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

Hi, this is Ryan Brinkman, the Automotive Equity Research Analyst at JPMorgan. Thanks, everyone, for joining us at the 2020 JPMorgan Automotive Conference being held virtually this year. This track is audio-only. You can submit a question, if you like, to management via the conference website, and I will be happy to ask that question for you on your behalf without identifying you by name or firm. So with that, I think we're ready to get going with Magna International. Very happy to have with us today Don Walker, Chief Executive Officer; Vince Galifi, Chief Financial Officer; and Louis Tonelli, Vice President of Investor Relations. Thank you, gentlemen, for joining us.

Thanks for having us.

Great. I don't know if you have any introductory remarks. Can I launch right into the Q&A?

Yes. I think you can launch right into Q&A. We released our results last week, and we had the investor call. So we think we covered most of the -- most things there, just go right into the Q&A.

Exactly. And I think, obviously, what's top of mind includes the impact of coronavirus. So I wanted to ask a few questions around that, starting with the impact -- the longer-term impact that is on profitability. Going into the financial crisis in '08/'09, profit margins for suppliers really compressed. But then they have rebounded to levels above prior levels coming out of the downturn as the industry normalized. I'm just curious this time around, as you think about the extra costs included with coronavirus including possible supply chain compression, I'm not sure. On the other hand, learning to be leaner. Just how do you think that shakes out for trajectory of margin for the industry overall in the current crisis and then for your company, in particular, as we eventually move past the present situation?

I think it's hard to say. There were some costs associated with the -- and ongoing cost as well associated with protecting employees in the plants, but the biggest chunk of that would have been in Q2. There's some costs going forward that are not material costs. I don't think there's going to be major changes in supply chain within the industry, depending on what happens with trade and tariffs between U.S. and China and place like that. So there might be some shifts around it, but some of this was happening anyway. So from a pricing perspective, I don't think much change. It's a pretty competitive industry. We continue to do all of our launch preparation and our innovation, working on a lot of manufacturing. So we, as I assume, a lot of other people will look at it -- take the opportunity or you force take the opportunity to do the restructuring that was planned, pull it ahead and do some extra belt tightening. So to that extent, we probably -- although it was painful in Q2, that will help us going forward. I don't want to project what the margins will be. It depends on how fast the industry recovers. One thing which was happening anyway was the revised NAFTA, the USMCA. That's done now. I don't know what the full impact will be on all of our customers, getting to the point where they've got the right amount of content that they need in North America, but that should certainly help Magna. We're the biggest supplier by probably a factor or 2 in North America. And the more that -- and also, there's some resolution as far as getting product across the borders from Mexico and Canada, and we've got big operations in both countries as well as the U.S. So I think that will be a benefit to Magna. We just have to see -- it's hard to quantify at this point in time. That should help.

I see. And then maybe just a similar question, but about capital allocation. Does the coronavirus crisis caused you to think any differently about capital allocation? For example, how are you thinking about how much capital cushion is appropriate, what the right debt-to-equity level is or the right amount and timing of return of capital to shareholders?

Yes. Our capital that we look, The Street know what our plan is. It's basically based on our business plan and it's a ground-up plan. That's come down a little bit, and that's not -- that wouldn't be unexpected. Some programs are delayed a little bit. The -- it tightened belts, obviously, when we have this much going on in the industry. But the capital, to the extent we continue to win business will, I don't think it changes a lot. We already updated our guidance, and we reduced what we thought we would be spending, but it won't change a huge amount. As far as our debt to adjusted EBITDA, that shouldn't change. The -- we're outside the target range now just because what's going on in Q2. But unless something changes, we think it's appropriate level. If anything going through this downturn, it showed we have a very strong balance sheet. So nothing will change there. We've continued with our dividend through the coronavirus, and we -- that's -- we've been doing this for over 10 years now, making sure we have sort of a continual step up, so people can understand that. We stopped the buyback. I think we'll have to wait and see what the volumes look like. We have an internal plan. We've discussed it with the Board, but like to see where the volumes are. We're in no rush to continue to buy back now, but to the extent we're not spending the money on acquisitions, then we're going to have the ability to continue to buy back at the appropriate time.

Yes. Ryan, it's Vince. Just to add on capital structure. We thought hard and long for some time on what the right capital structure is. And if you recall, our focus is ensuring that we're a high investment-grade rated company. So we have access to the credit markets, withstand any shocks of the system like COVID-19 and have the flexibility to do things with the balance sheet, if we had to, if there's a good opportunity. And I think as I look at COVID-19, our strategy has played out extremely well. I know we're over our kind of target ratio of 1 to 1.5x adjusted debt to adjusted EBITDA. That will come back on side real soon once we get through Q2 2020 from going into our 12-month calculation. So I don't see us changing our overall philosophy with kind of 1 to 1.5. Where you sort of sit in that is going to depend on the opportunities that exist, how comfortable we are with the macroeconomic environment. And how we stay within that overall target range is what we've done in the past is you buy back stock when you've got excess liquidity. And if you need liquidity, you shut it off. And then you can do other things with your cash resources. And so I really like it because it gives us a lot of flexibility. But at the same time, responsible with the capital that we have on the balance sheet. So if we're not using it and it's piling up, let's return it to our shareholders so they can reinvest it in whatever they like to reinvest it in.

Okay. That's helpful. And then just maybe lastly on coronavirus. I wanted to ask what impact you think it may have on the type or pace of technological change within the industry? Does coronavirus speed up, slow down or have no effect, do you think, on pre-existing trends, such as electrification, autonomous driving, et cetera?

I don't think there's too much of a change. I think of the push towards the sustainability and fuel economy targets and pressure from not only the general public and the governments, but also the expectations of the investment community is for companies to be doing the right things. It pertains to global warming. I think the -- so the pressure will be on for people to provide electric vehicles. I don't think there's anything that's changed that would say that the end consumers are going to buy them any faster than they would have before. There's still more money and people are looking to pay back in the price of gas. There's lots of levers that impact that. But after having said that, our projections for what we thought the penetration rates of electric vehicles by 2025 and 2030 really hasn't changed much. It changes slightly by region. I think there's a bigger push in Europe. So I don't think that changes the -- I think new mobility trends probably hasn't changed because of the coronavirus. You look at the number of people taking ride hailing and safety precautions and cleaning the interiors of vehicles. So there'll be some changes there. Probably too early to tell what the long-term impact will be. The one thing I think will be slowed down is the aggressiveness of the car companies, all to spend as much money as they were on Level 4 and Level 5 autonomous driving. And to some extent, even Level 3 because it's pretty difficult when we get into the details and testing and verification. I don't think it changes Levels 2, 2.5 because that's a consumer pull. And I think part of the reason the car companies are cutting back or doing more cooperation agreements on the Level 4 and Level 5, I think the market is relatively small. I think it's further out than most people were saying publicly. It's probably still in line with what we have been projecting for the last couple of years. And the car companies have to prioritize where they're spending capital. And I think they're spending more of it on probably electrification in Level 2, 2 plus than beyond that in Levels 4, 5.

Okay. That's helpful. I thought to ask around your complete vehicle assembly business. When it was first formed, it seemed a bit of a niche arrangement within the industry. In recent years, though, there's just been this explosion of start-up battery electric vehicle manufacturers looking to speed time to market by outsourcing production. I spoke with, as part of this conference earlier this morning, Henrik Fisker from his balcony overlooking the Pacific Ocean as the sun was rising. I didn't want to get into great details there, but we've seen this also in China and elsewhere. Just curious what you can say about the trend here, if there's anything you can say about Fisker, and then what have your discussions been like in China after you announced that you build a facility there. Are the automakers coming to you? What's going on?

Well, quick history. We bought Magna Steyr years ago.

'98.

Yes. Okay, 1998. And we bought it because they've got a very, very strong engineering -- product engineering, and they can program, manage, launch a complete vehicle as well as they have the assembly capacity. Our view is that the carmakers try to minimize their capital outlay and focus their spending is when they have small volume vehicles or unique vehicles that they don't have the people, they don't want to be spending the money on. They can go to Steyr. We've got a great reputation of being able to bring vehicles to market quickly, very high quality. And we got the most flexible assembly plant in the world, types of vehicles we make and the number of vehicles we can put down in the same line and through the paint shop. So there's been lots of speculation going back 6, 7 years ago. There's going to be all these new entrants and they're going to be spending -- they're going to be making lots of volume. We said publicly about 5 years ago, don't count on a lot of new entrants that's coming in [indiscernible]. People look at Tesla as being a relatively new player. They've been around for 20 years. But the one thing that I think has changed is the focus by our customers on trying to get return on invested capital up and where they're spending their money makes them, I think, take a hard look at what they should be outsourcing as a way of engineering and manufacturing. And if you look at the success rates of the new entrants, when you look at an internal combustion engine, it's extremely difficult. But as you move into electric vehicles being more competitive than they were years ago, it's probably easier for a new entrant to enter the market if they can get a, call whatever you want, skateboard, a system. Magna has got a complete system for electric vehicles, not the batteries, but everything else other suppliers do as well. So I think we're looking at it more seriously when new people say they've got -- they've raised the funds and they're going to try and come to market. So I'm not going to comment about any company in specifically if Fisker wants to say what they're doing, that's up to them. If you look at China, we started a joint venture there. We have a joint venture in engineering and a joint venture on the assembly with -- it was a brownfield plant, but we've expanded it. We're just launching the vehicles now. And we have a platform there that others could use. So that would be interesting, I think, to start-ups. If they don't have to engineer a new platform, they can put a new body around it. We can do that. So I think there's lots of potential there, but these things take a number of years to come to market. We can come to market very quickly, but still from concept to getting something out there, it's usually 2, 3 years, depending on what they're starting with. But we had good results there. We think we've got great capability, and we're excited about that business.

Okay. Very helpful. Next, I wanted to ask about the potential for M&A. Many parts suppliers are probably thinking more about shoring up their balance sheets these days rather than M&A. I'm curious, though, with your relatively less-levered investment-grade balance sheet, whether you may look to take advantage of the current situation by purchasing distressed assets or maybe not distressed assets, but attractive ones at lower prices? Or is the current environment still such that it is best to kind of stay focused on execution rather than be distracted by M&A? How are you thinking about that?

Well, I think in this time around, we haven't seen as many distressed suppliers where people going into bankruptcy protection. There may still be some, although most people seem to have come back and got through their working capital crunch. May be we see some followed, I guess, but our supply base seems to be fairly healthy. So that's an indication. I don't think there'll be a lot of people like the downturn in the financial crisis. We have a -- as we talked about, we have a pretty strong balance sheet. We used a lot of cash in Q2, but from a working capital standpoint, a lot of that's going to come back. So we're comfortable with the position we've got. We have the ability to make an acquisition. I think it would have been difficult to do any acquisition in the middle of COVID for lots of reasons. You can't travel and any public companies, I think, would be -- unless they were in desperate shape would be pushing back on it, getting back to more normal times. So there'll probably be some opportunities. I think the consolidation of the industry is going to continue. I think the big global suppliers of technology will continue to win business. And so I think that's -- that will still drive M&A. I still think the parts industry is growing because the OEMs, I personally believe they're going to be focusing their capital. So we'll probably see more outsource, especially with this new types of powertrain. So I think there's going to be some opportunities. Yes, we're focused on the business, but we've got lots of capability inside the company. We'd be typically looking for technologies that fit our product strategy in things like electrification, powertrain. There's good opportunities there to get technology or potentially some new customers or geographic strategy. But also, if we get somebody who's got capability and they're really undervalued and it creates value for us, we would also look at buying something if it was at the right price. But I'd say we're going to be fairly disciplined. We are seeing some opportunities out there, and we'll look at them and assess them.

Okay. Great. And relative to -- pivoting to electrification, could you just remind us of your average content per vehicle on internal combustion powered vehicles versus hybrid versus battery electric vehicles? And at your Investor Day earlier this year, you mentioned you expect to become one of the top suppliers in the electrified powertrain systems space. Can you just talk about what gives you that confidence? Whether the pieces are all already in place or if you need to maybe organically or inorganically fill out certain parts of the powertrain portfolio?

Yes. Coming up of average content is difficult, but we have taken our best guess at. It depends on the type of vehicle and sort of trying to take an average vehicle with average content. If you look at our content opportunity in the powertrain area for internal combustion engine, it's just under $2,000, say $1,900. If you look at the full EVs, we move up to about $2,300. 48-volt hybrids would be about $2,500. And then if you look at high-voltage hybrids, it gets up to be about $2,900, but that's our best guess. And as I said, there's lots of variance within that. We have been a leader in 4-wheel drive and all-wheel drive and in transmissions -- dual-class transmissions, which is very popular, sufficient. We've also got the hybrid version of that, which is -- we think, is really interesting product. We continue to develop product in the electrification space, but there are some building blocks in the system that we would be still -- we'd like to strengthen. We can do that through acquisition. We can do it through a partnership. So that continues to be a focus. There's a lot of competition in the full EVs. I think it's going to have some consolidation. A lot of people have been pouring a lot of money into it, but -- we are as well, and we're confident in our ability to grow that business.

Okay. Great. And then just on lightweighting. I think another way, your business is tucked by electrification is the focus on lightweighting, which is important for internal combustion engine powered vehicles also to reduce emissions and comply with regulations, et cetera. But I think for electric vehicles, it takes on an extra importance because of the impact on range. So how do you see the growth of electric vehicles impacting not just your powertrain business going forward, but also body and chassis? And when we hear about things like growth in hot stamping, aluminum casting or thermoplastics, can you just sort of tie that back to what it means for you from a content per vehicle growth or a market share perspective?

Yes. I'll make a couple of comments and see if Vince has anything to add. But you just talked about the areas that we have a lot of capability in hot sampling. We have a number of competitors that are starting there, aluminum die casting. We've got lots in the thermoplastic area. We've got full tailgates with a lot of technology. So we have a lot of lightweighting technology. We've also got aerodynamic products, which help fuel economy. And as you look at the shift from internal combustion engines to batteries that the weight in the vehicle shifts. So the customers will typically look at on a platform, where do they want to reduce the weight because fuel economy is important. So lightweighting is also important in the internal combustion engines. And then they'll figure out how much they want to spend per kilogram or pound of reduced weight. That usually drives the decisions. But we continue to see a lot of interest from our customers, and we're seeing good growth rates in all of these areas. And when people talk about what's going to happen, most people are talking about the change in the powertrain. It will continue to move to electric, probably long term to hydrogen, but it's a pretty slow transition. And things don't happen in a 2- or 3-year period. And then there's been a lot of interest on autonomy, as you said, Level 4, Level 5. I think it will be very small volume and further out there. But if you look at the core of the vehicle, no matter what the vehicle is, as long as it has to be crashed and even when it does have to be crashed, quite frankly, you still have to have a body, you have to have seats, you have to have interiors. So mirrors and latching systems, a lot of electrification trends, and a lot of these areas, a lot more content. So if you look at our product lines, you almost need to break it down, and we see growth in particularly all of our areas. It's not just in the electrification and the powertrain. And sometimes, we look at it and say, okay, we're spending -- how much money we're spending, what's returning going to be once return going to be. It's quite often, we're getting better business cases to invest heavily in our core products because they're not going away, and we're very strong in those core products.

Okay. And then maybe switching to ADAS. Within electronics, last year, you generated more than $0.5 billion of ADAS revenue. Have you done any work around where you rank in terms of ADAS sales? And sort of similar to the question on the electrification portfolio, after entering into partnerships on the LiDAR side, et cetera, would you say that the portfolio is where you want it to be? Or are there still gaps there that you're looking to fill?

I think from a product offering standpoint, we are not as far along as I'd like as far as winning contracts, but we are bringing our -- the first LiDAR production to market, it's a solid state, I think we're the first ones bringing that to market. It has been extremely difficult hitting the requirements. And I think a lot of the OEMs and the supply base, you're seeing the difficulty in making -- and actually get into a full Level 3 capabilities that have highway driving speeds, et cetera. But we like the technology. So if anything, we want to continue to do what we're doing in LiDAR. I don't want to take on a lot of new programs, quite frankly, until we see -- until we can make the good returns, and we got all the testing under our belt. But LiDAR, we're -- we've got the capability. Radar, we've got a very interesting radar. We're still doing the development. We haven't landed any big contracts in automotive, but there's other applications that we're very excited about the radar. But I'd like us to get some contracts. So we have more critical mass in that area. We've been looking at various things there. And cameras, we're already one of the leaders. And then there's a few other areas which we continue to invest in. We kind of do it through a partnership or with somebody else like domain controllers, things like that. So as far as the ranking, we're -- I'd have to get the sheets out. We -- our focus, quite frankly, has been on, let's get the capability, let's execute the contracts we've got because as we've been publicly spend a lot more development money on some of the programs last year and even through this year because it is launching through the end of this year. Let's be careful what we take on, make sure we've got what we -- with the building blocks to grow, but let's not take on too much. So I'm not too worried about the size we'd be. There's, I don't know, 7, 8 people in this space, various sizes depending on whether you're talking about radar or LiDAR -- LiDAR is very small, or cameras. I don't know coming ahead where we rank in that, but we'll be probably in the middle of the pack somewhere.

Okay. Great. There's been a lot of discussion on the supplier earnings calls this quarter about the different cost actions that suppliers have taken to try to limit decrementals this year and how much of those are temporary austerity versus more permanent in nature. Now last Friday, you provided an outlook for 20% decremental in the back half. I think that exceeded a lot of investors' expectations. So just sort of along those lines in terms of the permanence of some of the cost saves, et cetera, what, if anything, can investors read into how incremental margins may track in 2021 from the better decremental performance in 2020?

Ryan, it's Vince. I'll answer that question. So when you look at our outlook for 2020, the implied decremental margins for the second half of this year is actually less than 20%. You remember at the end of Q1, when we talked about what we saw decremental margins would be for sort of the last 9 months of this year, we thought it would be in the low 20s. We're tracking a little bit better. And a big part of that is due to the initiatives we've taken on restructuring and rightsizing the business and looking at our fixed cost structure. Certainly, people were laid off and some people were let go. And I view some of those as just variable costs. As production comes up, we'll bring those people back on. But I think around the organization, we did a good job of taking a step down in cost structure, really to reflect the reality that volumes are going to be softer in the short to midterm. So overall, we took about $150 million of restructuring cost in Q2. There's probably going to be some dribs and drabs for the balance of the year, but nothing really significant. And we'll start to see the benefits of that in Q3 and Q4, but we won't realize the entire benefit until we get into 2021. And once we get there on an annualized basis, the $150 million investment we're making in restructuring should yield about $200 million in annual savings. And that translates to about a $4,000 or $5,000 reduction in head count that we don't think is coming back. So I guess if you fast forward and you look at 3 or 4 years and bonds start to pick up again, I'm sure our fixed cost structure is going to have to adjust. But in the midterm, I think we've got enough people in place to deal with the business coming on.

Okay. And just a couple of minutes we have left here. I'll try to squeeze one in on cash flows. 2Q earnings were pretty in line. Cash flow was softer. You talked about a bigger investment in working capital, although it seems maybe a little bit bigger even relative to most of the other suppliers this quarter. Can you just talk about the reasons for that bigger use in 2Q and then visibility into and timing of the recovery of that investment as well as just the outlook for cash flows generally in the back half here?

Yes. So we've put about $900 million into working capital in the quarter. And recall, we came into 2020 with collecting about $200 million of cash in Q4 of '19, that was going to -- we thought we were going to get in 2020. So part of that is timing between the years. Some of the things that impacted us was some delayed payments from our customers, and we got that money back in July. Even our taxes, some from tax payable, tax receivables, so that creates some working capital. The government program receivables, so we got the benefit of that running through P&L offsetting some of the costs for inactive labor. But we got a pretty significant receivable on the balance sheet. And so when you look at delays and payments, taxes, government programs, that's about $500 million of the $934 million. And the balance of that just relates to restarting operations. Recall, Q1, we generated cash from working capital. If we go back over time, we make a pretty big investment in working capital in Q1 and Q2. So Q2 is a little of a catch-up for us. So as I look to the balance of this year, you get to the end of the year, depending on whether you got receivables coming in early or late, we should be able to get most of it or all of it back by the time we get to Q4 of 2020.

And what's implied is between $1.3 billion, $1.5 billion for the back half of the year.

All right. Really appreciate it. Looks like we're about out of time here. So thank you so much for joining us today and all that great color. I appreciate it.

Sure, Ryan. Thank you.

Thanks, Ryan.