Dauch Corporation (DCH) Earnings Call Transcript & Summary

This is Doug Karson from Bank of America. We're excited to have American Axle & Manufacturing with us at our Annual Leveraged Finance Conference this time virtually, and they've been a great partner in this conference. With us from the company, we have Shannon Curry, the Vice President and Treasurer Finance; and Jason Parsons, Director, Investor Relations. And I'm going to turn it over to Shannon.

Great. Thank you, Doug, and hello, everyone. I hope everyone is well. And I want to thank you all for joining us today and for your ongoing interest in American Axle. I also want to thank Doug and the BofA team for hosting this virtual conference. We're really looking forward to this discussion. And having some time for Q&A with you. As always, I'd refer you to our website and in our presentation deck for our forward-looking disclaimers on any matters that we may talk about today. So I'm going to start off with some overview remarks, and then we'll get right into the Q&A. So just taking a step back and thinking about this year. This obviously wasn't the year that anyone expected when we started. We had an unanticipated and severe drop in volumes and production in the first half of the year, which started in Asia, then worked its way through our North American and European operations in the first half. We moved quickly to adjust our cost structure to position ourselves to operate through the situation while maintaining strong support for our customers. As I said, we were able to quickly adjust our highly flexible and variable cost structure during the shutdowns, which went really pretty deep into the month of May. We have and are structurally adjusting our business to be successful from a cash flow and profitability standpoint at a 14 million unit U.S. SAAR level. So any volume upside to that will be a tailwind for AAM, and we're setting up nicely to benefit from higher volumes. Our third quarter performance was strong, and we'll talk about that today. I'd say we're cautiously optimistic about the fourth quarter and beyond. But as we all know, we're still in the midst of uncertain times as it relates to the pandemic in all the areas of the world where we do business. We continue to be very focused on the health and safety of our associates. The COVID-19 protocols and procedures that we put in place early in the year and have maintained throughout the year have been successful in maintaining a safe environment at our manufacturing facilities. And this is critically important, of course, for the health and safety of our associates and also in maintaining the stability in our operations so that we can support our customers' needs. We had a solid third quarter result, and we've reinstated our full year 2020 guidance, and I'll touch on some of those highlights. In the third quarter, we reported adjusted free cash flow of $217 million compared to $161 million in the third quarter of last year. Our adjusted EBITDA was $297 million or a 21% margin compared to 15.8% last year. Now this EBITDA did include about $22 million of customer ED&D recovery and other commercial items as well as some favorable FX. And you can see that in the walk that we've included in the presentation very transparently. But our performance was strong in the third quarter, even if you remove these items. The combination of our structure and cost savings, the resurgence in end customer demand and the low dealer inventories and desire for the dealers to replenish those inventories on their lots yielded nice contribution margin for us in the third quarter. And as we disclosed in the third quarter earnings release, our revised financial targets for the full year of 2020 is $4.6 billion in revenue, adjusted EBITDA of between $665 million and $680 million, and adjusted free cash flow in the range of $220 million to $235 million. Given the year that we've been through, that's a solid free cash flow expectation for the full year. As we start to look beyond 2020, we're also cautiously optimistic. We haven't given any guidance beyond 2020. We'd expect to share our 2021 target and updated backlog early next year. But that being said, we're seeing strong signs as it relates to consumer demand, especially for the vehicles and markets that we support. The light truck mix has been favorable, improving to 76% in 2020 compared to 72% in 2019, and we see the potential for this trend to continue in 2020 and beyond. As it specifically relates to the full-size truck SUV market, this segment share has increased over 18% compared to 17% last year and 15% to 16% that we've seen in years prior to that. The cost savings actions that we've implemented should continue to benefit us in 2021. And we continue to look for ways to identify further capacity optimization and cost reduction activities that we can implement in the company's cost structure. From a cash flow management perspective, we continue to prioritize cash flow generation as was demonstrated in our third quarter performance. With the volumes returning, combining that with our improved cost structure, robust CapEx management and an intense focus on working capital, we feel good about our cash flow outlook. Our cash flow allows us to support key growth initiatives, including CapEx requirements, which we do expect to be lower as a percentage of sales than what we've seen in prior years but appropriate and also sustained R&D spending, which is critically important to us as we move into the future. And it gives us the ability to still maintain capital allocation flexibility and remain focused on debt reduction, which is a key priority, as you've heard before and continues to be a key priority of our management team. We have no senior debt maturities until the year 2024 aside from minor amortization on our term loan. And we have a healthy debt maturity profile with plenty of optionality for us as we focus on delevering and maintaining that healthy structure. As it relates to our technology and our product portfolio, our goal is to focus on profitable growth and meet the needs of our OEM customers, whether that's through traditional powertrain, drivetrain programs or electrification programs. And even in this difficult operating environment, we're committing to investing in the future, as I mentioned, through our R&D spending. The R&D this year is roughly flattish year-to-date, if you exclude the lumpiness of an ED&D recovery that occurred in the third quarter. We generally, for R&D, would spend $35 million to $40 million in any given quarter. Our engineering teams are diligently working on the next-generation 3-in-1 electric drive units. And we'll be a leader in power density and compact design while providing solid cost value proposition to the OEM vehicle manufacturers. The portion of our backlog that's related to hybrid and electric vehicles are increasing and a large portion of our quoting and emerging new business opportunity relates to EV programs. I'm sure we'll talk about that in some of the Q&A today. We see the electrification wave coming, and we know that the OEMs will need a solid supply chain to provide both full systems and components. And the key for us is to be positioned and prepared to serve our customers in any way that they would like us to, and we are ready for this. We're excited for the growth opportunities that EV brings to us. So with that, that concludes my opening comments. Doug, I'll turn it over to you, and Jason and I are both available for Q&A that you or anyone in the audience may have.

Great. Thanks so much. That was a great overview. I guess, if you just give us a little color on -- we've seen a real spike up rebound in SAAR over the last few months. We're kind of running at 16 million units. How does your capacity utilization look? How is the supply chain supporting your efforts to chase the increase in production?

Doug, this is Jason. Yes. Look, from a capacity optimization perspective, look, we're running quite strong, especially in the key full-size truck SUV and crossover vehicle market. Obviously, the utilization will vary by region, by program, by customer, but I would say, strong. We've been working to kind of restructure our business to a lower SAAR level and allowing volume to be a tailwind to us. And I think we're seeing the benefits to that from a supply chain perspective. Obviously, with the pandemic situation, it's a little higher alert at this point in time. But our supply base has been incredibly supportive of us throughout some challenging times, and we continue to meet the needs of our customers and our supply base continues to meet our need. So definitely, keeping a watchful eye on any potential situations. But at this point, we've not had any significant disruption from a supply chain perspective, and they've been incredible partners with us.

That's good to hear. If we could just -- maybe a little big picture. So several years ago, you merged with Metaldyne, it seems to make a lot of sense to get scale in the industry. If you could just give us a little color on the strategy around driveline and metal forming and how that acquisition has met your goals and I guess that -- we could start with that?

Sure. Yes, that was an important acquisition for us, obviously, for many reasons, scale, product set, customer, expansion, among others. The integration of that is essentially complete. We continue to see some opportunities here and there to further lean out the business. But at this point, we just view that as ordinary productivity ongoing programs as opposed to integration. So we think that we had a successful integration and some of the benefits that we've seen would be the ability to be more vertically integrated. This is important to us as it allows us to maintain a high level of quality for our driveline products, as you mentioned, metal forming business unit and our driveline business unit. We also, now with the combination on the metal forming side, we're the biggest metal forger in the world, which helps us with our raw material purchasing. And the size and scale of this business continues to benefit us as we win new awards going forward. We have benefited from a wider customer base and the product offering, as I mentioned, and that will continue to help us as we focus in new areas and win new awards going forward.

Thank you. I'm thinking about the achievements you've made in that E-drive electrification, and I'm looking at Slide 6 and talks about expected lifetime revenues for book E-drive related business, about $1 billion or over $1 billion. Can you just give investors an update on what are the most important products that you're looking at across electrification? Maybe you can just touch on E-drive, E-axles and just give us some color on electrification?

Yes. Sure. So Doug, as you know, we have invested in electrification all the way back to 2010. We initiated a joint venture with back then Saab and then in 2012, we took that over 100%. And really have been working with technology on the bookshelf, kind of waiting for demand for EVs, both from the customer and the consumer to increase. So we started to see the fruits of that. Those investments really take shape in 2018 when we launched our first E-drive program with Jaguar Land Rover. So the largest program we have in the marketplace today is and we're supplying the front and rear E-drive for the Jaguar I-PACE. Fantastic vehicle. Our technology won 2 Pace awards. And Doug, you know the procedure comes along with winning those awards. Those are the first 2 Pace awards we won as a company and really acknowledge from the outside, the industry-leading technology that we have. We also won a collaboration award with our customer, Jaguar Land Rover on that as well. So since then -- since that launch, we've also launched on a small passenger car program in China. The Baojun E300 Plus with our customer SAIC-GM-Wuling. And that vehicle is really on the opposite end of the spectrum as far as the JLR, high-performance all-wheel drive crossover, and this being a front-wheel drive value brand passenger car. So I think what we've shown through the 2 businesses we've launched so far is that we can scale our E-drive products up and down the performance and value chain depending on what the customer requirements are in the regions. We have 2 more launches coming next year in 2021. One will be a E-drive on another premium European OEM, and then we have an additional launch going forward in China as well on another small passenger car. So we continue to see the benefits of this. We continue to see this as a significant opportunity for growth from our perspective. We have, as Shannon mentioned, a significant portion of our quoting and emerging business is related to higher performance vehicles. And this is a great opportunity for us. And I think one of the questions that comes along with that is we can not only scale our E-drives for customer requirements, but we can also have a scalable product portfolio, including gearboxes, subassembly components that we can provide to OEMs. For instance, they decide to in-source a portion or all their E-drive units. So I know there's some concern out there as far as how we would play in that world. And really, it's very similar to how we do in traditional IC engine -- OEMs have some in-house capacity to products we provide them today as well. So we feel very well positioned. Our technology is getting recognized in the industry as the industry leading. And -- but we're really excited about it, the next-generation stuff that we're working on today. Our engineers and team to really continue to capitalize on this growth trend going forward.

Great. Thank you for that update. I got 2 questions here from investors. So the first one I think relates to EBITDA levels. So the question is, is there any reason you cannot return to 2019 EBITDA levels over the next few years?

Well, I mean, look, what I would tell you, we're obviously not giving guidance beyond what we've provided for 2020, Doug. But we started the year expecting 16% EBITDA margins prior to the pandemic. Obviously, the production shutdowns in the second quarter had a significant -- first quarter and second quarter had significant impact on our business. But you look at what we were able to do in the third quarter. And as Shannon mentioned, even if you back out a few onetime items, incredibly strong EBITDA margins. And if you look at what we're kind of inherently expecting in the fourth quarter, again expecting in that 15% to 16% EBITDA margin range. So we're very optimistic. We think a lot of the cost savings that we have achieved in 2020 are sticky and will carry forward into 2021. The mix that we're seeing out there from a vehicle set, whether it be consumer demand driven or low dealer inventory driven continue to be beneficial to us. We obviously have things we'll have to manage through like customer price downs and maybe a little increase in launch costs and R&D costs, but those are all things that we've kind of baked in already, and we think we do offset those with further productivity within our operations. We're optimistic. We continue to strive to be at industry-leading in our market profile, and we're confident in our ability to do that.

That's a good framework. Thank you for that. I get another question coming in here regarding leverage. So as I'm looking at Slide 22, net debt and leverage ratio. So your net leverage ratio right now is 4.7% off of a net debt balance of about $3 billion. So if you could wave magic wand and get to the right leverage ratio, what would that be roughly? And how would you get there?

Yes. So we haven't given a specific target time frame to achieve any certain leverage at this point. But that being said, going back after the MPG acquisition, we talked quite a bit about specifically targeting 2x leverage over a certain period of time. There -- obviously, we had some setbacks and some reasons that we weren't able to achieve that. A couple of things, primarily the GM work stoppage that occurred around this time last year, that was a setback for us, and then, of course, the pandemic. That being said, while we haven't publicly reset our target. We continue to remain focused on working kind of trending towards those levels. We like the idea and if you look at some of our historical comments, we generally like to operate in 1.5 to 2x leverage. We intend to do that in 2 ways, both by growing and having strong EBITDA and also payment at the gross level of debt. So both sides of the equation, I think, is a focus for us as we trend towards that level over time.

Thank you. That's perfect. I've got another question coming in here. I hope this is fair. When you think about GM's decision to take some parts in-house, how that affect your planning, your budgeting? How are you going to compensate for some of that potentially lost volume?

Yes. I mean, I guess, I'm not sure specifically what the question is referring to from an in-sourcing perspective. But I know that, obviously, back in 2018, GM in-sourced a portion of the pickup truck axles and that sourcing decision is pretty much behind us at this point in time. And I know they've also announced their plan to do some of their electric drive units in-house as well. Really none of that is a news to us or a surprise to us, our planning doesn't change. First of all, I'd tell you, we believe the ICE engine, especially on the pickup truck side of the business, has a long way to run generations of vehicles. So I think as you see, GM has actually announced that they're opening up an additional capacity at another plant, pickup truck plant in Oshawa, Canada in the next -- in the near term. And so I think that reflects their view on pickup truck volumes as well. So we're going to continue to benefit very significantly from our relationship with GM as it relates to our key programs there for at least a certain period of time. And then as we've talked about in general, some OEMs are going to in-source E-drive unit production. We know that. Again, that's the same dynamic we experience on the traditional ICE side of things. What we've done is to set our company up to continue to have opportunities to benefit from electrification even when OEMs are in-sourcing that E-drive production. So we'll be able to provide, as I mentioned before, gearboxes, subassembly components, and we expect to play -- we're obviously working with all of our customers in how we can participate in that. We're confident in our ability to continue to stay a very -- become a very important player on that side of the business. So it doesn't change our planning at all. These are risks that obviously we consider as we're looking towards our future. And we still see a ton of opportunities for us to grow in this and participate in this even if some of our customers decide to in-source kind of the high-level assembly of their E-drive units.

Perfect. Thank you. I guess if you could just maybe talk about some of the good and strong initiatives you've had on cost, and just talk about some of the opportunities that still could be out there on cost reduction?

Yes. I mean from a cost reduction perspective, we were able to achieve -- our target is to achieve about $60 million of cost savings here in 2020. And between second and third quarter, we've got a really good start on that, over $40 million in the second and third quarter. So a portion of those, about 1/3 maybe are temporary cost reductions, things like salary reductions, reduced travel, those type of overhead temporary. We do expect some of those to come back. In fact, the salary reductions, we're terminating in the fourth quarter, so that will come back. But our plan really all along has been to try to replenish any temporary cost reductions with further fixed cost reduction in restructuring actions. So while we'll see some costs come back, we're also continuing to focus on further actions that we can take to either optimize our capacity or we continue to align our fixed cost structure with the new market demand. So we're confident that we'll be able to take that $60 million from this year and continue to see those results in 2021. And if we see opportunities to do more, especially as we see how demand continues to evolve over the next few months, then we'll do so.

Yes. And on the cash side, CapEx also is -- was a big opportunity for us this year, and we are very focused and committed to maintaining lower levels of CapEx spending as we move forward. We expect CapEx to be 5% or lower as a percent of sales as we move forward. And we're doing that through reuse of CapEx, reallocation of CapEx and really looking at our plant capacity opportunities there. So we'll stay focused on that as we move forward too.

Right. That makes sense. So a question come in here on the castings business. So with last year's sales castings, do you see any other opportunities to divest any portion of your business? Or do you have the right like footprint right now?

Yes. So I'd say we're always evaluating our over overall portfolio and products to determine what's core and what's noncore, and we'll continue to match our assets to what we view as future core business. So we don't have anything upsized to talk about that we've noted as noncore today. But in the future, we'd be open to divesting if that's the case. There isn't anything to think of that would be similar in size to the castings business unit. If we have certain elements that we divest, it would probably be much smaller in nature.

Perfect. Thank you. A question come in here on raw materials. Steel is a big part of your raw materials, how are you able to hedge those? What has the cost of raw material been kind of relative to your past experience?

Yes. Probably the most important raw material buy that we have, Doug, is a special bar quality steel. And from the industry perspective or the variable cost perspective is that we do have operational hedges in place that allow us to pass on -- pass through a significant portion of those increases or decreases on to our customer. So we do have an operational that the main thing to see that we track there is #1 scrap bundles, although there are several indices that are part of that buy. And that really hasn't been overly volatile over the last 6 months or so. So the good news from our perspective is when prices go up, we're able to pass those on to the customer, when prices go down, we pass that benefit on to them as well. So sometimes, it has a little bit of an impact on margin. But from a pure EBITDA dollar and free cash flow perspective, those changes typically don't cause changes in market prices, typically don't cause a significant dollar issues there.

That makes sense. That's perfect. So we just about hit 2:45, which will conclude today's fireside chat. Thank you so much, American Axle, for your continued participation in the conference. I didn't get to all the questions that were sent to me. So I may follow up with those investors directly. But again, enjoy the rest of your day, and thank you for all joining us.

Yes, thank you very much.

Thank you.