Dauch Corporation (DCH) Earnings Call Transcript & Summary

All right. Good afternoon, 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. Automotive Analyst here at Deutsche Bank. American Axle is a leading supplier of driveline, metal forming, powertrain and casting technologies for automotive, commercial and industrial markets. American Axle has also been ramping up its electric powertrain business with several initial production contracts as well as a few global partnership. And so we're extremely excited to be joined today by Chris May, who is the EVP and CFO of American Axle as well as David Lim, who is the Head of Investor Relations, to discuss how things are going. I think the format will be maybe to kick it off, a few introduction remarks from you, Chris, and then we'll dive right into some of my questions.

Yes. That sounds great, Emmanuel. First of all, thank you for hosting us here. We always enjoy coming to this conference each and every year. Deutsche Bank puts on a fantastic venue here and it's a great way to have some dialogue, interchange on what's going on inside the industry and some dialogue with some of our key investors and potential new investors as well. Before I begin any of our comments, of course, I would encourage everyone to go take a look at our website, www.aam.com for our forward-looking information disclosures. And really, I'll keep my introductory comments very brief because I think some of the key points will probably come out during Q&A. But certainly, 2024 started with our earnings release a few weeks back, about a month or so back. We started the year, I think, on a very positive note. We reaffirmed our guidance for the year. We continue to push on our initiatives for operational efficiency, commercial recoveries with our customers as well as we're seeing some level of stability in terms of our production inside of this year, calendar year '24 versus clearly what we experienced last year in '23 and also to some degree in 2022. So maybe with that, as we push through on the operational piece of the year, we also continue to be very focused forward-looking in terms of trying to pursue new business, but also continuing to secure the next generation of our key products that we enjoy today. And I think in some of the recent activities that we have seen inside the industry, I think those continue to become even more valuable on some of these key platforms that will run for a very long period of time. But from a technology standpoint, we're ready to, of course, meet the needs of our customers today, meet the needs of our customers smile, whether it be hybridization or electrification and pursue a nice great future for American Axle. So with that, maybe I'll just kind of pause, turn it over to you and the audience, whatever you may ask in Q&A.

Sounds good. Thank you. Maybe just let's speak a little bit about the environment and industry conditions. Can you provide an update on industry conditions you're seeing? And how is American Axle doing so far this year?

Yes. No, great question. I think this is a very key element for our operational performance as a company, obviously, as well for the industry. No surprise. We talked a lot last year about some of the challenges we faced from a volatility perspective in the industry, a lot of changes in customer schedules, not only just changes, but in particular, last-minute type of changes. And those can be very disruptive to our operations caused for less than optimal efficiency in our factories and then ultimately drive through our P&L. I think the good news here, we talked a little bit about this on our first quarter earnings call is we've seen a fair amount of stability, at least in production schedules in the first quarter. That has continued mostly into the second quarter. There was some preannounced downtime that some of our largest customers had here in the second quarter. We have experienced some of that downtime. But I think the positive trend here was it was preannounced and sort of more customary where in the past, if you experienced some downtime, you had some heads up and noticed that you can accommodate and deal with that versus just at the last minute. So big picture-wise, stability seems to be in good shape from an industry perspective. Hopefully, that will continue through the rest of the year. And we're off to a decent start as a company, both on our first quarter performance as well as we reiterated our full year guide at that time as well.

How are you tracking with some of your important U.S. launches this year?

Yes. From a launch perspective, it's more of a tail of second half for us as a company. We have some critical launches on the electrification space. Most of those are in Asia or India in the second half, and we're tracking very well to those. In terms of our sizable launches here in the U.S., we have two, both in the second half. One is really the next generation of full-size Ram platform that we supply. We supply the 2500, 3500, 4500 and 5500 Series for Ram. And that will be a big transition here for us in the second half of the year as they move into their next model. That is our second largest platform as a company. Also, in addition, as you know, General Motors is launching their new compact SUV, The Equinox, The Terrain, the XT4 and the Buick Envision. We are the primary all-wheel drive supplier for that. That's our third largest platform as a company. And that transition will also happen here in the second half. So -- but again, all of these are starting to line up to from a timing perspective, just as we had planned. But again, we have to face the big ones here in the second half of the year.

And what are you seeing in terms of the industry pushing out some of these EV launches and Rams. Is this impacting your business? And is it affecting your capital allocation priority?

Yes. Great question. I know that's probably the, I think, the largest element on most people's minds in the industry in total. This is -- it's a very dynamic time as it relates to EV in the space in terms of not only programs that are launching now, but also in terms of how our customers and end consumers are thinking about the near, mid and longer term as it relates to these vehicle applications. So we have seen, in particular, probably over the last now 4 to 6 months. Clearly, our customers sort of reassessing in terms of their vehicle launches, the cadence for which the timing they will come on, the ramp curves and the ultimate volumes. So that has impacted us. How? Meaning not necessarily current year impact but more in terms of -- as we think about the future, the quotation activity has certainly reflected some of these dynamics and uncertainties in terms of our customers seeking quotations in the markets for platforms that will happen in the future as they believe our view anyway, as they assess where they think these will ultimately land in the timing of it. So -- you probably heard us use the term air pocket in terms of some of the quotation activity, we certainly experienced it here in the last 6 months.

Now let's focus on some of the shorter-term dynamics in your business. You had a fairly strong beat in the first quarter. You chose to maintain guidance for the year. What are you assuming for the rest of the year, sequentially to get there?

Yes. So we reaffirmed guidance on our earnings call, as you mentioned, back in May. We had a nice start to the year. And of course, that start to the year, in our view, gave us a lot of confidence to deliver our financial performance inside of the guidance range. Of course, it's still yet early in the year. We have, obviously, as I mentioned a little bit about the volatility has been stable or less volatility, which is good. That is our continued operating assumption for the balance of the year. And we do also have some of these large second half launch that we talked about in terms of the Ram as well as the General Motors Delta platform. But some of the key underpinnings as we think about our guidance, we had North America production around 15.8 million. I know right now the current third-party indications are a little bit higher than that, but very close to our thought process there. The midpoint of our guidance reflects approximately 1.4 million full-size General Motors trucks on their T1 platform. That's a key underpinning to our business, sizable chunk of our revenue. And from a timing and cadence perspective, generally, we track as our business is about 70% to 75% North America timing with the North America production assumptions in conjunction with some of those back half launches that we will also experience, which generally brings a little bit of volatility to those specific platforms from a volume perspective as they come up and down. Meaning, runoff the old platforms, bring on the new platforms. But those are probably the main macros wrapped around our guidance at this point in time.

Now one of the impacts you had mentioned at the time was some pull forward of the GM full-size truck platform in Q1 as well as some downtime expected in Q2. When I'm tracking what's going on with IHS, it looks like Q2 volume might actually be better even than Q1. So any update on essentially how production -- downtime and production has played out?

Yes. Certainly, at the time when we had our first quarter earnings release back in May, our view was the first quarter production related to that full-size truck was very strong. We had some indications that they were trying to pull some of that production into the quarter, which, of course, supported us to have a very strong start to the year. They did announce some of the downtime in the second quarter. We had continued to see that downtime play out. It's basically contained to one production facility at this point in time. In general, the volumes have been pretty decent. It's still tracking towards the midpoint of our guidance.

Can you kind of mention the impact from non-materials related inflation from freight, labor, utilities that you expect this year. How much of this do you expect to be able to recover? And how are negotiations with automakers?

Sure. It's also a very key question to our operations. Certainly, the onset of inflation came on very strong back in 2022 for a variety of reasons. Some geopolitical as it relates to utilities and otherwise. But also, we've had a consistent inflation pressure as it relates to labor over the last couple of years. And then more broadly, inflation as that's permeated through the supply base as well as our indirect inventory suppliers, et cetera. So our goal for this year is to mitigate inflation through either commercial recoveries, aim for our own productivity. And I think, by and large, our guide into the year assumes small amount of residual inflation, but generally accomplishing that goal that I just shared with you. We do have some work to do yet on some of our customer recoveries. We do have a lot of it done, but we have some yet we need to close out here for 2024. I would tell from a timing perspective, if you think about '22, we settled with most of our customers around midyear. Last year in '23, it was much more weighted towards the tail end of the year, which we ultimately received final negotiations with our customers. I would tell you for 2024, we're tracking very similar, closer to '22 where we seem to have most of this behind us, hopefully by middle of the year, but we do have some work to do on that perspective. But we are experiencing inflation. Labor inflation, in particular, is very sticky. Some of the other elements of inflation, we've seen moderate a little bit, but still experiencing it. And of course, our supply base is experiencing the same level of inflation. And if they're experiencing inflation, they're looking for price increases from us, which we have to manage through, which is a form of inflation for us as well.

So I was going to ask you with respect to labor. Can you characterize for us the current environment now? You mentioned efforts to increase automation, where feasible. You mentioned the focus on plant loading throughout the year. So what can you tell us about the progress on these efforts in mitigating labor constraints so far?

Sure. Obviously, we talk a lot about labor in 2023. That was some of the challenges that we faced at the company, caused us for some of our operational disruptions and some of our performance challenges that we had last year in 2023. And that manifests itself predominantly in the United States, and it was really driven in large part by labor shortages. And we had to kind of work our way through some of these labor shortages. In some cases, we had to offer compensation increases to attract and retain more associates as we were facing turnover. We had to advance some of our training programs. But we also had to reload some of our facilities from some maybe call it, some of our facilities that were challenged more from a labor perspective, reload some of that product as you mentioned, to some of our other facilities that could have either labor or physical capacity to build some of that product. And these things I just shared with you take time to do. And I think in the third quarter last year, we laid out a pretty nice plan, transparent to all our investors on our website in terms of how we would sort of work through many of these challenges from a labor perspective, in particular. And I would tell you, we are tracking towards stabilizing our workforce, ahead in line now, a good wage structure, good retention program. Some of those people that we brought in last year, now you're starting to hit them at full run rate. Meaning, they've been trained. They're not producing excessive scrap. They're not going through the ups and downs of the new associates. And now you're starting to realize some of those efficiencies. We properly now reloaded all our facilities. We're starting to see the benefits of that, start to stabilize in our operations. And as you can imagine, this issue is circular, right? So if your operations are unstable, your labor becomes instable, you create excessive cost and that keeps going in a circle until you can sort of stop that. And I think the actions we have taken now over the last 6 months have really started, put in place, and we're starting to realize the benefits of these actions. You saw that in our performance in the first quarter, and I would expect that to continue to be favorable for us as we go forward.

Wanted to ask you about contribution margin. What contribution margin should we expect from the business this year and going forward relative to your historical average? And is there an impact from a higher mix of electrification?

Sure. From a contribution margin perspective, or variable profit as some people would articulate, if it's our existing product, our existing book of business on a volume basis, we have great operating leverage as a company. We will realize incremental margins on existing business for higher revenues of 25% to 30% in the short term. Of course, if it's a new book of business it's coming in at a fully loaded cost, obviously, it's lower than that. But on our current product set, I would expect our contribution margin to be in the 25% to 30% range. You see that very clearly on our year-over-year walks that we provide every quarter, and I would expect that range to continue into the near term. I see no reason why that would change.

And then obviously, you're focused on execution 1 year at a time and you have 2024 targets out there. If I look ahead to 2025, what are the puts and takes to consider from American Axle in terms of gross and margin projections?

Sure. And we're giving no guidance for 2025 at this point. I want to be clear on that point. But some of the things that we think about is we're stepping into 2025. Of course, first and foremost, production drives our business. So you have to take your view on the production in the marketplace. That would be the first recipe, I think about. The second is, we expect and it ties a little bit with your question on labor, continued productivity improvements inside of our own operations, especially on a year-over-year basis. Some of the other elements that we're beginning to invest in more heavily, of course, is automation that will drive some of our productivity, is some of the core productivity inside of the labor element that we mentioned as well as the throughput through our factories that will be critical for our success. We do have continued launch of new business coming in next year as part of our backlog. That will be critical for our success in top line revenue and profit conversion. So at the macro, I would call those are sort of the main drivers driving our operations today. Some of the things, of course, on our mind as we think about going forward, that would be -- those are -- the puts and takes away would of course, would be continuing to monitor volatility inside the marketplace. We have a large exposure to the Mexican peso, and that has strengthened, considerably over the last 12 months. So over the last several weeks, it's weakened a little bit with some of their geopolitical environments, we're going to continue to watch that very closely. And then, of course, holistically, macro inflation.

Wanted to shift a little bit to the electrification part of the story. So as we discussed, EV slowdown has been a big industry shift in recent quarters. How are you handling this changing dynamic? And obviously you have large market share on some of the combustion engine trucks. So does this EV slowdown provide you better cash generation opportunity?

Yes. So I'll answer that in reverse. The answer is clearly yes, to your last point. If internal combustion engine hybrid applications that we support here today have much longer life than maybe people realized 6 months ago, absolutely, that's very beneficial for our business. We have high operating leverage on these platforms, strong cash flow conversion on these platforms. And as I mentioned, one of our goals in my opening remarks, is to continue to secure the next generation of the programs we're on today. Many of our largest platforms, we have secured those, which will take that book of business well beyond 2030. So a book of business that has a long life to it, that's highly profitable, strong cash flow conversion is very good for American Axle. But as it relates to some of the other EV applications, we'll continue to support those as well. We've seen, as I mentioned, dynamics and slowdown of some of the quotation activity. But our product set for to support the pivotal electrification is in place. We've been winning awards in this space, and we're launching products in the space today around the globe. In our view, we've been quite successful at it, and we'll continue to do so.

Can you remind us the size of your EV business, currently? And your existing backlog, and any future goals?

So in terms of size, for our business on our '23 revenues. It was in the low single-digit percentage. Our backlog, as we disclosed, it's about half of our backlog that we announced back earlier in the course of the year. And our goal is to continue to sort of pace with our core product set and our customers' platforms that we support in terms of their transition to electrification. We announced a served market goal of greater than 10% by 2030. And of course, that's defined by our served market, and it continues to pivot around in terms of what the absolute will be in terms of forward-looking projections. But we see no reason why at this point in time, we cannot continue to achieve our goals for our 2030 time frame.

Can you just go over some of your major recent or upcoming BEV launches and what content you have on them?

So we have, most recently, in this year, we started this launch a year or 2 ago. And this is the first time the AMG Mercedes product. I think we've talked about it at this conference maybe 2 years ago. That was fed into a variety of derivatives. We continue to support that as we expanded here again yet in 2024. We have won several awards for beam axles in the Asia and India marketplace with several different customers. Those are launching in the back half of this year and some into 2025. So those are facing quite nicely. And we've also won, I would call Components Awards where we supply into directly generally into OEMs, a variety of different OEMs in Europe and North America, across Asia from a component perspective that ultimately end up in BEV platforms, and those generally tracking on track as well.

As the electrification portion of your new business backlog continues to grow, can you speak to the difference in margin profile of these wins versus the other things?

I know we get asked this question quite a bit. We do not provide margin profile, differences between all the different segments of the business that we supply here today. Our goal has been and will continue to be holistically as a company as a top-tier margin performer. In each business case, each award that we pursue from an electrification standpoint needs to meet the financial hurdles that we have as a company. And if we continue to perform at that level from a quotation and hurdle perspective, we'll be able to deliver that goal to continue to be a top-tier margin performance company.

And as you develop the electrification global footprint. Where do you see the biggest opportunity for American Axle for expansion?

Well, I think it comes in a twofold for us. One, I think, clearly, geographical, we're almost 3/4 of our business today is in North America, but we've seen EV business growth in Europe. We've seen EV business growth in Asia, in particular, China. So that would begin to sort of build an area that we have a lower exposure to. But I think maybe one of the underappreciated elements of our business is also expansion of segments. If you think about our company today, we are -- the majority of our business falls into the full-size truck, full-size SUV or crossover vehicle platforms. When we move into the electrification space, our drive units, whether we're on front-wheel drive, rear-wheel drive or all-wheel drive applications from a EV platform can now supply front-wheel drive vehicles, rear-wheel drive vehicles, luxury car platforms, skateboard platforms and, of course, conventional or typical CUV and full-size truck application. Some of these segments today, we really don't have a lot of exposure to, but they use the same drive units. And if you think about some of the wins we've announced in our past with electrification, whether it be the Jaguar I-PACE or the Mercedes product. These are vehicles that are traditional lines of business would not participate in. We're seeing some segment expansion into these areas, I would expect that to continue in the future as well.

Okay. Just a couple of capital allocation questions. Can you walk us through your overall M&A strategy going forward? And will you continue to target EV-specific in acquisition? Or at this point, does it have to be largely powertrain?

Well, clearly, having a powertrain-agnostic application is one of our goals as the company is to be at the macro level powertrain agnostic. What does that mean? That means we can supply ICE, we can supply Hybrid, we can supply EV. But in terms of M&A, maybe we should start to taking step back and talk about our capital allocation first. So obviously, we've been using our strong cash flow generating power of our company to continue to reduce the outstanding leverage of our company being taking gross debt down. We have paid over $1.4 billion of our debt down from 2017. I would expect that to continue. We'll continue to fund the organic growth and R&D investments necessary to continue to support our programs and new business opportunities in front of us as a company. And then we would pursue M&A activity where it makes sense. Of course, the last bucket, I would put in the shareholder activity, whether it'd be buybacks or dividends. And right now, we have, we do not have open authorizations for either one of those. Our focus has been on the funding the organic growth of the company as well as paying down our debt. But as it specifically relates to M&A that you asked about, if you look at what we have done over the last couple of years, in addition to paying down debt, using that internally generated cash flow, we have made some, I would call, tactical acquisitions, for example, most recently, Tekfor out of Europe. It was about a $400 million revenue -- dollar revenue book of business. That was -- had a lot of agnostic products into it. Also bought some BEV technologies that we didn't have from a forging perspective. But also played right in our hand of a consolidation and synergy play. So it really hit in my mind on the trifecta of some of the 3 areas we're looking for, for an M&A acquisition. Those type of things would be certainly things we would consider about the inside the envelope of our current cash flow generation.

And then how should we think about the use of free cash flow longer term? You've directed a lot of it towards debt reduction in recent years. Will that continue to get to that low to mid in terms of leverage? Or is there a different thinking pattern?

Yes. I mean our goal from a leverage perspective, and this is a net debt leverage and I'll call it, near to midterm to achieve a 2x ratio. We're a little over 3 today. We've continued to pay down gross debt. We'll continue to do so with our free cash flow generation. Once we start to bring that leverage down towards that objective, what it really does, couple that with our strong cash flow generation is to really then open up optionality inside of that capital allocation point book. I think it'd be a little premature to talk about the various options at this point in time because we have some work to do to get to those stated targets. But we're on a mission to do so. And I think our operational performance and our cash flow generation will support that.

Great these were all my questions, I see if there's any in the room. Any questions for American Axle? It looks like we're abundantly clear. You always are. So...

Well, thank you.

Thank you so much for coming in and talk us through that.

Thank you.