Dana Incorporated (DAN) Earnings Call Transcript & Summary

All right. Good morning, everybody, and thank you so much for joining us for this opening session of day 2 of Deutsche Bank's Global Automotive Conference. I'm Emmanuel Rosner and I'm the lead U.S. autos and auto technology analyst here at Deutsche Bank. It is my pleasure to welcome you here in this beautiful, brand-new Deutsche Bank Center to bring this conference back in person. And we're extremely pleased to start today with the team of Dana. Dana, as you all know, is a leading supplier of axles, driveshafts with diversified exposure across many different end markets, light vehicle, commercial vehicle, off-highway. Dana also has been able to demonstrate some very strong traction with vehicle electrification across end markets and in commercial vehicle in particular. And so I'm extremely pleased to have joining me today, Jim Kamsickas, who's Chairman and CEO of Dana; and Timothy Kraus, who's SVP and CFO, to discuss an update on the current condition as well as on the company strategy. So thank you so much for being with us today. And what a treat to have you in person.

Thank you very much, Emmanuel. Great to be here.

All right. So maybe just to set the stage, let's talk a little bit about the environment you're facing, the markets you're seeing. How has the semiconductor shortage progressed since the start of the year as far as the impact you're seeing on industry production and on your revenue? And are you seeing things improving sequentially? Any signs of green shoots here?

Yes, I'd say, it's always a little bit more difficult question for the Tier 1, the supplier than it is the direct OEM. We buy less microchips and -- leading up into our various inverters and power modules and all that stuff than they do. But from our line of sight, I would say it's slightly better. But it seems like for everything, it gets a little bit better there with all the challenges that we all see every single day on different -- other shortages, it can be labor or it can be materials. They tend to have an offset to each other and inconsistencies in schedules and so on and so forth. So the answer to the question directly, it feels like it's a little bit better. And then as more directly to your microchip question, mostly all of the OEMs see better line of sight in the back half than they had in the past. But I think we all would look back in our notes and say we've seen that, too. And then ultimately, something gets in the way of that recovering. So it's really a tough question to answer because there's a lot of unknown still out there, but most people that I talk to say it's getting better in the back half of the year.

That's encouraging. And then I guess what are you seeing in your commercial end markets? Do you still expect North American Class 8 volume to improve in the back half? And can you talk maybe about the status of some of the EV launches in -- that you have coming up in this market?

Thanks for the question, Emmanuel. A couple of questions there, of course. So on the markets, I always try -- I don't know if it's necessary to remind people, but very intentionally, we align our business in the light vehicle side where we're SUV, truck and up. And then, of course, we're across the off-highways and then across the commercial vehicle. In our markets, all of the demand is still significant pent-up demand. If you look at our days in the field on the light vehicle side of the business and very lowest numbers that we've typically dealt with over our career on a consistent basis. So that still stands out there. Commercial Vehicle, Off-Highway, still the demand is really strong. As you've read in many quotes from different OEMs out there, they can make as many as -- they can sell as many as they make. I could argue that, in many cases, that's the same for us. So we feel good about the demand. Certainly, everybody understands the macros going on and anything could change. But if it's a direct question [indiscernible] as a direct answer, that's how I would answer that. On the electrification side of the business, it's -- I would put it into these words, for all of you who have been watching us and seen how we started our journey in 2016 is to be energy-source agnostic for our powertrains, which I think we've executed on fairly well. The team has done a great job. It is -- somewhere that had to start. You actually had to start designing, engineering, validating and doing the things you do. The rubber is really starting to hit the road for Dana right now. We're quite busy. You'll see more and more of our products as part of our customers' products throughout all of those end markets I just referred to. So we still feel very good about where those are going. And again, we're energy-source agnostic on how we share, we share our capital if it's our capital is our human capital, if it's our facilities capital, if it's our actually equipment capital, it's been very intentional to do that, and it seems to be coming together, but we're quite busy to say the least.

Right. And I guess, same question for Off-Highway. How is market demand holding up so far? Given -- and given your relatively larger exposure to Europe within this end market, are you seeing any impact from the Ukraine conflict?

Yes, certainly a logical and good question. Same thing, really strong demand. And yes, albeit our strongest center of gravity is Europe for our Off-Highway business. We have -- our sales are distributed quite well around the world. And there's a long history as to why it's that way, but it's a good reason for it. But anyway, the long and short of it is, even with the Ukrainian crisis and all the other inflationary challenges, the pent-up demand has been so significant coming out of the V-shape recovery on COVID and everything else that we're just making sure that, like everyone else out there, that we don't let supply be a challenge for us and labor isn't a challenge for us and energy cost isn't a challenge for us and you manage through all of those things, but demand is not one of the things we worry about right now today.

Right. So I guess, to summarize it all, the demand side of the equation, you feel optimistic?

Yes, I do. And it's not just another CEO in front of you saying, of course, everything is wonderful. It's not that you asked a direct question on demand, Emmanuel. There's lots of demand. I can't look out there and go, oh, oh. Here's this, here's the bubble. And here it is. Here's the black cloud. It's not there.

Okay. Great. So I guess let's turn to the cost side of the equation there and some of the margin drivers. So back when you reported the first quarter earnings, you cut your 2022 EBITDA close to by about $130 million, largely due to cost inflation, partly commodities, but mainly other inflation. How are things playing out compared to these expectations?

Yes. I think the -- we hear this every day, I think, in the mainstream press and the business press, the inflationary and cost pressures that we're all facing. On the commodity front, they're playing out pretty much as we'd expected. We expected there to be some softening in the back half of the year, usually late in the year. We're starting to see some of the spot prices for some of the commodities start to ebb a little bit in our favor. Although most of the forecasts still have the commodities at elevated levels. So we still think that's probably the most likely outcome, and that softening will happen late in the year. On the inflationary cost side, we continue to see that unfold on an every day. So whether it's labor, energy, transportation, those all continue to be headwinds for the business. And it's something that we're dealing with operationally every day.

Understood. And I guess, I was assuming specifically on the commodities piece, you had originally assumed commodity prices to soften later in the year. Then the first quarter, you updated gross headwind to be, I guess, closer to $500 million, nearly doubled the previous expectation. Has it been playing out as you expected since Q1 earnings? And can the very recent pullback in some -- in steel spot prices still be helpful this year or later year or would that be for next?

Yes. No, I think that's right. I think we -- I just mentioned the spot prices, they tend to be pretty -- they move around quite a bit. Also, the business is pretty regional and prices for things like steel tend to be different whether you're dealing with North America or, say, South America, that's -- or Brazil, it's a very closed market or then Europe, where you're impacted by what's going on in Ukraine and increased energy prices. So yes, I think we still see that later in the year that, that softening should take hold, but -- despite some near-term differences in the spot market.

Understood. And then I guess the guide also included some $470 million or so of targeted recoveries, which would be offsetting 96% basically of the gross commodities headwind. Just trying to better understand this. Are these contractual or will some of these be negotiated over the course of the year? And can you comment on how these conversations have been progressing?

So I guess the answer to your question on contractual and negotiation. The answer is yes. So it obviously depends on both the customer and the end market. Some of the end markets, much more contractually oriented and it runs off of an index. We go in quarterly, generally in arrears and it works through the process works. As we -- as you've seen sort of the recoveries that we've been reporting, it works generally very well. On some of the other end markets, typically in the Off-Highway, much less of a contractual or normalized basis. It's usually part of commercial negotiations. Those are pretty typical. We have a tried-and-trued method. We're in talking to the customer on a variety of commercial issues all the time and commodities inflation are just now one more that have to be front and center in renegotiating with the customer. The 96% recovery is -- we tend to recover somewhere between 70% and 80% of the costs as they rise. Typically going to lag. So what you're seeing with that 96% recovery is really the softening of some of these commodity costs late in the year and that lag occurring. So costs coming down, still operating at higher pricing from the new discussions with the customer or the contractual obligations and then the result flows through. So...

And then, Jim, maybe your perspective on how these conversations are going? And we've heard from a lot of suppliers that these happen at a very high level because it needs to be a pretty holistic type of conversation. So how is that going with your customers? What is the reception been like? And is there a way to sort of like change the way some of these things are priced so that you have ongoing regular discussions for -- around that volatility?

Yes, there's a lot there. They're blessed, a lot of fun. Just kidding. No, I mean, sometimes they are, I like to believe depending on what your business model is and how you have your relationship set up with your customer, but they don't always have to be at the top-top, that's for sure, if you have that open transparency and honestly between the two of you. But anyway, there's no doubt that we're together with every customer on their conversations, and I'm sure you'll hear it from some of the OEMs you talk through today is they can't push everything through to every end market and assume they're going to still sell vehicles, but they also understand that there needs to be a very viable and strong supply base, especially in the powertrain and driveline like Dana. And so I think they've been very productive. To your second part of the question is, is that if you think back, it doesn't matter if it was 20 years ago and they'd started talking about copper and 15 years ago, it was talk about resin, all the way through all the commodities there. Mostly everything has had some type of mechanisms with -- I'm talking mostly on the auto side right now. And -- but even with that, we find there's always a new unique boutique materials that you don't have something for us. So we put new programs in with different customers on some of those things that just didn't happen to get put in place over the last couple of decades. And then as it relates to the other ones, let's take transportation. I mean there was never a reason to have mechanisms for that, for the most part and over time, but now we're coming up with different mechanisms in some circumstances with some customers. So there is an evolution to that. So I think it's -- I think they're -- generally speaking, the conversations have been productive and they're going in the right direction, but it's tough for everybody, right, for both sides.

Understandable. Yes. Maybe two more quick points of clarification on the cost side because it certainly is a very, very topical. So I guess, following this first quarter net heads in some commodities of $16 million, the existing guidance you have for the year implies just another $4 million headwind over the final 3 quarters of the year. Is that the right way to think about this? And how should we expect it to play out throughout the year?

Yes. I think we don't give quarterly guidance, but I think the way to really think about it is the reason it's so lopsided is because of our view that commodity is going to abate, and then we have that over-recovery. So what you're seeing is the over-recovery that's built into the back half, really in the late part of the year and a lot of the cost inflation and under-recovery in the first part of the year.

So the idea of this would be basically a net tailwind as we move into the...

Yes. Still a net tailwind. So -- as we're not yet in a place where we've -- commodity prices have come down enough to where the [ year of recovery has ] more than made up for that.

And then besides for pricing action, what can you do or what are you doing? What actions are you taking to mitigate some of the nonmaterial's pressure? Obviously, freight, labor, energy, what is the playbook here?

Yes. Well, the biggest one, I know you said it, but it's worth reinforcing is recoveries, recoveries, recoveries, recoveries. I mean it's just that the elephant in the room is so big that you just -- we're in a constant churn of meetings and discussions and data collection and analytics to make sure that we get the recovery. So I have to reinforce that point. But as it relates on your kind of how do you manage it through this self-help when you're going through all this stuff, I'd also establish another foundational point about Dana that we're different than everybody else is when we established the enterprise strategy in '16 and reset it in '18 as a refresh, we took what has historically been four business units that were completely independent, completely running by themselves, limited flexibility if any flexibility, to share capital, share people, share footprint, share customer relationships, all that stuff. These are long past. And so our ability to -- when you have -- may have a downturn in this market, but an upturn in this market is huge. So we find ourselves every single day being extremely dynamic being able to float between those and it helps us on the cost side of it. And then we've really put a lot of effort and focused that investment into manufacturing is core and improving our operational efficiencies, which are, of course, everything that you're all well aware of, it's not just operator efficiency but it's quality, first time through, scrap and all that stuff. So I feel really good about having -- sharing all those practices, policy, procedures and systems across the company is to put us in a good position. And then the other one is, although it's not really technically to your question on the cost side, to have outstanding customer relationships, supplier choice situation, we've got -- when I say we're busy, you probably -- if you're thinking about Dana, oh boy, that's because they got to launch all that electrification stuff they want, true. But also at the same time, we have a lot of sourcing on the ICE side over the last couple of years because in our markets, think about trucks, SUVs, still they're not the first ones to market, right, as it relates to electrification. We've got multiple new programs launching over the next 18 to 24 months that are coming on board that makes it busy times for us. So that establishes -- that helps very much on the top side, not on the cost side.

Great. Understood. And then just finally, before we move to a topic of electrification, how should we think about incremental margins in the second quarter and mostly beyond as volumes improve?

Yes. So I think, obviously, as volumes improve, generally, the flow-through is at the contribution -- I think as you think about it now, we're still experiencing pretty dramatic -- we just spent 10 minutes talking about the commodity and the inflation costs and pressures that we're feeling. Those will continue to impact margins on the contribution side as we move through the rest of this year. And then obviously, if the environment continues, it will continue to be potentially impactful as we go forward. Just to touch on something that Jim just mentioned, the -- as programs renew, that -- the inflationary pressures become less issue because the cost structure in quoting all resets. So that's really one of the big helps we'll get in terms of when you think about how the margin profile of the business progresses even if we stay in this heightened environment of inflation in commodity costs.

Got it. So then shifting gears, I guess, to electrification. Can you give us an update on the traction you're having with winning electric powertrain business? Which end market are you having the most success in? And what's your content opportunity there?

Again, thanks for the question. Just a little bit of framework again for the audience. If you think about Dana, certainly, you think about light vehicle, commercial vehicle, off-highway, but think about off-highway as well as construction, underground mining, material handling, so on and so forth. Bus market, another subset within commercial vehicle. Now ask yourself the question, as you think about when the electrification pull-through markets will come through and has your company been ready for that as it came? Our company has been ready as it came through. Our sales significantly this year is in the bus market. Why? Because bus markets have come through first. So it's gone well, and we continue to be ready as every single market comes. Now specifically -- more specifically to Emmanuel's question, is that when you think about Dana as well, we'll have more programs by different -- with less revenue and volume through them than the other ones. And the same thing goes for our electrification. We are going to win more electrification programs in commercial vehicle and off-highway than we will in light vehicle. It's just the law of numbers, right? But that doesn't -- the other side, as you know, our portfolio -- our financial portfolio, our revenue was higher in light vehicle. Why? The simple word volume, right? So we will still continue to win with a good distribution. If it's going to be exactly the same or not in 5 years from now or 10 years from now? Can't tell you for sure. What I can tell you is we will continue to win our fair share in each of those end markets. And our customers, we know that for fact because if you look at recent information, we've announced them in all the end markets, and we're quoting in all the end markets, and we're still tied with that same customer base that we've been for 118 years. We're still partners with all of them and they're finding pockets for us to be successful because we've helped them to be successful.

And with 50% of your backlog already from EVs, is $700 million in EV revenue by 2023 still the right way to think about it? Can you provide any color on some of the recent light vehicle, e-Propulsion system that you disclosed in the first quarter in terms of either volume or content opportunity in what that could do for revenue?

You see Emmanuel try to beat me into giving him a backlog story there. I'm just kidding. I'm not going to get in front of that relative to giving you where the revenues are going to be on EV and so on and so forth. But I will tell you that it is firehose central as it relates to inbound RFQ activity and opportunities to consider across all of our end markets. And there's no pulling back. I'd be shocked if your various speakers today say, well, you know what, with everything going on we've decided to pivot in different direction. I don't see any of that. And I mean, when I see in any end market, it's again, it's not 3 end markets. It's 8, 9, 10 end markets that we obviously share all of our capital that I referred to earlier across to all of those. And all customers are still -- got their plans as it relates to going to emissions free.

I guess maybe asking differently since we're not getting a new backlog question. What are you -- answer. What are you most proud of in terms of some of the EV wins? What platforms would you want to highlight in terms of what we should be really focusing on as proof of...

No, I think that's a fair question. To the question, so I'll speak with the examples, right? I mean as I talked about a little bit earlier, where the bus markets pulled through first, mostly overseas but pulled through first. We get a lot of revenue this year, and we will again next year. If you start where else is the next major pull-through market, people may not have thought of 5 years ago or 10 years ago, but think about the school bus market, which we have a very -- a large portion of that business. Let's face it, do any of us want to have our kids that are at the school bus with emissions that come from our old traditional buses and all the things that go with it? It's not terrible, but there's been a big push towards that direction, toward electric school buses. We're positioned in a very strong way. Very proud of that, not just because we have the full powertrain for e-Powertrain but because it feels like we're doing the right thing. Then we went to -- what's the next one lined up, obviously, last mile delivery. And if you think of some of the medium-duty trucks that are now out on the road, launching right now with Freightliner here in North America, launching the stuff with PACCAR this year. It's already starting to get on road. And I could use examples across other customers. I'm just proud that ultimately I think we got it right, right? There are a lot of people that maybe thought in 2016, this whole thing electrification, it doesn't make a lot of sense to me, how do we ever get there. I never said it was going to be 100% of the market by 2030. I just said it's reasonable in at least in our business, to be energy-source agnostic and not damage your business doing both at the same time, and it seems to come together from my point of view.

I guess just one more question from the previous one. I was asking about the content opportunity because you're talking about powertrain agnostic, but I think in some cases, this could actually be content accretive. Is it, yes?

Yes, it is. I mean, it depends on the powertrain, let me say this, but in the business which -- were you all know. But in the business, we typically use terminology 3-in-1, 4-in-1, 5-in-1, 6-in-1, whatever it might be. 3-in-1 is usually when you think about in the powertrain, motor, inverter, axle. It could be e-axle. It can be an independent axle. Don't really care for us. Dana has done independent and rigid axles for 100-plus years. It doesn't matter. But the content on that can be a way to think about that, if a vehicle already had an axle, the other one is obviously makes it 3x. Anybody can do the math. But sometimes, depending on the vehicle, you could have two motors, you could have two gearbox, you can have two inverters, you can have some type of sizable incremental amount of content to that. So as you see our programs continue to launch out there, you're going to see a kind of a mixed bag of content per vehicle.

And so there appears to be much more aggressive efforts by OEMs to launch electric vehicle pickups, SUVs and obviously, a lot launching this year and then coming up. What kind of content are you bidding for or winning on these programs and on light vehicles, in particular?

Yes. Again, I think we try to. I don't know if we do a very good job of it, but we try to do kind of bit of a rotation in our earnings call. So we speak to an example on electrification, two groups this time, two groups the next. So I think we've done a pretty good job of that, I hope. In the last quarter, we talked about in light vehicles, to answer your direct question, that it's a to be announced customer, but it's a -- life-of-program, over $1 billion worth of revenue program that's coming in the road, and it's got -- I won't get into 3-in-1, 4-in-1 and 5-in-1 again, but I'll just say it has significant content per vehicle increase to it. And so that's one of the more recent. But back to your question, we've been in the truck business. And we haven't been in the truck business for over 100 years just because we're the only guy there. We're there because we understand the end market, we provide the customer value by being able to think about some of the off-road enthusiast stuff that we do. I think everybody understands it between the Broncho, between the Wrangler. It's not because we have a cool logo on the side of the wall. It's because we understand the market, we go to the market. We help our customers develop vehicles from kind of grain to bread and then we go forward. Now think about that in electrification. Is it in their best interest to work with Dana and partner with us in the electrified version given our brand loyalty, giving our credibility in the markets, globally by the way, we think it is. And I think that has something to do with all the RFQs and work that we are already working on, other than that I can't disclose exactly what that is. But we're in play in all markets. I can just tell you that we are busy as the day is long in RFQs.

Right. And then let me just -- before I turn to some midterm targets and financial, let me ask you the in-sourcing question which is, I think this is sort of like often the concern among investors that it seems automakers are interested in -- some automakers are interested in sort of like developing and producing their own e-axle or somewhat be more vertically integrated in electric powertrains than they were historically in combustion engine. Do you see this happening? Do you view this as a risk?

Big kind of tongue-in-cheek answer to that, I don't care. And what I mean by that is that you're really selling capacity and the components and systems that go with that. If our business model, the we are set up, pivots when you think about the people, the capital and the actual products themselves, a lot of those are -- they transition up and down at scale anywhere from underground mining to commercial vehicle to light vehicles, so on and so forth. That said, the way we are set up, we sell capacity, as I like to say it. So I don't really spend a lot of time thinking about that. And the other reason I don't think a lot about it because like I said, each and every one of the end markets we have full steam ahead as it relates to RFQs. So ultimately, if you -- if we wake up 5 years from now or 10 years from now or something like that, and Dana's mix on the revenue is one direction versus another, I can -- I don't want to ever use the word guarantee, but I can guarantee you that the -- as we've gone from $5.8 billion in 2016 to over $10 billion in the short 5 years, the customer centricity and focus on the customer and creating value with them is going to continue. And as long as you guys are all stuck with me, it's going to continue to go in that direction, and we'll see where it goes. But I feel very bullish. Again, back speaking to the example, in light vehicle in Q1 that we talked to you about just a minute ago. But all markets, we feel good about it.

Great. I appreciate the color. So maybe just to finish off. Just wanted to get back to some of your previous midterm targets and see what would get you there. So you previously called for EBITDA margins of 12%. I think at some point, was by 2023 on $10 billion in revenues. Assuming it's going to be challenging, I guess, getting there by next year from this year's starting point, what is needed for you longer term to actually get back there or get there as a target? And how would you think about the respective contribution of your various segments towards that?

Yes. I think the -- obviously, we're already at the $10 billion in revenue. It's largely driven, obviously, by pricing increases coming out of commodities and inflation. Both of those are impactful to margin, right? Even if we were able to recover 100% of all the commodities, 100% of all the inflation that has come through the system since '19, EBITDA would remain the same, but margins would be lower. It's just simple math. So I think to get back to or to get to those types of margins, a couple of things have to happen. The environment we're operating in needs to revert back to a more normalized basis. So ambient levels of cost inflation, not the 6%, 8% we're running at now. And the other -- and the same thing on commodities. So if commodities were to come way down, we'd see the margin recoup as we recovered costing down and obviously, price downs that go along with it, again, on a lag. The other is, and both Jim and I touched on this a few minutes ago, as all of our programs globally renew, and this is across all the end markets, we're quoting at elevated levels of both commodities and conversion costs. So just think of, that's labor, that's freight, that's everything that's in the plant, transportation. So that's the opportunity where we'll be back in and be able to put the margins and the profitability back to where we were back pre-pandemic basis.

I guess, absent in the near-term normalization in some of these costs, can this be made up through some of the recoveries? Or just the math just doesn't work?

Yes. Well, so certainly, the -- from a profitability perspective, Jim made the comment, right? It's recovery, recovery, recovery, right? So obviously, and him talking to the customer and getting recovery. And as I said, even if you recover every nickel that's come through the system, your margins would still be impactful because we have higher sales with the exact same EBITDA. So that isn't going to be able to be outcome. The customer is not going to give you margin on commodity inflation that's coming through the system.

Understood. There's 5 minutes left. So definitely wanted to open it up to the audience if you have any questions. I do have probably another couple of questions that I we'd love to get through. Any questions in the room? Looks like I've done a decent job of asking them. So I'm going to keep going. Let's speak about free cash flow then. How should we think about the drivers and timing of free cash flow improvement towards the 5% of sales, which was your target?

Yes. I think the -- from our perspective, the business is still capable of generating over the business cycle, a 5% free cash flow return. In the near term, we're obviously impacted by lower EBITDA as well as higher levels of working capital that are really impacting the free cash flow. The other item that's really starting to come through is as we're winning a lot of new business, especially in the electrification, it comes with a level of investment. And those sales won't be contributing meaningful EBITDA in terms of incremental and cash flow until we get further into the investment cycle. So the prospects for the business from a free cash flow generation are better than they've ever been on a long-term basis given the growth in the EV business, but they're certainly impacted in the short term by the operating environment and the higher -- [ in meaning to carry higher levels of working again. ]

And then finally, when do you think you can reach margin parity on some of your EV products?

So we -- when we were out last fall with the Investor Day, we sort of laid out a time line. So 2023, we still believe the EBITDA on the EV business will be breakeven. And then a few years after that, it will start to become accretive. And ultimately, late in the decade, it should be -- or parity and then accretive later in the decade. It's really a size issue or -- for the business. Right now, we're growing sales quite dramatically year-on-year. But the contribution margins from those businesses are being really poured back into the development that we need to do for all the future business in order to grow our business by 2030, that's going to be a $3 billion business, which today is less than $0.5 billion.

Great. There's no further questions. I want to thank you both so much for coming to visit us here at the Deutsche Bank Center for all your time, for your insights. And I want to thank everyone here in the room as well for participating. So thank you very much, and looking forward to keep monitoring your progress.

Okay. Thanks and have a good, everyone.

Thanks guys.