Dauch Corporation (DCH) Earnings Call Transcript & Summary

Okay. Great. I think we can get going with the first presentation on day 2 of the 2022 JPMorgan Automotive Conference. Thank you again for everybody turning out our first year in person after a couple virtual. Very excited to get going with David Dauch, the Chairman and CEO of American Axle & Manufacturing. Also on the stage with us here is David Lim, Head of Investor Relations. David, I turn it over to you. Thank you so much.

Great. Thank you. Well, good morning, everyone. It's an honor and a pleasure to be with you here today. It's been quite some time since we've all been together face-to-face. So again, it's a pleasure to be here. With respect to American Axle, we had a solid quarter in the second quarter, just announced our earnings last Friday, $1.44 billion, $195 million in EBITDA and $114 million in free cash flow generation. So considering the volatile market and the disruptive market that we've been operating in, we feel very good about the performance that we've had. In addition, we made meaningful progress with our customers in regards to economic recoveries. So we're very pleased in regards to the progress that took place there. We had telegraphed and indicated in our first quarter that we would make that meaningful progress in the second quarter, and we did just that. Those conversations with our customers were fair but firm but balanced. And ultimately, we've had to absorb some of the economic increases, but at the same time, the customers addressed and stepped up to their responsibilities. Now we still got some additional things that we need to do for the second half of the year with respect to economic recoveries, but we'll continue to, I'm sure, find a resolution with our customers on that side of things. From a guidance standpoint, at our earnings call on Friday, we upped our guidance to our sales now in a range of $5.75 billion to $5.95 billion, EBITDA in the range of $790 million to $830 million. And free cash flow is still in the range of $300 million to $350 million, with CapEx still in the range of 3.5% to 4%. So we feel very good about, again, the second half of the year. We think buy-ins will get stronger as the year progresses. Clearly, the first half of the year on a global basis was impacted to the tune of about 3 million units because of semiconductors. We think there's another 1 million units -- roughly 800,000 to 1 million units of incremental impact that will take place in the second half of the year, but we're prepared to address those issues going forward. Within the quarter, we also had some very positive things take place, and we were able to launch our Mercedes-AMG electric drive axle, which is a very unique axle. It's actually a hybrid-type application that takes an internal combustion engine and pairs it up with a powerful electric drive assist application, gives you 0 to 60 under 3 seconds. It's one of the most complicated products we've ever made in our portfolio, but it also demonstrates the technology capability that we have. And that technology is standing for a PACE award right now, which is one of the highest awards you can realize in the auto space from a technology standpoint. Some of our incremental technology, our Gen5 technology for electrification, also standing for a PACEpilot award. That business has already been sourced in REE, as we mentioned to you earlier. What that program does is there's 3 main members to an electric vehicle or electric axle, I should say. It's the gearbox, the motor and the inverter. Our Gen5 technology actually integrates all 3 of those members into one, small, concise, package -- power density, package density with tremendous volume efficiency, which is what the OEMs are looking for. And we can do it at a value proposition that's attractive to the customers as well. So we're very excited about the partnership with Mercedes-AMG. Again, most people know a lot of the technology in the Europeans comes through racing or comes through their performance group. Once they can prove it out in their performance group, which is what AMG is, a lot of times, it finds its way to serial production. We're hopeful that we can continue to grow that relationship with Mercedes as we go forward. That piggybacks off of what we had done earlier with Jaguar Land Rover. So again, we've now got 2 demonstrated European OEMs that are very focused on technology. And therefore, we've been able to satisfy them with the technology that we brought to the table. And if we can do it for those 2, we can do it for anyone around the world, and we have meaningful awards around the world as well that I'll talk briefly about as we go forward. Also on the EV side of things, we won some component business with 2 OEMs: one, a domestic OEM; the other, a European OEM. Again, the way we're approaching the market right now is in 4 phases. One is in a component standpoint, so think gears and shafts. Second is a differential assembly standpoint, which we're doing for NIO, we're doing for the Hummer vehicle and other vehicles that are out there. Also the gearbox, we're doing that for a number of Chinese customers through our partnership with Inovance, which has been very well received. And then finally is in the final end item assembly state, which could either be in the EDU form, the Electric Drive Unit, or in an eBeam axle application, which we're quoting on those initiatives right now as we speak. From a Tekfor standpoint, we announced the acquisition of Tekfor. We closed on it on June 1. Tekfor is a large forming operation or forging operation based out of Germany. They're a global operation with 10 facilities. So we've now got 85 facilities operating in 18 countries with over 20,000 associates. So our organization continues to grow. They do about EUR 285 million in sales, a little over $300 million, and we actually acquired this business at a very attractive price at about EUR 125 million. When you factor in synergies and all, it's around 3x from an EBITDA standpoint. So we're very, very pleased with respect to the acquisition that we did with Tekfor. It's very meaningful from a synergistic standpoint. We'll see the majority of those synergies start to be realized in 2023, but it also brings tremendous diversification to us in the form of customer geographic and product portfolio expansion. 40% of their business is agnostic to the move from ICE engines to electrification. So that's a positive for us. At the same time, they expanded our electrification portfolio, especially in the areas of rotors and stators, which are used for motor-type applications going forward. So very complementary to our business, tremendous synergies to be realized there. And we're in the -- we just kicked off the integration process since we closed on the deal here on June 1. When you really sum up our business right now, I mean, we're really focused on 5 things, and it's really generating strong free cash flow from the business. We continue to do that quarter-to-quarter. We're outperforming most of our peers when it comes to cash flow as a percentage of sales. We're also being very disciplined in regards to strengthening our balance sheet by paying down debt. Each quarter, we're paying down incremental debt. First half of the year, we paid down $50 million in debt. Second half of the year, I'm sure we'll do that or maybe a little bit more than that going forward. But again, continued progress with respect to debt management. We're also working very hard to secure all of our next-generation ICE business. The majority of that has been secured, especially on our major platforms. That will again ensure strong cash generation for us for years to come, decades to come quite honestly. So we feel very good about where we are there. Most of the next-generation transmissions have already been developed. The engines are in their final stages of the last 1 or 2 programs to be developed, and the axles will obviously be adjusted from an engineering change standpoint going forward based on the amount of horsepower and torque that the OEMs want to introduce into the vehicle. So we feel very good about where the portfolio is positioned today, what we think the maturity and the duration of that business will be, which we think will be here for decades. Even with the increase in penetration from a market standpoint of electrification, we still feel strongly that ICE engines will be around. However, we're big believers in electrification. We've got the technology, and we continue to expand that technology, and we're growing our backlog in new business. Our backlog in new business from the 2022 to 2024 period of time is at $700 million, $175 million this year, $325 million next year and $200 million the year thereafter. However, we're still working on that 2024 period of time in regards to growing that backlog. And that's on a gross basis. So again, we feel very good about the growth there. The other important thing is that previous backlog, only 15% of the backlog represented electrification product. Today, 35% of that $700 million is tied to electrification growth in the different forms I covered with you, from components all the way to end item assemblies, but the majority of it being tipped towards the end item assembly side of things. So again, very good progress with respect to what we're doing on the next-generation business. Again, we're positioning ourselves by making big investments from a product standpoint to have the right portfolio to meet the customers' evolving and changing long-range product plan needs in the area of electrification. That's changing rapidly as OEMs are trying to reposition themselves. But again, our job is to make sure that we've got the right portfolio and to be agnostic to the market going forward. And that's the key word that I've been trying to drive in our organization, is the word agnostic. We've got the portfolio in spades when it comes to ICE and hybrid vehicles. We don't have any additional developments required in that area other than what the customer may direct. But in regards to electrification, we've got more work to do from an electrification portfolio standpoint to be able to cover the majority of the marketplace on the electrification side. And then last but not least, for us, it's just really continuing to grow that backlog of new business that I just mentioned to you. We're quoting on over $1.5 billion of new and incremental business right now. 70% of what we're quoting is electrification based. So you can see the switch or the pivot from the OEMs moving away from ICE-type business towards electrification, but there is incremental ICE business to be awarded, and we are winning that business or a lot of that business, but we're also winning our fair share of the business on the electrification front. So with that, I just want to thank you all for being here today and for your continued interest in American Axle. And Ryan, I'll turn it back over to you for any questions you may have or the audience may have. So thank you.

I thought to start with a few questions, including I'd like to get your latest thoughts on normalized demand in the United States, which drives the lion's share of the market for North American production, your largest end markets. Prior to the pandemic, we averaged $17 million sales for many years, but we're only at $13.7 million currently. The most proper suggestion why is because of supply chain constraints, supply constraints. But I was curious if you thought it could potentially be more complicated than that, right? We're selling vehicles for $46,000 now versus $35,000 pre-pandemic. So to what degree do you think we can get back to at these levels of prices or anywhere near them, pre-pandemic levels of production? If we are potentially in some sort of new period characterized by lower volume and higher price, how do you think American Axle is positioned for that environment?

Well, first and foremost, we've adjusted our business to no matter what the market demand is. And that's the responsibility of management, is to make sure we're addressing our cost structure to make sure that we can still provide a return to our shareholders. So point number one is we're making money even at a reduced production in SAAR level today. We've demonstrated our breakeven level down at the $10 million SAAR level years ago. So we've clearly demonstrated to the investment community our ability to manage our upside playbook when volumes are high but also the downside playbook when volumes are extremely low, which they have been for the past couple of years. I mean the auto business has essentially been in a recession in the last 2 years because of the semiconductor issue but also because of other supply chain constraints that are there. To your point, we're operating right now at SAAR about 13.7 million units. We've guided The Street at 14.3 million to 14.7 million units as it relates to production for North America. Inventories are extremely low. You've got most of it that are operating under 30 days. Historically, that's been between 50 and 75 days. We've got certain models that are operating in single digits. So it's not a sustainable market to be able -- from a supply and demand standpoint at this point in time. Yes, OEMs are making record profits. Yes, dealers are making record profits. But they also need to have product to be able to sell. And therefore, we got to be able to break the constraints that are taking place. I've already commented on the semiconductor issue, which is really the main thing that was impacting the supply base the past couple of years here, but it's much more than that. It's just the supplier -- the supply base or the supply chain is fragile as I've ever seen in my career. And I've been around for 35 years. Labor is a major issue that's out there compounded by all the raw material economic issues that are out there right now, energy increases, port delays, all the other things that we all know about right now. But to get back to your main question, I do think that this market will recover. I think it will gradually recover over the next couple of years as the semiconductor gets stabilized, but my biggest concern still is labor. If history repeats itself, we'll get back to a 16 million to 17 million unit SAAR. At the same time, based on where inventory levels are, it will take at least 18 months to 2 years to replenish a lower inventory level than what was historically put into place before. And that's where OEMs have a decision to make, is do they want to go back to those previous inventory levels or do they want to operate at a lower inventory level but drive those transaction prices up and minimize the amount of incentives that they're being offered. And you're seeing that take place today because of where the inventory is. But first thing, I think it will get back to a 16 million, 17 million unit SAAR. I think it will take a couple of years to get there. And then it will take us a couple of years to replenish the inventory levels.

Great. I wanted to get your latest thoughts, too, on the pace and progress of customer discussions to recover a lot of the premium costs that you've been incurring over the past year, including diesel, freight, logistics, natural gas, electricity, et cetera, and the likely impact to American Axle's margin. And maybe you can address it from a couple of standpoints. First of all, with regard to the current contracts, which didn't anticipate those premium costs, which I think you're hoping to collect on in the back half of the year here. But also secondly, what can you tell us about maybe some of the new contracts that have been signed over the past year or you hope to sign going forward amidst this new higher cost environment? Are you any better protected in these newer contracts? Should non-commodity supply chain cost surprise higher again in the future?

I'll start with your -- the last part of your question. As far as the new business that we're quoting, we're quoting them with updated economics, and we're winning business for those updated economics. The market is the market. The market sets the price. And therefore, we've got to make sure that we can protect our business. So we are quoting business with new and incremental economics associated with it. With respect to our current contracts that are in place, we have certain metal market provisions and indices that we follow that are part of those contracts. So some of those just allow for pass-through in both directions to the customer or back to us, in this case, mainly back to the customer based on the economics time that we're faced with. However, those agreements didn't cover everything based on the economic impact that we've seen here the past year. So that's why, as I mentioned earlier, we've been into our customers for not only just raw material increases but energy increases, freight increases, labor increases and other things, and we have had meaningful progress with respect to recovery there. But as I said, those conversations have been fair and balanced, but there's more work to do as we go forward.

Great. And I think one of the things that investors are most attempting to monitor with American Axle is how you plan to manage this transition toward electrified driveline solutions. So maybe to start that discussion or follow up on some of your prepared remarks, are you able to share with us the percentage of your portfolio that is ICE aligned versus EV aligned versus powertrain agnostic? And then the same goes for your backlog, right, which I think is a bit more EV aligned -- a lot more EV aligned than current sales. And maybe it would be helpful, too, to highlight some of your powertrain-agnostic products, which aren't discussed as frequently, such as those products to reduce NVH, et cetera, noise, vibration. Or maybe, I don't know, that even is aligned, right, because there's less road noise in EVs versus ICE vehicles, et cetera. How would you describe your exposures to these types of vehicles today? And do how you expect that to change over time?

Well, presently, our portfolio is heavily weighted towards ICE-related product or hybrid-related product. So I'd say 90% to 95% of our business is tied to ICE today. So 5% or 10% of our business is electrification based today. As I covered with you earlier, our backlog in new business is 35% electrification based. So we're going to continue to see penetration on electrification going forward. But again, it's a result of the market and where the demand is at this point in time. We've been in the electrification business since 2010 when we formed a joint venture with Saab back in the day. We acquired that joint venture in 2012. We've had technology on the shelf for electric vehicles, but the market wasn't ready for it. The market is now starting to really show that it is ready for it. At the same time, what we had on the shelf before, the market has shifted. So we're redesigning and redeveloping a new product to meet the changing requirements of the different OEMs. And it varies by region of the world, too, in regards to European is obviously strong on the performance side, high technology-based type products. Asians, mainly China, is looking for more of a value based and a balance between cost as well as technology. And then the U.S. was lagging considerably here but obviously trying to make up here with the Biden administration in regards to closing the gap between Europe and China. We've said all along that we think Europe will lead the electrification movement. That's taking place. Policy is being set. Decisions are being made by countries to ban petrol vehicles in certain countries. At the same time, China tends to follow the European policy, but they're doing it at an accelerated rate, and they didn't really have a petrol or a gas infrastructure heavily put into place into China. So they're leapfrogging a lot of the Western countries with respect to going right to EVs because they can do that. Our country here has a lot of work to do in regards to getting the infrastructure put into place for electrification. But back to the main question in regards to, again, 90%, 95% of our business today is ICE related. However, we do feel strongly that we'll continue to grow and be relevant on electrification going forward. And we expect a balanced mix between electrification and ICE as time goes forward. With respect to products that are agnostic, I mean, again, part of what I mentioned earlier on Tekfor, 40% of their portfolio is agnostic to pivot to electrification. That's just one example, but we have several of those examples. The other thing to remember is we're heavily weighted towards light truck. 80% of the U.S. market is light truck related. When I say that, pickup trucks, SUVs and crossover vehicles. What you're mainly seeing go to electrification first has been the electric vehicles. At the same time, you're seeing sort of small passenger car and midsize and medium passenger car that only represents about 10% of our overall business. So we're not going to be impacted there. What's paying the bills for the OEMs today are all the full-size trucks. And I think the full-size trucks will be here for decades, although there's going to be offerings and there already are offerings with the Ford Lightning and what GM is going to be bringing out already with the Hummer but then also with the Sierra and Silverado here over the next couple of years. But we'll win our fair share of the electrification business, and we'll make sure that we're agnostic to the market and let the market truly be the boss.

I wanted to dig in on the Tekfor acquisition. You referenced it was announced during 2Q, adding EUR 285 million of sales for an enterprise value of EUR 125 million. I recall you saying on the call that you paid maybe just roughly 3x the targeted synergized EBITDA. So this could add, what, $40 million to corporate EBITDA next year. Firstly, did I get that math right? And then secondly, the title of the press release announcing the acquisition was AAM continues to pivot toward electrification. So can you maybe remind us of the ways that Tekfor increases your leverage to electrification? How do their products or backlog in terms of electrification leverage, how does that compare to your own? And then what else maybe attracted you to the Tekfor acquisition beyond electrification, for example, customer geographic diversification, et cetera?

Well, first part of your question, yes, you did get the math right. And as I mentioned earlier, it's a very attractive acquisition for us and fits right in line with what we're looking for, high-synergy bolt-on acquisitions that we can integrate in a short period of time. The biggest attraction to us was the complementary business. It's -- they were the #3 forger in Europe. We were the #2 forger in Europe. So we essentially acquired one of our biggest competitors over there, gives us a lot more size and scale and economy with respect to managing business and buying steel in the future. It obviously opens up and expands our relationship with the European customers because they've got 5 facilities in Europe, 3 in Brazil, 1 in Mexico and 1 in the U.S. There's tremendous synergies, as I mentioned, from an integration standpoint into our existing operations or pivoting some of their existing businesses into other areas. And on the electrification front, as I mentioned, they provide rotors and stators that are advanced and even further advanced than where we were today, and we felt it was a great way to complement some of our electrification initiatives.

Great. And another interesting announcement that you made during the quarter in June was this award for Mercedes, right, to provide their performance division, AMG, with an electronic drive unit for their first ever plug-in hybrid electric vehicle. The car that it will be on, the GT 63 S E, it's very expensive, super high-end vehicle. So probably not a real volume opportunity for you, although we have noticed that sometimes when you're on one AMG vehicle, you tend to be on more of them, right? So maybe speak to the materiality of this individual award or a potential set of awards. But also, I'm curious if you think there are other maybe more important even takeaways for investors such as the demonstration of your technological prowess in the area of electric propulsion. Investors, I think, are trying to figure out, what role will American Axle play in the electrified drive space? Is it niche? Is it broad, et cetera? Now that you're on the 39-horsepower Baojun E300 in China and on the 843-horsepower AMG GT in Germany, does it stand to reason then that your products will be featured on all sorts of vehicles in between in the future?

Well, I just think this award validates our technology. I mean if you can do it for an 800-plus horsepower vehicle while at the same time, as you said, do it for a low-end vehicle out of China, you can do it for anyone. And again, we targeted the Mercedes-AMG business. Mercedes needed some help in regards to CO2 emissions. At the same time, we had tremendous technology that was attractive to them, validated by them and at the same time, done in partnership with them. And we're very hopeful that this relationship can continue to grow. We do think there'll be other applications within the AMG family or other variants that this business will spread across to. So it's very meaningful from a prestige and a technology validation standpoint. As you said, the volumes are a little bit lower just based on it being the Performance brand, but we do expect it to go across other variants going forward. At the same time, it's already garnering interest from other OEMs now that the announcement is out there.

Great. And last year, you announced a partnership with China-based Inovance to develop 3-in-1 Electronic Drive Units or EDUs featuring a gearbox mated to an electric motor and inverter. Is there an update that you can provide on that Inovance partnership? Have any new awards you've won over the past year stemmed from that partnership? Do you expect the products coming out of the technology development agreement to serve one geography or customer set or use case more than any other?

Well, the main antenna of the joint venture that we put together with Inovance was really to service the China market. They're obviously a motor and inverter supplier within China. We obviously are known for our gearbox capability. Collectively together, we've got all the 3 main members to the vehicle. We've been very successful as a partnership in regards to winning new business with the likes of REE Automotive and Sokon and Weltmeister, which are domestic Chinese OEMs. That volume only continues to grow for us. There's other business that we're quoting on in China today in partnership with Inovance, but we also have some other things that we're doing independently with some of the advanced technology that we have. But I can just say to date, our partnership has been received very favorably on both sides, and we're making meaningful progress with respect to winning new business in China.

Great. And what is the latest do you think on the decisions of automakers to insource or outsource these electrified driveline products? It seems pretty clear that the driveline-related content per vehicle opportunity is significantly greater, right, than for internal combustion. But then, of course, that needs to be mated against this potential greater inclination of automakers or at least some automakers to produce these electrified driveline components in-house with American Axle, I think, strongly believing that this dynamic is likely to net out positively in your favor. I just wanted to check in, though, with regard to what the latest might be out there in terms of insource versus outsource decisions that your customers might be making. And then in the case of the automakers that do decide to insource engineering or assembling, how do you think you may be positioned to provide component-level solutions at least? And what might the impact or implications there be?

Okay. Well, the make/buy is always a raging debate. I mean there's current insourcing today of ICE axles by the OEMs. There's also ICE axles that are purchased on the outside. I think you're going to see that same thing will take place with electrification. Many OEMs will want to bring some of this capability in-house because the engine goes away, the transmission goes away. They may want to control certain things with respect to the axle. Many of the OEMs have union-based agreements. So they're going to have to deal with the labor complement that's out there. Our job as a supplier, in this case, American Axle, is to bring a value proposition to our customers. No different than what we do on ICE axles today. We need to do that same thing in electrification. We're demonstrating our current technology, let alone our Gen4, Gen5 technology, received tremendous feedback in a positive way from our customers in regards to technology we have there. There's no doubt in my mind that there will be a balance between insourcing and outsourcing, but AAM will win our fair share of the business. And it's going to vary by OEM. The Asian OEMs tend to -- especially China base, tend to need the support of the supply base in a greater capacity. The Europeans, obviously, and Volkswagen, they've got IG Metall issues from a union standpoint that they've got to deal with. And then here in the U.S., in the Detroit Three, they got to manage their way through UAW. But again, there's other things that they can do to balance and address some of the labor issues that are out there, including retirement. I mean we've got a lot of Baby Boomers that are going to be retiring. At the same time, there's a labor shortage that's out there. The OEMs also have to deal with the ACES. The autonomous, connected, electric and shared all require some sort of capital investment by the OEMs. In our case, we're concentrated on electrification. So again, all we can do is bring our capability and our value proposition to the customer. And ultimately, they've got to make a decision based on their capital allocation.