Dana Incorporated (DAN) Earnings Call Transcript & Summary

Okay. Perfect. And I think we are live. Great. Thank you, everyone, for joining as we continue the CS Global Industrials Conference. I'm Dan Levy, I lead in the autos track of the conference. I'm Dan Levy, I lead equity research coverage of the U.S. auto sector at Crédit Suisse. I'm very pleased to have join us Dana and specifically, Jonathan Collins, CFO, as well as I believe Craig Barber, who leads Dana's IR efforts, is on the line as well. And it should be a good discussion. Anyone who has questions should send me an e-mail, I will try to address what I can. E-mail is [email protected]. And I'll try to weave in those questions. For those of you who aren't aware, Dana works on -- Dana is a supplier for both the light vehicle and off-highway commercial vehicle end markets, providing power conveyance products in both drive and motion sealing and then also on the sealing and thermal side. So with that, Jonathan and Craig, thank you so much. Glad to have you.

Yes, thanks for having us, Dan, looking forward to it.

Perfect. Okay. Why don't we dive right in? And I think the best way to start is just on doing an update on the end markets, what you're seeing thus far in fourth quarter and 2021. And maybe the best way to start there is if you could just give us an update on what you're seeing in terms of supply chain disruption, whether it'd be in Mexico or in Europe, and how much of this is embedded in the 2020 outlook.

Sure. Broadly speaking, fourth quarter is shaping up to be pretty good. So compared to what we had expected when we were out a month or 2 ago, both October and early indication on November sales are pretty strong. I'll just give a little color on each of the end markets. So for the light vehicle end market in North America, full-frame truck and SUV sales, and particularly our key programs, the Ford Super Duty, Jeep Wrangler and Gladiator, continue to be quite strong. So we're anticipating a strong top line in the fourth quarter in our light vehicle business. That also reads through to our Power Technologies segment, which is also seeing pretty strong revenues compared to where we were earlier this year coming out of the pandemic. On the heavy vehicle side, things continue to improve. We still anticipate being softer than the prior year in our heavy vehicle businesses, but they're getting better. We're seeing signs of life and some momentum even within the last 8 weeks of some continued progress and improvement. So broadly speaking, I would anticipate we'll continue to move up a little bit in the range of the guidance that we laid out at the end of this third quarter. As it relates to the supply chain, from a production, things are relatively stable. We are working on a couple of hotspots around the globe. You touched on Mexico. We have some facilities in Mexico that had some minor restrictions from production. We're working through that, continuing to see improvement there. And broadly speaking, we don't anticipate that will have a meaningful impact on the fourth quarter results.

Perfect. And then just on some of the heavier end markets, I think in the past, you were citing Brazil truck, India construction as weak points in the fourth quarter. How have those end markets fared?

Yes, not a meaningful impact internationally. But here in the U.S., we're continuing to see some of the improved orders for our commercial vehicles make their way into the production schedule. So it's increasing our confidence that things are improving there, both on heavy and medium-duty. Agriculture continues to be pretty strong on the off-highway space around the world. And we're seeing just modest signs of improvement in construction and mining, to a lesser extent. So positive trends. But certainly, the regions that we highlighted, both India and Brazil, continue to remain a bit soft.

Perfect. And then I don't know if you have a view on how these end markets shape up. I realize your demand crystal ball is as good as anyone else is. But any views as we look into 2021, whether there's going to be any inflections or changes in these end markets?

Sure. I think our early look at 2021 is a continuation of the fourth quarter trend. We do believe that the light vehicle market and in particular, our important segments, rear-wheel drive, and 4-wheel drive trucks and SUVs, we'll continue to see pretty strong demand into next year. So that's what we anticipate. We're obviously very excited about the major new product launch we have coming with the Ford Bronco. The orders for those vehicles have been spectacular, and we're really excited to support our largest customer as that really exciting vehicle comes to market. When we think about the heavy vehicle markets, we would anticipate that the trend of improvement in demand in commercial vehicle, particularly in North America, would continue, medium-duty and heavy-duty. And then I think on the off-highway side, we're cautiously optimistic. We're carefully planning and preparing for an upswing in demand to make sure we're there to support our customers, but we'll continue to watch orders and the leading indicators to get a sense of how that's going to shape up. But overall, I think we're looking at an improving situation as we move into 2021.

Great. Let's talk about -- I know you'll give your guidance next February or whenever it is you provide your fourth quarter outlook. But maybe we can talk about some early parameters for what to expect into 2021. And maybe you could just give us some broad strokes, some -- any assumptions we should be making, be it on incremental margins, the types of cost saves or restructuring benefits that you'll have for the full year, impact from commodity costs. We've heard this from a few different players. Anything on discrete cost. Anything you can call out, and then we'll get to the backlog piece, but let's just start there.

Yes, absolutely. So certainly, from an organic standpoint, the combination of the backlog and the end market demand, we would anticipate to have a pretty significant improvement in the top line. Obviously, second quarter of this year, we produced at less than half capacity. So we wouldn't anticipate that in any of quarter of next year. So that's going to be a meaningful improvement. The backlog will be a big contributor, and we'll highlight the fact when we come out in February that we'd anticipate next year's tranche, which was originally $350 million, is likely to be a bit better. We've won some business and even some of that will come to market. Late next year, volume expectations for the Ford Bronco were probably a bit better than what we had expected at this time last year. So certainly, strong organic growth heading into next year. From a conversion perspective, I think conversion in the mid-20s, similar to the decrementals that we saw is probably our early look on that. While we'll certainly have some permanent cost saves, we'll add back some costs associated with some of the temporary austerity measures that we took. On balance, we may have some opportunity there, but we would expect the incrementals to be comparable with the decrementals. The other major drivers we typically highlight, such as currencies and commodities, our early look on those is they're going to be a relatively small impact on a year-over-year basis. So I think broadly speaking, we would expect a pretty strong recovery on the top line with a nice conversion to help us get closer to where we would have been just a year ago.

And just to follow up on the commodity piece. Maybe you can remind us, I mean, we've heard from a couple of players just to watch out on commodities, or at least Adient just talked about commodities. I realize the exposures are maybe a little different. But specifically on commodities, you're saying that's still early look, probably relatively small impact.

Yes. Not to say that there won't be any, but for us, specialty steel is one of our major components. And we even anticipate right now that those are going to be relatively constant, not a major impact. We'll probably have some puts and takes. But a couple of years ago, we had a pretty significant increase. And heading into this year, we're expecting a significant decrease, which we did recognize. So at this point, I wouldn't anticipate it having a material impact.

Perfect. Let's talk about, same line of discussion, but on the cash flow side. Anything you can -- any parameters you can give us on whether there is deferred CapEx? Or is there any remaining working capital rebuild? Anything we should highlight there?

Yes, absolutely. I'd expect our -- if we kind of walk down our cash flow highlights, I'd expect our onetime cost to be relatively consistent within this year at an ambient level. Nothing surprising on the interest or tax front. And then as you highlighted, there will be a little bit of a rebuild in working capital, but we're not going to have a major source of cash from working capital this year, particularly because the light vehicle markets recovered so strong in the second half of the year. We really built those balances or building those back up in the second half of this year. But on the heavy vehicle side, where we would expect more of the top line impact and a little bit of new business, we'll build some level of working capital, but nothing too significant. On the CapEx side, we're -- we would not anticipate that we would have any type of catch-up. I think expectation for us in the 4% range, give or take, remains reasonable as we get some of these major launches behind us and return to a level that's closer to our annual depreciation expenses largely what I indicate. So we would expect obviously a significant improvement in free cash flow coming next year compared to what we saw this year with all of the lower production and the shutdowns mid-year.

And as far as the restructuring, you said that that's nothing much to expect there, correct?

Correct. Our onetime costs are going to be at a pretty ambient level. When the Modine acquisition, the automotive segment for the liquid cooling, closes in the first half of next year, we'll have some integration costs and some transaction costs, but nothing that's going to be too material or significant.

Perfect. And then that's interesting that you noted CapEx flat. I would imagine Bronco a significant program for you. Is it simply that you're leveraging the footprint that you have in place with Ranger, and that's why we don't see some elevated CapEx?

Yes, I think that's a really fair point. We've certainly highlighted that a lot of the infrastructure for this program is already in place. There's certainly a meaningful investment associated with program-specific CapEx, but a lot of that's going to be on the floor by the end of this year and up and running to support the launch. So you're starting to see the major launches, the refresh of the Super Duty, the refresh of the Wrangler, the launch for the Gladiator, the Ranger and now the Bronco, that big swath of CapEx that we've seen in the last few years is largely behind us. There's still plenty of room for growth in that CapEx number, call it in the mid-300s or at about 4% of sales in order for us to continue to grow and drive new products on the electrification side as well as support customers with traditional architectures.

Good. Let's maybe drill down on some of the segments before we -- and then let's actually talk one more before we close that out on the cash flow side. You suspended your dividend as did most. What do you need to see from an end market standpoint or from a business standpoint to feel comfortable reinstating that dividend or resuming share buybacks?

Yes. We've been indicating for the last couple of quarters that it's really just a stabilization of the market and a confidence in the ability to generate cash flow. That certainly has been improving and the Board will be reconsidering and contemplating that here in the near future.

Good. Okay. Let's go to some of the segments. And let's just start with Light Vehicle Driveline. I think interesting to see in the third quarter that margin was a little off. And I think you noted that there was -- just the velocity of recovery in North America limited that. Okay, now you're getting the background noise from me in a Zoom world. Have any of the premium freight costs that you talked about dissipated? And assuming production schedules remain elevated where they are because I think that, that end market is largely -- it's right now supply-constrained, any reasons why margins can't get back to that 12% level that you were hitting in 2019?

Short answer is no. There's nothing that's going to hold us back as we move into 2021. In the near term, in the fourth quarter, those costs are improving, they're coming down. We're getting a better handle on the supply chain. And really, what was so unique about the third quarter is very few times do you see a scenario where you bring all of your production to a halt. You really bring down your inventory to conserve cash and then very quickly have a ramp-up in production. So the -- what we saw in the third quarter is a very unique set of circumstances, and there were some efficiencies associated with managing that. But those are improving, and I would anticipate that the light vehicle business is on track for a significant margin improvement as we head into 2021. And I think that 12% range is a fair and reasonable expectation.

And following up on the Bronco opportunity, maybe you can just help us frame the magnitude of that opportunity? And specifically, how much does it look like Wrangler? We know that Wrangler is, I believe, one of your 2 largest programs. Are we talking about similar content per vehicle between Bronco and Wrangler? I assume it's going to be lower when you factor in Bronco Sport. And then what have you heard on potential upside to capacity? I assume that the comments you gave earlier on upside to the backlog doesn't contemplate incremental capacity that they allocate there. So give us a sense on the opportunity.

Yes, that's fair, Dan. Yes, that additional opportunity I was referring to is just our internal expectations. With the new vehicle launches, we tend to be a bit conservative on what we think the incremental production is going to be for a number of reasons. So when we came out with the expectations on the Gladiator, our backlog in that first year was considerably higher. The vehicle sold very well. It was very popular. The same is -- it looks like it's playing out with the Bronco. No, it would not require any incremental capacity, that's not the reference. But certainly, to your question on content, you're absolutely right. It's a full -- the vehicle is equipped with a full Dana driveline, so that's the 4-door and the 2-door versions. And then obviously, the Spicer SmartConnect system on the Bronco Sport. So from a content perspective, the 4-wheel -- 4-door and the 2-door versions are very comparable to the content you'd see on a Wrangler. So a significant amount of content, great opportunity for us, and we're really excited about the -- how popular the vehicle has been in the market and look forward to supporting the customer next year with that platform.

And given it's -- you're leveraging the Ranger footprint, does that benefit your Ranger contribution? And basically, you're just leveraging your footprint more? Just trying to understand how -- whether this can be margin accretive.

Yes, absolutely. Yes, absolutely. That's one of the positives here when we went through the Wrangler and Gladiator launches, and then the Ranger shortly thereafter. We had built a new state-of-the-art assembly location here in Northern Ohio. That plant has been up and running for a few years now. We're launching a lot of this product in our existing infrastructure. So certainly, this is going to be wind in the sales from a margin standpoint in that business.

Good. And then -- and I want to talk -- let's pivot to commercial vehicle. And I'll save more of my discussion for when we hit electrification. But maybe you can give us an updated sense on what we need to see margins hit back, ultimately go to double digits. Is it simply just all the end markets need to come together between North America Class 8 and medium-duty as well as the South America medium-heavy duty?

Yes. That's going to be a major driver. So heavy vehicles getting into that mid- to upper 200 range on an annual basis here in North America would be very helpful. Strong medium duty, we've seen some recovery there. There's more room to go. So market conditions are going to really help us get into that range. But one of the big drivers now is going to be -- we've seen a little bit of margin compression in this business due to the investment we're making in these big electrification wins we've had, particularly in medium-duty. As those programs launch here and we start to see volumes come online in a more meaningful level in 2021 and 2022, we're really excited about the contribution margin, the potential of those businesses. So these are largely software-controlled and enabled systems, smart systems that are providing meaningful value for the customers, programs or these vehicles. And we're really excited about how that's going to be able to help that business improve as well.

Good. Let's pivot to Off-Highway. And the interesting thing about that market is, we saw, obviously, like your other end markets, very significant declines in growth, but you basically have kept EBITDA margins near double digits or above double digits. So maybe just remind us what is it that you did that you've maintained margins as strongly as you have? And as the markets come back, is margin upside limited as you have to put more cost in? Or is there more permanent cost saves that allow you to return to prior mid-teen levels?

Yes. The Off-Highway Drive and motion team has done a spectacular job managing through this cycle. That business has the most significant changes from peak to trough. So it's in a sense, built for and structured in a way to prepare to rapidly flex cost, both up and down, and that team has just done a spectacular job. In addition to that, I would say that it probably has the most opportunity to just surprise to the upside on incrementals, particularly because we haven't seen how well the business can perform in a strong market post the integration of the acquisitions we made in the last couple of years. So there's well over $75 million of cost synergies that were delivered on the Brevini and the Oerlikons, Graziano and Fairfield businesses that we acquired. So we're really excited about what that business can do once we get back to a stronger level of demand.

Good. Let's move to Power Technologies. And I think the big incremental since the third quarter was your acquisition or your announced acquisition of a piece of this thermal auto business from Modine. So basically, nothing, I mean, when you factor in all of the liabilities you took on it, it's like less than 1x EBITDA. So any background for that? Just give people maybe an overview of what you're requiring in terms of what it adds in terms of footprint, product, et cetera?

Yes. So this is a business that is very similar to the thermal business we have in Power Technologies today. So Power Technologies, today, about 2/3 of the business is sealing and about 1/3 are thermal products. And these thermal products are largely liquid-cooled solutions. So that's what we bought from Modine. They had both liquid and air. We took the -- when you say air cooling, think of radiator, but we took the liquid-cooled products. So these are products that are used for oil coolers as well as in the electrified world to cool, power electronics and batteries. So really exciting business. It's very complementary from a product and a geographic perspective and a customer perspective. So it brings in some good technology, but it also gives us greater exposure to the European customers and some Asian customers, and it brings a footprint that's more concentrated in Europe. Our thermal business today is more concentrated in the U.S. So it brings a lot of balance from a geographic and a commercial perspective. It really helps to improve the scale of the Power Technologies business. So post-acquisition, the sealing, and thermal businesses will be comparable in size. And in particular, we've got quite a bit of opportunity for cost synergies because this is a business we're very familiar with. Most of what we do in thermal is within the automotive market. So obviously, came at a very attractive value, and we believe that a successful integration can lead to value accretion for our shareholders, and we can better serve our customers in the process.

And all of that is incremental to the ongoing initiatives you have in any case in Power Technologies, yes, because we just saw in the third quarter, I think it was your best margin in over 2 years, and I think things are finally coming together, whether it'd be from commodities or mix or geography. So that's on top of your ongoing initiatives in any case.

Yes, that's right. That's the business for us. That's traditionally been one of our higher-margin businesses in the mid-teens. You hit 2 of the 3 key things where we saw some margin compression, some geographic mix as well as commodity pressures, both of those have ameliorated. And in addition to that, we're past some of the new air-charged water coolers that we're providing in both Europe and in the U.S. We had some big launches in that new product category. So once we've worked through those, we think that business is in a position to continue to recover. And in time, we think that the Modine acquisition can also help to improve the overall economics in that segment.

Good. Let's sort of wrap up with electrification, frankly, we probably could have done an entire session on electrification alone. But let's wrap up on electrification. Let's just start on the targets. You gave previously a target of $500 million revenue for EV by 2023. And your last update with EV is 15% of the backlog. When might we expect just updates on those targets?

Yes. On the latter, which would be the backlog compartment, we'll give an update on that in February when we come out with year-end results and provide a backlog for the next few years. We'll give a refresh on that. As we've signaled and indicated, we certainly expect that EV is going to be a more significant part of the backlog in 2021 through 2023 than it was over the past 3 years we issued. We've won a number of programs, and we continue to see a lot of traction in the market for not only our full systems offerings but also electrodynamic components for a number of our customers. So we're very -- we're looking forward to providing that information early next year. As it relates to the 2023 target, we continue to see ourselves on track for that and a combination of providing backlog that gives us a view through then and an update on the remaining pursuit business will help provide confidence that we're going to be able to perform to that original target that we provided.

You've done a number of small bolt-on deals, Rational Motion, Nordresa, and you just did it in the most recent quarter, you announced Pi Innovo, TM4 as well. And I think this really boosts your software control capabilities. So are there any remaining holes in your portfolio or weak spots? Or have you really gotten everything? Or is it really as you see more opportunities in software and controls, similar types of bolt-on deals, you'll continue to pursue that?

Yes, I think that's right. We'll continue to focus on things that will help to differentiate our electrified propulsion systems. I got one of them behind me here in our tech center in Maumee, Ohio. And what we're really looking for there is additional functionality and capability to make our systems differentiated from other product offerings. So these are smart systems and the systems engineering and the controls logic and those help to provide significant value and make sure that the propulsion is there when it's needed, but also that the overall battery life of these vehicles is extended as much as possible. So I think you're right. That's where we'll continue to look. From a hardware perspective, we have all the major aspects covered. So we've talked about that quite a bit in the last couple of years. We have all the motor topologies we need from permanent magnet to induction and even synchronous reluctance capabilities. And on the inverter side and the motors, we have all the different voltage ranges we need. So we're highlighting and focusing on those additional software capabilities to further differentiate our products and our systems.

As you've done those deals, how has that changed the types of discussions that you've been having with customers? Has it expanded the scope or the potential set of new customers? Are you -- how much has it broadened the opportunity?

Most certainly. I think one of the best proof points for that is the Nordresa acquisition. So the team in Laval, Québec brought the capability of full vehicle systems integration. So all of the embedded software and the control logic to operate a full vehicle, and our customers have come to us asking for support there, and we were able to share the wins with PACCAR on both the Peterbilt 220 and the Kenworth 270. So that's a great example of being brought into a discussion and being able to offer value to our customers that wasn't there prior to the acquisition. And I could provide other examples from all the other talent and great team members we brought on, from TM4 in the commercial vehicle space, that SME and the off-highway space and as you mentioned, the Rational Motion and now the Pi Innovo team. So a lot of capabilities and additional discussions we're having with customers and value we can provide because of these businesses we've acquired.

And given the expanded capabilities, any color you can provide on where you've seen the most incremental opportunity, be it by end market, be it by region? What is it opened up the most significantly?

Yes. It would be fair to say that all of our advanced sales and engineering teams are absolutely swamped right now. There's a tremendous amount of activity in electrification. And with this broad set of capabilities, we're working with our customers on a number of projects and programs, helping to provide the optimal solution and deliver to them the technology that we've put into place to help advance their sustainability efforts and also to drive the adoption of electric vehicles.

We're getting close to time. So I want to try to squeeze in a couple more. We've heard a lot about your efforts on the commercial vehicle space. Let's maybe wrap up with one on light vehicle and one on off-highway. You talked about on the commercial vehicle side, you really have 2 sets of core capabilities, both in propulsion, the motor and the drive-unit, power electronics, but you also have the power system, the charger and the battery management, et cetera. So how do those capabilities translate or compare to where you are in light vehicle, where you have -- you're playing somewhat, but it seems a bit more tactically or opportunistically as opposed to CV, where it's much more broader.

Yes, in a long run across all of our end markets, we believe the value we're going to provide 5, 10, 15 years from now is largely going to be concentrated in the propulsion system. That's true for CV. That's true for off-highway and LV as well, too. As you noted in commercial vehicle right now, there's demand for full powertrain. So we've stepped up to provide that to support our customers. But we believe the content opportunity that we've talked about for quite some time, which we believe is at least 2x our existing purely mechanical systems is largely going to be where we're focused in the light vehicle and the off-highway markets as well as commercial vehicles. So you're right, you're probably not going to hear as much from us on the e-power system or the overall electric powertrain within light vehicle or within off-highway. But I think there'll be some examples that pop up. But broadly, for Dana, the real focus is on moving from a purely mechanical driveline to 3-in-1 electric drives and electric axle systems that are very well packaged, very power-dense and have the efficiency to help our customers bring new electrified product to market.

And let's just wrap up on the Off-Highway side. Again, we -- people better understand or appreciate the opportunity on the commercial vehicle and light vehicle side because it's just -- it's a bit more obvious. Maybe give us a sense of the size of the opportunity in Off-Highway. I think you noted you had some wins in the third quarter. And it's much higher content because it's on more than just the movement of the vehicle itself, you have moving arms, et cetera. So how does that translate to -- how much of that can be extrapolated to future Off-Highway opportunities? Help us size how large over time the opportunity in Off-Highway is versus, say, commercial vehicle.

Yes, the doubling of our content is probably the lowest common denominator in terms of opportunity across the businesses. And the reach stacker win that we announced at the end of the third quarter in Off-Highway is a great example. So this is a piece of drayage equipment in a port that's used to pick up C containers. And there, we highlighted that the content quadrupled compared to the mechanical systems that we currently sell on that vehicle, multiple gear reductions at the wheel end with Dana's electrodynamics to motors and inverters that are going to propel that system. And as you note, on that vehicle, that's just on the drive system. We also provide motion systems for these vehicles. So as we started to see the implements or the work services be electrified as well to the mechanical and the electrical content on those systems represent even more opportunity for us. So certainly, that's an area where the content per vehicle increase we're starting to see is quite a bit higher than 2x and will continue to grow as the motion systems are electrified.

Great. And with that, I think we'll leave it there. Props, by the way, on a very nice background behind you.

That was all Craig, but thank you. Appreciate it.

And I think we look forward to learning more about the narrative as it unfolds. So thank you to Jonathan and Craig, very helpful.

Thanks, Dan, it was great speaking with you. Take care.

Great. You can now close your session Open Exchange.