Dauch Corporation (DCH) Earnings Call Transcript & Summary

Joining us with American Axle manufacturing. I'm Doug Karson, the automotive analyst here at Bank of America. With us from AM, we have Chris May, Vice President and Chief Financial Officer; and Shannon Curry, VP and Treasurer. They've been great partners with us on this conference. It's a big commitment to come down during the holiday season, we spent a few days with our credit investors. So we're very grateful. As you know, AAM is one of the Tier 1 automotive suppliers out there. If you've ever had a chance to visit one of their plants, you can really see why it's a really magnificent facility. They've really been the best in the industry as far as quality. They've always prided herself in high-quality products. And with that, I'll turn it over to Chris.

All right. Thank you, Doug. Certainly, good morning to everybody. Before we begin, a couple of things. Again, thank you to Doug. Thank you to Bank of America for having this conference. It's always a great event each year. It's nice to be back in person and certainly discussing a little bit about American Axle as well as the industry as a whole. Before I begin, a couple of administrative items are forward-looking statements, you can see on the screen. You can also find those on our website. And also, I would like to give a quick shout out. We are hosting right before CES at the Las Vegas Motor Speedway, an investor technology event. It's going to be an awesome event if you have the chance to attend, please do so. reach out to our Investor Relations team. You can see the e-mail there on the screen, also on our website for your attendance there and get you coordinated. It's going to be a great day. Okay. So let's go ahead and begin. I know many of you are certainly familiar with American Axle. Some of you may not or may be new to the story. So just a very quick introduction. As Doug mentioned, we are a global Tier 1 automotive supplier. We operate really under 2 business units. The first one being our driveline business unit. That's probably the one when you think about American Axle, the one you would think about most prevalently. This is where our full-size truck franchise and driveline systems are housed. This is where our all-wheel drive systems, our EcoTrac systems are housed and also our electric drive units that we're in the process of launching to many different customers. We'll talk more about that later, is housed as well. On the metal forming side, this is key to our vertical integration strategy has been really since the foundation of the company, but has continued to grow and grow over the last 20-plus years, most recently an acquisition we did here in 2022, and we are the leading automotive forger in the world, many different components, many different customers really focused in North America and Europe from that standpoint. I'm not going to talk too much about our third quarter highlights. You can see them here on the screen. At the end of the day, it was a decent quarter for us. We continue to generate solid cash flow, almost $50 million. With that cash flow, we paid an additional $50 million down on our Term Loan B debt throughout the quarter, and we continue to navigate the challenges of the industry, which we'll talk about here in a little bit. But's I think most importantly, inside of the third quarter, what we talked about, we had some really key business announcements, some of them very exciting to us as a company, very focused on our forward growth. First, we'll talk about a couple of those as it relates to electrification. You can see a couple of names on the screen. You may not be familiar with in terms of when we talk about them because we are very focused on some of our core customers. But this is really where you're starting to see that electrification go-to-market strategy work very well for us. So Eco Mobility, which is a subsidiary of Pinnacle in India. This is our first beam axle business. So a new customer for us that will launch a great business win, but also to support Volvo. As you know, they are trying to convert their entire fleet of automobiles into electric. We are now a key component supplier to that strategy for Volvo. So 2 very key announcements for us, continued expansion geographically, continued expansion from a product standpoint and continued expansion from a customer standpoint. So right in line with our approach to market. And we'll talk a little bit more about that approach to market in a few more slides. Also very important to us here inside the quarter, we announced we were the recipient of 3 PACE awards. If you ask one of our engineers, they would tell you this is the Academy Awards of engineering and technology. So very proud to achieve these 3 awards. 2 of them were related to our recent product we just launched with AMG Mercedes, our P3 axle. And the last one -- the third one there on the right is associated with our next generation of eDrive units in partnership with RE automotive that we're beginning to launch that will go into production in 2024. So recognition from a body for our technology and for our advancement and our customer collaboration very well received within the company, and this is the first time we've won these really since 2020. So again, very impressed with our engineering and product set. And I know we like to talk a lot about electrification. We'll talk more about that later in the presentation. I know it's on a lot of your minds, that's our future growth mobility sector. But I would also tell you, our internal combustion engine business continues to be very robust, very solid for a very long time to come. and we continue to expand in that arena as well. So this leverages our core strengths of our global footprint, also leverages our capital efficiency. And you can see on the screen, 2 very key business award announcements we had also in the third quarter with new customers and Conquest products, and these are meaningful to support our continued backlog of business in the near term. So Chery Automobiles will be powering from a PTU and a drive module for their next SUV program in our Chongzhi facility in China. And then we recently won the conquest business for the Colorado Canyon, which is General Borders midsize pickup truck, and that will launch here in early 2023. So again, very key to our near-term backlog support and continued cash flow generation for the company. So as it relates to the backlog, this is our backlog for gross new business that we announced early in 2022. We will have a new update to this in early of 2023. But you can see here, $700 million backlog, continued growth in electrification, continued growth in size and continuing growth in diversification around the globe. And as I mentioned, we'll have an update to this backlog as we customarily do in a couple of months here. So in terms of financial outlook, this is the last outlook we had back on November 4, 2022. Sales of $5.75 billion to $5.85 billion. You can see our EBITDA range, adjusted free cash flow of approximately $300 million. And you can see also we continue to expect volatility inside of production schedules inside of the fourth quarter. If you listen to our third quarter earnings call, we articulated a fair amount of productivity or production volatility, especially in our full-size [truck] franchise that has continued here in the fourth quarter where we are still continuing to experience a high level of volatility on production schedules from customers, many, of course, as we've mentioned, other suppliers have mentioned with last-minute notification. So it makes a little choppy to deal with. We'll continue to push through that. This is our current outlook, but just to let you know, we continue to experience a high level of volatility in terms of production. So as it relates to our balance sheet, this is our debt maturity profile. You can see we're in really good shape, average life greater than 4 years. Next up on deck in terms of refinancing and dealing with and continuing to pay down as a term loan B that is in 2024. But for the balance of this, you can see we're in really good shape from a debt maturity standpoint. And as I mentioned, life greater than average of 4 years. And then from a sustainability topic, you can see here on the slides, various different targets that we've laid out here through the course of 2022 with our sustainability report that we published earlier in the year. These are new targets have been refreshed as we accomplished many of our key objectives that we set forth back into 2018, 2019 time frame and really increase our level of intensity in terms of target achievement here. I would recommend you to take a go look at our sustainability report. I think you'll really like what you see in terms of that report. If you have any questions and then I am certainly happy to take those as well. And this is a nice tie in really to our next topic from sustainability, transforming now the business on a go-forward basis into our electrification product technology. So we'll spend the next few slides here talking about how we go to market for our electrification, where our product stands, where that growth continues to find traction and then kind of sum it up here at the end and then open it up to Q&A. So on this slide, what do we think about in terms of our electrification? We certainly have an advanced technology platform, a global footprint to support key customers around the globe and really focus to go-to-market approach. And by that, I mean we support components to OEMs. We support full drive units to OEMs, and we have an expanding market segment, meaning in terms of the product segments we support into are expanding because of our technology and our products in electrification. And I'll show you what I mean on that in a couple of slides. But to start with, you can see our electrification global footprint really sourced around the world from an R&D perspective, from a production standpoint, and that's why we're starting to win these awards to support Volvo, ICA, others that we've mentioned here in the past. So we're in a good spot from that standpoint to support our customers and where the growth is in the market. Where does that translate into some of the key electrification wins, some of them I just mentioned. If you go back over the last couple of years that we've launched, certainly on the Jaguar I-PACE, which was our first large volume electrification drive units that we put in the space. We continue to support in the China market with Baojun, our AMG high-performance vehicle that we launched here this year in terms of announcements. We did that in our second quarter earnings call. We talked about the Pinnacle mobility, continue to advance in the China market with our partnership with Innovance. We serve multiple different OEM platforms from that standpoint and then really focus on our next generation of e-drive. And that's really going to be featured on the reproduct that will be out in the market by 2024, but that is really allowing us a platform to continue to grow our electrification business, has a lot of interest from customers, and that is also one of the ones that won that I-PACE award that I mentioned previously. And then from a drive component standpoint, many different customers, many different regions around the world really starting to leverage the core skill set of the company and our vertical integration approach as well. So what does this mean from a content per vehicle opportunity? This is a question, quite frankly, we get very often. The concern, of course, would be as electrification sets in. How does your content per vehicle start to transition with the transition of the automotive industry? And if you think about what I said, how do we go to market? We go from a component standpoint, which we believe is a strength of ours in terms of both vertical integration but also from customer mix as well as expertise and then full driving us to support if an OEM wants to do outsourcing of their drive units. So from a content per vehicle standpoint, from a component side, up to $500 on electrified vehicle, depending on the architecture. That's very similar to what we had experienced in our internal combustion engine platforms we support if we are a component supplier. On a full driveline, our drive unit application, our content per vehicle that we are experiencing now, and we're also in the quotation process in the future is over $2,500 per vehicle. Again, ultimately depends on the final architecture, but that's where the content range sits for our electrified product. How does that compare for internal combustion engine product. Our average internal combustion engine product, if we are the primary driveline supplier for it, all-wheel-drive crossover vehicle, for example, somewhere between $1,000 to $1,200. Our full-size truck franchise, which you know us very well for where we're supplying rear axles and front axles for full-size pickup trucks, midsize pickup trucks, full-size SUVs, that's somewhere in the $1,500 to $1,600 range. So you can see here, as the industry is pivoting towards electrification, -- our content per vehicle opportunity is very similar from a component standpoint. And if we are the primary driveline supplier for that electric vehicle significantly higher. So opportunity sits right in front of us in terms of revenue growth from this segment of the industry. On the next slide, this is also, I think, maybe an underappreciated element of our electrification pivot. And to be frank, this is one of my favorite slides. If you think about the core of AAM, we support crossover vehicles today and full-size trucks and full-size SUVs and midsized trucks and midsize SUVs in our core internal combustion business. So if you look at all the different product segments sort of on the bottom half of that slide, we support sort of the 2 in the middle, crossover vehicles and pickups. With our growth in pivot to electrification, our drive units now are starting to be featured on many different vehicle segments. We talked about the P3 application for AMG Mercedes, which is now on the P3 hybrid architecture, which is in the upper right. We talk about the Baojun E300 that we now supply in terms of China, sort of that micro car, if you will, in the middle. Our expansion with Re and their growth is into "skateboard" type designs that you see on the upper right. And we're now seeing -- and our Intavance electric drive units move into more passenger cars and crossover vehicles in the front-wheel-drive space that we would not have really participated in, in our internal combustion engine franchise. So this is a very powerful and compelling approach that we think will allow us to continue to grow not only in the content per vehicle, but expand the segment for which our primary driveline products will supply in the industry of the future. So if you bring it all together from an electrification standpoint, you can read all the different words on the slide, but really 2 items I would point out to our go-to-market approach to support OEMs, whether they want to build the drive units in-house. We are a key component supplier for that value chain. Should they choose to have the drive units built outside of their franchise into the supply base, our technology and our strengths in our global footprint, our technology and our ability to deliver, I think, will carry the day and allow us to continue to conquest in that space. And then our next generation of drive units that I shared with you will continue to allow us to gain customer interest will continue to allow us to expand and serve markets and continue to grow the business over the next many decades to come. All right. So wrapping it all up before we get over to Q&A. Hopefully, you have a little bit better appreciation for American Axle now than you did when we started this. And of course, any questions on your mind, we'll be happy to take -- but from a big picture standpoint, very focused on generating strong free cash flow, a conversion of EBITDA into cash flow, managing CapEx, managing interest, managing taxes and tightly managing working capital. It's allowing us to have a superior cash flow delivery as a company. Our expectation is that will continue. We want to continue to focus on strengthening the balance sheet. We continue to pay gross debt down each and every quarter. Importantly, for the foundation element of the company for the next 10 to 20 years is continuing to secure our traditional business. We announced earlier in the year of 2020, we secured our basically next-generation awards for our full-size truck franchise, that added over $10 billion of revenues well past 2030. So that's a key foundational piece for us as we advanced our electrification product portfolio that I shared with you. And of course, at the end of the day, position us for profitable growth as a company. So with that, Doug, maybe that concludes my prepared remarks. I'll turn it over to you if you have any questions or any from the audience, happy to take.

If you can just maybe share with us pre some raw materials that you've seen over the last year or 2 and the discussions we've had with OEM partners had a passing of those costs I think necessarily big topic.

Okay. Yes, the question asked for was related to increased costs that we are experiencing from our supply base and how we deal with that as a Tier 1 supplier. So in terms of elements of costs that are associated with -- we really face this in 2 elements. The first element is we have under contract and have for an extended period of time, meaning in many, many years, is there are industry-related input costs to the products we secure. So for example, we buy a lot of steel. A key component of steel is scrap cost. That's how this deal is made, nickel, moly, things of these natures. We have back-to-back arrangements for changes in those commodity costs with our customers. So we'll pass on cost increases or cost decreases as those change every 30, 60, 90 days from our supply base up into our customer. I would tell you earlier this year as inflation was starting to ramp it up on those commodity costs, we were approaching almost $0.5 billion of elements that we were passing through since really the 2020 time frame associated with these type of costs, we hold as a residual somewhere between 10% to 20% of that cost. Those have a moderated sum. But again, under contract, we do change pricing every 30, 60, 90 days, designed to protect the company and it's doing exactly what it's intended to do. The second element of that is, as everybody is facing inflation in terms of core base pricing that we pay to our supply base as they face raw material increases as they face labor cost increases, utility cost increases -- we've been in negotiations with our supply base through the course of 2022 to accommodate some of that and then in having back-to-back negotiations with our customers to recover some of these costs. Net for the full year, our expectation of raw material increases, utility and freight net of customer recoveries will impact us about $60 million. We're on track to achieve that through the course of 2022. We do disclose these in our quarterly year-over-year bridges and walks. But that isn't ultimately, at the end of the day, this is a negotiation with the supply base and then a second negotiation with the customers then generally been receptive through the course of the past year to pay for some, but not all of these type of costs. And I would expect as long as we continue to face inflationary environments for those elements, we'll continue to have those dialogues with our customers and supply base. So hopefully, that answers the question.

Question [indiscernible] so we are intelligence asset. We inquiet we had about $1.4 million our inventory, that number has been about $3.5 million units reconized through COVID -- the idea is the demand is the quarter right at looks like. We've seen an increase startup. I think we're seeing a inventory your discussions with orders, how do you feel about that [indiscernible].

Yes, certainly. The question relates to inventory builds at the OEMs and what is sort of our view, I think, on how that progresses over the near term to midterm. Our view has been and has been since really the beginning of here, we were certainly well under inventory levels associated with the key products we supply. Throughout the course of 2022, you have seen some inventory builds. But our predominant view is there is still continued very strong demand, at least for the vehicles that we supply into and think about full-size truck franchises, whether it be with General Motors, Ford, Stalantis, otherwise as well as some of our key crossover vehicle platforms where some of those vehicles were depleted significantly through 2021 in the semiconductor impact. You've seen some of that rebuild. We believe there will be continued strength from the end consumer to demand these type of vehicles. We do see the OEMs taking maybe cautious or moderation approach in terms of how much inventory they keep in the field. But we believe demand will ultimately continue to support production and there's probably a little ways to go yet in terms of inventory rebuild in the near term. So that will also help, at least from a supply base level of production. We don't see it getting back to sort of the pre COVID days in terms of inventory carries out where they were, call it, 100-plus days that appears to be off the table at this point.

And then I'll get one balancing question in -- on the balance sheet side, I think you've got your net leverage throughout the Q3, maybe you take that leverage down -- where are you in the kind of long-term target on that? What do you expect.

Yes, certainly, the leverage number that you articulated, Doug, is obviously, it's an output of net debt divided by our last 12 months of EBITDA. We continue to be very focused on our balance sheet from a debt management standpoint. We continue to pay down our gross debt each and every quarter. We have over $100 million. We've already paid down this year in 2022 alone, well over $1 billion since the acquisition of MPG in 2017 when we took on additional leverage. I would expect us to continue to try to work down our gross debt. Our long-term or maybe I should say, near to midterm target for net debt leverage, the key to try to get in towards that 2x. We have not articulated a time frame for when we would achieve that. Our focus is to continue to generate cash flow, continue to strengthen the balance sheet from a gross debt reduction standpoint and then obviously drive EBITDA to improve our leverage ratio. -- perception. So that's how I would articulate that. But we're on track. We continue -- that's a key piece of our capital allocation strategy and approach, and I think we continue to put our money where our mouth is on that one.

[indiscernible].

Yes. So the question is, how would a potential recession impact our business? Clearly, we're a Tier 1 automotive supplier. Our top line is driven by volume. So to the extent that volume was impacted, our sales will be reduced. I would give you 2 perspectives from that standpoint. In terms of "recession"we've been operating at near recessionary production levels for the last 3 years. Demand continues to be robust for the vehicles we support. But also at the end of the day, the vehicles in the field continue to decay in a road over time, miles-driven increases. So my first case would be if you saw a slight slowdown in potentially from a recessionary standpoint, we may be still be operating at very similar production levels because we are at quite near recessionary levels. Second, I would tell you is we have a standard playbook. We have published this through the past several years out in several of our investor relations materials of how we deal with recessionary environments, the triggers that we would go through to reduce cost, continue to protect cash flow of the company, and we would begin just to continue to execute that [tapered] playbook if it was necessary. This is the team that did this in 2009, did it in 2020, 2019, 2021. It's the same team here together, we'll continue to work through that. I don't know if that answers your question. from an electrification standpoint. Yes, so we've seen some, I would say, nontraditional driveline competitors into that space, Bosch, Conti, or Warner has a little bit to that extent, have certainly moved into the drive unit space. But what you have seen the OEMs do, at least from our perspective, is the engineering know-how, the quality know-how, the delivery know-how of a driveline supplier, handling heat management and motor handling NVH of a vehicle. It's a skill set. It's not something you can just sort of wake up tomorrow and do. So you're seeing the driveline historically oriented suppliers sort of win the business in that space, maybe coupling up and partnering with some of these others, but that's where we believe we'll continue to carry strength as we go forward on that. But yes, we are seeing some other competitors in that space.

And then if you're [indiscernible].

Yes. I mean the takeaway would be our -- in terms of the leverage ratio, it's an output, it's a mathematical equation, right? And if you look at -- I think of the previous question that I answered, I said, look, we've been operating at near recessionary levels in terms of volume of production that translates into lower EBITDA over the last couple of years. So continuing to generate cash flow, we'll continue to chip away the gross debt. Once the levels of production, you pick the year, when they come back up to meet ultimately demand, you're going to see that ratio move very quick. So it's a little longer view of your question, but it's the principles to see.

Sorry, just a follow-up on the question I had before they took the mic away. What do you expect to see like AUTOSAR over the next few years, 23, 24 and 25, when you're having your internal discussions? Yes. We have not provided any public guidance that we would issue in the early part of next year. So at this point, I'm going to point on that, other than some of the key ingredients of continuing demand for the vehicles we support, continuing to run at these recessionary levels at some point, vehicles do need to be replenished over time, And you're going to need to put back up and sell those vehicles. On your CPV slide, a similar question to one of the previous gentleman that I asked. If you commented from the CPV standpoint, right, you mentioned $1,500 to $1,600 CPV on a fully loaded large pickup truck.

Correct.

So if you can give us a flavor of that compared to, let's say, $2,500 on a fully loaded electric vehicle or some sort of large electric vehicle. What percentage or in dollar terms of that content, you guys make yourself or anticipate to make yourself versus how much you will be procured from others?

Yes, it will certainly depend because we -- it would vary on an electrified vehicle today, for example, and some of the product -- if you think about the main elements you have sort of design, assembly, gearboxes, components, a motor and an inverter, right? If you have a full 3-in-1 electric system. Obviously, we do design, we do the assembly. We do all the gearbox. We do all the components. It's a mix on inverter and motors right now. Our Gen 5 applications now that we're starting to support for REIT, we're starting to build some of those motors in-house. -- some we procure. Some of the OEM is directing to use certain motors in certain inverters. So it's a directed buy component. So it varies by customer and it varies by product. I would tell you on our traditional products and people seem to -- this is not a fact we talk a lot about, but some of our core products, especially the big trucks, have very, very expensive brakes associated with it that we don't build that the OEM direct buys for us to put onto our components. So there is a similar type of dynamic going on in traditional, not as big, but it is similar. I don't know if that answered your question.

How much does the motor [indiscernible].

It varies. We don't break down our bomb cost here public. Look, one of some of the larger components are motor inverter, but the cost inputs for the rest of the components are still very expensive. You're talking aluminum gearing and engineering, designing, assembly, all the capital required to do that is -- it can be expensive. So that carries a fair share of that load as well.

With that, we've been [indiscernible] what are the cost.

Yes, sure. Yes, in terms of why do others estimate production holistically and SAR sales rates differently and why are they level? I think at some level, it is the obvious. It is the impact that rates potentially could have, the impact potentially if you're entering into a recession. I think these are taken into consideration. They probably think a little bit about supply chain bottlenecks and is that going to continue to hamper production for a while. So I think these inputs are what weighs on their minds when they do their own investments of production. That would be my speculation. As it relates to, I think, production and volatility, we receive inbound notification from our customers, and it's not just one, it's almost all of our customers around the globe, by the way, in terms of this type of input. At times, they share with us in great detail what the reasoning is, sometimes it's semiconductors. Sometimes they will simply articulate they have another supply chain challenge or a logistical challenge, and they will go down for a period of time. And then there's other reasons, most recently now that they've just been silent builds that say, "Hey, look, we're going down for the next 4 days, no reason given. We could speculate it's a supply chain issue of some sort. But again, they don't articulate that to us each and every time. Clearly, last year, it was very semiconductor-oriented. We saw more now supply chain, semiconductors and other orientated type of volatility.

[indiscernible]

No. What we experienced, the proportionate share of -- especially in full-size trucks to production levels continues to be very resilient through peaks and troughs through different various levels of gas prices through different economic cycles. These demands -- these pickup trucks clearly are driving demand through work-oriented type applications, but there's also a very strong interest in this type of vehicle from many different people that buy these. And the ability to substitute this with something else doesn't seem to be an interest of many of the consumers that buy these.

Thank you very much for the Q&A. Great job.

Thank you, Doug. Thank you, everyone.