Dana Incorporated (DAN) Earnings Call Transcript & Summary

All right. Good morning, everybody. Thank you so much for joining us for this session with Dana as part of Deutsche Bank's Global Automotive Conference. My name is Emmanuel Rosner, and I'm the lead U.S. autos and auto technology analyst at Deutsche Bank. Dana is a leading supplier of axles, driveshafts, drivelines, drivetrains, with diversified exposure across light vehicle, commercial vehicle, off-highway end markets. Dana also continues to demonstrate growing traction with electrification and within commercial vehicle solutions, in particular, but certainly light vehicle side as well. So we're extremely pleased to be joined this morning by Tim Kraus, who's the SVP and CFO of the company. The format for this session will be a fireside chat around some of my prepared questions, but also topics from all of you in the room. If you'd like to ask a question, raise your hand and we'll bring you a mic. With that, thank you so much for being here.

Great. Thanks, Emmanuel.

So let's dive right into it. Maybe starting first with a little bit of an update on the environment you're facing, the markets you're operating in. How are things playing out so far for Dana in the second quarter? How do you feel about the rest of the year?

Yes. So I think we'll continue to see some improvement. I think it's small steps on the light vehicle side, especially in North America. And we're getting a little bit more consistency in production, both in terms of -- not so much in volume, but in terms of the consistency in terms of the order delivery and mix patterns from our OEMs. We're also going through a lot of launches in our Light Vehicle business right now. So Super Duty launched in the first quarter, continues to ramp into the second. So we continue to see that getting better sort of week to week. We're in the process of launching the Wrangler, and then a little later this year, Jeep truck. But -- so we have about 120 launches. So overall, I think we're seeing much of what we were expecting to see as we came through, which was a little better supply chain, better order patterns. And then from a market perspective, outside of light vehicle, off-highway continues to show strength across the board, so [ whether this ] be construction, mining, material handling. And then our Commercial Vehicle business volumes continue to be strong. I think the theme is a lot of these markets have been underserved in terms of volume over the last few years, and we're seeing that still continue to be. So overall pleased with sort of where the end markets are and sort of where [indiscernible] are continuing.

Yes, that's encouraging. So let's maybe dive into specific end markets one at a time. And I know on the light vehicle side, you're obviously more exposed to specific part of it with the light trucks. But overall, how are you seeing the volume outlook playing out by region? What do you view as the biggest risk factors and opportunities into the balance of the year?

Yes. So I guess, on light vehicles, so we're -- Emmanuel, I mentioned, we're predominantly a light truck supplier. So think of full-frame fixed- beam axle, so this would be Super Duty, anything that hauls or tows. So a big program is Super Duty, which -- I mentioned second largest program would be the Wrangler and Jeep truck, followed by Global Ranger. So we supply Ford with axles [indiscernible] Bronco. So it's -- I think we continue to see a lot of launches, as I mentioned. Commercial vehicle, we supply Class 5 to Class 8, so that's any -- or a bit more on the medium duty than on the long haul. But we continue to see both strong order patterns from the OEM and then also strong market share gains for us. We're starting to see a little bit of market shares moving around in commercial vehicles, especially in North America. And then Europe, our European business is -- a lot of it's off-highway and industrial. That market continues to be strong, both in -- domestically in Europe, but a lot of our customers' exports. Those markets be receptive and continue to see the orders. I think as we move through the year, we need to see how order patterns in the back half of the year progress. We don't see a lot of cancellations, and that will be indicative of how we see [ it going ] at this point.

This was a comment on all the end markets as well.

Yes. I mean, it's really, I think, about the same across. I think light vehicle is really -- I think we need a lot of pent-up demand for -- a lot of trucks we supply are really work trucks, and that continues to be strong. I think they just need to be able to produce and supply.

Now I think first quarter, you had a record quarter in off-highway. We -- is this sustainable? Are you expecting some sort of slowdown?

We did -- it was very strong. Order patterns, as I mentioned, continue to be good. Sustainable is all relative. The Off-Highway business tends to be dependent on commodities and other macro factors. So -- but we're -- I would say we're cautiously optimistic to see where those are -- where the end markets end up. But again, we'll keep our eyes as we get into the back half of the year to think about where we're at. Or I would suspect that it was pretty highly paced in the first quarter that -- keeping that up for a long period of time is probably not really [ sustainable ].

And maybe just the -- one more topic around the environment. What kind of visibility do you have into the commodity and other input costs, I guess, trajectory over the balance of the year? And how have the customer recovery conversations been progressing for you?

Yes. So we'll split the 2. So commodities, which is core metals, that's pretty tried and true with our customers in terms of recovery mechanisms. Those continue to work very, very well. We continue to see that being a tailwind for the year. In the second quarter, when we -- or in April when we came out with first quarter earnings, we tempered that a little bit just because we're not seeing quite as much of lower prices as we move out in the year, but we still see that as a pretty sizable tailwind for the business. On the inflation front, we continue to be encouraged with certainly energy prices being better in Europe than we were expecting. Freight's a bit mixed. Some freight's been coming down, and some of the lanes still are at a high point, maybe not the highest point. And then -- but I think overall for freight, the encouraging part is availability of containers and trucks to be able to haul. It seems to be getting better. We still think net inflation for the year is probably $50 million. That's down from last year, which was almost $120 million. So that is indicative of, I think, we continue to make progress on the commercial recovery side with our customers across the board.

Great. So I guess, maybe let's focus a little bit more on specifics of the puts and takes this year. I think you had a fairly solid first quarter. Earnings beat, you largely maintain your full year outlook, a few puts and takes. What are the primary puts and takes of expected second half versus first half of the year?

Yes. First quarter, we had some timing items that were helping the quarter, but we did perform -- the business performed a lot better. That was really driven a lot by the customer. And then, obviously, if the customer runs better, we're able to generate the productivity we need within -- in the plants. I think we continue to see strength across the board. I think we've got some -- back half, we've got a lot of launches. That's probably the one thing that we don't have within our control. Obviously, we control the launch within our own plants. But there's over 120 launches for the year that are throughout across all the end markets. We really do see that as being one of the items we need the customer to launch well, and we need the supply base for them to be able to support that. So I do think that the -- we generally think second half is a little better than the first half. We'll have to see how it goes. There's a lot of timing items that come in, especially in the EV side of the business. So -- but we're still cautiously optimistic for the year.

And within that, your light vehicle margin improved nicely quarter-over-quarter despite sort of like some of these important launches. What are the drivers there? And I guess, how do you think about that going forward?

Yes. So some of it was some timing of spend, but a lot of it was just seeing a little bit of incremental improvement from the customer. And then we delivered quite nice for the launches. So we didn't see any issues in the launches. So that helped quite a bit. But really, it's the demand and order patterns coming from the OEMs. We saw improvement in the first quarter. And when we get that, we can see how that can deliver much better margin. That's probably been the business that's been most impacted by the supply chain disruption and customer ordering and volatility patterns. It really -- it's a high-volume business. It's meant to run at rate. And when the customer is moving around, mix and volume pretty -- markedly, it really does impact our ability to convert on sales, even if the sales volume is higher.

Then you were mentioning this net $50 million headwind from inflation contemplated for the year. How should we think about that on a go-forward basis into 2024? Is that still an opportunity of something that you can go back to customers and negotiate? Or is that sort of like the fair piece that you guys essentially absorbed as part of the [indiscernible]?

Yes. I mean, if you think about it, right, historically, there's -- it's not like inflation is new. It's just been much higher, right? So historically, the 2% to 3% inflation, we've covered with productivity and obviously with pricing on the supply side in terms of driving that. The issue we've had is that we generally drive productivity to cover those costs. And with the supply chain and sort of customer order patterns, we aren't able to get that productivity out of the plant. But I think as we move forward, I think you saw the inflation is about 4%. It's still higher than where it's been, but certainly not at the 7%, 8%, 9%. It certainly puts us in a position. And if the customers continue to sort of get their order patterns back to something more normalized, I think you see it going forward as the inflation impact is, while still elevated, not nearly the impact that it's had over the last 2 years upon us. So -- but I don't think it's -- we're out of the woods yet. And -- but we'll continue to work with our customers on our ability to recover anything we're not able to get out of productivity.

And then on the other side, on the commodities front, your guidance contemplates a net tailwind of about $70 million or so, presumably as you recover some of previous year's impact. And obviously, the -- some of the costs are coming down. I guess how much of this benefit is in the bag versus dependent on spot prices or future prices? And any carryover impact into '24?

Yes. So probably a small amount of impact in '24 really depends on where the indexes end up. We don't typically buy off of the spot price. We typically are buying off of indexes, so -- which can be different. And we're getting reimbursement from our customers based on the indexes, not based on the spot price. So you have to be a little bit careful of just looking at the spot price and thinking it translates directly into how -- the cost side or the recovery side with the customer. So we continue to see that the prices of these commodities are abating throughout the year. You mentioned the $70 million, that's a combination of -- we typically recover from our customers only about 75% of our gross commodity costs. So historically, when prices rise, we only collect 75%. When they fall, we're only giving back that 75%. So that's part of the tailwind. And then there's generally a 3- to 5-month lag. So we're still seeing recoveries from higher costs. We're paying lower cost into the supply base because that's generally at a much shorter lag, and that's the $70 million you're seeing. The tailwind into next year, I mean, it's probably relatively modest, depending on where we end up for the year and with the customers.

And then you mentioned a heavy launch year for Dana. I think you have the Super Duty, the F-150 Lightning, Gladiator, Wrangler, quite a bit of important program. What are you doing to ensure smooth rollout? And how will this affect earnings throughout the year?

Yes. So like I said, I mentioned earlier, over 120 launches, probably one of the largest launch years in the company's history, and it really runs the gamut. You mentioned a couple of the big marquee programs for us, Wrangler, Super Duty. But we're also launching a lot of really important products in the EV space, so the GM Ultium battery platform. We're the supplier for the thermal management system for all of General Motors' Ultium platform, plus their global battery platform. That's a really large launch for us that's in the Power Tech EV space. But we're also launching electrified vehicles for commercial and for off-highway. So it really runs the gamut. I think for us, we follow a pretty standard pattern, right? We do a lot of work to get ready for these launches. We have a dedicated program management teams that are basically living in the plants to make sure that we launch these products. And if there are already issues, they get resolved very, very quickly. So I mean, we -- most of the stuff we've been doing for a long time, so it's nothing new. I mean, I think, our bigger worry is what we don't control. So obviously, on the customer side, making sure that they're launching well as we go through the year. But a lot of people, in terms of -- we've got significantly higher launch costs this year than we had last that's impacting our profitability. So as we run through the year, those -- and we move into next year, a lot of these heavy launches should be at volume and delivering better margins into the future than they are this year.

Let's focus a little bit on your efforts and traction with electrification. So you're calling for this year for us for $150 million in incremental EV sales, but a $35 million EBITDA hit from it, I guess. But I think in the first quarter, EV sales were actually a positive driver to EBITDA. So I guess, what played out better or worse than anticipated here? And how should we think about this on a go-forward basis?

Yes. The EV business is profitable on a contribution basis. We're just investing an enormous amount in -- not just in engineering but in really all the program management and other functions that go along with building a business from basically nothing into something that, by the end of the decade, is going to be a multibillion-dollar business. So that's impacting the margin. What you saw in the first quarter is really the timing of some of the spend that we're anticipating for the year. And we continue to be supported through government programs. And so we actually recovered some government grants that we were not expecting in the first quarter. The combination of the timing of the spend and the timing on these government grants, we came through with a profit. And I think that's what you're seeing. You got a little peek at the fact that our EV business is profitable at the contribution [indiscernible]. It's just going to take some time to grow that business to a point where we've gotten through the heavy investment in that contribution margin on a large-enough businesses is delivering a net EBITDA profit for the business. We think that's probably in '25, at this point, given the growth rate based on the book of business we have today.

But for this year, you're still expecting to spend [indiscernible]?

Yes, absolutely. Yes, I mean, if you think about the -- we talked about Ultium, but we are seeing a huge interest from our customers across the -- all the end markets. And we continue to invest in engineering and program management resources to support the programs that we expect to launch over the next 2, 3, 4 years.

Can you give us an update on your traction with winning electric powertrain business? In which end markets are you having the most success? And what's your content opportunity there?

Yes. So content opportunity, I'll take first. Typically, we see a 3 to 4x content increase. So if you just think about -- really easy, I'll take a light vehicle or a light truck. Today, you've got a ICE powertrain transmission engine driveshaft in an axle. In an EV, right, the engine, the transmission go away. We have very little content on that. We lose a driveshaft $300, $400 or $500. But all the rest of the drive content ends up moving on to the axle. So motor, inverter, thermal product, thermal management products, they all move on to the axle. So when we sell an integrated e-Axle, we're actually getting 3 to 4x the content. So we keep our regular axles. So we don't really lose anything other than the driveshaft, but we're adding a motor and an inverter and the cooling that adds that content and the contribution margin on that content to that axle. So the margin uplift -- or the content uplift is pretty sizable. When you think about where we're seeing the best traction, when we sort of started this journey back in '15, '16, our view was that the commercial vehicle space would be the first end-market to electrify, and that's really borne out, not because light vehicle wouldn't electrify. We just felt that the electrification you're going to see in light vehicle is on pass car, we typically don't. And we don't supply into the ICE powertrain segment. So that was not a segment we were going to play in. Ours is light trucks. That was going to be late because much of what we have in the light truck is work trucks and typically don't -- wouldn't be first to electrify. So we are seeing pretty -- we were seeing very, very good take rates and interest from our customers in commercial vehicle. For example, we actually make the PACCAR -- the Peterbilt 220 electric delivery van for PACCAR, because PACCAR wanted to get up the scale quickly and deliver vehicles. So we're actually -- our powertrain, our battery management system, our cradle, our axle, our motor, our inverter, and we're assembling the base trucks for them and delivering them to PACCAR, who's been delivering to customers such as PepsiCo. And that's been very, very good. We're also seeing a lot of interest in the off-highway space. We're not at the large end of the wheeled space, but at the smaller end. So you think about a lot of the cities in Europe are moving towards emission-free zones. So if construction needs to happen within those city limits, they need a compact wheel loader or backhoe that needs to be electrified. And many of those customers, they don't have the competencies in-house at this point to be able to do that and are buying full systems from us to elect for them. So across the board, we're seeing very, very good interest and new program wins in EV.

And I guess on the light vehicle side, there appears to be much more aggressive efforts by OEMs, certainly North America, for new electric pickups to launch over the coming years as well, I guess, larger SUVs. What kind of content are you bidding for in these programs, and on light vehicles in particular?

Yes. For the most part in the light trucks, anything that has a fixed beam axle, we feel we have the right plan. We continue to -- that market is just now starting to see the bid packages come in from the customers. And so we'll be participating in, and we believe we will win our fair share of those products as they electrify. If you think about it, right, the OEMs -- take Ford, it's just an easy example. They make the F-150 in-house. They make the F-150 Lightning axles and powertrain in-house. They outsource the Super Duty. We believe, for the same reasons, they will outsource the Super Duty when they decide to electrify it. And so -- and that's because it's higher -- smaller volume, higher variability and higher torque and towing requirements, where Dana has the technology to be able to deliver those for the customers. So we think the same rules will apply as they electrify, and they just haven't quite gotten there yet.

So you don't see any different dynamics between in-sourcing and outsourcing on the EV powertrain compared to the combustion engine?

Not in the space we play. I think they'll continue to have those issues, I think, around passer cars. But they're -- a lot of these products are already outsourced, not like they make these products in-house today. And we believe that the same technological and rationale that they do today for the ICE, they'll outsource the EV as well. And we're seeing -- and by the way, we're seeing the interest from the OEMs to actually outsource those. So it's not like we -- there -- it's silent. We just haven't -- they just haven't awarded those products yet.

I think you have 65% of your backlog already from EVs. Well, can you dimension your expectation for EV sales growth or mix in the near term and what impact will this have on margins beyond this year?

Yes. So I mean, we continue -- so a year ago, it was about 50-50. Now it's 65-35 in terms of the percentage of the backlog. I think that continues to climb. Most of what we're bidding on today across the end markets is electric related. The good news is our ICE business isn't going to go away. We're launching our largest -- 2 of the largest programs right now with new ICE vehicles. So those will be around for a long, long time, which is great news for us. But you will see, over time, the mix really shift to EV. So I think the sales growth will be in the EV with, I think, only moderate slippage in the near term on the ICE business, which will be great for us. In the near term, we will continue to have some margin impacts. But we do think the -- as I mentioned earlier, that the EV business in '25 ends up becoming a profitable business, just going to be large enough at that point. So...

And size-wise, in terms of revenue expectations?

So revenue expectation this year is sort of $700 million, maybe a little higher than $700 million. I think by the end of the decade, we're talking about a $3 billion-plus business. I mean it's going to be a sizable business for Dana across all the end markets. And for us, we're investing in technologies that we get to leverage not just in light trucks, but in light commercial vehicles and in off-highway. We have motors that, in the same range, we're using for a commercial vehicle, and we'll use them for the largest of our light vehicle trucks. So that's the kind of leverage we think we're going to be able to get out of the investments we're making today as all the end markets start to move more and more into electrification.

Great. And then, I guess, maybe a final topic, some of your midterm targets and aspirations. So I think earlier this year, you outlined this new midterm expectations for sales of $11 billion to $12 billion, I think, by 2025; EBITDA of around $1 billion plus, which implies margin 8%, 8.5%. What are the primary drivers to get there? And what is assumed from a macro industry conditions perspective to support this trajectory?

Yes. So the -- to get there, I think the key will be that we don't need large end market volume increases to get there. A lot of that's being driven by the backlog, which is volume-neutral. I think the big thing we're seeing as we come through over the next couple of years is really the normalization of both the supply chain and the customer order and mix patterns. That will help drive and deliver the productivity that's needed to get the margins back to a more reasonable level. The other part that we'll see is we have -- as we run through these launches and we start to turn over these programs, we have the opportunity to reprice them. So if you think about Super Duty or Wrangler, right, those are programs that we bid on a couple of years ago. They're at between the time we award and when we do SOP. It's very typical that we'll go in and renegotiate price. All kinds of things change. Obviously, cost change, but also there's engineering changes and the like. So we're using those opportunities to go in and renegotiate. So there will be some on the pricing side as well that I think will drive margin as we move out into '24 and '25.

So what has changed from your previous midterm goals of 12%? I think I know this dates quite a few years. But I guess is that -- how should we think about the normalized margin profile of your various...

Yes. I think it's really -- we didn't give a percentage because it's really tough. If you think about just over the last 2 years, right, $50 million this year, $100 million to about $120 million of net inflation, right? That's $120 million of EBITDA that's out of the business, but that's the net number, right? We've got a gross number and a sales that come in that compresses margins quite considerably. So the idea that you're still going to end up with a 12% margin, even if we recovered 100% of all the costs, not a single customer is providing margin on those cost increases. So the margin is going to be compressed regardless. It's going to take some time to get back to 11%, 12% margins. I think we really need to think about the business in terms of where does the EBITDA dollar amount and where do program economics come out. So as we went through and are dealing with some of the new programs to come on, we've told the commercial teams, and we have the discussion all the time, "Look, we're not worried about the margin. What we're worried about getting back to is the economic returns for what we've invested in these programs." And so while we get pricing and we get -- we will get better margins than where the programs are today, they won't be at the same margins as we originally bid them, but they will be at the same program economics. So the same return on invested capital. And that's really how we're thinking about or I'm thinking about the business today is I'd love to see 12% margins. But I know what I need in order to return the right amount on the capital I'm investing in the business, and that's what we're really focused on. And so it won't translate into the same percentage because the math doesn't work the same way. But from a dollar contributed on what we're investing, we should be fine.

And I guess within that overall sort of like 8.5% margin [ probably ] a decade or so, how should we think about the normalized margin profile of the various segments within that?

Yes, we don't really break them out. But our Off-Highway segment tends to be our best-performing segment. I think Power Tech is going through a big transition right now from where they were with the ICE engine into the battery cooling and fuel cell space. That's an opportunity, I think, we should see some margin expansion. And our Light Vehicle business should see margin improvements as we move through. If, for no other reason, just the repricing on these programs, but I think it will be -- you'll see typically better margins across the board as we move through.

And on the free cash flow front, I think the goal now is around 3% of sales in 2025. And again, that's down quite a bit from the previous goal of 5%, which was given at the 2021 Capital Markets Day. So how should we think about the drivers of that? And what has changed?

Yes. I mean, I think it's what we just talked about the margin, right? So if I add $1 billion of sales, because I recovered costs, but it doesn't come with any margin, there's no cash flow that comes through. So you have to -- it's another one where you have to think about the dollars of free cash that are coming off and not just the conversion on a percentage basis. So we have higher sales. And again, if we recovered 100% of all those costs, there's still no cash flow that comes through on that. So you're getting a squeeze on your free cash flow percentage. So again, when you start to think about it, again, how much free cash flow is -- the sales dollar is generating and all those. Is that free cash flow getting the returns we need for what we're investing in the business? And that's where we're focused because I think that drives shareholder value at the end of the day, not a percentage. I know you guys like to see the percentage because it goes into your model and whatnot, but I think it's -- look, as we move through and we sort of get further and further away from these last couple of years, I think you get to see some of these things return to normal. Because we'll be investing capital at inflated prices and they'll have to flow through and get the margin for it, but that's still a number that you've got.

And on the EV side, do you still have line of sight to bring the EV business towards profitability in 2025 as you accelerate your electric investments?

Yes. No, I think, yes, we're still comfortable based on the book of business we have today that, that business ends up being profitable. I think the first quarter is really the thing to think about, right? That was some timing, but the business -- the core business itself is profitable at a contribution level. And so as we sort of get through this initial phase, we wouldn't -- we're developing base core technologies now. And as that ends, and we're able to put those products into production and see the contribution margin go through, you'll see the total investment as a percentage of the EV sales start to come back to something more normal. And then you'll see the profitability overall in the business.

And then last one for me. It seems like the $3 billion or so or more in EV sales by 2030 is still a reasonable target. I think you also said it would be accretive to margins by then. Is that...

Yes. I think the business -- I mean, obviously, it's a long way away, and there's a lot of moving parts, but a $3 billion business, right? Right now, the only business we have that's greater than $3 billion is the Light Vehicle business. So at $3 billion, our view is that it should be -- it should have margins that are at least commensurate with where we're at with the rest of the business. And at $3 billion, it's a sizable-enough business to cover the fixed costs that are invested in. And at that size, we get a lot more leverage across all the end markets than we're even getting today at $700 million or $750 million.

Makes all lot of sense. I think we left almost 2 minutes for questions in the room, if we have any. Right in the front.

How do you think about the -- like the competition that you're seeing in the EV space, you're still winning new players, software, hardware experts integrated as well. Are the competitors that you're coming up against in the EV product space the same -- usually the same people? Or are they brand-new players? What's your kind of assessment on this?

Yes. I mean it's certainly more competitive, especially, I would say, think about the light vehicle space. The suppliers that are core powertrain suppliers that make engine and transmission parts, they very much need to find a home. I made a comment that our core product doesn't go away, but theirs does. So yes, they're competing for the same programs. So where we used to see 2 or 3 competitors, now we're seeing 8 or 9. I think at the end of the day, the customer is still going to award programs based on the same things that they've always awarded programs on, and that's cost, technology, delivery, right? All of the things that we do really well are going to continue to be what drives the customer decision. And of course, it's not really that easy to make a fixed beam-axle, and we've been doing it for 120 years. So I think that gives us a distinct advantage. And we have added, over the last 5, 6, 7 years, capabilities on the electrodynamic side, so motors, inverters, power electronics, that gives us the ability to deliver either components or a full system. And that full system, a lot of times, we go in and we'll talk to the customer, not as much on the light vehicle side, but certainly on the commercial vehicle and the off-highway side where the OEMs just don't have as much in-house knowledge. And we're really -- being able to demonstrate the capabilities we have for integrated systems and help them understand what issues they're going to run into as they start to electrify the end products. And they understand that we have that knowledge -- a deep knowledge in those things, in those competencies, we think that makes us the clear choice for the customer to award the programs to us.

Awesome. It looks like we're precisely on time. Great. So Tim, thank you so much.

Thank you, Emmanuel.

Thank you, everyone.