Dana Incorporated (DAN) Earnings Call Transcript & Summary

Grateful to have Dana with us today. They've been great partners with us for many years in this conference. For Dana, we have John Geddes, Vice President and Treasurer. Joining him is Craig Barber, Senior Director of Investor Relations and Strategic Planning. Craig has been a very good partner for us and a lot of the fixed income investors that have asked him questions for many, many years. As you know, Dana is a global leader, provide power and energy management solutions for vehicles and machinery. Its products include axles, driveshafts and transmissions to electrodynamic, thermal, sealing and digital solutions. Dana is a supplier nearly every major vehicle and engine manufacturer in the world and operates in 32 countries around the world. I'm going to turn it over to John for some prepared remarks, and then we'll jump into a fireside chat.

Okay. Thanks, Doug. Thanks for coming this morning to learn a little bit more about Dana. A little bit of background. We're an old-line company that was founded in 1904, and that is driving towards the future. We have about 40,000 employees, 140 major facilities in 31 countries, and we've a very diverse base of customers, countries and end products. In 2021, we had a little under $9 billion in sales, and that figure is forecasted to grow to a little bit more than $10 billion this year. Slightly less than half of our sales are in North America with the rest spread around the world. We operate in 3 distinct end markets: Light vehicle drive systems, so think of pickup trucks, SUVs; commercial vehicle drive and motion systems, think of medium-duty, heavy-duty trucks, buses, specialty vehicles; and then off-highway drive and motion systems and so you can think of that as agriculture, mining, construction, forestry, material handling, et cetera. And then we also have a Power Technologies group, which serves all 3 segments with ceiling, thermal and cooling products. As Doug mentioned, our technologies include axles, e-Axles, driveshafts and differentials. On the Motion side, we supply winches, slew drives, gear boxes and hydraulic components. And as the industry transitions to an electrified future, we have a full suite of electrodynamic components, such as high- and low-voltage motors, inverters and power electronics. Our thermal business, which was historically focused on the ICE business supplying oil and transmission coolers, now includes battery, motor and electronic cooling capabilities. And on the ceiling side, we have historically provided gaskets. Going forward, this also includes battery and inverter housing gaskets. And finally, there's digital. As we move from mechanical to an electrical future, we have smart systems, and we supply the digital infrastructure of that as well. So this picture gives you an idea of the reach and application of our products. I mean you can see that there is a -- up in the upper left-hand corner there, there is a Jeep Wrangler, which we have supplied since World War 2, and we were recently awarded the program for the next-generation Wrangler in Gladiator. We also have buses there, a Zamboni, reach stackers and in the upper right-hand corner, you'll see some electrified lawn care equipment, which is a relatively new market for us. So we think we're well-positioned to benefit from a transition to electrification. We have a strong ICE business as a foundation, which gives us global manufacturing, customer reach as well entry into several different end markets, the -- which will allow us to leverage those capabilities as it moves towards electrification. We have the ability to deliver a complete e-Propulsion system to the various end markets. And we believe that, that has a 3x product uplift or content uplift versus our current products. And in addition, because they are -- they tend to be smart systems, they come with higher margins as well. So when we talk about a complete e-Propulsion system, this kind of gives you a picture of what that is. So we refer to it as a 4 in 1. So in that 4 in 1, you can see motors, the underlying mechanicals and then the power electronics that will drive the vehicle. And then the thermal management that comes with the battery cooling, battery enclosures, and the motor and electronic cooling. So this -- we are the only supplier that can put together a 4-in-1 system, a comprehensive system across multiple mobility markets. Okay. A quick update on the market. In the left-hand side, you can see we referenced OEM production efficiency. As you know, the OEM manufacturers have had trouble with -- issues with their supply base, which then trickles down to us. In terms of production efficiency, we tend to have more downtime, more changeover time, more what I'll call stranded labor as well as increased freight and inventory to deal with the supply disruptions or the different -- what I'll call the different patterns of production. And this is -- while it's gotten better recently, it's still not where we have historically been. In the middle, you can see that we have cost inflation trends. So energy, labor, transportation, they've all hit us over the past year. We are working with our OEM customers to recover that cost, but those are one-on-one discussions, not what I'll call systematic similar to steel which tends to be more systematic. So we are continuing those costs recovery discussions. The strong dollar has also hurt us on a translation basis on our sales and our EBITDA. I will say that metal prices are moderating. So we've seen them come down, primarily steel from their peaks in the first half of the year. And there, we have a more systematic mechanism to recover those costs. And in fact, we expect that to be a slight tailwind to our profit this year. And then on the market demand, dealer inventory remains low. End user demand for our key products is still strong. And then you have the order books are strong for the -- or we've been -- we've seen that the order books for the heavy vehicles are strong going into 2023. So how does that translate into an outlook. We reaffirmed this outlook in our Q3 earnings call, which was last month. The guidance is for $10.1 billion in sales, which is over $1 billion increase from prior year. Of those sales, about $600 million will be EV products, which is up over -- up $230 million, translates into adjusted EBITDA of $720 million and free cash flow of $200 million. And then I want to point out, we have a very strong balance sheet, strong liquidity. At the end of Q3, we had $1.3 billion of liquidity, which -- with a little under $400 million of cash, over a little over $900 million of revolver capacity. And then you can see our debt capital structure allows us a lot of flexibility. We have no debt maturities until April 2025. And our credit facility does not mature -- our $1.15 billion credit facility does not mature until March of '26. And then I will just leave you with this. We're changing the world through e-Propulsion. We think we are well situated to benefit from the transition from mechanical ICE engines to the battery electric vehicles. With that...

Do you guys hear me? Yes? Great. Thanks so much, John. Maybe just dive into the EVs for a moment. In the Q3, it looked like you had $73 million year-over-year improvement in revenue from EV organic. I think everyone knows Dana makes some of the best products in the industry. I get a lot of questions of how well you're positioned. A lot of the auto suppliers are -- you seem to be very well positioned. You've recently won some PACE Awards. How do you think about the EV migration, like what platforms or products do you think make your company stand out?

I think we're very well positioned on the EV side. Obviously, I think -- if you look at it, we have the base mechanical, right? We have the axles on which to build upon. And we are -- over the last, let's say, 5 or 6 years, we developed the capabilities through some acquisitions and internal development to electrify those axles. And then we also have the base of the thermal business. So what we can provide is a complete integrated electrodynamic propulsion system with the only supplier who can do that, and we can do it across multiple mobility markets. So we have customers coming to us to help design and integrate the propulsion system into their vehicles, which is instead of just supplying a component here or there, we can do the complete system, and we see them coming to us to ask us help them do that.

At this point, are there any major margin differentials between ICE product and EV? Is there upside down the road for EV? Is there any different type of content dollar amount? Or is it kind of too early to tell?

We've said that we believe there's a 3x uplift on the content per vehicle. So if you think of what we supply now is we have the axle, right? And then in a lot of cases, we have the driveshafts. Okay? The driveshaft goes away as they move to battery electric vehicles. But what you get is you get the motors, you get the inverters and then what you also get is the smarter system, so you get the digital component. And so the combination of those items, I think, gives us more content per vehicle or opportunity for more content per vehicle and expanding margins as the vehicles get smarter.

And Doug, currently, the contribution of that product relatively small volume today because it's just starting out -- the contribution is positive it's just we're continuing to invest. So what you're seeing is the investment over the current contribution margin, which is holding back the overall margin. But that's a good problem to have because over half of our backlog is coming from EV product, almost all of our development work we're doing today is on EV product for future programs. So it's really -- we're just getting started. And again, most of what we're seeing today is in the commercial side, the heavier product. That's the sector that we have played in traditionally, and that's the one I think we can do the most for in the near term, but eventually, I think you'll see it spread across all the markets, including off-highway.

That's great. Took the notes here. So driveshaft goes way, we get motors, inverters and digital components.

And that's in the end state. I mean, John mentioned the 3x, and we put that 3x number out there speaking of this is when we see kind of full absorption in the marketplace and the whole systems in play. Currently, especially if we're doing integration work much, much higher than 3x today. But again, over time, it will likely level out.

That's helpful. That's great. Maybe talk to us a little bit about recovery in commodities. Commodities have gone up a lot. We've got excellent relationships with all the OEMs. It's a fine balance on how much recovery you can get and how much of the OEMs want to give. Kind of where we are in that continuum now. Some of the commodities have fallen a little bit. Steel is that -- like peaked about a year ago, now it's trying to be a little more moderated. Just give us a little color on that.

Okay. Let's -- let me break that into 2 pieces. So you mentioned steel. We have historically had a program with a lot of our customers, most of our customers where we systematically recover commodity costs with those suppliers. So if steel goes up, we recover that from our supply -- from our customers, I'm sorry. We recover that from our customers. So steel goes up, we get those recoveries. There tends to be a little bit of a lag to that. So you'll see, I don't know, maybe a quarter lag on the recoveries. But that's systematic, that's built into the system. When you get to, what I'll say, energy, labor, freight, that is not systematic. Historically, we've been able to cover those costs through productivity and those were our responsibility. As the costs have gone up significantly over the last, let's say, a year or 2, it's requiring discussions with our customers. So it is one-on-one discussions going through trying to get to equitable solutions. Those conversations are -- they continue and they will continue into the future.

So the steel recovery, and that's been in place for a while. Have you ever put out like a public percentage of how much steel you're able to pass through? Is it like between 50 and 80 type of thing?

Yes, it's -- traditionally -- I mean, or normally -- we're not in a normal time, but normally, it's between 75% and 80% of commodity prices we can pass through with a lag. It is usually about a quarter lag on that recovery. And sometimes we'll over recover, sometimes under just depending on the situation and how fast prices are moving. And it's across all 3 of our end markets where we see that with different degrees of responsiveness.

That's helpful. Thank you. Recession is always a fear for any investor that invests in any auto-related company. We've got low inventories and pent-up demand theoretically for the auto industry. I'm kind of wondering how that will hold. If we do go into a recession, will the demand really be pent up? Does your team have some contingencies if we do go into recession what type of cost takeout you can have? And how do you think kind of "breakeven" would be? How would you do in an environment where production is down 10%, for example?

Okay. Well, as I said, inventory is still, as you referenced, are low, demand still seems to be strong for our key products. But I think you can just go back -- in my mind, you go back to the COVID year, right, on what happens that is an extreme example. But when production was shut down, we went into cash conservation mode. We cut discretionary CapEx while still supporting programs that our customers needed. We cut all the discretionary spending, and we wanted to make sure we maintained cash and liquidity. And so we continue to look at those sources of cash and liquidity. We increase the size of our revolver over the years to ensure that we have liquidity. So we'll -- whether sales go down 5%, 10%, whatever that may be or whatever scenario you want to look at, we have a capital structure that we think provides us flexibility. No near-term debt maturities. And we will just -- we will conserve cash and then our operations. We know how to flex a lower volume.

Maybe just follow on that with the balance sheet question, just to keep my numbers straight. So with the adjusted EBITDA of about $720 million, the net leverage ratio stands around 3.4 at 3Q. That's a reasonable safe leverage, I think. Do you feel like you want to bring that down? Are you comfortable with that level?

We've stated that we would like to get down into the 1 to 1.5 range of leverage. And that's going to come from a few different areas. So you get -- our EBITDA is a little lower this year than it has been in the past few years. So as you get EBITDA increase, you'll get some pick up there. And then over time, we will pay down some debt or at least reduce our net debt to help get us there. But we're pretty comfortable in the 1% to 1.5% range. We think that it gives us the flexibility that we need and that the deal with unforeseen circumstances, I guess.

That's a good leverage target. I guess, kind of one more on the balance sheet. Industry consolidation kind of comes up a lot. It's a tough industry and sometimes being bigger it's better from a synergies or cost takeout. I'm not asking your comment on your appetite for acquisitions, but how do you see this may be playing out in the industry? Do you feel there's more consolidation to come? Or do you feel like as we head into maybe recession type economy, if people hold off.

Not sure. I don't know if there will be more consolidation. I will say that if you look at what we've done over the last, let's say 5 or 6 years, we've built up our ability and our capability for the transition to electrification. We've integrated that within our operations. And that as we move forward, if the industry consolidates, we're going to compete, and we think we're in a good position to compete regardless of the name you may see on the door.

That's helpful. We were chatting a little bit earlier today on labor. I've got about 20 companies here, and I think [indiscernible] are really kind of suffering with like tight labor markets, and some can't -- or maybe in the automotive services side can't really find enough employees. How is labor look? How are the labor costs? I guess, any upcoming kind of thoughts around that.

Yes. So if you go back, I mean, a year, I guess, 1.5 years ago, whenever, it was tough to get labor. I would say today, we're in a better spot where we can get the labor. The issue is more around the cost of labor has definitely gone up. And that as we've had these, I'll say, inconsistent ordering patterns from our customers, we intend to have more efficiently -- inefficient labor. So whereas before, you might cut back on labor a little bit as your customers pull back or change their order pattern. We don't do that. So we have what I'll call more stranded labor, and we're bearing those costs. But as far as getting the labor, I think we're in a better spot than we were a year ago.

So some of the production schedule is normalizing. Some suppliers have said [indiscernible] OEM production is going down and they have to inefficiently kind of change their labor force [ just in ] the next couple of weeks. We're hearing that's getting better. Chip shortage was the main driver of it. Then there's some other like supply chain issues. Just from your vantage point, have some of those kind of production [indiscernible] have they gotten better?

I think it's gotten slightly better, but we're still having issues. So you still get the production is down or the changeover -- they change the production, right, which causes us to have the changeover, which creates inefficiencies in the plants. So I mean it's primarily a light vehicle issue, it does -- you get a little bit of it in the other markets. So I'd say it's getting better, but we still expect some of that to carry through until 2022.

Yes, a little more on that. When he says the changeover, specifically meaning that what product is being produced changes. So what you may be hearing from others, and we see it as well is that you always may not take as many down days, but they may call us on a Friday and say, Monday we're going to run product X when we thought they're going to run product Y and then that requires us to change -- not just -- we're going to produce that day, but we have to change our supply chain. We have to make sure we have the inbound parts. We may have to expedite freight. We may need different labor. You may need different skill sets, so you have to run people in and out. That's what's driving a lot of the extra cost. The total sales for the OEM maybe up, but -- and for us, perhaps, but the cost of that goes up. That's the choppiness that we continue to see.

Can we talk about free cash flow for a moment. So free cash flow for 3Q was excellent at $77 million. I think you may have guided to free cash flow of $200 million for the year. Pretty strong numbers. I mean, how do you feel like the working capital is where you need to be and without giving us color on 2023, I don't think you have a guidance, but how does your free cash flow picture look?

Well, you're correct in that we've guided to $200 million for this year, which is up over $400 million from last year. And a lot of that is working capital management. So if you go back and look at last year, we're carrying more inventory in part to deal with what Craig just mentioned, the inconsistent order patterns. And so this year, if you go to Q3, we -- it was a focus on working capital. And you're going to see a lot of that improvement in cash flow is due to working capital management. So we've worked with customers and suppliers to better align terms to the current market. And we're going to continue to focus on that. We think free cash flow is an important metric. It allows us to provide a return to shareholders, but also provides some flexibility to the leverage target we're looking for. So we'll continue to focus on that.

So we've got about 5 minutes left. I would take back and maybe open up for the audience, if anyone has any questions for Dana while we have them here. Gentleman back there. Okay. If any does have a question.

You mentioned electric motors a couple of times for e-applications. I mean who do you think long term or what do you think the split is going to be in terms of OEs making the electric motors themselves versus supplier?

So it's a great question. And it's going to depend. I love that answer. And what we found doing this over 100 years is that the OEs will make the components, the subsystems that make sense for them. A lot of times, it will be determined by volume and complexity. So the higher volume, lower complexity parts that they can use across multiple platforms, the OEs tend to make themselves. And it's across all of the different products that they make. If it's a lower volume, higher capability, more complex application, they tend to outsource it. So in our business, we don't do a lot of pass car work today, and frankly, never really have since pass cars tend to not use our style of product. They tend to be front-wheel drive cars and the ICE configuration or in electric configuration they have very small -- relatively small, I'll say, less complicated electric drive systems. Now certainly, we can sell those type of components to them, but likely the OEs will absorb that work in-house as they've been doing. Take batteries for instance. They can use batteries across multiple platforms so they can commonize that and they can make large-scale production. So we, of course, aren't going to be in the battery business. But we will be in things like thermal management for batteries because it's a very technical application, something they likely won't put capital in place, and we can do across multiple OEs and supply of those type of systems. Same with electric motors. We will do the motors that make sense, generally the larger motors. Again, motors that we can integrate into our drive systems, and we do it across off-highway applications for [indiscernible] that use motors to drive the vehicle but also do the work on spinning the motors. We do it in commercial vehicle for relatively large motors. We do it in the small truck and SUV world as well for electric drive systems that use the axles. Again, it's really going to depend on how the OE plays out, but there's going to be a place for the supply base across many of the segments, it just may not be for everything, which it isn't today.

I'll jump in with a quick topic here on the ICE business. Let's not forget that it's an effective business...

Will be for a while.

Right. I think you're being sourced for the [ 2023 ] Jeep Wrangler and Gladiator programs. Can you just give us a little color on the significance of those programs?

So I get the history. We love the Jeep Wrangler program. I think it's -- Dana has been supplying the driveline for that system since there was a Jeep, going way back into 1940s. So it's 80-plus years that Jeep has been riding on our drivetrain. And so we're more than excited to continue that tradition going forward. It's -- in the U.S. or North America, for our light vehicle business, it's one of our top 2 or 3 programs. So it's a very large program. And it's always been a great program, too, because people that want a Jeep Wrangler are going to get a Jeep Wrangler. And it's the same thing for Gladiator, and even as other programs have rolled out and there's some competition there, maybe some other OEs that have something maybe similar, which, by the way, also happens to run in Jeep Wrangler, we've seen the Jeeps still remain very popular. So that market, I think, is a fantastic one. We're more than happy to continue that.

And then I guess last question from the middle isle.

Can you just talk to us [indiscernible] rating spectrum, the leverage target of 1 to 1.5 is certainly going to be an uplift in ratings story, if that's the case. Just give us a little color on your discussions with the agencies.

Yes. We talk to the agencies on a regular basis. We have said we would like investment grade rating metrics. And so I think that's the key is the metrics piece because we can't -- we don't rate ourselves. So it's up to the agencies to decide where they want to rate us and some agencies have different views than other agencies on our sector. But as we look at it, we think if we get the metrics, that's what we can control and the rates will kind of fall out based upon their view of, I guess, the industry, us in general, but we've stated that we would like to get to those metrics and where the rating falls -- it will fall.

All right. That concludes our meeting. John and Craig, thanks so much for taking the time today [indiscernible] one-on-one for meetings.

Thank you.

Thank you, everyone.