Magna International Inc. (MG) Earnings Call Transcript & Summary

Good morning, everybody, and thank you for joining us for this session with Magna, as part of Deutsche Bank's global automotive conference. My name is Emmanuel Rosner, and I'm the senior U.S. autos analyst at Deutsche Bank. Magna is one of the largest automotive suppliers in the world, operating in 4 segments: Body Exteriors & Structures, seating, Power & Vision and Complete Vehicles. We're very pleased to host with us this morning Magna's CEO, Don Walker; and CFO, Vince Galifi, for a discussion. The format for this session will be a fireside chat around some of my prepared question as well as questions from all of you on the call. To submit a question, please type it in the box on the left side of the webcast window. I highly encourage you to do so and to get involved in this discussion. Only I will see your questions, and I will ask them on this call without mentioning your name or affiliation. So with that, Don, Vince, thanks a lot for being with us today, and I will just hand it over to Don for some quick intro remarks. Don, over to you.

Thanks, Emmanuel, and thanks, everybody, for joining us. I'll just make some high-level points, and then if people have questions, we'll get into more detail. When the first -- the COVID-19 first hit us -- obviously hit us in China, and everybody knows the trend, we put about 20 work streams in place, everything you can imagine for a public company dealing with over 160,000 employees around the world. The -- I've been very pleased actually that the governments as well as the industry as a whole really got together intelligently with the medical communities and unions, et cetera, and have really got -- did a lot of good work on PPE, supporting the community as well as what we're doing going forward for the industry. And we do have a good restart. Obviously, China is up and running well. We're probably 85-plus percent capacity utilization, and the industry seems be going well. Europe has been up for a number of weeks now. That seems to be going well. Also, North America has recently come up. I was concerned about Michigan. Finally, letting us restart. And then Mexico still a little bit unknown because the virus is still not under control down there, but the government has been very supportive. I think everybody understands how important this industry is for the overall economy and to get some revenue and people back to work, get revenue back to the governments. For the most part, the -- we haven't seen a lot of issues within the supply base. Our suppliers, or what I'm hearing from other OEMs, the OEMs seem to be okay. I think it's going to change some things. The big unknown right now is what happens to the end consumer. So we've been working with local governments to make sure the dealerships can get open as well, and you've seen some initial indications of it coming back in China. We'll see what happens in Europe and North America. But there seems to be pretty good order books from the OEMs we've been talking to. There are still a few outliers, Brazil, Russia. They're not big as far as interconnecting with the rest of the industry. They're not big for us either, but we'll have to watch that. So overall, I'm pretty pleased. We -- there's -- we're running scenarios for cash early on. I think everybody else did. And we can talk about that issue we did. But we're in -- I think we've always thought we were in a good financial situation, and we continue to think that. There's going to be some opportunities, but, quite frankly, we wanted to make sure we just understood where things were, how fast we get back to work and what the follow would be and things that I talked about. We have looked at what we think may change, if anything, on the trends for EV penetration. We don't think there's much change. I think ADAS and the advanced, like, Level 3, certainly level 4, Level 5 spending will slow down. The USMCA has now been passed. If anything, that's kind of a bigger impact going forward on sourcing in North America, and Magnus is the biggest in North America, probably almost twice as big by sales than anybody else so that we should be a beneficiary there. And people are still working through RBC/LBC impacts, things like that. But overall, I'm pleased to see a sort of getting back to normal. I'm sure there's going to be spikes as society opens up, but I think our industry is in really good shape with the PPE, the distancing, the protocols we've got in place. So I'll be surprised if anybody moves to shut part of the auto industry production down again, with this to have such a big impact to the government, so I sort of looking beyond COVID at this point in time.

Beautiful. Thanks for this overview, Don. And you probably answered my first 5 questions as part of it, so this is just great and efficient. Just one quick follow-up on this. I was pleased to hear your thinking of the Europe ramp-up is going well. We have heard from a few of other suppliers during the past 2 days, but they were a little bit complaining about start and stops, a little bit of lack of visibility in terms of schedules in Europe and what they could do for efficiency or decremental margin. Is that something you're seeing as well? Or that's very manageable?

I'm not that close to give you an intelligent answer, quite frankly. I haven't heard of anything, which is good. I am sure there's going to be bumps in -- the operations have normally run as a JIT operation, probably trying to fix the schedules. So you don't have people jumping through hoops to -- if there's tight supply anywhere. I haven't heard too much. I think the shift patterns will probably depend on how fast you are buying vehicles. I think short term, they'll -- they have order books. That's what I'm hearing, those with plants that are kind of up and running. So I'm sure we're going to have blips here and there. And I haven't heard of anything big. Will be some inefficiencies probably for a while, but I'm assuming we get back to a steady state pretty quick.

Yes. That's great. And then one more follow-up on the current state of affairs. Have you seen any delays or cancellation of some of your major launches scheduled for this year or future programs?

I haven't heard of anything material. I think some of the outlier products, they may delay. They're going to try and save money. I think this whole situation has been a cash drain for everybody, so I think the OEMs will try and preserve cash where they can. So they got some new specific programs. But for the most part, new launches -- unless they were interrupted in testing because people couldn't get at work. I think engineering kept on going. Or making tooling. So there may be some slight delays on upcoming launches. We'll probably see the impact maybe things we're going to launch a couple of years down the road, and maybe they're fine-tuning what they want to launch. So I've heard bits and pieces, like nothing major, in my opinion. And then you'd say, well, if there is a delay, what's that mean? Well, that, I guess, depends whether you've got higher content on the old model rather than the new model, and everybody would just have to assess that situation. So I think there's going to -- this is going to drive some more pressure in the industry to be more efficient on invested capital. I think we're going to continue to see more cooperation with the OEMs, whether that's on Level 3 spending, Level 4, Level 5, on maybe sharing technologies, common testing procedures to reduce the cost on ADAS-type products. I think you're going to see more consolidation of the supply industry. And I also think you'll probably see less vertical integration of the car companies. They've got to spend their money on new product. And they can get -- quite frankly, they can get more pressure on the supply base and better pricing by outsourcing. So depending on what the rules are with internal workforce as they'll make their own decisions. But I think you'll probably see an acceleration in outsourcing. We've seen a bit of a pullback in global programs the last number of years. Anyway, I don't think all OEMs feel like they have to be in every region of the world. So I think some of the big-picture trends will probably -- some of them don't change and some of them probably accelerate a little bit.

Understood. So let's maybe switch gears to your own outlook, starting maybe with the growth. So your first quarter growth above market was very strong, in the double digits. How sustainable is this looking ahead? Was there any specific temporary factors that will reverse?

Yes. Emmanuel, I think you -- it's Vince. I think if you look at first quarter and kind of adjust it a little bit for where our operations are located, I think if you look at global light vehicle production coming off, and we certainly outperformed that in a big way. But a big chunk of that is because we're underweight China and China was down. I think if you adjust it for where we're actually located and look at what happened to production, production was down. And we outperformed that anyway. We didn't come down as much as the industry did in where we're located, which is kind of what we would have expected. We pulled our guidance because of the uncertainty. But it's -- when you go back to our Investor Day presentation that we did in February and kind of looked at where we were in 2019 and where we expect to be in '22 and we looked at kind of where the market was growing, we had relatively flat market -- flat volumes. We had growth in each one of our segments faster than the overall industry. I think Star might be an outlier because it's got specific programs. But if you look at our Body Exteriors & Structures group, our Seating group and our Power & Vision group, they were all growing overall production. The fastest growth areas will be our Power & Vision segment group because of some of the newer technologies as well as the growth in transmissions and our Seating group.

And I guess specifically over the rest of this year, so I would think the geographical mix that you described sort of like goes the other way in the second quarter with most of the shebang in basically Europe and North America versus China doing quite well. And then curious -- so would you agree with that? And then curious about whether your, I guess, Investor Day framework applies for the rest of this year as well in terms of outperforming the market? Or are there any specific factors here that would not apply?

Yes. I think if you look at overall global production, it's going to depend where production is up or down. But if you look at the relevant markets that we participate, I don't think see any reason why we wouldn't outperform the relevant markets that we're working in and selling things and building things.

Understood. And looking back at the, I guess, the last big downturn in auto, so I think Magna at the time was able to gain some meaningful market share through the downturn. Have you identified any similar opportunities in the market to take business from competition either organically or inorganically?

Last downturn, there was -- a lot of suppliers had overleveraged themselves, and I think they were buying business to flip it and there was a lot of financial players in. I don't think there's been -- I don't think there'll be any bankruptcies and restructurings, so there probably won't be the same opportunities there. I do think the -- maybe it takes a little bit longer, but I do think what I said earlier about the consolidation of the industry and more outsourcing, I think that's going to be a help. But it wouldn't be from one quarter to the next, like, takeover business. I'm sure there's going to be some people that fail for various reasons, but I don't anticipate anything really material.

And what role do you expect, if any, Magna to play in this either consolidation of the industry? Or any interesting M&A opportunities for you in this -- in the current environment?

Well, I think not much changes in our history. While we've historically always had good growth rate, we've always outgrown the market, that's mainly because we're very competitive and we've been spending a lot of money in R&D. And so that's -- hopefully, if we continue to do a good job there, that will continue. Second part of your question was a bit broken up. Are you asking about acquisitions?

Yes. Does the current environment open up some opportunities for you?

There hasn't been a lot of opportunities right now. And typically, the immediate opportunity is if somebody goes into restructuring, there may be some of that coming up. We'll see as everybody has to work through their working capital expenses to get production going again. I do think there's going to be opportunities for M&A. We can -- we've -- we always have a list we're looking at. We really haven't changed our criteria. It would have to be a good financial deal, obviously fit our product strategy and our technology strategy and where they're located geographically, are they going to restructure and et cetera. So we -- there are areas we're interested in. We wouldn't go into product areas we're not already in. It would be more strengthening and enhancing the capability of what -- of the major product lines we're in already. So there probably will be some opportunities, and we'll track them. And we're not desperate to make an acquisition, but if the right one comes up, we have a strong balance sheet. We have -- we have good cash flow. So if there's a move that makes sense, then we have the ability and the interest in doing it.

And one follow-up question from an investor. So I guess they were under the impression that one of the main points of your debt raise was -- that you're looking at either major takeaway wins or M&A. Is that now the case? And if it's not, I guess can you just go over some of the motivation for the debt?

Yes. Certainly. Let me start off. Don, you may want to add something. I think when you look at kind of our capital structure, we've got a philosophy on leverage ratio, which is well understood kind of 1 to 1.5 on adjusted debt -- adjusted EBITDA basis. And if you look past this year, the expectation is we're going to continue to grow sales and EBITDA, we're going to continue to invest organically and we'll also invest in an inorganic way as well, like we've done in the past. Maybe more, maybe less, but I expect we're going to continue to make some M&A transactions. As I look at the balance sheet, we have enough liquidity to withstand a real challenging time. We designed it for that. And I think we're just being a little opportunistic that interest rates were so low. We were able to get a 10-year term. We were able to upsize the deal because it was well oversubscribed. And when you look at our debt profile today after the debt offering, the maturity is spread over a pretty long period, and they're pretty consistent. So we're not really ransomed to a bad time trying to raise some debt. The cost of taking on this debt, less than 2.5%. To me, if I could take the $750 million, put it on the balance sheet, and even if it sits idle for a bit, I'm confident that we'll use it either in the business organically, inorganically, or eventually, as our EBITDA gets up, continue to buy back some stock with the cash we have on the balance sheet.

Yes. That's a great framework. Let's switch gears to some questions on margins. So in the first quarter, you delivered relatively strong decremental margins of 23% or so. I think you indicated that 28% decrementals would be realistic through the rest of 2020. What are -- will be the primary driver of sort of achieving this? Is it -- are you flexing down your costs further? What sort of actions are we talking about to get you to that low 20%?

So you're talking about -- so in Q1, we talked about on COVID-19, decremental margins were about 23%, and we talked about the balance of this year being in the low 20s. And sort of what are the things that are going to get us there? I think, well, a couple of things. A really important factor is where volumes are going to be. We certainly had done a whole bunch of modeling, as Don talked about, and we used different volume assumptions. But if volumes fall completely to 0, and that's an extreme, I think it's going to have a big impact on decremental margins. But I think if you have a more normal-type recovery, I think it's just the actions that are being taken across the organization by our general managers at the plants or what we're doing at the group offices and the subgroup offices. I think it should just drive that overall decremental margin that we talked about. Now there's a couple of things that could impact that mix of business. We certainly assumed Magna Steyr is a chunk of that overall change in business. If Magna Steyr is more or less, that'll have a positive or negative impact on that decremental margin. The second thing is where ultimately sales come out to be, because, as Don talked about, we'll continue to invest in program management, we'll continue to invest in electrification and autonomy. So it's kind -- that's a fixed cost. But if sales come down in a bigger way, the decremental margin is going to have a bigger impact just as a result of those fixed costs. So we're electing not to take the foot off the accelerator because we want to continue to invest for the future.

So just following up on this because I'm fully on board with sort of the magnitude of how it's influenced by the magnitude of the volume decline. But I guess back to your comment of if there was 0 production, I mean, North America and Europe in April, for all intents and purposes, probably had about 0 production and some piece of May as well maybe for North America. And so implied in your comment of low 20% for the rest of the year, that's basically Q2, Q3, Q4, and I'm sure it could be different by quarter, but it feels like Q2 has the potential to be worse, which means that you would actually have much better decrementals in the second half to get to that low 20%. Am I thinking about this right?

Well, I mean that's certainly one situation to think about. I think the other thing you got to think about is what top-up payments have we given to our employees in Q1 versus some of the other quarters with some of the government incentives that we're going to be able to book in future quarters that may have not been booked in the first quarter. And so there's a lot of things going on. And even -- and remember, when we did our modeling, unlike our other forecasts that we've given, they're usually from the bottom up. This was done at the corporate office with some of our staff here. We've got lots of experience doing this. So it's not kind of back of an envelope. It's pretty complicated in how we come up with it. But depending on which model you took and how long the shutdowns were and how quickly you're going to come back would certainly impact the decremental margin in Q2, Q3 and Q4. So I do expect decremental margins will be different by quarter.

Understood. So I guess the adjusted EBIT margin in Q1 was down to about 4.7%. Can you just remind us what your longer-term margin target is, I guess, obviously, post downturn? Any sense of time line of when you think you could achieve this? And I guess how -- where do you need the volumes to be to achieve those targets?

Yes. So let's look where we get for 2020. When we go back to Investor Day, we laid out for the investment community where we thought we could take margins in each one of our segments on a consolidated basis in 2022. And that was based on a couple of -- some significant assumptions. One is foreign exchange. The other was production volumes. The other was the business that we have on hand today, which is substantially pretty well all booked. I think the volume assumptions between '19 and '22 were relatively flat. There wasn't growth built into volumes. And the growth in sales related primarily to new contracts that we've got, and what was driving some of the margin expansion that we were expecting was contribution from higher sales, some of the investments we're making in electrification, autonomy. We're going to start to see some sales. We're going to see some of the additional costs we incurred in '19 and continue to incur in '20 fall away, and that was going to help margins. So we were expecting back in, I guess, the beginning of the year on a consolidated basis to be somewhere between 7.6% and 8%. Let me remind you, on a consolidated basis, we're 6.5% in 2019. So if -- I don't see at this point any reason why if volumes got to where we thought they were going to be in '22, which is flat to 2019, why we couldn't be at the same margin levels that we thought just a few months ago in January. I mean I got no evidence at this point to believe something else. But having said that, we do need to get through our business plan, which we're going to do later on this year, we need to look at volumes, we need to look at foreign exchange and all that and we'll update the market at that point in time.

That makes sense. And so the main driver would be really when could those volumes get back, I guess, to that level?

I mean to get to those -- we don't just need volumes to get to a margin improvement. So let's just be clear on that because there's a lot of things we were doing to drive margin other than just a contribution from higher sales. And we had some operations where we had some inefficiencies. We've talked about that in the past. We've been making progress in '19. We continue to make progress in '20. So that's going to help drive overall contribution. Another big impact is going to be lower engineering and other costs related to some advanced ADAS programs. We've put a big investment in 2019, a big investment in 2020. Those programs are launching in '22, the end of '21, '22, '23. So that spending is going to go down, and we'll start to generate some revenues. So all that's contributing to margin expansion. I still expect that to happen regardless of volumes. I think volumes is just going to help us. It's going to be a tailwind.

Understood. Shifting to cash flow. You're targeting reduced CapEx for the year, 10% to 15% from the previously disclosed target of $1.7 billion. Where do you expect to be making these cuts? Is it more near-term discretionary actions? Or can CapEx be maintained at these levels?

Yes. It's across the board. When you're tight in cash flow and you want to reduce things, you make decisions on things that can be postponed, you may look at the -- and if you don't have a payback in a certain period of time, you can improve it. If we -- it's a whole combination of different things, and this is sort of a ground-up process we go through. So I think our 10% to 15% reduction this year is -- would be my best guess where it is. Is this sustainable? Depends on which business we win. The more we're winning new business, then we always have to hit our return on invested capital targets and our IRR targets. So I think as long as we're being careful on what we spend money on, we have a good product development process and really understand the best manufacturing techniques, we're going to try and -- we'll spend the capital that we need to support the business, but I think that's probably a pretty good range. We can reduce it this year. If it continued to be really tough, we could probably squeeze it out next year, but there are some things you don't want to delay forever. So it's -- it kind of depends on the circumstance we're in. But we've been focused on free cash flow the last few years. I think you can see that in our metrics. And we'll continue to be focused on that going forward.

So let's switch over to some of the technology and products. One question from the audience, I think, specifically regarding to your Magna Steyr business. Do you expect any new entries in the automotive sector that would call for someone like Magna to this -- to build it for them like Amazon or Apple?

To make sure I understand, if you're asking for -- if -- do we expect any new competitors in the area, I would say no. We've got NedCar, which is a very specific situation. We've got a couple of players, but I don't think they're looking to expand. We're a bit unique in that we're the biggest manufacturer and we've got full capability to engineer vehicles as well as launch and manage the supply base. So we have a new joint venture plant going up in China which is part of the Magna Steyr. If the question -- so I don't expect new competitors. We're really competing against in-house operations, and if they have specific vehicles or they don't want to expend capital for new greenfield plants, which I do believe will be the case, they're going to be pretty careful in their cash, and I hope that gives us some opportunities. As far as new customers, anybody who's thinking about getting into, I'd say, mobility solutions that are 3 to 4 wheels, especially if they require paint and their crashworthy vehicle, any new entrants, you would assume they'd go to somebody like a Magna Steyr to help. So yes, I think with the new entrants, more electrification, more autonomous driving technology, then we're going to see new players that we can go after as new customers.

Great. On electrification, which product categories in your portfolio do you see the most potential as it pertains to electric vehicles? Where are you most excited about?

Well, through the acquisition of GETRAG a number of year ago, we have the dual-clutch transmissions. And then we have a hybrid -- one of the reasons we really like the product they had developed was you can easily make it a hybrid by adding the motor. So that's an area which we expect some good growth in. But we've also done a lot of work and we're continuing to do a lot of R&D with some partners on electric rear axle drives and front axle drives and things like that. So we're spending a lot of money in development. I think a lot of competitors are doing that as well. There's a lot of new solutions out there. So it's a combination of areas. But I think if you had to look at the biggest single sales impact, it would be the DCTs and hybrid DCTs.

Yes. So if you look at the businesses we've been awarded, we have been awarded work on the hybrid DCTs, and that's going to be launching. Don talked about the investment we're making in electrification. We do have a number of programs starting up in China through our HASCO joint venture on e-drive systems, and they're quite significant in terms of volumes and as well as revenue. That's not going to show up on the sales line because it's equity accounted, but it's a significant part of our growth then on the e -- electric drive systems for our company.

And the work you're doing on the development side, if they were to materialize into a win in the other regions, those would be consolidated?

Yes. The HASCO joint venture is mainly China. The other wins will be -- the other wins are consolidated. Yes.

Right. A similar question, I guess, on the ADAS side. Where -- which product or technology -- where do you think your -- you have probably the strongest position among the various components there? Or I guess where is the -- your competitive advantage?

Our strength has been both in capability and patents. It has been in cameras, and it's front cameras, rear cameras, surround-view cameras. And that continues to be where our biggest capability is. We have developed the new solid state LiDAR. It's been very expensive to get it to market to meet the specifications, but we -- the customers are quite happy with that. It's low volume, though, in the foreseeable future, but I think that volume will grow. We do have a new radar system as well, and we're quite excited about it. But it's -- we haven't landed a big program on it yet. And we're doing work in domain controllers and other areas like everybody else, but Magna has come from the camera business. That's still our strength, and we continue to build from there.

On the mobility side, I think you recently invested in Waymo. What was the motivation behind that in the context of some of your previous, I guess, tie-up with -- I think you have a tie-up with Lyft, which you've sort of then undid. So just a little bit more color around the investment there.

Yes, we had invested with Lyft, and it was more of a cooperation because we want to do -- we didn't want to spend the money on Level 4 and Level 5 sensors and all the technology, software associated with that. We worked with them for a couple of years. Became -- I think the volumes in Level 4, Level 5 are a long way out. The technology is coming along, but it's very difficult. And the technology that's being utilized in sensors for Level 4 and Level 5 are different than the technology for Level 2, Level 3, which is where we're concentrating. That's why -- and we were expensing the money we were spending with Lyft on an engineering standpoint. So we decide we want to focus more on Level 2, 2.5 and up to 3. So that's why we still have a good relationship with Lyft, and I think it was a very good -- we learned a lot from it. We still are open to work with them on anything, and I think they'd say the same thing. We made the investment in Waymo and more of an equity investment. We don't typically do that. But Waymo can say what they want. But we've been doing work with Waymo. We're already doing some conversions. We have the ability to modify vehicles through our Magna Steyr. We're very interested in seeing where that industry grows -- goes, what -- is there any opportunity for us to be working on the full sensor suite package, maybe sensors, but they're putting everything together, integrating into the vehicle. And so that's why we're doing that. We're not expensing money in our P&L for that. It's more watch what they're doing and taking advantage of what we're doing from an engineering, from a Magna Steyr perspective at this point in time. But we're hoping to grow that.

Great. I think we're close to about fresh out of time. So Don and Vince, I really want to thank you so much for joining our conference, for all the insights, being with us this morning. I want to thank everyone on the line for participating, for your good questions. And stay with us. We have the management of Lear Corporation up next in exactly 10 minutes. Don and Vince, thank you so much again.

Thank you.

Thank you.