Dauch Corporation (DCH) Earnings Call Transcript & Summary

All right. Let's move on. Representing American Axle, we got Chris May, Chief Financial Officer; and David Lim, Head of Investor Relations. Gentlemen, thank you for joining us. Good morning.

Morning.

Good morning.

So I had a few clients earlier today saying, "Hey, when you're up there with Axle, please have the comment on some of the volatility around GM production schedules in the market and how that might impact on the quarter. So maybe we can meet start off with that and then we'll go on to the other topic, we will go on to the aperture after that.

Sounds good. Thank you, Adam. Thank you, Morgan Stanley for hosting this event. It's always a wonderful event to come out here and discuss key topics of the day. Before we talk about our remarks, I do alert everybody to look at our forward-looking statements. You can find them on our website and all our IR materials -- it's good reading. It's great reading and now I just made General Counsel happy, so I'm good to go.

They have really low handicaps -- good golfers.

Yes, they do. Look, we came out of second quarter. We had a decent quarter for the company. We had a really strong cash flow delivery, looking towards the back half of the year, kind of -- we saw some positive momentum on lower volatility in the second quarter. Thought process was stepping into the back half, we would see continued improvement in volatility. What I will tell you, sort of from a trend perspective inside of the third quarter, to your question, Adam, is we've actually seen an elevated level of volatility with some of our customers, in particular, General Motors. And some of the key plants that we supply into, we've seen 2 to 3x the amount of downtime this quarter than we did in the second quarter of this year. And it was sort of a little bit widespread. They hit some of the light vehicle trucks and light-duty truck plants. We've seen some other plants they've also articulated in some of their press releases. So -- there's been a fair amount. And of course, that impacts us negatively from a revenue perspective. Inefficiencies have caused probably a little greater than we've seen here inside of the second quarter and it really starts to constrain a little bit of our production. So we absolutely have experienced that inside of here of the third quarter.

So are you able to say how many days lost.

We have not articulated -- I mean, obviously, we still got a little bit yet to go here inside of the quarter. But just trying to calibrate towards some of the specific plants we ship to, as I mentioned, sometimes in some cases, 2 to 3x the number of days that we experienced in the second quarter. We've not -- we didn't articulate in the second quarter, how many downtime days we've had at each respective plants. But it's been a fair amount here.

And some rules of thumb again, to remind people, and we can do it off-line as well. How much per day, how much per week -- the exposure to General Motors.

Well, I mean our exposure to GM is about 40% of our revenues, Stellantis is 20%, Ford a little over 10% and it's not wide based. I mean it is a specific plants. You have to sort of bifurcate out.

But the plants affected were -- how are they -- would they be representative or SKU.

Well, it was mostly -- some of the -- the plants, of course, that impact us are their truck plants. You can see their production per day at some of these plants. And as you know, we have high content anywhere, $1500, $1600, $1700 per vehicle lost in some of these plants.

So you're going to lose something there, right? And so tell me what -- how do you then gain it back? Or what -- from your experience with that level of disruption that you're witnessing right now, what would -- how would you think ahead in terms of your ability to make up for that? Could it be done by the end of the year or we would need more time than that.

Well, look, certainly, we build to their schedules. So if they choose to make their production up, obviously, we're ready and prepared and capacitized to do so. So look, there are key products that have strong demand inside of the market from the light truck segment. So we're still very optimistic and bullish on those platforms holistically. So we're ready to build.

Looking beyond GM, the worst seems to be over on the production side at least, again, GM aside. In the weeks following 2Q results, GM aside, any other comments on the disruptions? Or is this really just an isolated GM kind of situation.

I would say we still saw volatility at some of our other customers. It seemed a little bit more outside with that one customer in particular here this quarter, but we still experienced it at other customers. And it's for a variety of reasons. They don't always share with us why. But what we're told it's generally a supply chain issue or a constraint issue. And in some cases, there's been some logistical challenges inside of North America is our understanding.

Without isolating a specific customer, but you would have a view on demand, not just the schedules that you're told. It's a pretty tricky environment right now. There seems to be a lot of pent-up demand. In my opinion, I'm pretty impressed how sticky price has been, and I'll say volume has been too. And while we're starting at all the pace of inventories in the channel. Well, yes, tell us how would you see inventory levels in the channel? And what would be any other comments you'd have on forward demand?

It looks like forward demand, maybe we do the 2 smaller ones that are relative to us first. I think, Europe and China. We've seen some uptick in European production. I would say we're still very cautious on how we think about that going forward. But it has at least through the course of the year, been positive for a lot of different reasons, but cautious. In China also, I think we're a little cautious on that volume. But again, that's a very low exposure for us for a company. So our main area of focus, of course, is North America in terms of demand for ultimately the vehicles and the platforms we support. So from our perspective, from an inventory rebuild from a vehicle -- in the vehicle park out in the space, there's -- we believe there's still upward demand elements inside of consumers, right? Vehicle ages continue to age in some of the key segments that we support. But if you really break it down into a couple of the, call it, buckets. So from a light truck, pickup truck standpoint, right, demand from our view, continues to be good demand but it looks like the OEMs to sort of level into maybe from an inventory level where they want to be. So they're producing to that demand. And they appear to be doing a really nice job of, I'll say, managing that supply-demand curve from a pricing element that you articulated. From a full-size SUV segment inside of North America, we see demand very strong, very low days on hand in terms of inventories on hand. I think it's in the mid-20s, which is very low. I mean it takes a while to get one of those trucks and there's great demand for it. So we still see very strong demand for that product on our bills as well as our customers. And then from a crossover vehicle segment, which is a key element for our business as well, they sacrificed some of that production over the past 2 years really to support truck production when semiconductors and others were constrained. So we've seen now a nice, steady rebuild of inventory but a nice strong demand for that product as well. So I think the crossover vehicle segment seems to be doing well from a demand perspective and slowly building their inventories where they need to be.

What you're describing makes sense? It seems a bit like a mix headwind. Am I wrong? And any other comments on mix?

For us? Well, look, I think when we -- when that comment comes, it often comes to the OEMs from a mix question. Hey, is mix going to impact you negatively going forward? Our view would be this, truck demand continues to be robust and steady and strong. If the OEMs should want to build additional mix from their perspective, adding in more crossover vehicles, that's generally more volume for us because our truck franchise will continue to run decent. They'll add crossover vehicles. So that's actually very good for us. That's additional -- it's additive, right? It's not really you're not going to move pickup truck production for crossover vehicle production. It's a different....

But the concept of during COVID when they were constrained prioritizing your higher mixed vehicles, just would assume that, that would represent -- or maybe what you're describing is more neutral, not just as simple as looking at...

No. From a mix -- a pure mix inside of a full-size truck, we think of mix, we think 2-wheel-drive 4-wheel drive impacts us. And that has a very strong correlation in terms of mix to us, but we also see a very healthy 4-wheel drive mix. We don't see that changing. So when the OEMs are adding their "mix" which is crossover vehicles, generally speaking, it's positive to us. It's giving us additional volume. And that's what we saw play out over the last 12 months.

Let's turn to cost inputs. And some material cost was easing, -- maybe there's a little volatility now. I'll see what the [Saudis] are trying to do. It seems like they're trying to create a little more inflation ahead of -- well, -- let's see what happens. We'll see -- I'll cut that comment. But anything you want to call out in terms of tailwinds, headwinds and then also on labor.

Just holistically, economics...

Yes, just thinking about your -- what's going into the factory and what might have changed over the course of the summer?

Yes. Last year, we had a fair amount of inflationary headwinds associated with pushback from our supply base as they had labor and cost increases, utility cost increases and generally broad inflation that was impacting their products. So we saw a fair amount of headwinds associated with that last year from our supply base. We also faced significant utility headwinds last year from inflation. And labor, we saw some last year, transformed that into this year, and I think it was a net $60 million impact to us last year, net of recoveries. Step into this year. We still have, I would say, a little bit of residual inflation coming from our supply base as they were continuing to experience now as we're positioning more towards labor inflation, right, coming through that chain. So we see continued a little bit from our supply base. So a little bit on the labor side from an inflationary headwind economic piece. I would say utilities, as you know, have come down to our benefit. We stepped into the year, we thought we'd have a net impact to us of about $20 million. And through the first half of the year, that's where we set about $20 million. Our customer recoveries to mitigate some of this is a back half story for us, and we're actively working on some of that today.

What's the confidence on those recoveries?

Look, I mean their confidence is high. We have work to do. We still have to close some of our larger customers. Last year, we got, I would say, a majority of that done in the second quarter, the residual in the first quarter -- third quarter. It looks like this year is going to be third and fourth quarter activity.

So let's play out a UAW scenario where your OEM customers and your [D3] exposure is what it is, you are disproportionately exposed to their labor cost inflation, let's say, whatever it is, 30%, 40%, I don't know. They -- how do you think of that in terms of, if they are then looking for savings, as they see their margins -- their profit margins been hit 20%, 30% on paper, and they'll make their efforts to try to recover that. What do you do as an organization to try to prepare for that? Where is there may be some low-hanging fruit for you?

You mean in terms of them coming back to us on? Look, at the end of the day, we have a contractual price with our customers, both sides should honor that. And I would expect that to be the case. We have critical products with a lot of technology in them, and I would continue to support that. And obviously, we'll look for productivity inside of our shops like we always have to mitigate our costs to continue to provide them a value product.

Any other directional puts or takes for the remainder of the year or into '24? Do you want to....

Yes, I think as we step into 2024, if you think about some of the -- a little bit of overhang we've had into this year would have been launch costs especially in the first half as we were getting up and launch in the Colorado Canyon in particular for GM, normal launch cost at that site, that's a huge launch for us. We have obviously some inefficiencies associated with a lot of this volatility. So I would expect that to diminish. Well, we're hopeful it's going to happen third quarter. Obviously, there's some pressure in the third quarter, but focusing on the run rate and exit rate into '24, I would expect that to diminish as well. And then if inflation moderates, that should be positive for us. The other element from a headwind perspective, the peso, we're a large consumer of the peso in Mexico. We have sizable operations there that support our North American operations and the peso has strengthened against the dollar. So we have a little bit of that associated with into next year. But if things stabilize, we'll have our core productivity programs, so it will start to then accrete back into the favorable performance of the company in addition to the things I just talked about.

So peso inflation, labor inflation in Mexico.

Well, I mean, there's always -- labor inflation in Mexico is generally higher as a percentage just based on just absolute percentage-wise, but it's manageable through our productivity programs.

Questions for Chris or David? I want to draw I think I am on it. You guys can calm down if you want. All right. Let's move into the strategy around the portfolio. Chris, you and David like to emphasize your agnostic product portfolio and how you can offer customers everything from ICE to hybrid and now to full EV in terms of the components for integrated e-axles and the like. They work with Mercedes, AMG and others, Jaguar, et cetera, being part of that. When you consider the majority of your business is, kind of even by the OEM and the [admission is] at some form of the adoption or runoff, if you will, while 40% of your backlog is EV, doesn't that present an opportunity for you to kind of really make some pretty chunky capital allocation decision changes and that could be beneficial to shareholders.

Absolutely. I mean we -- it's set up to our existing business, right? You hear it when David talks about agnostic from a product portfolio perspective, right? So we have a very highly installed, strong, capable segment of our business in terms of our infrastructure to support the existing products today, which will have a long tail on them, highly cash accretive, won't require a lot of capital to invest from that perspective. It should be long runoff from a cash flow generation. You continue now to see a high interest in our product set from an electrification standpoint. We have announced several wins recently over the last 12 months in our eBeam axle space, probably the feature one, which was earlier this year, which was Stellantis, which will launch in the back half of the decade, which will be a fantastic program for the company. We've won now a couple in India and China, and we're also seeing a sizable interest in our component business, which is allowing us to really flex and utilize our existing capital infrastructure as part of our vertical integration from forging and machining now supporting those components either into ICE or into electrified vehicles. So from a capital allocation perspective, we think we can put a reasonable amount in to grow the business from an organic perspective and have the cash flow yet to continue to strengthen our balance sheet or use for other purposes.

Tell us a little more about the Stellantis program or what you can't tell us.

Yes. So I mean we're limited on what we can say. It's a very meaningful program from a size perspective that launches in the latter part of the decade. It features our eBeam axle, which as you know, on our ICE business is core bread and butter for the company in terms of beam axle. We have now taken that -- I'll use the word niche market. It's a very big market. So it's not really it's small in terms of niche. But from an expertise into now our eBeam space and that will launch in a couple of key platforms for Stellantis going forward. So it's a sizable program, really, frankly, very excited about this win.

So would love your views on CapEx and R&D as a percentage of sales, not any individual year, but the trend in the years ahead given the change in the business mix and how you think about a blend of ICE runoff versus EV run on in terms of your margin development?

Sure. Well, let's talk R&D and CapEx, especially as it relates to, call it, the pivot of some of that product portfolio into electrification. As I mentioned in my previous remark, we think we can really minimize some of the capital investment in our ICE, which gives us a nice cash flow runoff generation piece. On the investment then to make that pivot from an R&D perspective we articulated, call it, 12, 18 months ago, we would step up our quarterly R&D spend to about $35 million to $40 million per quarter as we built out our electrification portfolio, I would expect that run rate to continue for a period of time. As that portfolio is then built out, that should decline and it would somewhat be replenished as we're launching new programs in the electrification space. So we think we're sort of near the peak of what we have to invest from an R&D perspective on a run rate basis. And over a period of time, at some point, that will then start to decline, right, as we've made that pivot on some of our products which we think is a nice trend for us. Especially then because you're getting towards the latter part of the decade, you're launching these new programs. They're coming online and your R&D is starting to step down. From a CapEx perspective, very focused on the intensity of the capital required for these new businesses. We've done, I think, a very good job of minimizing our current capital expenditures today. And over the past couple of years, and really, that's allowed us to leverage our installed base, look to optimize that and look to make it also flexible. Some of this equipment is going to be able to support both ICE and electrification, which will minimize the investments we need to make for an electrification space. You'll have -- our goal, at least we articulate sort of in the medium term is to keep our CapEx at 5% or less even as we're making this pivot. Where would you see that maybe elevated? It could be concentrated in a year or 2 if you had a couple of very large programs come on you all at once which at the end of the day, it's a good investment for us to make. But we think based on our purchasing power, what we've learned on our optimization and our flexibility in our capital, we can really keep both of those R&D and CapEx in reasonable ranges as we make this pivot.

David, anything you want to add there?

I mean everything he said, I mean, that's the way that we're taking a look at it is upfront investment. And then once we get the platform all set, and then it's just at that time, just programs that roll on.

Electrification, just broadly, from today's perspective, I mean, say T0 to T3, if EV adoption in the U.S. is slower than expected, is it good, bad or neutral for your business?

If it is slower?

Yes.

Yes. Oh, it's absolutely good. I mean you have this very heavily capacitized installed ICE base that are on fantastic programs that our customers and their customers love. And we won't need to invest a ton of money and to continue that for a long period of time. And as you know, we're on the next generation of almost all of our big programs today. So well -- we're under contract well beyond 2030 from -- so it would be very positive from a margin and a cash flow performance.

Coming to the audience again, burning questions. I know I'm excited too. I can't -- I can barely. No. Okay. Come on guys. I'll give you another chance. Okay. I'm not going to give up on you yet. Let's go to the financial outlook. So the capital allocation strategy. Leverage stood at 3.3x at the end of June, you generated around $100 million last quarter of cash, you don't have any significant bond maturities until '26.

We have a small piece in '26 and then a larger stack in '27...

So kind of when considering changes in the rate environment and the growth of your EV business, where is the sweet spot of your leverage? Where can you take it? Where do you want to take it? And how soon could you get there?

Yes. Look, I would tell you, our sweet spot would be sort of around the 2x levered perspective. And why do you say that? Well, that brings us more in towards, call it, the average or so of our space, right? We're a little bit heavy compared to our peers. We get a lot of pressure associated with that. That's no surprise to anybody. But our focus has been deploying that cash flow to reduce the gross indebtedness of the company. So we've -- over the last 4 or 5 years, we've paid down almost $1.3 billion, $1.4 billion of debt. We'll continue to do that going forward. The leverage number has been a little bit sticky because we've been in this sort of lower production environment. So our EBITDA has been a little bit lower. So that calculational leverage has just sort of been sticky. So once the volumes start to uplift, once some of these productivity initiatives start to uptick over the next couple of years, we'll continue to generate cash bringing that gross debt down, that leverage number will move very quickly. But our objective in the near midterm when we get towards that 2x net leverage.

And just to give you a chance. I think I know the answer to this, but confirming that your business is sufficiently self-funded, and that you're -- you have enough self-generated capital, even given your growth objectives and the changes in your customers' portfolio that you're not -- there's no -- I won't say 0, but no elevated risk of equity dilution.

No. We believe our cash flow generating power of the company can clearly service our debt, meet our capital allocation needs and continue to pivot with the industry towards electrification.

Adam, one thing I wanted to add to -- add was your question about if EV adoption happens faster, I think we'd be in also a great position in that scenario, too. Because the OEMs in our view right now, they don't -- they probably don't have enough capacity to supply all the vehicles that they would produce in a fast rising uptick scenario. So in our view, we win both way.

I mean I think that -- I'll just be -- if you've read my research, your overwhelming customer exposure base, I think, is going to be a very small fraction of the volume they've targeted. And I think that the UAW negotiations have kind of -- if they were about to pull back dramatically on their EV programs, you're not going to announce that way before UAW. You want to kind of go in there with options. I think that when reality sets in, they see their labor costs go up a lot, and they see that the EVs are piling up on lots and the warranty issues attached to them. I'm a nice guy, well, I think there's going to be a bit of a -- we need to recalibrate. That doesn't mean to give up, but a recalibration could mean a very, very significant pushing out to the right. And I think that, that's going to contribute to the U.S. market being the slowest adopting EV market in the world by far. And the segments that you're exposed to will be the slowest adopting segments within the lowest adopting geo. So that mean that you can relax and be complacent, I don't know, and you're not. I kind of get nervous whenever I hear auto suppliers investing in BEV stuff I like who told you to do this? Or was this informed by a press release or a conversation with a product development person and an OEM customer that's probably not going to be there or not make the product they said they would. That makes me nervous. But I think you're pretty darn well positioned. -- in either scenario.

And to your point right now, and as everybody knows, infrastructure -- that's what need to be nailed down on infrastructure...

Onshoring is really easy politically, I think, to announce getting it done. We will see guys, we'll see. One more chance. Like if someone asked a question, I would say, I'd buy -- I can definitely buy you a beer. I'll make you a drink. I can't promise gummies, but there may be other people. I can't say that. Anything else? Any other final remarks from you guys as you think we didn't hit on or you've had a lot of meetings this morning said they were good meetings. The topic you wanted to kind of...

Look, the topics that continue to be asked of us today, I would expect throughout the course of the day. Obviously, it's a busy week for our customers. They've got a few things on their hands, they'll navigate through and we'll navigate through that accordingly. We think we're well positioned, as you say, to leverage should the pivot dial down a little bit on electrification. And I think the products we're on, as you know, David Dauch was here, he would tell you very bullish on the full-size truck segment for us. And we're very cognizant of the cash that we invest into that business to make sure we're harvesting that over a long period of time. seems like a were. So we'll get through this year, but we're looking forward to next year.

Got it. Well, thanks, Chris. Thanks, David. Thanks for spending time...

And for you, Adam, go blue.

Go blue. Always, yes, be there. Thanks, everybody.