Dana Incorporated (DAN) Earnings Call Transcript & Summary

Okay. And I think we are live. Welcome, everyone. Thank you for joining. I'm Dan Levy. I lead autos research coverage at Crédit Suisse. I'm glad you can join us as we continue Crédit Suisse's ninth Annual Industrials Conference, [indiscernible] of the conference here. Glad to have with us Dana, who is a leader in driveline technology or power-conveyance technology, I think that's the better way to put it. And we are joined by Jonathan Collins, Dana's CFO; Tim Kraus, Dana's Treasurer; and Craig Barber, who leads Dana's IR efforts. We're going to go through a series of fireside chat style questions. Anyone who has questions, please feel free to e-mail me, [email protected]. I will be glad to weave in those questions anonymously. But otherwise, Jonathan, Tim, Craig, thank you so much for joining.

Thanks for having us Dan. Looking forward to it.

Thanks.

Great. Well, let's kick off just with a little bit of an update on how things are trending in the fourth quarter here. What are you seeing versus the expectations that you laid out on your third quarter call, where you've laid out some reduced visibility in the schedule. So just maybe start with how the quarter is trending versus the expectations you last laid out.

Yes. Unfortunately, no helpful information or news relative to the improvement in the trajectory. Things continue to be challenging throughout the supply chain as well as our production schedules from our major customers across most of our mobility markets. So broadly in line with what we saw when we were out recently with third quarter results. We continue to work with suppliers around the world to make sure that we're prepared for when the ramp-up occurs, but production schedules are generally in line with what we had expected just a few weeks ago.

Are you seeing any -- I know you talked about reduced visibility and schedule. Is the visibility getting any better on the light vehicle side?

Not necessarily. We continue to see changes to schedules at customers that are certainly more significant than what we're accustomed to. We continue to hear from them that they continue to make progress on securing chips and things should improve. But I would say, relative to what our expectations were for the fourth quarter, we think the top line or the demand side of the equation is going to continue to be constrained by supply and largely in line with what we expected.

Great. And then maybe just a comment on what you're seeing commercial vehicle off-highway, just a mix between an off-highway, between construction and mining versus the ag, maybe just broad strokes of what you're seeing in those segments.

Sure. From a demand perspective, the fundamentals remain strong, that is true for light vehicle as well, I probably should reference that. But the back orders for commercial vehicles are very high on the backlog, what the fleets would like to order remain very high. Production continues to be constrained by material. I would say, less of an impact in the off-highway segment. So as we touched on when we were speaking last, the agriculture markets have been pretty strong for a bit now, which has been a big positive for us. We continue to see signs of life for improvement in both underground mining and construction. The feedback we're getting from our customers is they're anticipating an uptick in production moving into next year. So we've been preparing ourselves for that. And that's a segment that we expect is going to be a real bright spot in the near term. So we've highlighted the fact that we made meaningful inorganic investments in the off-highway segment through the acquisition of Brevini and Oerlikon's Drive Systems business. And we've yet to see the full potential of that business on a post-synergy basis because of the pandemic. So as volumes start to really improve, we're really excited about what the incrementals can be in that segment and what the overall profit profile for our Off-Highway Drive Systems business can deliver.

Great. Let's continue the line of questions and talk about sort of maybe the setup into '22. In broad strokes I think what we're trying to get at is, maybe what are some of the puts and takes as we're bridging from 2021 into 2022, and I think you've given us a sense of volumes, generally, the view is volume should be better. You just mentioned that on off-highway. But maybe you can talk about some of the margin considerations as we're going from '21 to '22. I don't know if you have any granularity on the type of commodity cost that you might see, other cost inflation which I know you've mentioned more recently labor energy costs. So some of the margin puts and takes and any discrete items you can call out there.

Yes. Happy to get some color on the major drivers. Obviously, we will be out with our guidance early next year as we normally would for the year. But as you look at those major buckets, we generally see the market the way that you described. We expect demand is going to improve. The implication for margins is that as our customers' schedules stabilize, we should become more efficient. So not only will we ship more product, but the the fits and starts of dealing with downtime that on short notice should start to improve and help the incremental. So we see higher volumes as a real benefit on the organic side of the business. From a commodity perspective, it's worth noting that we do hope for commodities to come down, and we think we see signs of that. There are a number of third-party sources that indicate that we should see some improvement on that, likely in the second half of the year. But in the first half of the year, the commodity prices we'll be paying will be considerably higher than the same periods last year. So it's going to put a significant pressure on margins on a year-over-year basis in the first half of next year as we lap the relatively lower commodity costs that we saw in the first half of this year compared to the second half of this year that we expect to continue into early next year. So that's going to be a headwind for us. Obviously, the other thing that we've pointed to is we continue to see a lot of commercial success on the electrification front. So we are ramping up investment there. We highlighted that that's going to be a 100 basis point headwind to margin throughout the entire Dana business over the next year or two. So that's going to hold back margins. We'll see some step up in the spending there. But broadly speaking, the volume is going to help and these other areas are going to be somewhat of a headwind, but we'll have some more color and dimension that for everyone here when we report year-end earnings likely in the February time frame.

As far as some of the other cost inputs, you know be it labor or things beyond commodities, presumably some of those costs are going up. What's the potential for incremental performance to offset that? Or should we expect some pressure from other costs that you have out there?

Yes, it's a fair point. And Jim touched on this in the Q3 call during Q&A, where he mentioned that the nature of our inflation, recovery mechanisms with our customers work reasonably well for ongoing normal inflation, but we're clearly in a very unique environment. So conversations with customers around not only raw material cost recovery, but other inflation are continuing. And those -- the nature of those discussions is different than it has been in the past. So it's not all going to get addressed entirely on efficiency even though we will have some, but certainly we're having to engage with -- in recovery discussions with customers that have been different than what you would see in normal state environment. So more color to come on that as we move into early next year as well.

Yes. And then I just have questions come in here. I'm getting this one. A question on -- this is a more discrete item, the collective bargaining agreement. That -- any color on what the full year -- what the impact is to 4Q? And presumably, that's a onetime hit that doesn't repeat in '22?

Yes. Our labor agreements in the U.S. have -- in North America have been ratified. So that's behind us. We will incur an episodic onetime or unique expense in the fourth quarter, but that's consistent with what we had indicated when we put out our full year guide. So you'll recall on Page 14 of those materials, we called out the impact of that in the fourth quarter. So it's in line with that. As we move into next year, the general wage inflation, as you would anticipate, the step-ups are going to be a bit higher than what we've seen historically just given the labor dynamics, but we'll factor that into the outlook. And obviously, there's a lot of other things as volumes improve that are going to help to offset some of those impacts.

Great. Let's jump into the segments and just do a bunch of sort of one-offs on the segments before we go into EV, which has obviously been a big story for you. So maybe we can just start with light vehicle. Third quarter, I mean, generally, the margins in light vehicle have been doing really well. You were down to 6%. That's the ex commodities is more like 9%. When the commodity headwinds come off, what's it going to take for the segment to get back to 12%? Is it just really as the industry volume comes back and as we have consistent volume that, that segment can get back to that 12% type margin that we're seeing?

It really is. It's those 2 factors that you just highlighted. Obviously, commodity costs have to abate. The rapid spike has led to a very meaningful impact, which you highlighted has been well over 200 basis points of margin compression in that segment in the very near term. But really, it is a more consistent production schedule and the ability to run at the rates we've seen in the past. So earlier in the year before the chip impact was fully felt in our light vehicle segment, you can see the potential of that business to perform when production is running normal. So we get back to more stable and strong demand from a production perspective and couple that with improved commodity costs and allowing those recovery mechanisms to catch up, and we should be in a better position exiting next year in the light vehicle business.

And why is it that in that segment, we've seen more severe commodity pressures versus some of the other segments? Is it just the dynamic of the recovery mechanism that you have in place, is there a difference between that with other segments?

Yes, it's largely just the way that the agreements are set up. So the timing and the lag associated with those recoveries is the primary impact on the commodity side in the light vehicle business.

Great. Commercial vehicle, maybe you can just give us a sense of what it's going to take for that segment to reach the high single digit, low double-digit margins. I know that, that segment has been pressured, yes, where you've seen the bulk of your EV investments and there are some programs there. Is that just a matter of some of that spend dissipating and ramping up on some of those program volumes?

Yes. So I mean, probably the better way that we're thinking about it, and we'll communicate this clearly as we move forward is ex EV, the CV business can get to that high single digits. We still even believe in the long run, a double-digit business on the traditional product as same factors we talked about on commodities abate and production schedules continue to improve at the right point of the cycle. But overall, including the EV investment, that business is going to remain closer to where it is for a while because it's going to be a few years before the contribution margin of those new EV programs really start to offset the accelerated spending. We really tried to highlight at our Capital Markets Day a couple of months ago that this part of our business is leading the way for 3-in-1 electric propulsion systems. So much of the work that we're doing on motor development, inverter development, the mechanical development, bringing these systems together is occurring in our CV business. And our other businesses are really going to benefit from that in the long run. But because the medium-duty category is really leading and now it's even moving into the heavy-duty part of commercial vehicle much of the investment is concentrated there. So we talked about that 100 basis point headwind for overall Dana and electrification, and the majority of that is concentrated in our CV business.

Great. And then off-highway, and I think you alluded to it. It sounds like that business could see a step up as the volumes continue to get better, which is good margins. I mean, look, in the third quarter, you were at 16%, 17% ex commodities. Just how much more runway is there in that -- is there in that business? And where are we in mix between ag versus construction and mining, where it sounds like you're talking about -- you're starting to see some better mining data, mining construction generally favorable mix. So margin dynamics in off-highway any color you can give there.

Yes. I mean the foreshadow I can provide there is that we think there's a significant amount of upside in both of those segments in terms of where we are in the cycle. So we believe moving into next year, we anticipate both of those areas are going to improve significantly. Ag has been doing well. We have a line of sight into the fact that that's likely to continue. So it will be -- it's been a long time since our off-highway business has seen all 3 of those moving in the right direction at the same time. And obviously, with the synergies that we achieved from the acquisitions there, we think that the incrementals could be stronger than they have been. Certainly, the inflationary environment has put some pressure on that. But we are really excited to see what that business can do at that point in the cycle, and we think it's coming.

Great. And then let's just wrap with Power Tech. What -- this is a segment that's gone back to 14% margin, really strong. What is it that's driving the recovery here?

Yes. So continuing improvement in the performance of the business, some things that we could help ourselves on. So obviously, quite a bit of work has been done in that business on commodity recovery mechanisms over the last couple of years from a launch perspective, some of the major products that we launched in the thermal side of the business have improved. And then the aftermarket is a very important component of that business. So the aftermarket, largely for the sealing products has performed well. So a combination of those factors has put Power Tech in a position, where on a year-over-year basis, they've been able to expand margins most recently by more than 100 basis points. So that's a business that we think can be one of the better margin profiles for -- in terms of Dana's segments. So we're very encouraged there and the team is doing a great job executing.

Are you with Modine canceled? Are you looking at other bolt-ons? Or was that just purely opportunistic and as other opportunities come along great, but if not, that business continues as is.

Yes. Team is very focused on the organic growth opportunity. So to your point about Modine, that was the epitome of a very opportunistic situation. I mean obviously, we weren't going to pay anything for that. And with the cost synergy potential, we thought it could be very accretive. With that behind us, team is very focused on the organic growth opportunities that battery cooling and fuel cell plates represent. So with the announcements we made in late September at our Capital Markets Day, the major pickup truck programs in North America that have been announced, the battery packs for those pickup trucks are being cooled by the long ThermaTEK solutions. So very excited by what we're bringing in there. And then obviously, we expect to see some growth in the fuel cell plate business in the next few years. So I think there's a great organic growth opportunity for Power Technologies as we shift from the internal combustion engine to electric vehicles, and the team's laser-focused on that. So great trajectory and runway in that business with the assets that we have today.

Great. let's pivot to EV. And I want to do a bit of a I mean, this may not be as incremental, but I think it helps provide some good perspective. I think we're seeing a very robust narrative today. We saw that back at your Investor Day in September. Efforts across the segments, wide range of capabilities. I mean this is not where you were several years ago. So give us an appreciation for how all of this came together? What were the moves that have really unlocked a much wider set of opportunity in EV today than you've really had in the past.

Yes. I mean the talent of the Dana team is overwhelmingly the most important factor. So we have some of the top talent in the industry that's laser-focused on the innovation, utilizing the capabilities that we have to deliver the right solutions for our customers. From an asset perspective, you have to remember that the products we produce for an internal combustion engine vehicle today are purely mechanical. And what we recognized a few years ago is these mechatronic solutions that we would have to provide for electric vehicles, needed to be fully designed, engineered, manufactured and serviced in-house. So we didn't want to be in a position where the majority of the content of the system had to be procured on the outside and the engineering integration would have to happen with third parties. So we made some moves that a few years ago may not have been completely intuitive, but we started with the acquisition of high-voltage motor capabilities via the TM4 acquisition and with that, came great capabilities and inverters to control those traction motors. Shortly thereafter, we realized that we not only needed the high-voltage capabilities, but needed to satisfy low voltage requirements for some of our customers, particularly in the off-highway space. So we acquired SME and shortly there over -- thereafter Ashwoods. So that gave us the broad range of topology from permanent magnet to induction and synchronous reluctance to meet the needs for all of these electric axles and electric propulsion systems with in-house capabilities. More recently, we see the opportunity to differentiate the performance of these systems with the software control. So we've made acquisitions like Pi Innovo, Rational Motion, Nordresa, bringing us a very broad suite of capabilities in software and controls for these systems. So when you put all of those components together, the reason that we're winning in the market with electric propulsion is our customers are giving us the feedback. They really see the value in a turnkey solution for our electric axles or e-transmissions or e-hub drives. We highlighted all 3 of those types of technologies at the Investor Day and showed a number of vehicles and demoed a number of those vehicles that are using those capabilities. So really, it was getting those foundational capabilities and giving all of the people within Dana on the technical side, all of the tools they need to deliver these systems for our customers. So we're really happy with those moves that we made, and we're getting great feedback from our customers on the value that these systems deliver.

Let's unpack some of those points that you made. Let's just go to the capabilities you talked about because you do have a wide set of capabilities across mechanical systems and motors and power electronics software. Within those product areas or even within your segments, maybe you could just discuss your moats and where you think you have the best areas to lead? Is it largely within the commercial vehicle segment? I mean just give us a sense of where you see especially within those product areas.

Yes. It's interesting. It's in the same categories that we've built our traditional franchise around. And that is typically vehicles that require very high torque and very high payload specifications. So they're typically used for work or for off-roading capabilities, whether that's in light vehicle or in commercial vehicle and even in the off-highway market. So when we made our investments, we made investments in technology that have high-voltage capabilities when we talk about the on-highway and heavy off-highway applications to be able to move these vehicles forward. So our focus is taking those component capabilities and building out systems that deliver very high torque output that do so in an efficient manner, that package well and that are very durable like our brands have a reputation for in the market today. And that's where we're really seeing that success is when we can bring them a solution that is a complete Dana solution, and we can stand behind and tailor to meet the needs of the vehicles that our customers are seeking to electrify.

Could you just talk about the bidding activity and maybe where you're seeing the most traction right now?

Yes. And this is something we really focused on at the Capital Markets Day. So I'll draw to your attention to a couple of things. We obviously had over a dozen major new wins that we announced a couple of months ago across all the end markets. So we had to veil some of the ones in light vehicle and a couple in the commercial vehicle space weren't able to name the customers yet. But these are products that have been awarded to us in a broad range of e-Propulsion systems, certain cases where our customers are looking for components of the systems, our first major motor win where the customer is going to use that in their systems. We announced that day as well, too. So these are all very exciting. But one thing that we really drew attention to is within the light vehicle business. So we included a page that highlighted about a dozen key opportunities we're working on that have been in development for a while that are coming to RFQ. And a couple of things I'd draw to your attention. These are a number of full-frame truck programs. And there are also ones where the opportunity we're looking at our 3 in 1 systems. So it's a combination of full electric axle or electric propulsion system. So we made it clear. We don't win them all. We probably won't win all of them. But we think we're going to win our fair share, and this is going to go a long way to demonstrating that we're not only going to see success in the heavy vehicle portion of the business, but also in the light vehicle side as well, too.

And to your point about win rates, I mean, is there any way to contrast, I don't know it's very early to [indiscernible] what your win rates have been on EV programs coming up for bid versus, say, the traditional programs. And I realize there's probably a lot of nuance and difference across the segments, but maybe you can compare and contrast win rates.

Yes. I think you're right, it is a little bit difficult to dimension. Qualitatively, what I can highlight is that we're doing better than we expected. So quite candidly, when we stood back and anticipated the segments inside of the heavy vehicle markets in particular, where we were going to be strongest, our performance has been a bit better than we anticipated. And really, the feedback continues to come back to us from customers that the investments that we've been making over the last couple of years in integrating these systems and taking all 3 of these components and optimizing them for the vehicle applications really played out very well in commercial vehicle, continues to an off-highway and early feedback from light vehicle customers is very positive as well. So we've been a bit surprised. Key wins in the medium-duty segment we're really excited about. We've talked about the wins with PACCAR at Peterbilt and Kenworth, obviously, with Daimler producing e-propulsion system for the Freightliner Custom Chassis vehicle, MT50e. And then obviously started to see some wins on the heavy truck side. So we announced not only the ones that we had highlighted previously, but also the first major motor win that's going to be across a broad range of vehicles. And then another major customer that's adopted our Class 8 electric axle in the North American market. I hope to be able to talk about that customer here in the near future.

One more on the content side before we go to margins. Maybe you could just give us a sense, you said you're looking at EV content looking to be 3x your current ICE content. How does that differ by segment?

Yes. It is very consistent across the segments. So you'll remember that the reason we're in all 3 of these end markets today is because all of our end markets need robust drivelines and the applications are have a lot of similarity. They're typically rigid drive axles with drive shafts that are transferring torque from the north of the vehicle to the south or to all 4 wheels. So the situation where to that mechanical content or the axle, we have, the motor, the inverter and the software and controls is pretty consistent in our on-highway businesses in light vehicle and commercial vehicle as well as in the off-highway segment. The nuance or the difference in off-highway is the adoption of eHubs, where hydraulic motors are going to be replaced by electric motors and the power electronics that regulate those. So that 3x content per vehicle opportunity, we believe, is going to be pretty consistent across all of our Drive Systems businesses.

Great. Let's talk about margins for a moment here. Maybe you could just give us a sense, you said you're aiming to be breakeven by 2023 EV margin accretive by the end of the decade. What are the factors that are going to impact the margin of your EV business? Is it just a function of investment?

Yes. The primary driver is just the moving up the volume curve. So as new programs come along, the contribution margin on the business is good, it's healthy, gives us very high confidence in the long-term margin accretion potential. But right now, the volumes just aren't high enough to generate the dollar contribution margin to offset the investment. So we want to be very prudent here. It's in a very important time in the industry. Our major customers across all 3 mobility markets are deciding who they're going to partner with on next-generation systems. So we're making sure that we're making the right investments in the core technology to stay ahead of the curve to make sure we lead with electric motors and inverters, but also making the investments in the application engineering to ensure that they meet the needs of all of the different vehicle types that we serve. So it's really going to be a function of actually spending more on a dollar basis in investments every year. But really as the volumes ramp up, the contribution margin from the new EV sales will eventually offset that investment and lead to a really attractive financial profile as we get towards the end of the decade.

Great. And then as we think about the spend, which you said it's $500 million by the end of this year, billing by the end of 2025. Help us appreciate what these relative spend levels are? Is this because you're looking to achieve a certain set of functionality? Or is this just these are the resources that you have available. This is what you can spend. And then if you have more resources, if you could spend more, does more spend unlock more capability?

Yes. I think that's a fair point. So part of the reason that we are spending more is the commercial success. So our win rate has improved, which leads to a greater investment in the application engineering. But I would also try to characterize the last few years, a meaningful portion of that investment has been inorganic, bringing the hardware and software capabilities in-house and then another meaningful portion of that $0.5 billion investment has been in ramping up the organization and putting the right people in place, the engineers and the teams to deliver these applications. The next few years that is going to shift away from inorganic, and we're going to start investing more in capital expenditures. So we highlighted we have a lot of relevant equipment on the mechanical side, but we need to invest to achieve scale in electrodynamics, both motors and inverters. So that's an investment that we're going to make. We just made a public announcement of a new facility that we're putting up in Europe, really excited about producing motors there. So those are going to be the types of things you'll see more of and then a continued acceleration of the operating expenditures largely on the engineering side to bring these programs and this technology to market.

Great. One final because I know we're running over. But thank you again for the time. Maybe you could just compare and contrast some of the in-sourcing and competitive dynamics across -- I think you talked about the competition, but let's maybe talk about the insourcing. Where are you seeing -- how would you contrast in-sourcing trends between, say, commercial vehicle and off-highway versus the light vehicle side. And then when we get to light vehicle, is the answer there that -- I mean you have some programs up for bid, but really, it's Power Technologies that once you factor that in, that is what enables you to net-net keep your light vehicle content?

No. We think the opportunity for electric axles in the light vehicle market is very strong, and that's why we disclosed the programs that are out there right now that we've been involved in development on and our quoting. So we see great opportunity for that business to grow above market as that incremental content comes into the system. This is one thing that we really tried to drill into a couple of months ago as the outsourcing trend. I think the dissidence is that our light vehicle customers started electrifying programs where they were already producing the drivelines for those vehicles in-house on the traditional side. And so there hasn't been a lot for us to talk about. But that's really the reason we disclosed the programs that we're working on is the vehicles in which we provide drivelines today in light vehicle are going to electrify. We're working with our customers. We think they are great opportunities for us to grow our content, not just in Power Technologies in battery cooling to the light vehicle market, but also on the electric axle or the electric driveline side.

Great. I know we're over time, but very insightful and resourceful as always. So Jonathan, Tim, Craig, thank you so much, and look forward to hearing more from you.

Thanks for having us, Dan.

Thanks, Dan.

Thanks.

Great. Thanks. Okay. You can close out the session.