Dana Incorporated (DAN) Earnings Call Transcript & Summary

All right. Thank you, everyone. As we continue day 2, the Barclays Global Autos Mobility Tech Conference. I'm Dan Levy, lead U.S. autos research coverage at Barclays and very pleased to have with us Dana, a leader in power conveyance, is that the way to...

That's the way to say power conveyance. It doesn't matter if we're moving the vehicle or with in motion or work circuit on, say, a piece of construction equipment.

There we go. Very pleased to have with us Tim Kraus, the company's CFO. We're going to go through a series of questions, fireside chat style. Anyone in the room that has questions, please feel free to raise your hand. Anyone that's on the webcast and ask questions, please feel free to e-mail my colleagues, Joshua Cho or Daniel Lai, first name.last [email protected]. And they can ask questions and honestly. But with that, thank you so much, Tim.

Pleasure to be here. Thanks.

So why don't we just start with a little bit of an around the world and an end market overview. And if we're going to start with the light vehicle side of the business. And I think the obvious story for you in 3Q and especially in 4Q as the UAW strike. You said roughly $250 million of revenue at the midpoint was the number. There was a more draconian scenario as well. Maybe you can give us a sense of how this is playing out now that the strike is over. Has there been any recovery, et cetera?

Sure. Yes. So the numbers are right. So we had given a high point, low point. Basically high point strike ended the end of October and low point would have been that they ran through the end of the year. We got really close with the strikes being settled. Obviously, there was some ramp-up in November. So obviously, for us, some significant programs were affected Super Duty, Jeep Wrangler, Bronco and Ranger, were impacted. So restart has been, I think, a bright spot. The OEs are all back up and running. I would say they're north of 90% today versus where they were pre-strike, so that's very helpful. Some of the programs are a little slower than others. But all in all, I think we're in pretty good shape. They continue to run. I don't believe they're going to make up really much of that production. Many of these programs were already running relatively strong given that they're light truck programs. And so the opportunity is probably limited to make up a lot of it here throughout the end of the production, maybe a few days here and there, but I think we're where we're at.

How much were the inefficiencies associated with the strike and just how quickly are those recovering?

It's been, I would say, pleasantly surprised me, it's not the right one, but it's been better than I think it could have been given what's happened over the last few years. The customers were able to get back up and running and running relatively efficiently and pretty quickly. Right now, we're not quite back to where we were pre-strike, but it's pretty close.

Great. Another key or central theme that we've seen in the light vehicle side is obviously a lot of instability in production schedules, a lot of volatility. And I think back, there was once a time when your light vehicle margins were much higher. At the trough, I think at one point, you had like 3%? Or there was...

Yes, don't remind me of those.

All right. Those were rough days. So we've seen a lot of recovery. So maybe you could just give us an update of where we are on recovered production stability, health of the supply chain? And what is the opportunity for light vehicle driveline segment margins to see further recovery as we get greater stability ahead?

Yes. So I think if you look through the first 3 quarters of this year, we saw improvement in both schedules and stability in terms of product mix, really beginning in the back half of the first quarter and then continued improvement through second and third quarter on most of our programs. And of course, I think there's been a little bit of retractment given they took 6 weeks off on some of the programs. But like I said, I think they're back up really close to where they were. I still think they don't run nearly the way, even close to where they close, but they still have room to grow and get back to a pre-COVID level in terms of their stability and scheduling. So I do believe that as we continue to see that improvement, we'll continue to see the ability for us to convert at better margins. And you saw that in the first couple of quarters. Our ICE conversion, especially in light vehicle was good. And a lot of that was by the fact that we had more stability in those structures. And a lot of the improvements and the efficiencies that we need to get back out of our plants, we can do when the customer runs much more stably.

Great. Commercial vehicle. So just end market outlook, there's a number of third parties that are forecasting some declines in commercial vehicle volumes for next year. If you look at Europe, North America, especially Class 8 different estimates, but it's forecast to be down. How do we think about in a weaker environment for Class 8, what the impact is to you? To what extent is there offset from aftermarket, which I believe is a significant portion of the commercial vehicle segment?

Yes. So yes, I think the CV segment has been, especially in North America, where it's the largest portion of that segment for us, has been strong. For us anyway, you can't look at the market overall. Where we skew towards Navistar and PACCAR. So you really need to look at, hey, what does PACCAR's production look like for next year versus what perhaps some of the services are saying. But yes, I think that we're probably weighted to a bit of a downturn or some headwinds on volume in North America on CV. For us, we also have a pretty sizable CV business in South America. That was pretty heavily impacted this year with volume. We do see recovery starting to build in South America, and we think that continues into next year and should be a bit of an offset for maybe some of the weakness that might show up from a North American perspective.

If I recall correctly, and correct me if I'm wrong, when you have downtime or if you have weaker volumes in commercial vehicle, the decremental margins are not as bad because there's a better ability to flex. Is that correct?

Yes. No, I think that's right. We typically don't see the same decrementals in CV. And right now, where the volume is and the mix, it does, even a slight volume downturn, we should be able to manage pretty efficiently.

Great. Off-highway, it's been a relatively outperforming segment. And I think the question that's arising is are the end markets within off-highway at or near peak. How do we think about the overall end market exposure in off-highway and the relative strength? And what your view is on the go forward?

Yes. Obviously, it's a market that's been up for quite some time now. Those cycles tend to be a little narrower than they might be in, say, a light vehicle. So the idea that next year, we might be starting to see some weakness wouldn't surprise me. I think you do have to look at it by segment. I think Ag's probably one that's been a pretty decent performer over the last few years. It probably is one that's more exposed to a bit of weakness next year. Construction for us, which are a big part of it. It still seems to be holding relatively well. We'll see as infrastructure products projects come on. If construction stays strong, then I think we're likely to continue to see maybe not strength but not really a whole lot of weakness in that. And then you've got mining and some of the other ones that are really tied to commodities, and so we'll also have to see where those end up. But yes, I wouldn't be surprised if you see a little bit of weakness in the end markets in off-highway as we move through this year and into next.

Can you talk about the mix considerations because generally, construction is richer mix for you versus Ag. So from a mix perspective, a slightly weaker Ag is...

Yes, there's one that has to be done, that Ag probably is the one you pick, it tends to be the portion of off-highway with the lowest margin impact. So a little bit weaker Ags not necessarily on a mix perspective. But we're also gaining market share in a number of different categories across our off-highway segment. So even if volume might be down a little bit next year, we do have backlog and new program growth that we think helps to offset some of that as we go through. So there's a lot going on in the segment, both from a traditional ICE perspective and from an EV perspective as many of our lower our low-voltage products start to gain acceptance and more of, I'll take an example of a compact the compact construction equipment that usually is used inside of the city starts to be required and more customers start to deploy that in city centers where emissions are being regulated and restricted so.

To the extent that you have some slight weakness in volume, again, just commercial vehicle, we said there is a better ability to flex. And in the past, this is the Dana system flexing. This is part of your operating DNA. We think about off-highway again, what's the ability to flex if you have some slight end market weakness?

So the best position for Dana relative to off-highway is to have our customers tell us a little bit further in advance. We are able to flex well in off-highway generally. The problem when we're not able to flex effectively is when customers drop orders out overnight, right? It's a very short notice. We tend to have long supply lines. We tend to operate in places where short-term layoffs can be done, but you need to plan for them. So that's really the key for us. And so we're obviously staying in contact really closely with the customers, making sure we understand what their scheduling is. And as we start to see any weakness, we'll start making the proper changes to our scheduling to flex for it.

We've seen within off-highway, very solid margins, mid-teen margins. Just give us an appreciation, I mean, obviously, the M&A that you've done is now a handful of years ago, but what's been sustaining these premium margins in off-highway in ways that we just haven't seen in some of the other segments?

Well, first, we've had pretty sizable growth. So that helps, right? You're filling up the plants, so you continue to get that good flow-through and conversion on higher sales, obviously helping. The other is it's a mix of customers, a lot of different customers. And a lot of them are based in Europe and have been subject to the same inflationary pressures that we especially around labor and energy freight. We have been very effective in being able to go back and get recoveries from customers there that are in those segments versus say, light vehicle where we have a handful of customers, very large programs, and those tend to be more difficult conversations. The other part there that continues to help is there's aftermarket within the off-highway segment that we're able to make sure we get pricing to recover those increased costs in that as well.

Maybe just a quick comment on Power Technologies.

Sure. We have it. So Power Tech, that's a business that's been going through a lot of changes over the last few years. Historically, it's been 2 business. It's been ceiling, so think of engine gaskets and the like and thermal management, so oil coolers and transmission oil coolers. The transition of that business, we're now a major battery in electronics cooling supplier. So GM BEV 3, we're the supplier to GM on their Ultium battery platform across all the car all their vehicles. And that's a big growth area and an opportunity to really take technologies that are really core ICE technologies and make them applicable into an EV environment. On the ceiling side, this one is a little bit harder to grasp, but about 20-plus years ago, we started doing a lot of work in fuel cells. And so we're in the process of launching our first high-volume bipolar metallic plate plant to supply fuel cell plates for Robert Bosch, and that's a technology that came out of our sealing business. So you think gaskets you think fuel cells, it doesn't come to mind, but the forming, coating and sealing technologies that you use for a gasket or the same basic processes that you use for making bipolar metallic plates for fuel cells. So both of those are really exciting new programs and new products for us on a business that's really thought of as probably a real ICE centric business.

Right. This is a helpful overview of the end markets. If we can maybe just get some directional comments on 24 and 25 on some of the different factors. And maybe actually just want to start on 25. Earlier this year, you gave us a target of $11 billion to $12 billion in revenue, $1 billion plus of EBITDA. Just the EBITDA side, this year, prestrike you were on track for $800 million to $900 million, what are the broad considerations in bridging to this $1 billion EBITDA? Is it just simply the function of the contribution margin on the higher revenue, which it's an incremental $1 billion from here, and that gets you to 20%. That's going to get you to...

Yes. I think if you look at where we started the year and you come up pretty strike, we're well ahead of where we thought we would be for this year, and that should carry through, obviously, the strike haircut that a bit. But I agree. If you just look at sales growth, both ICE and contribution margin on EV, even considering higher EV spending that we will continue to spend at least when we came out in February with that. We knew we were going to be continuing to increase investments. It's the path from where we're at now to $1 billion plus in 25 is still right in front of us. And again, some of that also includes what we've seen and what we talked about earlier, which is our customers continuing to get healthy with their production schedules and being able to get more of that efficiency force through and drop through to the bottom line. But I think that, that's still firmly in front of us.

Great. If we could just talk about some of the directional puts and takes. Inflation this year, actually, it's coming in, you think you mentioned below, you had guided to a $50 million headwind. It's coming in actually a bit better. What are the underlying currents within inflation? And then you're probably going to have a higher labor cost next year, are you getting some recoveries from this year? Or is it new costs coming online? How do we net everything out?

Yes. I mean, obviously, this year, inflation has been on a net basis better than we thought. Obviously, those are gross and net of recoveries. Next year, obviously, we're still putting together the plan and trying to understand where we think inflation is going to be, is a big part of it. But yes, labor will still be a big consideration certainly outside of North America. Many of the countries in which we operate in have statutory cost of living adjustments, which are driven off of the ambient level of consumer price indexes or base inflation. So those will come through. The rest of them, we continue to see those same costs flowing through our supply base. So we don't see a return to where we were historically over the last 10 or 15 years where inflation is 2% or 3%. We still think it's probably elevated from those levels going into '24 and perhaps beyond. But we'll see. I know I saw that I think European inflation was like 2.5%. So it's starting to get back into a manageable level.

FX, obviously, that's been a drag this year. How are you thinking about transactional FX?

Our biggest impact on transactional FX is really in places where we manufacture and we have a cost base in one currency we sell in another. We tend to manage a lot of that through hedging that comes through versus the transactional, which we just have as a matter of course. The other is a number of the highly inflationary countries where we operate, which is Argentina and South Africa. Those continue to be a place -- we have pretty robust agreements with our customers to recover those, but those tend to be the places where we see the biggest impact from transactional FX. Translational, I mean, right now, as we look at where a lot of the rates are probably isn't a major headwind or tailwind for us next year, but we'll see where we end the year.

And wrap on EVs and then I'll transition broadly to EVs. It's really tracked at a positive this year. And I think the commentary is that because of timing spend, this is how you've had these tailwinds. To what extent is there a catch-up on spend next year?

Yes. So I think there's a couple of things driving this. We've managed the spend, I think, pretty well. One of the things is we've been bringing on a lot of costs, especially from an engineering perspective. One of the items driving the lower spend this year is we're just getting better at and bringing on these resources and getting them to be more efficient faster. So that's going to help us as we move forward. In terms of the timing, yes, I think we will see some of that catch up next year. But I do think what we're seeing in the walks this year on the EV side is the EV business that we have is contribution margin positive. And that's what we're seeing come through. And that's really the positive, I think, to think about. As we move forward and we continue to grow this business, while we're still going to be investing a lot and there will be some catch up, we'll continue to have good positive contribution margin from these programs to help offset some of that and move us into. I mean, remember, we're going to do about $700-ish million in EV sales. In 2016, [indiscernible]. So I mean it's 7 years, you take a business from basically 0 to $0.75 billion. it's a lot of investment that has to be made.

Great. Let's talk about the transition broadly. And I think the theme that we've seen this year, the focus has been this slowdown from a period of EV for you. Now admittedly, our focus is more so on the passenger vehicle side. Your efforts, yes, you do have some efforts on the passenger vehicles, so we'll get to that. But the primary efforts have been within the commercial vehicle segment. So to what extent are we seeing this slowdown play out also on the commercial vehicle side?

So from our perspective, when we started down this journey 6 or 7 years ago, our primary focus was on commercial vehicle. We thought that the use case, the duty cycle for commercial vehicle, if you think of city buses, school buses, last mile delivery, those made the most sense in terms of where the drive for electrification would come from. We continue to see that. We don't really see much slowdown at all in the adoption rates with our customers in that. They want last-mile delivery. Think about an Amazon truck. It starts and ends at the same place every day as a known duty cycle knows what mass is going to be on the truck. They don't have an infrastructure issue with charging because extensively, that's already been taken care of at the distribution center. So many of the things that are headwinds to adoption from a light vehicle passenger car perspective, you don't see it in CV. So we continue to see that business growing. And we've been surprised throughout the journey, like how well it's progressed, and we think that it will continue.

Is the bidding activity, the same, the quoting activity? Is that holding in? Any shift in quoting activity on the commercial vehicle side?

No, we continue to -- I mean, the vast majority of our RFQs from customers are around are all electrification. Earlier this year, we had a backlog where 65% of the backlog was EV. I don't see that changing. I see the backlog continuing to shift towards EV as we move through, especially since when we think about backlog, we don't replacement programs don't account for us when we talk about backlog. So it's really net new business and net new business is primarily EV, and we don't see that changing.

And the shape of ramps?

We've never gotten the ramp curve correct yet. So I mean I think that it's par for the course as you go through and have a brand-new business or industry that there's all kinds of changes that happen. There's a difference, I think you got to remember, there's the public's perception as to how many of these vehicles were going to be sold and then there's the OEs and our own perception, so our own work. So those don't always line up. And I think we continue to be on track for how we were thinking about the market over the last few years and how we've capacitized and invested for it.

Right. Let's talk about light vehicle, which is a focus. You don't have much in the way of what we call these Gen 1 EV programs. And these seem to be the primary programs that are getting hit in this EV slowdowns. To what extent are you seeing development, bidding, RFQs for next-gen programs shifted at all on the light vehicle side?

So if you think about light vehicle for Dana, we're not a primary pass car supplier, at least not in driveline. We do supply in on the Power Tech side. Our view was always -- was that our light vehicle programs would be the last to electrify because they typically are large heavy-duty trucks, real-wheel-drive off, 4-wheel drive vehicles that we're going to be next gen, right? And I think that's still our view. The slowdowns are Gen 1. And from our perspective, we're still seeing the same level of RFQ activity. It's all EV related as we had seen over the past year. So I think the interest from the light vehicle OEMs is that these products are going to electrify. And our view has been that even some of the wins that we've already announced, those were still a ways in the future. We didn't give any timing, but it's not like these were going to go into production next year anyway. So it's a long road to get from a dead stop to producing the highly effective EV vehicles for large trucks and SUVs. And I think we continue to support that, and we don't see any slowdown in the quoting activity from the OEMs.

What about the scope of the programs? Because the data value add is that you have capabilities across a wide set of products within the eDrive. It's both, if I recall correctly, it's both the mechanical and the software side of it. You've done some M&A to enhance your capabilities to have power electronics suite. So to what extent are you seeing a wider scope of product engagements with OEMs willing to maybe give you more of the system or outsource money you can answer that both for light vehicle and commercial.

So the answer is yes. Originally, when you look at the -- I'll take the CV, right, the original like CV conversions were all, hey, I'll take an ice truck and I'll put a direct drive motor inverters, battery packs on it. That's certainly been driving a lot of the products. Now that's really shifting to integrated e-Axles, where the motor and the inverter are right on the mechanical axle, a far more efficient system. When you think about the light vehicle side, we're fully integrated. So we make motors, inverters and the mechanicals. So you think about a 3 in 1. We like to have it as a foreign one because I think the other part of the system that's really important and the OEs across the spectrum are really starting to understand this is that the thermal management of these systems is really, really important in order to drive efficiency, especially when you think about range and stuff, those types of things in the vehicle. So I think our ability to design a fully integrated 4 and 1 thermal optimized e-Axle is an extreme advantage when we're going in and working with customers to develop the next-generation integrated e-Drive programs. I think the other thing to think about is when you think about the large end of the light vehicle truck market and the lower end of the commercial vehicle, the motor architectures and size and power densities, those are pretty much the same motor size for us. So we have the ability to take a motor we're developing in a CV and use it in an LV customer and help that LV customer, even if its volumes might be a little bit lower, than he has in [ PACCAR ] and still gain scale on those motor and inverter and electrodynamic components that other driveline suppliers on the light vehicle side don't get the advantage of because they're not selling product into all these end markets.

So clear to say, I think, at the EV Investor Day a couple of years ago, it's like a 4x CPV increase potential for was a 4x?

3.

It was a 3x? Okay. That's still very much that opportunity is still on track.

Yes. I mean, if you just imagine the vehicle. You've got like a real drive truck. I got an engine and transmission a driveshaft and an axle, the engine and the transmission go away. I mean if you make pistons, your product has gone away for us. We lose the drive shaft, which is a couple of hundred bucks. But the power source and the controls, the motor and the inverter they move up on to the axle. So we're selling a fully integrated axle. That's about 3x content for us when you build in the motor and the inverter and we make those. So we're vertically integrated. We pick up all that content.

Maybe you could give us some color on the spend trends within EV. Just give us a sense of how significant the spend is today? Are you keeping it in line? It sounds like from what we're hearing, what we're seeing in Light Vehicle is a bit unique. You're really not seeing this as much on your end. So is it fair to say your spend plans are still very much on track on the EV side?

Yes. I think we continue to spend -- we don't have 25% margins. So we've always had to be, I think, very deliberate in how we were going to spend those dollars, and we continue to be, I think, deliberate and efficient and we are always looking for and evaluating where we should spend those dollars and how we can get the best returns on them. And it's a very dynamic market. It always has been. This is not a new thing. If you go back 3 or 4 years, the market was changing pretty fast. We continue to, as we move through and make our plans and develop our next long-range plan, we'll make decisions. And then it's like going into battle. The battle plan is great until the war starts, and then you got to throw it away and deal with what's changing in the environment. And that's really what we do every day, and we'll continue to do it in order to make sure that we want to have the products capabilities that our customers are demanding and that we can do it in a way that we can deliver financial results for the shareholder.

You had previously guided that you would be EV break even this year. Earlier this year, you said that, that target was going to be delayed to something in the 23 to 25 time frame. So maybe give us a sense of what the timing is that you're looking at and the key drivers. Is this just scaling? Or is there something about, okay, you still have to spend, but there's maybe some opportunities where you could be a little more judicious on the spend?

Yes. I think right now, we still see that as where that breakeven ends up. Like when you think about what the quoting activity is and the timing of the programs and how much more efficient we can get in terms of how we spend the dollars, I think there's a lot of moving parts. But principally speaking, 25 around breakeven, I think, is still an achievable goal for the business. It obviously is predicated on continuing to have the sales growth and the contribution margin off of those sales. So as long as we continue to see the level of growth that we had previously planned for, I think that, that's still a goal that's within reach for us.

Folks, questions? Okay. I will continue. And I know we're running tight on time. But maybe you could just provide some comments on capital allocation. You ended third quarter at roughly 2.5 turns of net leverage. What are you targeting? I assume it's sub 2x. And then how does the capital allocation playbook change as you further deleverage?

Yes. We're comfortable below 2, I'd like to see us 1 to 1.5x on leverage. So when you think about capital allocation, the first place we'll continue to spend capital is on supporting the growth in the business. That will continue to be our #1 priority as we continue to build out and grow the business, both the ICE and the EV business. And then to the extent, there's still capital available will support the dividend and then delever. I mean we talked about this earlier. The growth in EBITDA by itself is going to help delever the business from a metrics perspective. So a lot of that will just come through natural growth in the business because, quite frankly, our debt really hasn't been driven up a lot. It's the EBITDA that's been hand strong or a bit lower. That's really been driving up the leverage ratio that we have over the last few years.

Is there an opportunity on the M&A. I mean you've done bolt-on M&A to boost your EV capabilities. Is there an opportunity to tack on more capabilities, do some consolidation?

Yes. Well, from an EV perspective, we have all of the capabilities we have. We believe we need to be successful across all of the end markets today. Are there bolt-on opportunities? Sure, there could be. I think they'd be small, and they have to be very targeted to something that's very customer -- we have a customer that needs something that we don't currently have. But I think that's unlikely from in the near term. We'll continue to build out our capabilities, mostly organically versus inorganically from any perspective.

Hope we're at time. We'll leave it there. Great. Thank you.

Of course.