Linamar Corporation (LNR) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Georg Fischer's conference call and live webcast. I'm Andre, the Chorus Call operator. [Operator Instructions] The conference is being recorded. The presentation will be followed by a Q&A session. [Operator Instructions] The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Andreas Muller, CEO. Please go ahead, sir.

Good morning. Welcome and thank you for joining our conference call about the divestment of GF stake in the U.S. automotive joint venture, GF Linamar. Present on our side our CFO, Mads Joergensen; Head of Investor Relations, Daniel Bosiger; Head of Corporate Communications, Beat Romer; and myself. Let's turn to Slide 2. In the year 2015, GF and Linamar agreed to set up a joint venture and a joint operation in the North American markets. You may recall that this joint venture was producing its first samples in the year 2017 and started its serial production towards the end of 2018. The location back then has been chosen in the region of Asheville, which is in the state of North Carolina. Since 2018 onwards, we have ramped up several large projects. A few examples you can see on the slide on the bottom right, for example, structural components such as cross car beam members but also shock towers for international GF customers. We also have a part of the production allocated to components in the powertrain section. As you can see on the picture, there is a ladder frame and an engine block illustrated. The joint venture is approximately 40,000 square meter in production, and it has 12 die-cast machines which have been installed over the last 4 years with sales in the year 2021 of approximately $120 million and 450 employees. Let me turn to Slide 3, our rationale for the divestment. Overall, we have to admit that the financial performance was clearly behind our expectations. And so we had different views regarding turnaround and growth ambition of this company in North Carolina. The vast majority of the joint venture key accounts are also large key accounts of Linamar. So you can imagine that the big 3 of this large machining company, which is actually the world's biggest independent automotive supplier in terms of machining, Linamar, are the big 3s around the world. Linamar is, we have to say, very close to these customers and we believe also with a higher influence than GF. The structural problems in the region, and I would like to remind that when we have decided on the location in the year 2015 and '16, we have faced an unemployment rate of approximately 7% in that region is today a full employment environment. The situation in the aftermath of the pandemic have even further accelerated the shortage of labor and therefore have highly weighed on a quick turnaround. Let me now move to Slide 4. GF Casting Solutions Strategy 2025 remains unchanged. Our organic growth sales ambition of 7% to 9% remains unchanged, which ultimately results in the range of above $1 billion in sales organically. We reiterate our return on sales targets of 9% to 11%. And also, we're going to confirm our global footprint. We have already set up a sales and engineering office the recent weeks in Detroit to keep and maintain and service our customers in the U.S., and we will further inform about our North American approach in due times. With that, I would like to conclude a brief introduction to the topic, and we are now ready to take your questions.

[Operator Instructions] The first question comes from the line of Jörn Iffert from UBS.

There would be two to three, please. The first one, with your know-how in magnesium and you have created and you also shared with your joint venture partner, Linamar, don't you see now the risk that maybe Linamar is using this know-how now also entering other regions you're operating in like Europe and APAC with this magnesium lightweight materials? So is there any clauses or options in the divestment contract? The second question will be, please, would you be so kind and give us an indication how the Casting Solutions division would look like in terms of reporting in 2021, if you would restate for the divestment of Linamar? And also what is now roughly the CapEx run rate you would expect for Casting Solutions going forward?

Thank you, Jorn. First of all, we have agreed that there is no protection nor no competition clause that means for GF, but also for Linamar, obviously, we would have access to all markets. Setting up facilities across the world is not something which would happen overnight. Yes, you're right, the know-how in magnesium is in this entity located and it can be leveraged, but there is, as said, first of all, a way that you would have to set up in some other regions of the world a facility. That may answer your question. And I would like to pass on the second part of this question to our CFO, Mads Joergensen.

Thank you very much, Andy. So the company, GF Linamar, generated last year sales of USD 120 million roughly. So you would have to probably slice off about $110 million of the sales in 2021. We have also explained that we have been struggling with the financial performance of the unit. In 2020, the operating loss was north of $20 million. And we also indicated that this -- the last year, 2021, was even worse, it was north of $30 million. So you can add back $30 million to that small -- let's say, the breakeven result of the Casting Solutions last year.

In terms of capital expenditure, we would probably -- last year, we probably have invested $20 million less than we showed at $135 million.

As an additional consideration on this topic, this is not, first of all, an unexpected move for -- discussions about the way forward started already last year in the last quarter. So therefore, it was also clear to GF that we're going to look into an alternative setup, how to serve the North American markets.

The next question comes from the line of Martin Flueckiger from Kepler Cheuvreux.

Actually, I have three. Firstly, I'd like to start off with more of a strategic perspective of your divestment. I'm just wondering how you consider the strategic impact for GF Casting Solutions now that you're divesting your JV participation in North America. How big a strategic setback do you think that is for GF Casting Solutions? And how quickly do you think you can ramp up your automotive business in that region now that the JV is gone? That would be my first question. Then the second question is on the current supply chain constraints that we're seeing particularly in automotive, but of course, in many other industrial segments. How is that developing now that we have 5 weeks -- 5, 6 weeks of war in Ukraine? And how do you perceive the risk of natural gas shortages in Europe as a result of a potential Russian intervention here? And finally, my third question would be on Machining Solutions. Recently, we've seen the VDMA in Germany, the association for mechanical engineering, lowering their growth estimate from 7% to 4% for machine tool demand in 2021 -- sorry, 2022. And I was just wondering, earlier on at the beginning of the year, you had a very strong back -- order backlog in Machining Solutions, if I remember correctly. And I'm just curious now on how demand is developing and how your order books are developing here in order to get a better feel for the potential -- the commercial potential for the division this year.

Thank you for your questions. I will know more in detail about your first question, which is for the relevant topic of today. It is, of course, in terms of the strategic setup we have communicated in the past years certain setback, but sometimes you have to do a step back. And as said, we have set up sales and engineering office in the Detroit region as well, we are currently evaluating our North American approach, which we will inform you in due times. And it's obviously of utmost importance that we serve and communicate with our key customers, which are global customers, very closely at this point of time. I would like to remind you that approximately $30 million of sales conducted in the U.S. have been done with products produced outside the U.S. It is clear that not large-scale casting body and structure components can be imported, but there are a couple of body and structure components which are easily being freighted in containers. And so we did -- we also secured during the course of 2021 a couple of large orders from our Chinese facilities which are due to be delivered to the North American markets. So we remain present in that region for sure. And -- but at this point of time, it was the only right decision to do this step back. Now this acceleration of the situation aggregated by the labor shortages, but also these certain shortages over the last years put this company into a situation where we had to change the way forward, as said before. Supply chain constraints, I will not speculate about the political situation about the Ukraine war and [ where it all can fall ]. This is quite an intense discussion. So far, the European markets have been affected, as you all know, by the supply shortages out of the Ukraine here, predominant the products of cable harnesses which have been produced in the Ukraine, which are currently being relocated to other regions, that obviously have affected us as it has been seen in the media, car and our OEM customers. The question number three, Mr. Flueckiger, about the machining and the mechanical engineering association information, you have to keep in mind that the German market is, by and large, a power production market for the automotive industry, which is not to be compared with the GF Machining Solutions business, which normally is the equipment production. So I think that's made to your question two and three.

Next question comes from the line of Walter Bamert from ZKB.

Raw material cost has not been used as an explanation for the disposal. If magnesium and aluminum handle -- can you handle that price increases or fluctuations that you have seen in the remaining casting business and in addition, raw material cost in the piping business? In the first months and years, you have been quite good in absorbing and passing that on. Is that still the case this year? Or should we assume that there is a disruption with the ability to pass on higher input costs?

I would like -- I think I'd take your question, but I would like to remind that we are today talking about the divestment of our stake in the joint venture, GF Linamar, in the U.S. I think there is no change to our statements we did during our media conference just a month ago about the annual results 2021. Raw material costs are being passed on to customers with time lag. Fluctuation of this cost, obviously going to create sometimes profit, sometimes losses. Availability of materials is not an issue. And the piping systems market power is continuing. Why should it disrupt just because there is a calendar change? So with that, I think that I would like rather to refer back to what we have said during our media conference.

The next question comes from the line of Christian Obst from Baader Bank.

Yes. First, on the overall CapEx since 2015. So how much have you invested in the U.S. into that joint venture so far? So -- and this then comes to the next question is the capital invested in Casting Solution is a little bit loss of $500 million. How much of this capital have been to deduct for the remaining activities there? And then taking a longer view on Casting Solutions there, you have approximately 10 years of a negative free cash flow in this area in your planning. And if we're taking out the current problems we have, when do you expect Casting Solution to become free cash flow positive? These are the first questions.

Thank you very much. I will ask our CFO to give you a short statement about your questions.

The CapEx invested in the plant since the inception is slightly more than CHF 180 million. Half of that, however, has been paid by the partner, Linamar. Overall, the property, plant and equipment in the company is about CHF 150 million and adding on top of that another CHF 35 million for net working capital. That's what we have in that company at the moment. In terms of free cash flow, we have issued a guidance I think at the year -- the annual financial analyst conference, and we are sticking with that between CHF 150 million and CHF 200 million that remains as we stated before.

But this is for the group. I have a question for the Casting Solutions only, when will this become positive on a structural basis?

Typically, the -- I mean the free cash flow, we don't disclose on divisional levels.

Okay. Do you expect any further impacts on your balance sheet, any kind of impairments from that kind of movement now?

As you see from the press release, there is -- the transaction itself is neutral from a consolidated EBIT perspective, which should give you an indication what the margin is between book value and the purchase price.

Okay. And you talked a little bit about your -- how to serve the U.S. market. So is the strategy going forward really to become some kind of a meaningful player in that market? Or you're only saying, okay, we are serving now what is some kind of an opportunistic approach but in the end, we are concentrating on Europe and China or Asia?

It is -- as we said, we are not changing our strategy view on the setup of our Casting Solutions business in terms of serving our customers across the world. We're serving already today our customers in various end markets where we might not have production presence. So as said, we have secured orders and acquired orders in the year 2021 for the U.S. market, which being supplied out of China, but also being supplied out of our European facilities. But as said, we will inform about our North American approach in due times.

Okay. And how do you split your customer approach between Linamar and what you are serving now?

No. It's -- as I said also before, we have agreed on no competition. That means we all will go for the customers where we believe our capabilities match perfect. I think it is not a secret that we have a strong setup with European but also Chinese and Japanese customers, but also some U.S.-based customers are in the portfolio of GF, and we're going to continue to serve these global clients, as we said before.

Okay. And then last but not least, the Linamar press release is, of course, a little bit more positive when it comes to the future of these facilities going forward. So they are saying that they are increasing their structural components per vehicle and this is a strategic priority and they will be more agile and may see market opportunities and so on and so forth. And they are also highlighting the very strong customer base. So it's still a little bit -- yes, it's interesting that you are saying just because of labor shortages and the current losses, you are getting out of that joint venture. But it's okay, it's just that...

Okay. No. Thank you. But this is not what we said. It is also that we have diverted in terms of our growth aspirations and ambitions in the 2 partners. That is also clear for us. It was of utmost importance to settle and to get into smooth operations before we would largely continue to invest. We see that investing in casting facilities normally is a journey between 3 and 5 years. That's quite a complex production process. So it's not that simplification, and I think that needs to be considered. But as I said before, Linamar is one of the biggest suppliers for machining services in the world and by and large, the biggest one in the North American markets and therefore, very well represented across the 3 states, Canada, U.S. and Mexico. And obviously, they can leverage their current setup in regards to the facility, but they also have capabilities across the U.S., which they can leverage in terms of operations.

[Operator Instructions] The next question comes from the line of Alessandro Foletti from Octavian.

Do you hear me now?

Yes.

Okay. Sorry for that. I have a couple of questions. First on maybe on the strategy again. Can you tell us what went wrong really at the end of the day, was it the choice of the location, was it the choice of the partner, was it the fact that you went for a greenfield approach instead of buying something? What was really the core of the problem here?

I think I said that, first of all, obviously, we have been confrontative the challenges given us during the COVID pandemic. So the year 2020 was hardly a year where we could exchange person and therefore, transfer know-how. And in the aftermath of the pandemic, we have seen that labor markets have changed, also the local situation has further worsened. I said it before, we -- when we have chosen the location, we had an unemployment of 7%. Whereas during the quarter of the last years, and particularly after COVID, suddenly the unemployment rate went to a full employment and we have now less job searching then of open positions in that region. This has been definitely one of the reasons that the ramp-up has been heavily affected. In addition, we have seen the shortages of chips affecting our clients and therefore, led to very erratic calls that didn't help either. Obviously, it didn't help either by having a smooth operation to ramp up our processes. And ultimately, yes, we have to admit that we didn't succeed over a period of 4 years in terms of our financial expectations, which would not have been that we should be on high profits, but also the losses have been exceeding our expectations. And therefore, we also thought about how to turn around and there have been a slight different view on how to turn around, but that is okay in terms of having 2 parties. And therefore, as said, we have worried about the way forward already since last year, and we have worked on an, say, ideal solution for our clients, but also for our employees which are at that facility. And that has been ultimately the conclusion, is a greenfield approach to be preferred versus a brownfield or by acquiring a company that's dependable. We have very successfully ramped up a lot of facilities across the world. But also in China, we have set up more than 3 facilities in the Casting Solutions divisions very successfully over the last 10 years. So no, I wouldn't say that greenfield is a challenge. Speaking the worst option compared to acquiring a company, no, definitely no.

All right. Thank you for this information. My feeling -- sort of my feeling is a little bit that you were sort of unlucky although if you -- because many of the things that you say are sort of due to accumulation of factors, obviously, that are also beyond your control and beyond also the control of your partner. So I just wonder why exiting now, it's just that you were not -- maybe 1 more year would have been enough.

Look, at one point of time, you're going to have to follow decision, and we have felt this decision. We haven't been unhappy about our partnership, not at all. I think it is a very competent partner we have and how it's always been in a friendly and in a good faith. And so when you are friendly and a good faith, you still can have different opinions, right? So no, it is -- as said, at one point of time for us, it was clear that we're going to have to change the setup, and that's the moment when we have felt this decision.

Right. And do I understand you correctly that this exit here is not an indication that your commitment towards casting in general has changed or is beginning to change or is beginning to think about maybe changing?

Thank you, Mr. Foletti. This is obviously not the case at all. But -- so this is a decision on how we approach the North American market. As we said, we will come up with an idea how we approach the North American market in due times, so there is no impact on the remaining part of Casting Solutions. Our Strategy 2025 remains unchanged for all our 3 divisions. Maybe just on the state of a clarification on the question before from your colleague, the values given by our CFO have been in U.S. dollars?

No. That's Swiss francs. CHF 180 million.

Okay. Okay. So it was -- okay.

Oh, everything is Swiss francs then.

Yes.

All right. So since we are talking about...

All the numbers he did was...

All right. Excuse me. Since we are talking about numbers, can I ask you for a [indiscernible] here? You say the transaction is neutral from an EBIT perspective. So that would mean that the income from the disposal minus the loss sort of wash out, is this the way to see it?

Basically, it's just the book value -- the consolidated book value of the entity when we deconsolidate it, it matches with the income that we generated from this -- the proceeds we have from this transaction. So that when we deconsolidate it, when we sell it, the effect of that transaction is 0. What is important for you to understand is that we already had it 1 quarter in the books.

All right. But I assume that...

And an important piece of information is that the situation did not improve in the first quarter compared to previous.

Right. So you make a small profit that goes against the loss, the operational loss, is the way to look at it?

It's a wash. It is a wash.

Right. And on the CapEx side, there was a question from a colleague before. Can you give an indication of the CapEx '22 for the whole group now? Because maybe with this, it has changed a little bit.

The CapEx for the whole group is -- it's 10%, I would say. 10%. We -- our guidance for CapEx for 2022 is CHF 200 million roughly and the audited was for this entity below CHF 15 million. Last year, we invested CHF 18 million in GF Linamar and for the budget was less than CHF 15 million. So it's not so material to our CapEx, this entity.

Right. And maybe my very final one, sorry to hold you down on this. But the joint venture is a 50-50. So you made the comment that the sales $110 million, $120 million is obviously half of the total sales, right, if the 50% is the...

That was very good question, Mr., a very good question. We only -- the stake is 50%. But since we had the operational leadership, we were fully consolidating the -- that's why also all the numbers we're giving are 100%. From a cash flow perspective, half of that is then financed by our partner.

Right. Okay. Understood. Okay. Fine.

Just for clarification once again, what you said about the transaction, the transaction is a wash, right? The operational effect for the first quarter is in the books of GF, just for clarification. So it's not a wash on operational performance and transaction combined. It's only on the transaction.

The next question comes from the line of Daniel Koenig from Mirabaud Securities.

I have just a little question on your export business out of Europe. I was wondering if you want to increase this activity, a; and b, how profitable is this business in the current environment where transport costs are quite high?

Thank you for this question. It's not only from Europe, it's also from China. The business has been acquired during the course of the year 2021. And yes, it is profitable and it is considering current freight rates because most of these businesses are dealt in ex works Incoterms. Existing business which we have is long-standing business, which is also in Incoterms, ex works. So therefore, I think this is important. This is more about the capability to be able to produce and to design these kind of products which have been done from our European but also from our Chinese facilities.

We have a follow-up question from Walter Bamert from ZKB.

You made a point very clear that you will inform in due time about the casting strategy. And I think it's also clear that for the time being, the setup that you have now that works in North America. What is wrong in my thinking? So certain imports will certainly help and will continue because you had that before, but this is not the solution for global automotive customers who require also that to produce on the North America region. So greenfield is not an option. It takes too long, does not really work in the current labor setup. So we will see sooner or later M&A in Casting Solutions again. Is that correct? Or is there a wrong point in my thinking?

You are highlighting one point which is not in the -- let me say, that wouldn't be the most wanted solution for that, to be very honest with you. I think we're going to inform in due times about our North American approach. There are a couple of options. You haven't listed all of these options, but please bear with us. We will inform in due times where we're going to solve and serve the North American market.

There are no more questions.

Well, thank you very much for your interest in our shortly announced conference call. We wish you all a pleasant day and a great weekend. Thank you.

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