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

All right. Thank you very much, everybody. Thank you for joining us this morning on the 10 a.m. session here at our CIBC Eastern Institutional investor conference. It's my pleasure to have with me this morning virtually the Magna team. With us from Magna are Vince Galifi, EVP and CFO; Eric Wilds, EVP and Chief Sales and Marketing Officer; and Louis Tonelli, Vice President, Investor Relations. This will be a fireside chat format. So we have a bunch of questions online, we'll go through. But for those on the line, there is an app for you to ask questions as well. And for those that type one in, I will get to those on the app here. But Vince, Eric, Louis, thank you again for joining us this morning.

Maybe I'll just start off with more of a macro question in terms of how your operations are performing. Back in August, we noted your facilities in North America and China saw capacity near where it was pre pandemic. Europe was lagging a little bit. Where do you think sit here today? And given the rising COVID-19 cases in certain jurisdictions, are you seeing any supply disruptions, any labor shortages? If you can give us an update there, that would be great.

Yes. Good morning, everyone. Thanks for having the team here. I'll tell you, I'd rather be in Montreal than in Aurora. And Eric I'm sure you'd rather be in Montreal than in Aurora, right? It's taking some time to get used to what's been going on. So yes, you're right, we did update kind of back in August with our results kind of where we were in North America, China and Europe. It's fair to say, I don't really have an update as much time hasn't gone by. But what we said back in August is as we look at North America, North America was ramping up. We continue to ramp up for the balance of this year. Pretty strong [indiscernible] levels are at some good levels. China had bounced back pretty well, in good shape, a little bit less than kind of where we anticipated, but fairly strong as well. And if you recall back in August, we said Europe was softer, but I think you got to take that into context. Coming into 2020, we're expecting a softer Europe with all the things going on in Europe. And the comeback hasn't been as quickly as kind of we would have expected when you look at the bounce back in North America and Europe. With respect to COVID cases, we all look at the numbers, and certainly in certain jurisdictions, the numbers have been moving up more recently. I'll tell you what we've done in our organization. We developed this pipe up back in -- we started working on, I'd say, February, March time line and figuring out how to get employees back to the plant floor and to our offices safely? How we would work with our suppliers? How we would track our suppliers? And I think that went off extremely well and successful. And what we more recently started to focus on is our playbook to -- or an update to a playbook in the event that there was a second rising of COVID and how will we deal with our plants, our employees? How will we deal with the supply base? I haven't really heard a lot of noise about having issues with suppliers or with our employees, employees not showing up for work. I know that we have been really accommodating to employees, and they have some personal commitments that are challenging for them. So I know we've been working with them. It's not as smooth as it's always been. But I haven't really seen that impacting our operations so far.

That's a great update there. One of the things we saw with your second quarter results as well and some of your outlook was -- I know -- the incremental margins that were better than I think a lot of people would have expected. So you had a good Q2 showing, I think, in the high -- low 20% range. I think you're guiding to better than 20% in terms of decrementals in the back half of the year. Maybe speak to some of the drivers that are resulting in margin performance that's probably outperforming what people would have anticipated given the volume declines? And what that means for incremental margins as volumes do start to return here. Do you see that being a nice tailwind?

So when you look at just kind of '19 and '20, there were things that we were expecting from a margin performance standpoint. You'll recall back in '19, we had some underperforming operations in our Body Exteriors & Structures group, we talked about Seating. And we have been working on those in 2019 to improve overall margins, and we're seeing the benefits of that in 2020. So that's carrying one. We also talked about our Lyft investment in our Lyft spending, in particular '19 going away in '20. So that was something that we were contemplating. And there was some restructuring that we had already booked into the plan. But kind of I sit back and look at our business in Q2 as well as the second half of this year, I think there's a couple of things that really stand out on the positive side. One is, I just think everyone across the organization with decentralized operating system just control down. And what do we do? I mean people get paid based on bottom line results, just like we saw in the great financial crisis. And there's just a lot of things that are going on. We're looking at how we've done things and should we do things differently. So part of that restructuring what we've done, which is incremental to what we were thinking, is just looking at the business a little differently. Looking at our processes. We have the time to kind of sit back, and we kind of -- the business grows and grows and grows, and this gives us a time to kind of pause on what we're doing. And we've been able to have some real cost sale. And the question I kept on asking was, okay, are these costs would come back as volumes pick up? I was assured that the numbers we've been talking about cost completely out of the system. One group, I would say, in particular, that kind of stands out and we look forward as a separate segment is our Magna Steyr group [indiscernible] assembly operation. Frank Klein, relative new President, had really focused on looking at the cost efficiencies in that business, and that started off in 2019. And we were expecting and built into our original guidance and improvement. But his performance there and that group's performance has been extraordinary. So that's going to continue. We've also benefited a little bit from mix and Magna Steyr, that's helped us. So I think when you kind of put that all together, that certainly helped us on a margin perspective. When you look at incrementals, we really haven't given an outlook on incrementals. We have been focusing on decrementals. I just say pre and post COVID, if we were at the same volume model and a same mix of business, that our margin should be higher for some of the reasons that I already talked about. But it's certainly depend on volume and little bit mix.

Right. That makes sense. Maybe just turning to what you're seeing from governments here. I think we've seen a number of jurisdictions look to accelerate certain green initiatives as part of their fiscal policy. And one of those items is EVs and electrification. I think Magna has been pretty consistent in how you view the adoption of EVs and probably the most right versus a lot of other forecasters out there. And so maybe there's more of a question for Eric. How -- is there any change in EV adoption expectations pre and post this pandemic? And what you're seeing out there in terms of bidding or what OEMs might be looking to do coming out of this crisis?

Yes. Thanks, Kevin. You know what, when we look at the EV penetration rate, we had our forecasts that were pre COVID, and we see those holding at this point. The incentives, for sure, are encouraging the general consumer to buy the electric vehicle. So you see that in Europe, you see that in China, those incentives. So it is creating that market demand. As well as other legislation, like, for instance, in Europe, where they have their CO2 requirements and OEMs have to try and maintain a certain level of performance over their whole fleet. So when we look at the EVs, we do see it may be accelerating a little bit. But it's kind of continuing down the same path. And we're also, I think, as an industry, are continuing to work on the development. And then I think to your point, from a competitor side, I think the auto industry, in general, is a competitive place to do business. And so while we have challenges on investments and things, if anything, you see maybe some of our customers, when you read recent announcements and things that are public, as they work to try and mitigate some of those investments, they're looking to try and share different things across companies or across platforms. But from a general standpoint, I'd say it's within our normal stream of business and kind of meeting the expectations of what we've been working towards.

Right. That makes sense. If I think of -- and maybe, I'll kind of combine these questions. I suspect you've heard this, and obviously, we've heard it as well. This perception that electrification could be margin dilutive to Magna. And I think it's been clear you have a lot of products to make it competitive during this evolution here. But do you see that as a risk within your powertrain division that the continued penetration of EVs is a margin headwind for your powertrain division?

Kevin, I guess you have to ask like -- I was just going to -- overall time frame. Are we looking over a short period of time, are we looking over a longer period of time? And one of the -- one question you didn't ask is what happens to returns on capital. So if you think about kind of our electrification strategy, and it's going on in a couple of places in the organization. We've talked about this for some time as what's the level of vertical integration in our business. And what we've said is, as we started off, if we're going to be understanding the technology, make sure we can put them all together, design it. But I think when you're looking at some of those current components, we said we're probably not going to make the investment and think of it more outsourcing versus in-sourcing. And as the business continues to grow, to look at some of the more critical components to vertically integrate that. But when you move from little vertical integration to more moderate to a normal vertical integration, that's going to have an impact on overall margin. The more we vertically intergrade, the higher the margin is going to be. And what our task has got to be as we move along that and we gain capabilities and positions ourselves with the customers that we continue to generate the appropriate returns. So that's kind of key. When you look at the time frame on electrification, it certainly dilutive in the short term, for 2 broad reasons. First is, we're investing in what I call core platform technology that once you've got to develop, we're going to be able to leverage that with a number of OEMs. So from an accounting perspective, that's all being extense. It's not like providing induction mobile pricing and if we put on the balance sheet, we amortize it over a period of time, you get hit day 1. So as that core technology has developed, we leverage -- we're going to continue to build on that when we get revenue. You'll see the impact of that being positive on margin as that becomes smaller as a percentage of revenue. I think the other thing to keep in mind is that I'm looking at whole stuff from an electrification standpoint, where we're spending money today on application engineering, capital. If those programs are not starting for 2, 3 or 4 years out with volumes really ramping up. So we're penalizing our P&L today. So that's why I said, I think you should look over a longer period of time and this revenue starts to come online, if margins go back, approach a more normal level. In any particular period, the good news is we continue to win business. The bad news is as we continue to win business, we got to be more application insurance, so that's a negative of overall margins. But when I look at the business case, it's actually a decent look forward on electrification for us.

I would just -- I would just add that we're talking about EVs here, but there's a big chunk of hybrid, right? I mean, there's actually more growth in hybrid group, if you will, in the next 5, 10 years than EV. So that's an important area as well. And of course, we have the hybrid DCT which is a growing area for us.

No, that's a great point, Louis and maybe dovetails into -- I want to touch on maybe a growth opportunities in China. It's roughly 5%, I think, of your consolidated sales, maybe a little bit higher on an unconsolidated basis. It seems like you have a lot of things on the go there. So if I could just kind of knock a few of these off. So maybe first off, you'll have a joint venture with BAIC to begin producing EVs in, I think, late 2020. And I think the capacity is for 180,000 vehicles per year. Maybe if you can just provide us an update what the timing of this production facility? Has it shifted at all given the pandemic? And then just talk about medium to longer term, the opportunities to expand your complete vehicle manufacturing in China, it does seem a competitive advantage for you. Is this a significant growth lever in that market?

Yes, Kevin, in terms of kind of the ramp-up. So remember, we developed a platform to our engineering joint venture with BJEV. We consolidate that and that company is the biggest producer of vehicle. The first of these vehicles is launching on that is 10 new vehicles that are launching over some period of time. The volumes are so low, I mean was there impact by COVID, okay? We're not giving -- the numbers are so small. This really is -- and I think we -- if we look at the program, we're pretty well on track. I think when you look at Magna Steyr in China, even broader than China, right? We think Magna Steyr is an enabler for our overall business on a component side. But if I just focus on Magna Steyr, in particular, in China, as we continue to ramp our business in the BJEV joint venture, if we do have some capacity that's not being used, we do have the ability to take out some other opportunities within that joint venture as part of the discussions that we're having with our joint venture partner. So we look at China. We look at BJEV with Magna Steyr, and we're excited about how we're positioned and an important market for us. Because we have been focused on growing more in China with all efforts, including Magna Steyr.

And on that point, you recently signed an agreement to acquire the majority of ownership in HLZX, which will just expand your seating capabilities in the Chinese market. Can you just speak to the strategic rationale? Why now the strategic rationale around this, I guess, this acquisition to kind of bring in the rest of the JV? And is Seating a core focus for your growth in China? Is that something we should be reading out of this?

Yes. So you know what, it's probably easier to say Honglizhixin than the initials, HLZX. That's what I will refer it, please. So maybe just a little bit of background, right? So we have an existing joint venture, and I think we've got a couple of operations there. And one is just in the middle of start-up. And when we looked at our partner, they had an additional 10 Seating facilities. And then you've had the capabilities on the foam side, the trim side, the structure side. And as we were talking to them, we ended up joining forces and taking control of not only the joint venture with the 2 facilities, but the additional 10 facilities. So that gives us a broader presence in China. It gives us more exposure to the Chinese OEMs. And we should be able to leverage that scale and that critical mass to continue growth Seating in China. Remember, we do have a number of other relations -- a number of other operations in China, but this is certainly going to help us to grow. We'll have increased vertical integration. We'll have total engineering and testing capabilities. It just broadens our capabilities in an important market. I would say that, look -- you asking about the Seating, China has sort of a core strategy for Seating. I think that China is a core strategy for a number of our groups and you think about what we're doing on the our Cosma side or what we're trying to do with Exteriors, or even with mirrors, for example, what we're doing with Magna Steyr. And the Seating, we've been underrepresented. And I think some of the things we've done over the last couple of years through transactions and through program awards, certainly has put us on the map. And now we're going to continue to take that base, grow our presence in a pretty important market for us.