Dauch Corporation (DCH) Earnings Call Transcript & Summary

All right. Hello, everybody. Thank you so much for joining us for this session with American Axle as part of Deutsche Bank's Global Automotive Conference. My name is Emmanuel Rosner, and I'm the lead U.S. Autos and Auto Technology analyst here at Deutsche Bank. I'm extremely pleased to be joined by Chris May, who is the CFO and Vice President of the company. American Axle is a leading supplier of driveline, metal forming, powertrain casting technology for the automotive, commercial and industrial markets. American Axle has also been ramping up its electric powertrain business with several initial production contracts and a few important partnerships. So very excited to talk about all these topics. Today, the format for this session will be a fireside chat around some of my prepared questions. [Operator Instructions]. So with that, Chris, thanks again.

Well, thank you, Emmanuel. I appreciate that. Certainly, it's a great conference yourself in Deutsche Bank, but it's a wonderful event. I appreciate coming here every year. Thanks.

So yes, maybe to kick things off. Do you want to talk to us a little bit about how things are playing out so far for American Axle? Second quarter, and how do you feel about the rest of the year?

Yes, certainly. And before we begin all our remarks, I would remind everybody to check out our website for all our FD disclosures. You can see that at www.aam.com for matters that we're going to talk about here today. So yes, why don't we transition a little bit? Maybe I'll just give a couple of opening remarks holistically on the business. I know second quarter is on the mind of many, but also our electrification business and how we are doing from that perspective. If you think about we started the year really at an exciting event at our Technology Day out at CES, we talked about our framework and how we are going to continue to grow our business, pivot into electrification, rewind -- fast forward that clock now 90 days later to our first quarter earnings call. We had some really significant announcements that we spoke about on that call, one, and probably the biggest one was our Stellantis e-Beam win. That is a significant contract for the company. We'll talk -- I'm assuming -- we'll talk a little bit more about that as the Q&A goes along. But we also continue to advance our electrification globally. We announced another e-Beam win in the India market with Jupiter. We also announced wins on another SUV program associated with our components. And we face off to the electrification market, both on beam axles, drive units as well as components. And we'll talk a little bit more about that as it goes along. And then, of course, it's a very active bidding process. But as it relates to specifically maybe a business update for the second quarter and full year, obviously, we provided our guidance back in May, where we continue to -- we have not updated that guidance at this point. But where we continue to see the second quarter a little bit of the themes of what we saw in the first quarter. In the first quarter, I'll remind you, we experienced a high level of volatility as a company from a production standpoint. We saw a lot of down weeks from our customers, multiple customers, not just one. As we moved into the second quarter, I would say those down weeks started to reduce. So we saw less full down weeks though still occurring. We had, for example, some of our largest customers were down near the end of May. But what we started to see was a continuation of a reduction of schedules sort of at the higher end or trimmed down a little bit. So we saw maybe cancellation of over time from our customers or maybe they reduced the shift versus the full down weeks that we experienced in the first quarter. So what does that mean? That means continuing some reduction in sales, so not at the volatility impact level that we experienced in the first quarter with full down weeks. In addition, in the first quarter, we experienced a lot of launch expense and inefficiencies in particular tiding with labor availability. We expected that to continue into the second quarter. We articulated that. What I would tell you, we continue to experience the launch expense that we are incurring as we're launching some big programs here in 2023. And the inefficiencies associated with labor availability continue to impact our operations, probably a little higher than we would have anticipated stepping into the quarter, but that continues to challenge us, but we continue to work through that. We are optimistic, we will continue to bed these issues down and see improvement in the back half of the year on both launch expense as well as some of the inefficiencies associated with labor availability. So I think that sort of frames where we sit for the second quarter.

Yes, absolutely. So I guess on the forward-looking view, I think you previously indicated that the low end of your full year view, our guidance was predicated on major volumes aligned with IHS at like down 2% or so. So implying really that sort of like the mid or high end of your outlook is probably a bit better than that. I guess what gives you confidence that volume could shake out better than that? Is it based on your customer schedules? And then given that some of these truck inventories among the Detroit 3 running, I guess, closer to the new normal stock levels. Do you see any risk of proactive downtime for that?

Yes. So I think the 2 data points that we have provided inside of our guidance as it relates to volume was certainly the North America production at a macro level. We're at 14.5% to 15%. You see that is about the higher end of that is where S&P Global sits right now. But you see that sort of continuing to soften just a little bit through the course of the year from S&P Global although not significant. The other element was associated with the General Motors full-size truck platform, where we said our guidance was predicated on the low end of our guidance was essentially flat year-over-year for production builds on the full-size truck applications, the higher end of our guidance would be a 5% to 10% increase year-over-year on those builds. But I think a little bit of your question, Emmanuel, dives into the sub elements and the days on hand we're seeing in the field and the production cadence from our customers. And if you take that full-size truck program from General Motors, you really see -- you really have to break it down into 3 elements. There's the light duty, the heavy-duty and the SUV application, which collectively make up the General Motors T1 platform. And we're seeing different dynamics play out on these 3 subsegments. So let's start with the light duty applications. So obviously, those have grown inventories in the field that are a reasonable healthy level now, if I believe, from General Motors, they would tell you that, at least that's what they've publicly articulated. It's also where you see them taking downtime in the first and second quarter kind of from our view, tightly managing these inventories to market demand. We continue to see very strong demand on the HD platform, which is the heavy-duty truck and low inventories in the field and very low inventories in the field on the SUV application, which is also in very high demand. So we see production very strong on that platform. So you really have to take the 3 or the platform, break it down into 3 and then the risks associated with that going forward to the tail end of your question, I think they'll continue to closely monitor the light-duty application for that truck. The heavy duty and the SUV continue to still be in very robust demand with low inventories in the field. And they'll obviously take, I think, our view, they'll continue to take very sound proactive management tools to manage those inventories properly in the field.

You spoke a little bit about the rest of the year, but what are you seeing with respect to your important U.S. launches this year? How should we be thinking about the associated launch cost progression throughout the year?

Yes. Our single largest launch that we have this year, and it's a big launch year for us holistically. But we are on the all-new Colorado Canyon GM midsize pickup truck, which was launched effectively in the first quarter, is gaining volume and scale back end the first quarter into the second quarter. So a lot of our launch expense and the normal extra cost, if you will, or inefficiencies to get those up and running at full scale we've experienced in the first quarter. And as I mentioned in some of my opening remarks, we continue to experience that here in the second quarter. And that should level off once it reaches capacity and build run rates with our customer and those costs should start to taper off in the back half of the year.

Let me ask you the potential risk of disruption from UAW negotiations. What have you learned from the 2019 playbook, I guess? And how would you go about it if there were to be some disruption?

Yes. Certainly, that risk exists. It's something we are closely watching. I'm assuming everybody that's listening is also closely watching, but we also don't know how it will manifest itself. So we were impacted in 2019 when our largest customer had a work stoppage through the negotiations. It was almost -- I think it was 5 or 6 weeks of down across the North America operations for that entity, and it impacted us significantly, and you can see those amounts we disclosed back in 2019 for those impacts. But what we knew going into that and what we learned going into that was you need to pay close attention and speed and reaction matters to these events. And our flexible operating system, I believe, gives us the tools to do that because we don't know what's going to happen in the back half of the year. We do not know how these negotiations will work their way through or which OEM may or may not be impacted. So -- but the key lesson is to be flexible and to be quick and react with speed. And I think our operating system is designed to do that. We learned those lessons in 2019. We've learned those lessons through a variety of events over the last 10 to 20 years. And that's the recipe to be successful to mitigate any negative impacts associated.

What kind of visibility do you have into the expected commodity and other input costs over the balance of the year? And how have customer recovery conversation has been doing?

Yes. Let's talk about maybe the cost piece first, and then we can talk to the customer recovery. If you think about maybe the main cost drivers that we have experienced over the last, call it, 12 to 18 months. In particular, the spirit of your question is as it relates to, I think, inflationary and increased pressures. On the purchase component side, there's really 2 tails. One and is a very significant one is the index-based costs that we receive from our supply base that we pass along into our customers. That continues to go up and down. It protects the company, our contractual arrangements, both with the supply base and our customers. It was coming down, I would say, meaningfully in the back half of 2022, though through the course of 2023 now, we have started to see these indexes start to increase in their costs, and they reset every 30, 60, 90 days. So visibility, it's a market-based commodity that gets purchased. It's scrap steel, it's aluminum, it's nickel. We try to just assume flat for the rest of the year, and we have these mechanisms that protect us from either direction that it goes, but they are trending up recently. As it relates to purchased elements from our supply base, we had net inflation last year. We disclosed a $60 million net of customer recoveries last year or purchased component increases, utilities and freight. And if you think about those 3 elements here in 2023, we continue to have pressure from our supply base for price increases as they are facing labor cost increases, inflationary pressures on their business, and we're actively negotiating with them. Obviously, we'll have another conversation after that as we actively negotiate with our customers for those increases that we're experiencing. But those pressures continue here in '23. Utilities have abated some. You saw the record highs, if you will, in the, call it, second and third quarter of last year. They had come down. We have benefited some from that, but also our pass-throughs to customers associated with that have come down as well. So while we benefited some, not in its entirety for the utility change. And then freight has begun to ease some. So we're seeing some slight benefits from that. So that's sort of the cost piece, hopefully, it answers your question. As it relates to our negotiations with our customers, this is a key priority for the company here this year. We've been in very active dialogue with our customers. A similar timing cadence that we saw last year in 2022, where our cost through pass-throughs to our supply base, inflationary costs. We then went into active discussions with our customers sort of in the second and third quarters of last year, realized then arrangements and contractual updates at that point. We see that same timing play out here in 2023. So we're very active with our customers. I would see this as sort of a second, third and fourth quarter type of an event for us to bring closure with our customers. So we still have some work to do on that, and it is a meaningful assumption inside of our guidance.

Meaningful assumptions for?

To negate some of these cost increases through customer recovery.

Okay. Perfect. And so I guess, as you look at the balance of this inflationary pressure in the second quarter for the rest of the year, do you feel that you're largely derisked for the year, or is most of it still needs to be achieved?

I think from a -- the ones that are variable, obviously, we have protection for contractually. I think we have a reasonable line of sight to where our inflationary pressures are coming from our supply base as well as our labor costs. We've experienced a lot inside of the labor cost element from an inflationary standpoint that seems to be leveling out, though still elevated. There's work to do yet, as I mentioned, on our customer recovery piece in the back half of the year. That's how I would think about your question.

And what are you seeing in terms of labor availability in particular? It seems like there's obviously been pretty big issue? Should we expect this to improve, or is this not your base assumption?

Well, it certainly was a very large issue in 2022, and we've taken a lot of actions through the course of last year to mitigate some of this. And we've seen some positive elements to that, but we still have -- this is more of the United States dynamic, by the way. We continue to see in select sites here inside the U.S., in particular, in some of our smaller locations where the struggle to get and retain labor has been a challenge. There's a cost element to it, and there's also a skill set element to it. And that continues to be a very active issue that we manage as a company, but it is manifesting itself through inefficiencies and some premium costs for that sort. But as we continue to sort of get each facility kind of where it needs to be, put those efforts around those, the issue starts to mitigate itself a little bit. So it's going to still take us some time here this year. We're hopeful that by the end of this year, we get most of this behind us, but it is probably -- if our CEO is here right now, he would tell you this is his #1 concern for the company is to deal with labor availability, both from availability, from a skill set, from a cost perspective. And some we are very actively managing.

Focusing on your Tech 4 acquisition, I think it was supposed to be initially contributing about $150 million to $200 million in sales for the year. I think you delivered $100 million in the first quarter alone. Is this a fair run rate? Or were there some onetime benefits we should be accounting for?

Yes. So the year-over-year step-up that you referred to is for the full year. And keep in mind, we acquired that acquisition back in June of last year. So you will see the first quarter and 2/3 of the second quarter will have a disproportionate year-over-year benefit on revenue and profitability associated with that, and then you're into run rate from there. So you'll see again that happen in the second quarter, and then it should be you're at run rate as a company.

So can you remind us of the expected margin profile of the business?

So we purchased this business back in June of last year, we articulated our purchase price of close to about $100 million. It was about 3x synergized EBITDA, which implies sort of the low double-digit margin perspective from this new incremental business coming on once we hit synergies. And we're on track for delivering those. And as we said, it'd be 18 to 24 months from the date of acquisition to get full run rate of synergies, and we're about a year into it.

And I guess, if we get over the next year-or-so some element of volume recovery in various markets, what would be the contribution margin we could expect relative to historical average?

Yes. No. Our historical average from a change in volume or our variable profit is anywhere from 25% to 35%. It depends a little bit on the mix of product. So generally, if we're doing a blended average, we say 25% to 30%. And I think that's one of the great elements of our operating system, gives us great leverage associated with volume increases. And I would expect just on pure volume alone that we will realize those contribution margins of, call it, 25% to 30% on incremental volume. Do you know the rest of the business you got to take a look at, whether it's R&D spend or if you have a couple of inflation elements you need to deal with. Obviously, those are outside of that scope. And on pure volume, yes, we should realize 25% to 30% contribution margins.

And I guess as we look ahead beyond this year is what are some of the midterm targets you're aiming at the company? What are the drivers to get you there?

For 2023?

No, I guess beyond 2023. How do we think about this -- the business growth and margins beyond 2023?

Sure. Look, I think volume, obviously, is a key element to this, and I just articulated our variable profit we can deliver to drive volume growth, will drive sales growth and margin growth in isolation. This year and probably some of next year, we'll continue to spend robustly on our R&D spend. We've been run rate near that $35 million to $40 million a quarter as we build out our electrification product portfolio. You're seeing us win business there. But that then should start to taper off as our full platform is developed around the globe. So you'll see some pickup from that perspective on lower R&D. And then I think in terms of some of these inflationary costs that we've experienced in '22 and in 2023, especially as it relates to labor, those are very sticky costs. And the speed of onset was quick and the slope in inflation in labor was steep. Our productivity system through time has been designed to offset these type of inflationary elements, but not at that speed of onset. So you're seeing our productivity system start to gain hold and traction as we move on automation, as we move on our core basics of productivity. Through the next couple of years, it will get back some of that inflationary cost or should get back some of that and mitigate inflation going forward. So we're looking forward to those elements as well. That's how I mean kind of the basics of the business, that's how I see that playing out.

Perfect. Shifting gears a bit and focusing on electrification, so you announced last quarter that you secured major e-Beam Axle win with Stellantis. I was curious if you could provide some detail on the expected volume and content opportunity there? What is it that you provide that enabled you to essentially win this award and outbid I guess, your competitors for it?

Sure. Yes. This is a really exciting announcement for the company back in our last earnings call. Unfortunately, there's not a lot of the program details we can provide. As you know, it's with Stellantis and its front and rear beam Axles or e-Beam Axles. It is a -- just in terms of context, it's a significant win for us, both in terms of platform and revenue dollars in content per vehicle. So and it will launch in the back half of the decade. So exciting win for us. But you're asking why did we win this? What allowed us to be successful with the significant award? If you think about what this is, this is a front and rear e-Beam Axle. And if you think about the heritage of the company, what we're built around is traditional internal combustion engine beam axles, supports a lot of different programs that we're on. So that skill set, that knowledge base, the scale the cost optimization on all the components associated with this type of a platform is right in our wheelhouse. And our engineering team did a spectacular job working with the customer to give them a product that they needed for this vehicle, and holistically, the team brought us to a great cost proposition for the customer. So all that together, this is right inside of that sweet spot. I talked about in my opening remarks, we launched the year out at CES and we talked about our served market. And there was this really unique niche inside of our served market, which was the beam axle space in electrification, which is really our core bread and butter. We think we have an advantage inside of that space, and it's starting to play out. This win is one of those examples.

Have you quantified the content per vehicle opportunity on this?

So we've quantified content per vehicle for electrification holistically. If we're just a component supplier, it's up to about $500 per vehicle, which is equivalent to where we sit for an internal combustion engine. If we are the primary driveline application, we have articulated that we can be up to $2,500 plus on content per vehicle. On a comparable ICE vehicle, we're about $1,600 of growth. I would tell you, this win is significantly higher. So you'll hear us easily with over $2,500 plus, plus. So it's a significant content per vehicle for us.

Because there's a whole system?

The whole system, it's a front end, it's a rear and it's significant.

Okay. Now do you see this award as serving as a building block for expanded or new award opportunity either with -- obviously with Stellantis potentially or with others? Like is it sort of like standardized enough that this can actually be helpful to win other one?

Absolutely. There are standardized elements of this that we can apply to our overall platform. At the end of the day, each driveline system is a little unique for each vehicle. But absolutely, this is something others have taken notice that we've won this. It shows and demonstrates our engineering prowess. It shows our competitiveness as a company. And our experience on past awards is when we win awards, obviously, we gained some buzz around the announcements others take notice. They say, "Hey, these guys are in this space, let's go talk to them." They won this one manifest itself into new awards. And of course, once it gets into production and on the road, I mean that's really when it will shine and we'll continue to gain even more interest from others. That would be our expectation.

I think you've given a number of $1.8 billion in lifetime EV revenue book to date. Does that include this Stellantis award as well?

That does not include.

Does not, okay. And it looks like at least when it was given it was 50% of that was from Europe. Is this more like a timing impact or opportunities impact? How do you expect the mix to play out by region?

Yes. And -- so we disclosed this earlier in the year. And if you think about our journey on our pivot to electrification, we've been winning components, I would say, globally, North America, Asia and in Europe. Our drive units that we have won have been with Jaguar, which is in Europe, AMG. As you know, I think we talked about last year, we announced at this conference that platform.

I was hoping it would be part of one of the...

I was hoping I drove it here. But -- so another European obviously based. So we've seen some initial wins on that space in that region for our drive units. But now since we've -- that time, we've also added wins in China through our partnership with Inovance. We have the Stellantis win, which will be more spreaded evenly across different regions. So it's just more of a timing thing. I think you'll start to see it form more weighted towards our traditional structure as a company in terms of where some of our core products will be fitted.

And I guess 1 more question around this EV award process. Insourcing versus outsourcing. You see the pattern in EV being fairly similar to what will happen on the combustion engine side? Or are there any differences where automakers specifically would like to be in-sourcing more or less?

Yes. Certainly, this is one of the great debates and discussion points we have. I mean our operating assumption, and it was part of our served market analysis that we released earlier this year, is there will be a significant amount of production done by the OEMs, and there will also be a significant amount of production done on the outside by the supply base. We continue to face off to this market, we will supply into the customers' components for those that want to do it in-house, and we'll obviously provide drive units for those that look to outsource this. But in terms of timing, our view has been the initial wave most of the OEMs are doing a lot of this in-house as they gain scale, as they add platforms, as they widen the vehicles that these are on, they're going to reach to a very cost-competitive and very technical heavy supply base to supply a lot of these components. So that will continue to emerge through the balance of the decade in our view. But again, we assume this is going to happen, and that's playing right into how we go to market and strategy as well as our served market and our win rates, et cetera, inside of that space. But people also forget -- you asked also how does this tying with internal combustion engines. Almost every driveline system we provide today, our customers also do those in-house. General Motors does, Stellantis does. So we're -- and this is a dynamic we're very used to and participated in a meaningful way both internal combusting engines and will participate in a meaningful way of electrification.

I guess the longer-term goal is, I think, a 10% market share of the addressable market, $2 billion to $3 billion in revenues by 2030. What does the trajectory look like and then to get there? What are your EV sales today? And where do you see -- when do you see an inflection point being?

Yes. Our EV sales today would be low single digit as a percent of total revenues, and that's really just dependent on timing wise and when these programs are launching. We're winning a lot of component wins now that are starting to launch with some of these early vehicles. We already talked about some of the electric drive unit wins that we had when those will come online. For example, the big one with Stellantis will be back half of the decade. And if you think about our core product set that we play in, generally speaking, full-size truck applications, SUVs, heavy duty, light duty. A lot of these are converting more later in the decade from ICE to electrification than they are in the upfront. So you'll see our journey towards our conquest in our served market, it will be almost like a step function. So you're going to win these components. Those are launching now. Those will start to grow with the market. We'll pick up some electrification wins. And then as our bigger programs come on, you'll see step functions up into 2030 to get to that kind of quest for 10% of our served market. But it's really just a function of when these programs are out in the market.

And then building off of that, what will the margin trajectory look like for the EV business. It seems like much of the R&D is may be front-end loaded, certainly as a percentage of revenues. So when should we expect margins to hit sort of breakeven levels and beyond.

Yes. We have stated our goal as a company as we make this pivot to electrification is to continue to be a top-tier margin producer. But the journey each individual element, each new book of business that we win really goes through the same process on its margin life cycle. And the electrification is, especially on the drive unit side is no different. You'll have upfront R&D spend, some of which we spent now, some of which we'll continue to spend to build out platforms. Some will be unique to the particular win that we have. That will transition then into the launch phase. So you'll have these launch costs inefficiencies to get them up and run them at rate. They're starting to step into low volumes and then it will hit volume at scale. And as you go through this, you'll go from a cost spend to a lower margin to run rate margins and where you want the program to be and were awarded that. That profile, that -- those functions of that will -- are true for electrification. It's true for our ICE program too, they go through the same dynamic. And those are happening inside of our business with the launch of each win. So what's your answer, your best margins, of course, will be when you add volume, you're going to work your way towards that as the particular program steps its way through its life cycle.

And then ultimately, any reason for the margin profile to be different than your existing business or at some point it...

We have not provided specific margin targets other than say, our goal is to continue to be a top-tier margin producer inside of our space.

Got it. And I guess -- do you view yourself as a consolidator in the combustion engine market in this environment? Like will there be more capital deployed by you on the combustion engine side? Or at this point, it's really mostly about electrification?

Look, we see -- we have a very strong book on our internal combustion engine product, both from a driveline, but also from a metal forming, we're almost a $2 billion metal form producer. It's the largest automotive forger in the world, and there's a lot of interesting opportunities inside of that space. We acquired Tech 4 last year. We've acquired a couple of small ones in the years prior to that where we can really leverage our capacity, our steel buying power and a few other things that make quick returns, good strong financial sense inside of that space. If opportunities like that presented themselves, something we would absolutely continue to take a look at. As it relates to electrification, there's different technologies we would take a look at. But yes, we've seen small bolt-on elements we can do inside of our capital structure today, continue to pay down debt as well and still serve the various needs of our cash flow to those different elements. So I would expect something to happen, yes, we'll take a look at it.

And I guess that takes us to my final question, which is capital allocation. Can you talk to us about the time line you're reaching the 2x net debt to EBITDA targets? And then how are you thinking about capital allocation.

Yes. No, great question. Capital allocation, of course, is always top of our mind. Our focus now is to have a balanced capital allocation. As you know, we've been heavily prioritizing the reduction of our outstanding indebtedness. Since our MPG acquisition, we paid down over $1.3 billion of debt, and we've continued to pay down debt almost every quarter for the last couple of years. I expect us to continue to reduce our outstanding debt. We'll take some selective advantage of potential small bolt-on M&A like we just talked about and like you saw us do with Tech 4 if it presented itself, but in balance, right? We'll continue to strengthen the balance sheet. We'll continue to focus on pockets where we can grow our business and really leverage from a good strong financial perspective on consolidation.

Sounds good. We still have 2 minutes for questions in the room, if there are any. If you have raise your hand.

When you look at the business going forward and the electrification, e-drives, any reason to think that, that business would produce a higher return on capital than the existing business does today?

If we think about the capital expenditure associated with those electrification business elements, you break it into 2, meaning the component side and the drive unit side. So the component side, in many cases, we can leverage a lot of our existing capital base that's already installed. So you can continue to generate a strong return on those capital elements. Inside of the drive unit space, we go through when we have a bidding process we have financial hurdles we need to maintain cost of capital is a key piece of that, return on capital is a key piece of that. I would expect us to continue to have strong returns there and also leverage a lot of the capital that we already have installed today, especially that's one of the strengths we have on the e-Beam Axles. We do all beaming architecture today for internal combustion engines. We can leverage a lot of that type of stuff as it transitions and pivots into an electrified world. So we are trying to leverage through the maximum amount we can. Our installed capacity, our installed capital to achieve the right return on capital through the pivot in the industry.

Any other. So we're crystal clear.

Great. Thank you, everyone. Appreciate Emmanuel.

Thank you for giving us update on Axle. Thank you.

Thank you.