. Just touching on one last area besides the safety protocols, everything we've done in that area, like so many other companies have. We still have in this process a fairly significant launch backlog that I'm going to refer to in just a couple of examples later in the deck. This was an announcement that we made just a few weeks back, yet another significant electrification win for us. And electrification for us is probably quite different than most. And then our business strategy has to be to set up the company to be energy source-agnostic, if that's internal combustion engine, hybrid or full E, electrification. You can see in the kind of bottom left-hand corner that Dana's capabilities goes anywhere from filling out what we call the power cradle that essentially replaces the engine all the way back through -- we don't make batteries, of course, but we cool the batteries and do the thermal management. And we do -- for that matter, we do the thermal management throughout. We also have the 3-in-1 electrification as it relates to our own in-house motor and inverters as well as the gear box that Dana has long been known for. And that feeds over into this European platform over more recent note that will come into production towards the end of next year. Just kind of a walk. We made a -- just like we said we would back years ago in terms of filling in the white space. What we didn't necessarily know for sure was we'd be filling in the white space to make sure we're ready for the disruption of electrification. But we did put that in our strat plan, our enterprise strategy in 2016. And you can see kind of the bolt-ons that we've done to fill out the portfolio of electrification assets with people that have done it. I mean a lot of folks think, oh, well, electrification just started a few years ago. Well, not really, even before Tesla and before a lot of others, there was electrification out there. It was in pockets. And so we strategically went out and acquired not just the capacity to do it but the human capital that have been putting electrification and what we call electrodynamic components in the field, either on buses, medium duty, could be even area work platforms, but pulling it all together to have one full-blown electrification competency across our company, which we scale. And then on the far right, I just quickly mentioned that Rational Motion, even albeit in the middle of the pandemic, small acquisition for software capabilities in Cologne, Germany, to help us launch the program that we just talked about. Last but not least in my area is just to kind of go back to the sweet spot of what Dana is definitely renowned for, that being the off-road enthusiast market, high-performance market. There's different words that are used for it. But here, again, similar to our long heritage on the Jeep Wrangler, Gladiator, so on and so forth. Bronco entering that space. You can see that the Bronco Sport, which will launch towards the end of this year, is all Dana content. And then on the right-hand side, of course, is the full-blown Bronco that will be coming out next year. Very proud to be a support partner for Ford Motor Company on this program.

And maybe just a couple of comments, this is Jonathan, on the financials on Slide 8. You can see that at the beginning of the second quarter, we laid out some key priorities to conserve cash and maximize liquidity. In the second quarter, as we managed through the shutdown and the restart, we're very pleased that we made significant progress on reducing our inventory, flexing our conversion cost, really stepping back on our capital spending to be more in line with the cash inflows of the business. And then we also took some actions to make sure we preserve liquidity that you can see on the right-hand side of the page. The punchline here is, as we left the second quarter, we feel very comfortable with the significant cost flex and cash preservations that we executed. We have more than ample liquidity to continue to manage through the balance of this year, which positions us well for what you can see on Slide 9. As we see our markets recovering, probably the bright spot here for us has been the light vehicle market and in particular, full-frame truck demand, has been very strong sales in the second quarter or higher than we would have expected a few months ago. So inventories on some of our key vehicles are low. That's leading to a very strong production schedule in that segment. The heavy vehicle markets are a little bit of a different story. We started this year with softer expectations in both these markets, but certainly, the disruption of economic activity has adversely impacted these. We are seeing stability in the agricultural segment as an example, but still soft demand in construction and mining. And then on the heavy vehicle side, not only has Class 8 demand been softer, but medium-duty has been soft as well, too. So we're well positioned as these markets will recover, but albeit on the heavy vehicle side, a bit lower than what we're seeing in the light truck. So that's all leading to an expectation for the third quarter, and we expect to have at least 50% sequential growth compared to the second quarter, which is certainly going to put us in a position where we will return to profitability across all measures and generate significant cash flow in the second half. With that, Ryan, we're happy to take any questions.

Yes. Great. I'll start off with a few on coronavirus we've been asking for really all the firms at the conference, starting with the outlook for profit margin as we move past the crisis. After the global financial crisis, margins actually increased for the sector. Just curious how you're looking at it this time around. You got headwinds associated maybe with compressed or made redundant supply chains. I don't know that social distancing lasts forever. But on the other hand, there could be tailwinds. A lot of companies are reporting learning to do more with less, really battening down the hatches on SG&A, et cetera. Curious what -- if you feel any differently about the longer-term margin outlook for the company, good or bad, as a result of the virus.

Sure. From a profit margin perspective, we laid out last year that the growth that we're seeing across our traditional and electrified products was going to help to lead to margin expansion for Dana as well as improved free cash flow margins as we get past the major investment cycle we've been in, in the last couple of years. We believe that remains true. And I think there's some validity to the assertion you just made that as we've gone through the last few months, we certainly pulled a lot of levers from a cost standpoint. And I'll steal one of Jim's phrases. A crisis is a terrible thing to waste. We look at this as an opportunity to make sure that we will continue to become more efficient and continuously improve. And I think that there could be some benefit coming out of that as well, too. So as the markets begin to recover and the production volumes cooperate, we believe that the long-term margin trajectory, both profit and free cash flow, remains very bright for Dana.

Great. I want to ask a similar question but about capital allocation. Curious if the virus caused you to think any differently about how much capital cushion is appropriate, targeted leverage ratio or return of capital to shareholders, et cetera. I think you're one of the companies that stood out as not having levered the balance sheet to buy back stock. It looks probably smart in retrospect. And we're previously already targeting investment-grade type metrics for more commercial-type reasons. But does that just sort of reinforce your previous inclinations? Or do you think even more conservatism is warranted? You tell me.

Yes. We think that our previously stated ambition of moving towards a turn of net leverage remains the right target. Obviously, it's going to take a little bit longer now for all intents and purposes. This year's free cash flow generation, certainly going to be less than what we expected precrisis. But from a capital allocation standpoint, we're going to continue to plan to -- as we improve our free cash flow, use that towards paying down debt. The capital structure we have in place, particularly on the debt side, is suited for that. We don't have any maturities coming in the next 3 to 4 years, but we have term loans that we can pay back without any call premium. So we're set up for that, and that's something that we'll continue to look to do. But we think that continues to...

That's helpful. And then just finally on the virus, we want to know if you think it will have any impact on the type or pace of technological change. Does the virus, for example, speed up, slow down or have no effect on pre-existing industry trends such as vehicle electrification, et cetera?

At least our early signs around that -- Ryan, thanks for the question, is there's been no change across our end markets, across our customers. They see it as being core to their enterprise strategy, and just jumping around on your enterprise strategy for flavor of the month is probably not the smart thing. The only tone I would give you a little bit is that it's always been the case in mobility supply, but I would say even more so now. Any OEM would tell you that they can't be everything to everybody and do everything. And so in the powertrain space to which we participate, we'll participate in different pockets. And if things change relative to the overall economic conditions, maybe it's a little bit more that we'll be doing than maybe they would be doing, but we'll see how it goes.

Great. That's helpful. Good color. Maybe just sort of continuing along the lines of electrification, though. Maybe talk about your leverage, firstly, to nonlight vehicle, commercial truck. You've talked a lot about that one. But what about some of the other -- electrification, some of your other end markets? Mining, I think it's kind of been there, right, underground. You don't want internal combustion too much. But agriculture, construction, those might be slower, off-highway. Port vehicles sometimes gets mentioned. What are you seeing there?

Well, actually, you did a great job almost indirectly summarizing what the circumstance is. But let me first say with one public service announcement on electrification, there's not a market that hasn't stepped it up in some form or fashion. Stepping it up from 0 to something could be just having initial conversation. So take, for example, front-end loaders or something of the sort. Maybe that's not necessarily the best fit, but it doesn't mean our customers aren't considering it for obvious reasons that are out there. But back to your overall summary, you're absolutely right. I mean if you think about port cities and ports, I mean it's kind of hair on fire, we're going fast in those areas. And obviously, our synergy of having the typical -- the types of products required there from the heavy axle to power -- to some form of transmission, albeit it could be downsized, could fit or not. But certainly, the e-Propulsion stuff fits, as you mentioned, and it ties very -- there's a lot of similarities in our business to our underground mining equipment, which we've been doing electrification on for quite some time.

Okay. And I thought to ask, too, about some of the new emergent, disruptive players in the space, the extent to which you're targeting doing business with Nikola or Proterra. You've got the partnership with Hyliion. I'd love to hear more about that. And beyond that, and I know -- I'm sure the answer is not to do business with everyone. But there was a point where Nikola's market cap exceeded that of PACCAR briefly. I mean to what extent do you think the incumbent players that you already do a lot of business with are going to be big players in this market as well?

Well, I think they're going to be big players. There's no doubt about that. I mean I'm pretty sure everybody in the audience would definitely agree to the fact that an OEM that's been doing business -- I'll pick one of your customer examples. PACCAR, I believe, have been in the business over 90 years, if not over 100 years. I mean it's a fantastic company. Everybody knows it's a fantastic company that if anyone thinks that all the other experiences and capabilities they bring to having the full-service network, dealership relationships, great products for so many decades that they're not going to be prepared for electrification movement, I mean that would be kind of a crazy thought, right? So first to answer your question is they're going to be prepared. No different than the balance of our partner customers in the commercial vehicle and off-highway market. That's the first thing I'd tell you. As it relates to Nikola, as it relates to Proterra, at the end of the day, we're in touch with everyone and everyone is in touch with us. This is a whole different kind of stratosphere right now in terms of where people fit. All we know is what our strategy is, though, we are going to be the same thing Dana has been for 116 years. We're going to focus on powertrain, albeit this would be more of an e-powertrain. And it gives you full capability to go through that. Yes, we've gone further with it with our capabilities to do vehicle integration with our partners as well as things up in the cradle, as I mentioned, but that's just a knowledge-based. That's a knowledge-based game. So when our customers come to us, they don't have to guess, hey, have you been working on cybersecurity plans? Or what about over-the-road updates? Oh, what about this? You're not guessing any of that stuff. You're doing it now in the early stages. So when they need us for just the full powertrain stuff, we're going to be there like we always have been.

Great. Maybe just diving a little bit deeper into the commercial on highway, electrification, sticking with electrification, though. Could you talk a little bit about the average content per vehicle that you have currently today on the predominantly internal combustion engine? And then how high could that go? I've heard a couple of different numbers, 2000, 10,000, et cetera, depending upon what they select from you. When it all shakes out, what do you think the multiplier is in terms of content per vehicle for you on electrified trucks versus internal combustion would you say?

Sure. Probably the baseline to start with is just a driveline. So an electrified driveline, we believe, based on what we've seen so far in the market, we'll have content that's at least 2x what a traditional driveline was. It's pretty intuitive because what's happening is what we refer to as the electrodynamic components, both the electric motor and the power electronics or the inverter that control that. That propulsion unit moves inside of the driveline in a typical e-axle or e-drive configuration. So that's the one thing when we look from a longer -- long-term perspective for Dana, we see as an incredible growth opportunity. And that's why, as Jim mentioned, with those slides at the beginning, bringing that content in-house for those electrodynamic components is critical. There'll be a lot of cases where we'll partner with people. Customers may use different electrodynamics. But having our capability to deliver a full system creates a pretty significant content just on the driveline. The other example that Jim gave in the slides was the powertrain for the medium-duty vehicle in Europe. In that example, you're going to find that the content is much higher because it includes the e-power system, which includes the battery, battery management system, all the auxiliary power functions on the vehicle. And that will be significantly higher multiple. It's much higher than 2x. But 2x is kind of that parameter we've given for moving from a traditional driveline, which would be multiple axles and a drive shaft to any axle or [ set of axles from that ].

Okay. And I don't know that you want to get into content per vehicle on an individual program, but anything you can say to sort of dimension the Bronco opportunity because it just seems like since the vehicle was unveiled that -- I'd be interested to see where the IHS forecast go after everyone's seen the vehicle. Ford said on their call they've got a tremendous number of orders, almost like a Tesla Model 3, Tesla-like number of orders. Do you see this as a potential like big home run? And if it is, I know you're a big, diversified company, but is it a potential needle-mover in terms of financial results?

Yes. Undoubtedly, the Bronco is a key pillar of our strong backlog. So you'll remember, Ryan, the way we calculate our backlog is it's incremental new business net of any business that we've lost. So if you hold volume and foreign exchange content, you can take that tranche of backlog and add it to this year's sales to get next year's number. And earlier this year, we affirmed a very strong backlog and a meaningful tranche, $350 million coming online over the next couple of years. So that's certainly going to be affected by lower production volumes this year in 2020. But as we look to next year, and we anticipate the market continuing to recover, the Bronco is a meaningful piece of our backlog and we're incredibly excited about how that vehicle [ can perform ] in the market. And I would say, as we have with most of our backlog, we tend to be reasonably conservative on how we think about it. So certainly, the number of orders that have been taken are a very encouraging sign, and the unveiling of that vehicle and the consumer response appears to be fantastic. So we're really excited about the content that we have and the support we're giving our major customer on that platform.

Yes. I said in this session yesterday, I'm probably going to sign up. I want to get one of the 2-door turquoise ones. Looks really cool in the ads. Maybe a question on -- you tell me what driveline configuration I need to order it with. Maybe a question on power technologies. I mean on the one hand, I've heard you say it might have the softest strategic coherence in the event that we were in a favorable environment. I don't know if it were -- would be a candidate for disposition. On the other hand, don't the electric vehicles and even fuel cell vehicles have some sort of unique thermal management needs? Is that something that you could -- that could even be a tailwind, reasonably attractive to that business?

Yes. And I think you summarized it correctly on both sides of that. But there is with electrification that people didn't see as much pull-through 5 years ago as it is today. It is a different world. Our battery cooling business and our electronics cooling business is not only a good opportunity for content per vehicle. But in terms of having a strategic advantage or competitive advantage of being able to manage the thermal management on an electric pipe system, there's no engineer that you'd find out there, electrical engineer that wouldn't say that's like, oh, by the way, critical. So it is a nice piece to the puzzle. I mean obviously, our fuel cell technology and fuel cell plate business is also there. Obviously, it's further out from most people's perspective. But it's not like it's not important to our business because you got to keep kind of a toe in the water and we've been working on fuel cells for almost 2 decades now. So we feel like we've positioned the company pretty good in power technology. In any company, you should have optionality in all your business and we certainly have set it up to be as such for power technologies.

Okay. I wanted to touch on services as well. I think it's relatively small but typically seen as less volatile and higher margin. I don't know what you can say there. There's the tire pressure monitoring. Where is the potential for this? Would it be more organic versus inorganic? Is it more in the nonlight vehicle applications? Would it ever be large enough to actually be a significant thing to think about when it comes to financials?

Yes. We've been pretty clear that we do not believe that in the long run, it's necessarily going to be a fifth business unit. But we do see great opportunities to introduce high-margin applications that support our customers. When we unveiled the strategy just a few years ago, one of the key pillars of that was being close to the customer, customer centricity. And when you're close to your customer and you understand the pain points that they have, where we have knowledge of systems or parts of the vehicle and we can understand their pain point, we can bring solutions forward that can be delivered, be it software as a service that can have really attractive margins and help to improve our relationships with our customers as we solve problems. So we're going to continue to invest in that and look for opportunities to make outsized or attractive returns by solving problems for our customers. However, the beginning of your question, we've never suggested that's really going to be a fifth pillar of the business.

Okay. And Jim, you talked about how you're a supplier to all mobility types. We have Meritor on the other day and they just do the commercial side. Jon, I think we did a dinner with you last November, December. You talked about $175 million of maybe synergies between the various different end markets. Just sort of maybe revisit the logic there and how you think that continues to benefit you. I'm curious, if -- in addition to the cost synergies, is there any kind of go-to-market benefits, I don't know, when it comes to where you're sort of in between the light and the commercials. I don't know, it's sort of the large -- the heavy-duty light vehicles or something like that. How are you seen by the customers relative to somebody who's only focused on a particular end market?

Yes, there's a couple of questions in there. At least I'll try to discern them. First and foremost, the customer synergy. Let's start there. There are a lot of customers that pivot and have both, as we define it, light vehicle and commercial vehicle or they have commercial vehicle and heavy vehicle. So starting there and having a bridge on your customer interface point is certainly one. If there is ever second, ever -- if there was a time in the history of the mobility industry to have scale benefits on your product technology, it's right now. I mentioned it real quick earlier as it relates to our ability to adapt and scale benefit from our products, our electrified products, our software and everything else that we're doing as it relates to anywhere from -- in all of our segments, from the largest underground mining equipment to the smallest area work platform like you'd see in a Home Depot or Lowe's or something like that. It's all interchangeable in its own way. And certainly, the learnings is interchangeable. So if anybody ever question the multi-end market participation by Dana, I think they probably wouldn't be doing so now when you think about us heading into kind of the next generation, next industrial revolution that's right in front of us. Our company is prepared for it because they learn every day by touching and smelling it, working with it and providing value for customers. What's a better way to learn than actually do it yourself?

Yes. And maybe just to touch on the cost side. We did mention at our Investor Day last year, we had $175 million of cost synergies across primarily the 3-drive systems business because, as Jim said, we're making the same product. So significant benefit in core engineering, purchasing, manufacturing and even in the servicing or the back office of those 3 businesses. And we think as we continue to integrate these acquisitions we've done in the last few years, that number, we believe, will grow to be over $200 million in the near future. The other major benefit we see is the core technical investment and the integration of the mechatronics of an electric drive unit or an electric axle is technology that is relevant for all 3 of those end markets. So by investing in that core technology, one of the advantages we believe we have in all of our end markets is the ability to amplify that investment across all 3 markets rather than just one. So we think that that's going to be a big benefit for us for the coming years.

You've got a question from an investor about whether it would be reasonable to assume greater than 25% incrementals in 2021 as industry volumes normalize and cost saves stick.

Yes. The challenge with pegging a single number for us is obviously the end market that we're in and the ability that each of those represents as they recover at those rates. So you could certainly see a situation where -- with some of our more profitable segments. Off-highway is our most profitable segment. When that comes back, it comes back in a very strong way. It can pull our overall incrementals up, but it's certainly going to depend. The one thing I would highlight is that if you take a look at the information we put out in our Q2 earnings release, we effectively flexed $900 million of cost in the second quarter of this year. So sales were down about 50%, about $1.2 billion. And the profit flow-through on that was about just under $300 million. So those decrementals were about 24%, and that means a significant cost flex. Of that, obviously, material is a major component as we shared in the past. That's a big part of our cost structure, but also, we had significant reductions in labor and overhead and SG&A. And when you think about those areas, we've highlighted some of those things we've done will be permanent in nature. So I would expect that some of the difficult decisions that were taken in the second quarter that are more permanent in nature will help to improve the incrementals of all of our segments and all of our end markets. But the overall tail of the tape will be heavily impacted by the rate of improvement in the 3 end markets.

Okay. Great. Thanks. It looks like we are out of time then. So thank you so much, Jim and Jonathan. Appreciate all the color here today.

Okay. Thanks for having us.

Thank you.