Dana Incorporated (DAN) Earnings Call Transcript & Summary

Take your seats, we're going to get started. Next up, we have Dana. We're very happy to have Tim Kraus, Vice President and Chief Financial Officer, here with us today. Dana is a company that is really interesting, crossing a number of end markets outside of light vehicles, heavy-duty and commercial vehicles. I think one of the interesting things is, despite some people maybe not appreciating it as much, they are making a very good transition towards the EV worlds across all segments. And I think in some ways, having that exposure to off-highway and commercial might be giving them a very interesting unique opportunity to expand in markets where they're actually able to make money on EVs, maybe sooner than other folks in those end markets. So Tim, thank you so much for joining us today.

Maybe -- First, maybe if we can get into just sort of the -- what's going on in the industry at large and how you're seeing volumes develop here in 2023 and maybe even beyond. Really, as you think about sort of the schedule normalization, what we've been hearing from a number of folks in the industry is it's getting a bit better, but it's still a little bit volatile. And this is more on the light vehicle side than commercial and off-highway. What are you guys seeing from your customers as far as schedule fulfillment and volatility on mix and the like?

Yes. I think volume tends to be a little better, right? They're not dropping out a large amount of volume. But the ability -- volume and mix -- or I'm sorry, mix is a -- it continues to be, I think, a challenge for the customers really across the end markets, I think. I'd like to make the comment that they have a set schedule they'd like to make, but I think a lot of times, they're building a lot -- what they can make based on what the part availability is. So -- and that's really tough for folks like us where we tend to have -- especially if you think about light vehicle and commercial vehicle, I guess off-highway too, it's a very -- the mix changes tend to drive a lot of costs into the plants. And light vehicle, especially is a volume business, right? Like the set up, run and really drive the efficiencies from that volume. And when they're changing mix a lot, you miss out on those opportunities.

And have you guys quantified what sort of that disruption cost was in 2022 and what you might think it might be in '23?

We haven't said publicly. It's obviously a mixture of both idle labor, obviously, changeover costs. There's a lot that goes into it. We're obviously -- we work with the customers to try to make sure that they understand the impacts they're having and how we can work together really to try to minimize the impacts on it. But we're out -- we think this continues to get better as we move through the year, and we're really thinking the second half of the year starts to show a bit more improvement than certainly last year and the front part of '23.

Okay. And then we think one of the other headwinds, which might be switching to a tailwind as far as inflation on input costs. What are your thoughts on that sort of near term? And how much of a headwind was that last year going into this year? And then as you think about sort of recoveries potentially there on that and then the incremental, sort of, penalty of this cost volatility, what are the discussions and recoveries like with your customers?

So I feel like we're in every day, having a discussion about recoveries. Obviously, the rate of inflationary costs on the business are starting to slow down. We're not seeing that. I think all of us experience it every day as we kind of go through the rigors of life. For us, inflation last year was about net $117 million headwind. This year, we see that number being somewhere around $50 million. So it continues to be impactful, both to pure earnings and to the margin profile in the business. It is -- it's a mix, right? We still see large amounts of energy although the rate of change in energy, obviously, is down. Labor is a big factor. The inflation that we all saw last year is flowing through in cost of living increases across all the businesses, which are now showing up in labor costs. So it continues to be impactful, and we're in having those discussions really every day with the customer about recoveries and how we can get those margins back.

I mean -- but what we're hearing is there almost seems like there's a bit of a change in the discussion with the automakers, where there's more price recovery coming from these incremental costs and the inflation. Is there anything really changed here? Or is this really just kind of blocking and tackling in the short run, and we're going to be back down to sort of 1% to 3% price downs once we get through this?

Yes. I think the -- if you think about -- I mean, we obviously operate across a number of different end markets. So you think about light vehicle, which is sort of your typical 1% price down. Or we think of it as more productivity sharing with the customer. The customers, I think, really want to get back to that normalized level, which is why for the most part, cost recoveries aren't becoming sort of contractual kind of like we have with commodities, because they believe that this situation we're in with the high inflation is going to revert back to sort of the way it was. I mean we'll have to see where that ends up. I think as this has moved on, most of the customers in all the markets have been more constructive around recoveries. I think the -- you see $117 million last year, only $50 million this year. That -- some of that is really recovery-driven with the customer. And some of that also is we have a lot of new programs coming on. And typically, when those programs come on, they get repriced. They have a number of different aspects to them. So we see some of that coming through as well in the business, really across all the end markets.

So in the new programs, you're definitely seeing a little bit more improvement?

Well, it is. I mean, typically, when we end one program and begin another, right? You bid the program in a number of years before it end, and there's been engineering changes, cost structures have changed, and that's really a typical aspect when you get ready to launch and go back and sort of settle up with the OEM. There's probably more to discuss with the OEMs today than there was typically, but we're following the same path.

And when you think about labor, there's kind of maybe 3 sub questions. I mean, first, when you think about labor inflation, what are your assumptions and your thought around that? Is that something that you can potentially unwind as you go through '24 and '25 after you have some inflation this year. Second, I mean, are you having a hard time finding folks? I mean, if we see production ramp up significantly, are there any issues with availability of labor? Forget about the price. And then the third thing, the UAW is going to have a pretty contentious round of negotiations with GM, Ford and Chrysler, likely Stellantis to start with. And there's a good chance that there might be a strike later this year. It's a little bit outside of the inflation cost issue. But have you guys seen anything as far as order patterns or anything like that from Stellantis, or are you prepping or hearing any prep for that in advance of those negotiations or potential strike?

So on the last one, really, obviously, we keep an eye on it. But not really -- we don't have any position or we aren't seeing anything specific relative to how the OEMs might be preparing for the discussions with their labor unions. On your first one, I tend to believe, and I think this is probably true, labor inflation is pretty sticky. Once you give a pay raise, it's pretty hard, I mean, to get back. So I think those cost structures are going to end up being far more permanent in nature than others, such as freight or energy, which tend to move with the course of economic activity. On your second part, I think labor availability is starting to get a little better. I think we saw it as we redid our labor agreements a couple of years ago, and starting wages are now, in the plants, pretty competitive. I think that certainly has allowed us to attract the labor we need in the plants. I wouldn't say it's easy, but I think it's better than it was, say, 2 years ago.

On the backlog, what you mentioned before with respect to kind of Doug's kind of question. I mean if you look at the backlog growth, it's been pretty apprised at [ $203 ] million. You have a record backlog of $900 million right now. What do you think is driving that? And it seems like a lot of it is coming from the EV side, which we'll get into the products in a second. What is the key driver of that growth impact?

I think the key driver is we -- we're delivering products and developing products that our customers across all of the end markets want and that their ultimate customers are demanding. And I think that's the real driver behind the growth in the backlog. Obviously, the mix of that backlog has changed dramatically over the last few years, which our EV backlog now stands at 65% of that. So -- and that's, again, reflective of an early recognition on the part of Dana to shift to EV. You mentioned this in your opening comments. I mean, we are the only supplier that is capable of delivering a four-in-one EV-integrated system. So we have the capability to not only manufacture the hard parts, right, the traditional axle. But the power electronics, inverter, motors and then the cooling system that goes along with it. So our thermal business, which historically has cooled engine oil and transmission oil has transitioned into -- having the thermal dynamics to manage the thermal properties within the integrated e-Axle. And I think it gives us a distinct advantage and really a product that is optimized for what the customer's application is. And that's really what the heart of what's driving our ability to [ continue to ] expand the backlog.

And when you think about that 65% that's EV, how do you think the margins are? Or what's your expectation for margins on that portion of the backlog? Is it average? Below average?

I think with every new product, right, we're spending an awful lot on developing the program. So the programs overall are healthy from a contribution perspective. Overall, the margins in the business continue to be held back by the enormous amount of investment we're making in technology and product development to continue to push forward in the EV space.

When would you expect them to more than just contribution margin positive? I mean, when would you expect that kind of get to corporate average? Is this a question of scale?

Yes. It really comes down to when we get to a scale. I think a lot of this depends -- I mean the market is moving pretty rapidly and changes quite dramatically. But as we move through, we thought that by the end of the decade that the businesses should be should be comparable. I think that's probably still a fair assessment. But we really -- if you think about it, we have built an EV business from scratch, right? We're a 100-year-old company -- 120-year-old company that has really reinvented itself in building what will be a multibillion-dollar EV business from scratch. So as we saw with Ford, right, coming out and trying to split the business, right, there's a lot of investment that goes into that.

How does the process work in the commercial vehicle and the off-highway market as far as the bidding for four-in-one axle or other EV products that you have that's different than the light vehicle side? And is there an opportunity to price when you're going through that quoting process, add good margins and returns in those somewhat more fragmented markets? Or is there -- are you running into the same challenges there? Meaning, are they a good seed market to develop the initial scale on this EV technology and then bleed it into the light vehicle market.

Yes. I think -- if you take a step back, right, if you think about the non-hard-part version. So the motor, the inverter section, I think -- the advantage we have is that we are supplying motors and inverters, the electrodynamic components for all the end markets. That's going to allow us to gain scale along with light vehicle, which should give us a cost advantage over others that perhaps only play in commercial vehicle or off-highway or light vehicle, because we have the volumes associated with all the end markets. I think when you think about the bidding process, CV, they're all slightly different. Off-highway is probably the most diverse end market with numbers of customers. And I think there, you have smaller customers that need a lot more development work and systems integration work. They just -- they don't have that in-house. They don't have it on the ICE side, they don't have it on the EV side. So there's an opportunity where the customer sees a lot of value when we bring. Now those are also much lower volume programs, which tend to be better margin. You can see that just in the margins across the businesses today, right? CV, I don't think there's much difference between selling the CV customers an EV system versus an ICE system. They're right now in the sort of the ramp side, so they're not looking to have multiple suppliers. But I think long term, they probably do end up with -- you could be ultimately still multiple suppliers into that business, and the competitive landscape would be as it is today. So I don't see much difference in how we bid for the EV business on the commercial vehicle side today as we do the ICE side.

And one of the interesting things is as the powertrain is evolving here, it does sound like there's more opportunity for you to run light-duty, commercial, and off-highway in the same plants, meaning there are parts that will spread across the segments. Is that true that you might have greater opportunity to scale across all 3 verticals?

Yes, absolutely.

I mean -- we haven't had in the past.

Yes. I mean on the electrodynamic parts, certainly, right? Let me think about it right. The motor that goes into a light commercial vehicle and the motor that can be used in a large pickup truck, they're in the same size range, power range, right? They can be made and the components can be made in the same plant. Delivery of the final axle, those would still be made in separate plants as they are today, but we don't see any need to put new concrete down to build those axles. We'll build them along the same lines that we're building the ICE axle today. So we won't -- where we can get the scale is on the electrodynamic components. And when you go to the assembly, we'll just use the current footprint we have for the customer and deliver them the e-Axle along with the ICE axle they might have for the same basic truck.

So one of the challenges the industry faces is the capital intensity actually going up dramatically. But if you can scale across end markets, I mean, could your capital intensity actually or could you become more capital-efficient overtime?

Well, we think we think we will become more efficient. I think you can see just from the -- our view now, right, we're spending quite a bit on CapEx a lot more than we have generally. And that's reflective of the investments we are making in EV plants. But these are really EV plants on the motor and inverter side, not on the, like, axle assembly side. And then we continue to invest in new space for our Power Tech business, for battery cooling.

So maybe if we can get to product specific, if you could talk about this. I mean it sounds like you're supplying -- you have content on the Silverado and [ Sierra ] EV and the F-150 Lightning. But obviously, you have content on a Super Duty. How different is sort of the launch process? Because I think these are both -- Super Duty is launching this year. Silverado and Sierra is late this year. Then the F-150 Lightning is a -- it's a running contract win. I mean as you launched that product? I mean how different is that for you?

So those are the products you've mentioned. So if you think about those products are really on the battery cooling side of the business, right? So Lightning, we do the battery cooling. And then for GM, we do the Ultium battery plant. So that's their common battery platform that they're putting in all of their vehicles. And so those products are -- I mean, if you think about it from a power technology side, we're running those products off of lines. And those lines grow as volume comes on for those -- those from -- I would say the launches aren't particularly different, right? We understand how to launch product, we are launching products for a long time. The good news is like if you think about it, right, we've been making battery coolers for a number of years now, and it's now just starting to ramp where you're getting more volume. So some like we're kind of starting from scratch trying to launch these products. These products have already launched and are really working their way up the volume chain, which is where we're at today.

So is a battery cooling system on a Silverado and Sierra and an F-150 Lightning a lot more similar than -- or sort of more similar that you can scale in a way that you couldn't scale axles, right? I mean it seems like there's something happening here in the markets. And what you're offering the folks where you actually could gain scale and have less differentiation and really like, once again, drive better capital efficiency and margins?

Yes, we can make battery cooling for the Lightning and for the Ultium battery platform in the same exact plan. No question, right? We don't generally make axles for the Super Duty and the Wrangler in the same plant or -- they don't tend to work as well. But yes, in those cases, yes, we can make it. But it's no different than the current thermal technologies, thermal business we have today. We make coolers, right, oil coolers in the same plant for multiple engine applications across multiple OEMs. So the business scales in the same way around the battery cooling and electronics cooling versus, say, the core axle or drivetrain technology.

You had a question?

I want to maybe talk a little bit about some of the cost inputs. You've got kind of ICE new businesses, you've got EV businesses. We've seen raw materials be not just supply them actually physical raw materials being issued. Can you just give us a little overlay of what you're thinking on the cost side?

In terms of -- well, so I think when you think about core commodities, right? we -- this year, we see commodities abating throughout the year, becoming actually a tailwind for us. So if you think about -- and I'll speak broadly, but this is really around light vehicle, we typically recover through contractual obligations, about 75% of our commodity costs. Those typically run on a 3- to 5-month lag in terms of the recoveries we get from our customers. So as commodities increase dramatically over the past year plus, we were recovering those from our customers about $0.75 on the dollar, about 3 to 5 months in arrears. But we're generally paying those costs immediately or very soon after to our supply base.

Just to catch up.

Right. So as you move through this, as the commodities start to abate, right, we stop paying the higher cost to our suppliers, and then we catch up with our customers. So both on the lag and then, of course, we're only giving back to the customer what we gave them in the first place, which was 75%. And so that then ends up becoming a tailwind for us in the current period.

One of the things that we've also seen on the four-in-one axles, I mean, you've got other companies that are out there that are going after this as well, right? I mean -- and stuff that might not be as advanced once in you might -- you seems like you're kind of a little bit at the leading edge. When you think about power electronics, inverters, electric motors and then sort of the combination in IDM or an e-Axle however you want to -- however the application ultimately works. It seems like the competition there is ramping up in a very significant way. And as powertrain content drops out on the ICE side, there's kind of a flood of competition heading towards the electric powertrain. What do you ultimately think the automakers are going to look for when they're -- in their suppliers to really differentiate and allow you to win business in a way that's sort of robust and supports your business versus sort of this, what seems like sort of a splintering and a lot of folks going after this? And in addition what -- versus what they're doing sort of in-house because they are trying to do some of this stuff, in-house as well. I mean how do you think is sort of the competitive landscape as you go after this, maybe getting tougher or maybe not as tough over time and the in-sourcing potential?

I mean I think the basic tenets of supplying the OEMs doesn't change between ICE and EV, right? Quality, delivery, technology, the reasons the automaker outsources a drivetrain or an axle to a Dana or someone else I don't think changes whether you're under an ICE or EV. So I think they're going to be looking towards the supply base to be able to continue to supply those. I also think that the -- we believe that the reasons why the automakers have outsourced certain types of powertrain components under the ICE model will continue under the EV, right? If you think about one of our largest customers and our largest programs, which is the Super Duty, right. Ford makes the F-150 axles in-house, right? They don't make the Super Duty axles in-house. So why is that? Well, in large part, they sold an awful lot of F-150s. There are only a few variants of those axles. They can make them very efficiently in their own plant. When you look at the Super Duty, it's not one truck. It's an enormous number of variants, right? The 250, 350, 450 or even the 550, right? There's Duallys, there's an enormous number of differentiated products within that product line and the volumes are much smaller. We believe the same reasons that they outsource those types of products to a Dana in ICE will work under EV. And then they will choose the supplier for the same abilities, right, technology, delivery, quality. For Dana, what we offer the customer is a detailed understanding of how these systems integrate, how to make them more efficient, right? So if you think about it, it's not just the hard parts, it's how the hard parts, the motor, the inverter, how the power electronics work with the rest of the system. And then how that system is cooled, all those drive efficiency into the drivetrain, which allows them to either get better range, smaller batteries, all those have a cost or a performance component, which is valuable to the OEM because it's valuable to the people like you and I that are going to buy these vehicles ultimately. So I think we have a -- you mentioned we're a bit ahead of the curve. We have a very, very strong understanding of the thermal dynamics of these systems and how to optimize them. And in some cases, we're actually helping the automakers understand or the customers, it's not just the automakers, but across all of our end markets, how these systems act, how they interact with the rest of the vehicle and how to make them more efficient.

Got it. I've got a bunch more. Are there any questions in the audience? Okay, I'll keep going. I mean you guys have mentioned that your content potential on EV versus ICE is I think is 3x. I think that, about that ballpark? How much do you think you're actually -- you can capture? And maybe if you can explain sort of the difference in the actual content that gets you there?

Yes, it's interesting. So you just think about just -- I'll take your typical like, just thinking of pick-up truck. We typically today supply drivetrains. So if we just think about the core light vehicle drivetrain market pickup trucks: Bronco, Super Duty, Wrangler, it's not a pickup truck. But heavy use rigid beam axle components, right? Today, there's an ICE engine, there's a drive shaft and there's a rear axle, maybe it's all or 4-wheel drive. But -- and it's simpler sense. If you think about it in a -- today, we supply that axle, right? And we probably supply the drive shaft as well, right? So you think about what's going to happen, the ICE engine goes away, the drive shaft goes away. So we lose a couple of hundred bucks with the content on a drive shaft. But what happens is all of the powertrain component or value that was sitting in the front of the vehicle in the engine has moved south and now sits essentially connected on to the axle. So you think of the electric motor, the transmission. So typically, these have a certain amount of gearing and they're not simply direct drive one speeds. These typically be 1 or 2-speed gearbox that sits along there, along with the power electronics. So if you really think about it, right, the axle, we don't really lose any content within the axle. So we lose a little bit of content on a drive shaft. But then we pick up all the power electronics and the motor, so you think it's 1/3 of 1/3 of 1/3, right? That's 3x the content that we used to have because everything that used to be in the front of the vehicle has moved south. And when -- and the drive shaft is relatively minor. I mean I mean it's a nice business. But that's -- for us, that's the only business that really effectively goes away in a shift from ICE to EV versus somebody who makes -- making up piston rings or something like he just won't be as many piston rings made. So that's why our content per vehicle goes up in an EV world versus an ICE. Because basically, all the stuff that used to sit in the front of the trucks, it moves and sits on to our base product and our base product does not go away.

I was going to hit on the capital allocation, do you want to ask a few more?

Yes. Go for that. I got a [indiscernible] after.

So leverage is a little bit elevated now because of the EBITDA given the market conditions. But you've always kind of had a good keen focus on the balance sheet. If you could just give us a little bit of thought about where do you want the balance sheet to be? How -- with the free cash flow where it is? Will you be able to afford some of the expansion into more EV technologies.

Yes. I mean, I think we've traditionally managed the balance sheet. I think appropriately, some maybe say conservatively, but I think we operate in a in end markets that run through business cycles. And so our view on leverage is one that should take us through the business cycle that is 1 to 1.5 turns over the long term. I think when you think about the free cash flow we do generate, if you look at operating cash flow right now, almost all of it, right, this way, nearly all of it's going into paying for investment into the business. We'll continue to make the investments that we need to support and grow both the ICE and the EV business, and continue to take any excess cash flow in your market for making sure we keep the leverage where it needs to be.

Do you see any M&A.? There's been some M&A, 2020 to '21, we haven't really seen a lot very recently. Is there any scalable kind of business that you could think.

Yes. I mean most of the acquisitions we've done over the last 2, 3, 4 years have been concentrated around sort of 2 main areas, most of it in the EV space, right? So deploying the capabilities that we thought we would need to be competitive and offer the products and capabilities that the customer is desiring then. We also acquired a number of companies in the off-highway space. Now those off-highway companies also came with gear technology that actually works very, very well on an EV side. So there were some other tie-ins to those acquisitions. But principally, when you think about it, where we sit today and the investments that are needed, we don't see a real need for any -- we don't have any holes in sort of the capabilities that we need to be competitive and deliver the products in an EV's perspective. Look, there could be some small technology that comes along that we think is helpful, and it fills a niche. But for the most part, we have everything we need.

[ Exact ] infrastructure to make [indiscernible].

Right now it's really commercializing a lot of that and really scaling it to be -- to meet the demand from the customers.

Maybe if we could just talk about the 2 end markets that are not necessarily core to a lot of our other discussions, commercial vehicle and off-highway. In the commercial vehicle market, I mean, some of the things have been running sort of layman's terms fairly well. I mean what is your view on what's going on in the commercial vehicle market from a cycle standpoint, backlog orders, it sounds like it's pretty strong.

Yes, it continues to be strong. I think they -- like all the OEMs across all the markets had trouble producing vehicles last year. And obviously, there was a lag when you think about 2020, 2021. A lot of that got pushed into this year. So those -- the order books remain very strong in commercial vehicle, and we're supplying the automakers or the truck makers for those needs. So we see it continuing to be strong throughout the year. I mean, obviously, it's very economic dependent. So we'll see as we go. But this year looks very strong with the order book.

And off-highway?

Same thing. I think off-highway, there's a lot of factors. Off-highway is a pretty diverse base, from underground mining to forestry, to ag and construction. So we continue to see that market, which has been underserved, just like many others, to be strong. And customer intake continues be well. That's a market that can change pretty quickly. But with commodity prices still being relatively cooperative, it tends to put money in the pockets of farmers and others to buy equipment.

Great. I think with that, if we -- unless we have any questions in the audience, we're going to wrap up. We'll finish just a few minutes early, so everybody can get on to lunch. Tim, thank you very much for joining us today. We really appreciate the time.

Thank you. Thank you, John.

Thank you.