Dana Incorporated (DAN) Earnings Call Transcript & Summary

So we're going to get going with the next presentation. Once again, I'm Ryan Brinkman, the U.S. automotive equity research analyst at JPMorgan. Very excited to get started with Dana, including their new CEO, Bruce McDonald; and Craig Barber, Vice President, Investor Relations. Bruce and Craig, thanks so much for coming to the conference.

Thank you.

Okay. Look, since you became CEO in November last year, it seems there have been 2 major things happening at the same time. Number one, the off-highway sale. And number two, a massive materially margin-enhancing cost-cutting program. There are a few drivers of the cost cutting, including less spending to support growth areas and old-fashioned execution. But maybe to start, I'd love to get your sense on the degree to which the 2 major things may be linked. The simpler corporate structure in conjunction with off-highway sale allows you to become leaner and more efficient with less overhead. Where are you finding the overhead savings? And how much of it has been catalyzed by the decision to sell off-highway?

Okay. So there's a lot to unpack in that one. But I guess I'll maybe start with the decision to sell off-highway was really triggered by the fact that we are trading at an automotive, I'll say, maybe even automotive light type multiple, even though we had an accretive off-highway business. So it just wasn't being reflected in our stock price. And so when you ran the sort of sum of the parts analysis of Dana, on what we could sell the off-highway business for. It was materially accretive, like 40%, 50%. And so when my appointment was announced last November, we came out and we said, "Hey, we're selling this business." We'd already made that decision, but we came out of the closet, I'll say, said we were going to do it. And we got a fairly significant run up in our stock price because people kind of got it, like we're trading at 4.5x or 5x and this is a 7 or 8 type multiple business. Times a pretty big number, right? So we accreted higher as the uncertainty around that transaction diminished. Then the cost reduction side, Ryan, was really around kind of backed into the number a little bit in the sense that we said, "Hey, if we do sell the off-highway business and capture that value unless we can maintain our margins and improve our cash generation. It's going to be kind of a one and done event, and we're just going to be in a situation where significantly deleverage, we have a capital return and then we kind of have nowhere to go." So when we ran all the numbers, we said, "Hey, we need to pull out $300 million -- at least to $200 million, at which we layer up to $300 million." And I was kind of fortunate in that being on the Board previously, I did some access to our cost structure. And when I went in there, the Board sort of said to me, well, "How comfortable are you that you can cut the $300 million?" And I said, "I'm highly confident." And the savings really came in 3 areas. First, you made a characteristic about cutting some growth investments. I wouldn't characterize it like that. I would say we were overinvesting in light of the risk in EV. And so the -- Dana for the last 3 years, and I'm part of this because I was on the Board and approved the strategy is there is a huge opportunity for the company. We pushed all our chips and went for it. And if you went and go back, say, 24, 30 months ago, we would have been here saying, "Hey, we've got a huge content per vehicle growth story, $4 billion, $5 billion of growth opportunity." If the market would have moved in the direction that we all thought at the time. And this, by the way, is not a Dana unique issue, obviously. Where when I came in is, look, we were still investing a lot of our free cash flow, like all of it. And a lot of our engineering resource in pursuing electrification businesses that were inherently higher risk and the market wasn't -- was basically voted with their feet. We don't like it. You're taking all of our money, investing it in long tail, high-risk projects. So I had to sort of reverse that coming in. So about roughly speaking, 1/3 of the $300 million we cut is investments that we're making in electrification. And not to say we aren't making any. It's just right now, we've got the customers co-investing in it or upfronting the engineering, whereas before we are taking it all 100%. The other 2/3 has really been just radically simplifying our structure, we're going to be much more North American centric. So there's a lot of corporate expenses that we had in Europe, Asia and South America that we've eliminated or pushed into our businesses. We deleted our Power Technologies segment and combine that with Large and Light Vehicle. We had aftermarket split in 2 different businesses. We put all that together and had a corporate piece. And then if you just look at the corporate overhead that we had as a company, it was probably sized for a business that was going to grow to $12 billion, $13 billion and not a business that's going to be -- sort of $7 billion, $8 billion, so a pretty radical reduction in, I'll say, the manager and above level in the company. So it's been the quick wins, I'll say, there's more opportunity, but the $300 million of stuff that we could kind of recognize quickly and focusing on what I would say is about $1 billion of our $7 billion cost base.

And to follow up on that comment. You're not one and done. I think it's a great analogy. You're not one and done because you still have the restructuring program to go. But what about the degree to which the transaction itself can continue to provide benefit? I mean, the stock's up 98% since November 25. 91 points better than the S&P, up 7%. And the average auto parts flyers underperformed that by quite a bit. But what about the share repurchase? Because if you're not one and done, you've got the restructuring savings, the share repurchase enabled by the transaction can really amplify that. Maybe just scope out the magnitude there? And then also the benefit to valuation for new Dana from delevering the balance sheet. What could happen?

Yes. Yes. So again, a longer answer than a question, I guess, here on this one. But I guess a few things. So first of all, the way we've positioned new Dana here and Dana post off-highway. And by the way, just the transaction, we expect to close probably at the end of November, but in the fourth quarter for sure. For those of you who may be not familiar with it, it's $2.4 billion of net proceeds, of which we will take a big chunk of that and reduce our debt so that our net debt post the transaction is about 0.7x EBITDA. And then we've announced that we will return $600 million or approximately 25% of our market cap by way of buybacks this -- before the end of this year. We've done -- we did just a little bit over $250 million last quarter. We've guided to another $100 million, $150 million this quarter and we'll do the balance of that $600 million over the course of the fourth quarter. For next year, we're going to be -- we've guided and we've talked consistently about being 10% to 10.5% margins for next year and 4% free cash flow. We walked through on our earnings call kind of how do we get to next year because some of the commentary has been around it seems, I'll say, aspirational, I think, as a quote somebody said. I view it as a tap-in putt. If you just think about this year, we're guiding to be around 7.5% you annualize our cost savings. In other words, the $300 million, the $310 million, about $225 million of that flows through this year. So another $75 million to $80 million next year. That's 1 point. So it takes you from 7.5% to 8.5%. If you look at stranded costs that we have, we think we can take out conservatively -- that's another 40, 50 basis points. So that gets us to the 9s. And then a combination of some new business that we have coming on stream from our backlog, which is about $300 million. And I'll say, a very conservative view in terms of what we've been able to do from an operational improvement perspective, it gets us into the 10.5% type range comfortably. On the cash flow side, we've done a little bit more work on this one since our call. Because there's some question about like we gave sort of a total cash guide for the year, inclusive of both continuing and discontinued ops. So if you sort of take our $275 million at the midpoint, and you think about what -- how much of it is off-highway and how much of it is Dana on a go-forward basis. About $125 million is off-highway. And the way on calculating that is taking their EBITDA, their change in working capital there, taxes and then also attaching the interest savings that we will get next year to that business. That lays them with cash for about $125 million. The rest of the company, which then reflects like the ongoing interest expense and the cash taxes, which are lower for the ongoing part of Dana. Our free cash flow for this year is $150 million or about 2% of sales. So how do we get to the 4%? We got 200, 300 points of margin expansion. That falls right to the bottom line. We've talked about lower onetime cost next year because we've had to do some restructuring around the off-highway sale. And then we will have slightly higher CapEx next year as we capacitize for increased volume on the Super Duty and the next-generation Super Duty launch, which is in late 2028.

Great. And the benefits of the off-highway sell are obvious, but just wanted to check in, though, on the potential for any dissynergies and if there may be ways to mitigate those. Starting on the cost side. I'm not sure there were a ton, maybe in purchasing. Can you just confirm, are the cost-cutting targets you've given inclusive of any headwinds? And then on the revenue side, I'm guessing what synergies there are between the various segments is more between light and commercial vehicle driveline or the Class 4 through 7 kind of meets together. But just checking if there's anything to consider there, too, or just how you're thinking about dissynergies generally?

Yes. I would say the dissynergies are very manageable. I would say the only area is in the purchasing side of things. And from so far what we've seen, I don't see it being overly problematic. On the revenue side, I would say the only area where there is some benefit in us being combined with maybe on the motor inverter part of our business, the light, the low-voltage side. The low voltage sale of our motors and inverters did not go with Allison's sale. That's something that they're interested in. But because we haven't bought that business back from Hydro-Quebec yet, we couldn't include it in the transaction. So as things stand right now, we still have that. So I would say it's not really going to affect us in any material way.

Great. Thank you. And of course, while there's a valuation benefit to delevering the new Dana balance sheet in terms of the multiple. Just curious if there could also be potential commercial benefits to -- in the past, management has talked about wanting to drive toward 1x net leverage, given that it could be helpful in securing business in the electrification space, where you might be competing against non-levered technology companies or it might be helpful in winning business with certain foreign automakers here the Japanese referenced is preferring supply lower leverage. Just given you're likely to be well below 1.0x here, very soon, 0.6x, something like that. How are you thinking about the potential for any commercial benefits?

I'd say a couple of different ways. I mean, we want to be at 1x through the cycle. That's kind of the number that we've talked about. As it relates to new business, I would say 2 things about Dana that we hear a lot. One is our leverage target. And obviously, we're in a product that people have to source many years in advance that's highly engineered, so switching costs are difficult. So to the extent we have a safer balance sheet, definitely makes us -- we're not going in there with one arm tied behind your back. Also, they don't like having agitators in there. So the fact that we were able to buy out Carl Icahn from his position and hence, sort of reposition ourselves as a normal type supplier. That will be helpful. I don't expect a year from now, we're going to say, "Hey, we're growing way quicker than we could have before because of our balance sheet." I think it helps at the edge. We do have -- I would say we do have more opportunities to reinvest in our business to both grow it, but more importantly, expand our margins because we starved our business of some things that we otherwise shouldn't have because we were chasing growth. And I'll just -- I can give you kind of a few examples. If you look at our manufacturing footprint, we need to do more restructuring, and that will lead to a significant benefit in our cost base. If you look at -- if you went into our factories and went into an investment-grade BorgWarner, [ AV Leader ] or something like that, you would see a radically different level of automation. And I'm not talking about Tesla robots manufacturing things. I'm just talking about basic AMRs, AGVs moving material around, basic robotic arms, unloading and loading machines or unstacking pallets and things like that. We've got hardly any of that as a company. And there's just I'd say, $100 million type opportunity just from low-level automation. Same thing on -- if you just look at what we manufacture, and take a look at our true manufacturing cost from an activity-based costing point of view. In other words, like how much of our overhead is directly attributable to specific functions instead of just smearing it across based on sales. We've probably got over $100 million of things that we make that we lose money on. So I still see even though I think you said breathtaking the amount of cost that we've taken out of our business, I still think the opportunity in front of us is even larger than it's behind us here.

Interesting. And just to follow up on that point, we've all been very surprised, right? You started with $200 million in November. You said The Street called it aspirational. I think I used the word ambitious. Look, it was over 20% of total company EBITDA. It was over 40% of pro forma new Dana EBITDA at the time. And also as a company that had really struggled to restore its margin to pre-pandemic levels after most of the supply base already had. So buck it out again, where are you getting these savings? And the relative -- I heard one-tap putt earlier, but some of these must be easier to achieve than others. Some of them are more in the bag than others. How much sits down at the plant level? It seems like not a ton actually. It's a little bit more --

It's largely -- it's very little at the plant. There is some plant level SG&A, but a minor amount. It's like just -- may just help you out here. So let's just take -- just call it the $300 million. Roughly speaking, 1/3 of it is what we are spending, like I said, on electrification. So if you think about our CV, commercial vehicle side of our business. It is a -- and same thing with motor and adverse. It is a -- you could sort of think about catalog type business. We spent a bunch of money over the last 2 years developing a suite of products that will then be application engineered tailored to a specific need at a relatively minor cost. On the -- so that -- the investments behind us, we have the full suite of products. So even without me coming here, that would have dropped down this year anyway. On the light vehicle side of the business, we were chasing business, a lot of upfront investment, both in capital and engineering on programs that -- with the benefit of hindsight, were far too risky. And if you look at, I'll say, of the 20 or so electric vehicle programs that we have in flight right now, ranging from big to small, every single one of them is financially challenged either customers in financial distress or bankrupt, the volumes are a fraction of themselves. The program has been canceled. The job one date has been deferred, et cetera, et cetera, et cetera. And so we've unpacked that, renegotiated the way we go to the market. Not to say we're not investing in electrification because we are. But it is upfront in terms of engineering. It is customers putting their money into the capital. It is having volume -- I won't say volume guarantees, but a volume pricing matrix so that we make sure we uncover our investment and we've been very successful. So that's like $100 million of the $300 million, just the quoting disciplines not continuing to invest in new products for the marketplace because we're just not seeing the demand. The other 2/3 are -- it's really span and control. It's $25 million, $30 million is eliminating the Power Technologies segment, probably $25 million or so is combining our aftermarket operations between some corporate, some in CV and some in Power Technologies. There's probably $30 million, $40 million of reduced corporate costs outside of North America. And then I would just say, if you just looked at our general corporate overhead costs as a comparator to what I would say is normal. We are on the high end, and we've trimmed that back. And a lot of those cuts have been in the Senior Manager Director Vice President level.

Very helpful. Turning to your North America driveline business. Given that light vehicle really, it's largely North America electric entirely, but -- what impact do you see from -- on the specific programs or type of programs that you supply, like Ford Super Duty, some of the Jeeps and SUVs, from the relaxation of the federal greenhouse gas and corporate average fuel economy standards that Congress passed in July?

Yes. So for our light vehicle business, the best way to think about it is it's really 5 or 6 programs. It's Ford Super Duty, it's Wrangler. It's Gladiator. It's Bronco, it's Ranger, maybe Maverick to some extent. I mean that's the bulk of our business. It's almost all of those are assembled in North America, high USMCA compliant from a tariff point of view. Some cases, they are advantaged -- our customers are advantaged versus their competitors, particularly, say, on Super Duty from a tariff perspective. These are Super Duty being our biggest single platform, over 10% of our sales. It's a work vehicle. The decision to go electric is going to be economic. So it's going to be, "Hey, it's dollars, it cents. Is it worth it?" Help -- there are some -- because of that's the way the Super Duty truck is graded, reducing the CAFE requirements could be helpful in terms of some of our customers are still planning on electric variant to that vehicle, not just Ford but GM and Stellantis as well. And so if there's a relaxation, these are going to be programs that they electrify because they need credits, not because the underlying economics are favorable. And so to the extent some of that stuff goes away, it will be helpful.

Great. Next, I wanted to ask on electrification to follow some of the earlier comments about the $100 million of savings. Obviously, there's a headwind to your electrified driveline portfolio, but a tailwind from all of the savings and with what we just talked about the tailwind to those programs on the ICE side. When you net it all together, I feel like for most of the companies at the conference, there's like a silver lining to the EV slowdown, which is we have to spend less. But for you, would you say it's actually a large net tailwind?

Yes, for sure. Just because of the amount of cash flow and P&L that we're invested in it and the payback being so far out. Now I'd say if you look at our electric vehicle business overall today, and this would include like things we have on the thermal like the battery, cooling plates and things like that. Like it's still a several hundred million business for us. And I would say we're at the point now where without there being this massive investment in the growth side, we can -- that business will start to turn accretive as opposed to being -- I mean you've sort of seen in our earnings call over the last 2 or 3 years like electrification on our bridges was a negative kind of quarter after quarter after quarter. That business will turn positive for us. We still have good electrification growth in our backlog. It's just not as much as the several billion that we thought it was before. It's more like in the few hundreds of millions.

Very helpful. Wanted to ask on near-term capital allocation, including the change recently between the time of the off-highway sale announcement in June and the 2Q earnings call in August, you upped your targeted return of capital this year beyond the ordinary cash dividend from $550 million to $600 million. And you also went from saying that the $550 million could consist of some undetermined combination of buyback and special dividend to just entirely buyback. So firstly, could you talk about the decision to increase the payout? And then secondly, what drove the preference for buyback over dividend?

Yes. So I'm glad you asked that. It's probably the most important question. So first of all, as we generate more cash and we upped our guidance here in terms of cash flow and earnings. And as we continue to do well on our -- on generating cash, it will go all towards returning capital to shareholders as well as on a go-forward basis because we'll be appropriately levered post the transaction. And so all free cash flow in the intermediate term, the way we've seen it right now, will go back to shareholders. You're right in terms of our original announcement sort of said TBD based and really based on what's the underlying financial value of our stock. And do we see our stock as trading -- how is our stock trade versus its intrinsic value? And I guess the way I would look at that is we've guided towards how we get to our 10%, 10.5%. So when we calculate the intrinsic value of our stock, we're using our number. If you look at where I think the consensus is for margins next year based on the reports that I've seen so far. It's more like in the lower 9s and based on that, including your note, you get to a stock price in the 24 or 26 range. Well, our math is at a higher number. So right now, it's very simple. We're buying 2 shares and getting on free from my perspective and hence, all the money is going to buy back.

All right. I love the confidence. What are your thoughts on some of the recent on-shoring announcements by automakers as a result of tariffs? For example, we've seen GM investing $4 billion to bring back a number of body on frame pickups and SUVs, crossovers, beds from Mexico to Michigan, Kansas, Tennessee, Nissan is bringing more road crossovers from Japan to Tennessee. Honda's moving the CRV from Canada to, I don't know, Indiana or Ohio, I imagine. It looks like a lot of your light vehicle driveline facilities are clustered around the Midwestern United States, more so than Canada or Mexico. Are you in a position to benefit from this onshoring trend? Have you maybe had any preliminary discussions with automakers about supporting their onshoring activities?

Yes. I mean, not really because for -- again, when I sort of say where our exposure is, they're almost all made here Maverick is an exception, but almost all of them are assembled in North America. And so we don't -- it's not like they're bad. It's just -- they're already well positioned. So there's not an opportunity reposition. Maybe with the one exception, I know you have this later on your questions on Super Duty volume uplift. And so that is something that is a goal program for Ford. They're uplifting their capacity by, I think, it's just a shade over 20% by introducing into Oakville. And that kicks in next August and ramps up to full -- a full run rate of just under 60,000 by October.

Well, let's move to talking about that now then tomorrow, I have Navin Kumar, the CFO of Ford Pro. And one of the questions I'll be asking him is, are you really going to go forward with this $3 billion investment for your most profitable product, when right now, you'd be paying a 25% tariff. And even if you didn't -- there's still USMCA coming up, in July next year and Treasury -- Secretary or Bessent it was, said we're going to renegotiate NAFTA. We don't want vehicles built in Canada when they can be built in the U.S., et cetera. So I don't know what's happening there. But -- and I haven't heard you say -- it makes all the sense in the world. I'm sure you're going to supply that product. Maybe you haven't officially announced that, but where would you supply that product from? And what would be the implication to you if it was built in Canada or the U.S.?

Well, it is built in the U.S. now and they're adding capacity in Oakville. And I can tell you, it is a goal program because, obviously, we had the same question. And we do have to spend a fairly good chunk of capital this year and next year to help us -- we're not putting any footprint in Canada. Everything that we supply will come out of the U.S. So it's adding capacity to our existing footprint in pretty short order. I would be shocked if they're not going to do it given the lead times. I was actually in Oakville last week. They are expanding the -- I mean the plant is vacant right now. It's idled because they were going to put some electric stuff in there. But they are expanding the plant, adding rooftop. I suspect they sell a half decent amount of Super Duties in Canada. I don't know if it's 60,000, but if you think about their market being 1/10 size of ours roughly and they sell 300,000. I mean, it wouldn't surprise me if they sold 30,000, 40,000 of them in Canada, and so making them there is probably to some extent, makes sense. And maybe what time is he on because I'd like to listen in, but there could be a UAW element to this, too.

You mentioned that The Street was at low 9s EBITDA margin for next year. You're targeting 10 to 10.5. Can you maybe help us -- what can you say you increase the confidence and in modeling that? I mean you're doing 7.4 to 8.1 this year for new Dana. So what's the walk to 10 to 10.5? You gave the confidence in the cost saves. What else is required to get the kind of end market backdrop, et cetera?

Well, no improvement in the end markets. This is 100% within our control. It assumes that the markets stay kind of where they're at right now. So if they were to fundamentally improve if we were to see off-highway kick up in advance of CAFE or not CAFE, the clean air standards in 2027, we're starting to see a pre-buy, we're not expecting that, but those things would only help us. So the only thing that we have from a top line perspective is about $300 million of our backlog that rolls in, some of which is the Super Duty, probably about 20% of that would be the Super Duty volume for next year. So it's all within our control, and it's -- like I said, it's a short putt.

I just got one follow-up there and I'll turn it over to the investors, on the no improvement in end markets. I want to ask about what you're seeing for commercial truck demand in North America and Europe. On the 2Q call, you said, well, North America is a little bit softer. The headwind didn't seem overly huge. You said, you actually managed to raise guidance and you said there's actually tailwinds to commercial truck in EU, South America. Now other suppliers this quarter sounded actually a lot more negative on commercial truck. There could be different 5 through 7 versus 8 split. I think you might have a little bit more South America than them. But what are you seeing out there?

Yes. So for us, I mean, just to put it in perspective, so CV North America is about $1 billion business for us, and I think that's the area people are focusing on. The rest of our CV business be Europe. And we have a big, like you said, big business in South America. And so South America is holding its own, a little bit of softness with some of the interest rate increases here. Europe is actually doing better bottomed out. So I would say if you think about our North American business, yes, we may have -- maybe $50 million of like 10% risk here in the back half of the year. But in the scheme of our -- of the revenue guide, like that's like 1.5% of our total sales. It's manageable. And obviously, in terms of our guidance, we don't plan on everything going right in there. So I view our second half guidance absolutely middle of fairway. I know there's been a lot of questions about walking from first half to second half. But you'll see a market increase in our margins in Q3 beyond like in Q2, we were at 7.5%. We've guided to a sort of that number for the year. You'll start to see the benefits of improved operational performance the higher level of cost save. A lot of that's going to be flowing through in Q3, and you'll see a massive step-up in margins year-over-year and versus -- from Q2 to Q3. So it's not really going to be a long-term wait and see.

Very helpful. I've got more questions. Why don't I pause and see if there's any questions in the audience for Bruce. One upfront, please.

So a lot of the things we're talking about today are decisions and debates that took place probably 1.5 years to 2 years ago, if not longer. What are the things inside of your executive team conference room that you're sort of debating and raising questions about now about the future of the business?

Yes. I think a couple, we're -- I think we feel pretty good where we are right now. As the changes that I've talked about that we've made as a company have been -- certainly had my full team, the executive team engaged and to some extent, I've pushed them maybe a little bit in some areas, but not very many. We ask ourselves like we're going to be very, I would say, more North American-centric now, like 70 type percent. Really got to look at what we can do to become more global. And that's, I'd say, a little bit of a dilemma for us because if you think on the light vehicle side, we don't really have if you look at our product portfolio, it doesn't match up well for Asia or Europe, like there are no big volume Super Duty, big SUV stuff out there. So it doesn't really mesh well for us on the commercial vehicle side of things. The European, the -- and the North American market operate kind of differently, more in-house manufacturing in CV in Europe on -- in China, we're a fairly small player, it's probably going to be much more of an electrification story there where it's not going to be so much here in North America. We're strong. So I'd say the strategic questions are probably more on the CV side and how we position that business for the long term. And or should we be in that -- in those markets or should we be more concentrated.

And just maybe lastly, if you could comment on the competitive environment within the commercial vehicle driveline market. I was curious what impact, if any, you've seen from the Cummins acquisition of rival Meritor?

Yes. I mean, it's -- it's a very -- it's a bit of an oligopoly here in North America. If you look at the marketplace. We're in some customers that they're not. They're customers that we're not, and there's other places where we compete sort of head-to-head. In a lot of cases, our products are almost substitutional. And so we compete with them. They're a good competitor. I would say there's opportunities for us to gain share, mainly because we've taken some actions to -- I think we have an advantageous cost position now because we've opened a brand-new commercial vehicle facility in Mexico. And I think we have a cost base coming out of a world-class facility versus our peers, and that should position us well to gain some share over the long term.

Great. Very helpful. We are over time, so please join me in thanking Bruce and Craig.

Thank you.