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

Thank you, everyone for joining as we continue on the CS Global Industrials Conference, the Autos track. I'm Dan Levy. I lead equity research coverage at Credit Suisse and very pleased to have join us, as we continue on the Autos track of the conference. Magna International, one of the largest Tier 1 auto suppliers globally. And on with us -- on the line with us is Vince Galifi, CFO; Louis Tonelli, who heads Magna's IR efforts as well as Jim Floros. I think Vince is going to give us some opening comments, brief opening comments, and then we'll run through questions. To the extent you have any questions you'd like to address, please e-mail me dan.levy, D-A-N dot L-E-V-Y, @credit-suisse.com, and I'm glad to address them to the extent possible. But with that, Vince, Louis, Jim, thank you so much for joining.

Thank you.

Thank you, Dan, and good afternoon, everyone. Thank you for joining the session. Maybe I'll just start off. We reported numbers not that long ago for Q3 and kind of reflect on our performance in Q3 and I thought it was pretty strong. We came back with some good growth in operating margin and sales and some of the rightsizing actions that we took in the second quarter certainly paid off handsomely. We also updated our guidance for the year. We moved up sales, margin and the amount of free cash flow this business is going to generate for the year. That's all positive and based on that guidance, if you kind of look at implied Q4 results and compare that to last year of 2019, we're assuming in North America and Europe, that production volumes are going to be down year-over-year somewhere between 4% to 6%. But we're guiding sales. When you look at the range of sales guidance, it could be up to -- up 11% from a year-to-year or flat so that's pretty good. And stronger EBIT, stronger net income and between $550 million to $750 million in free cash flow. We're not out of COVID yet. I'm hopeful that globally, we'll move out of this real soon and get back to kind of a more normal course to state for business in our industry and across the globe. So Dan, do you want to maybe fire away with some questions?

Great. Yes, and thank you. It's a good open. Let's maybe start with a question that we've been asking everyone else. Let's just start very near term. Obviously, we've heard about rumblings in terms of COVID disruption to the supply chain, be it in Mexico, be it in Europe. Maybe you could provide some color or context what you've seen, the types of supply chain inefficiencies, if it's more pronounced in any one place. And how much of this is embedded in your outlook for 2020?

Yes, Dan. So when we got into COVID, we stepped up our review of our supply chain, looking at certainly, whether they're going to continue to be able to support us and whether our suppliers were financially strong. And we've dealt with some suppliers that we were concerned with. I think when you look at kind of what we've seen so far in Q4, we've seen some hot spots in Europe, primarily. But nothing noteworthy that we haven't been able to manage to this point. And I kind of look at Europe generally with a lockdown that have been placed, that have been a lot more predictable than what they were earlier on in the year. So, so far, so good. I think the -- as I look into the end of the year, with Christmas coming around, I think it's going to give an opportunity from some suppliers that may have been a little tighter to catch up and build some inventory banks, which help the industry as it comes back into production after the Christmas holidays.

Good. And maybe continuing along the line of questions on the near term, let's -- if you could just give us a little context on the third quarter and what we can extrapolate. Third quarter margin, 8.5%, really strong. And aside from some of the government support programs, you have [an existing] 70 basis points. I guess what we're wondering is what can be extrapolated into 2021? What was unique and shouldn't be extrapolated? And then I have some follow-ups on 2021 parameters, yes.

Yes. So we did -- as we said, we did report some pretty solid margins, 8.5% in Q3. We did have some government support for our 70 basis points of benefit, which we're not going to be able to push that into Q4 or even next year. So if you adjust for that, we're about 7.8%. I think that's a good base to start thinking about '21. I'm not quite ready to talk about '21 margins, but maybe just to give you a little bit of color, I think what we're going to see is the continued benefit of some of the restructuring actions that we took in 2020. I think they're going to continue to help on the bottom line and continue to grow up until 2022, when we expect to realize all the benefits of those restructuring activities. I think one of the negatives probably going into '21 is as we get back to normal, I think some of these discretionary cost controls that we put across the organization are going to start to creep up a little bit. Think about travel, for example. Nobody has been traveling. When we get back to a more normal state we'll see some of that picking up. I think when you look at some of the underperforming operations that we've been focusing on over the last year and a bit, certainly have contributed to the growth in margin in Q3 and expected good performance in Q4. Expect to continue to see some improvements so that should help us in '21. I think as you look at '21, some other things that, and I don't have my head around it completely yet, is the level of launch costs, the new facility costs, commodity. Those commodity costs that could impact margins, plus or minus. Mix of business could also have a positive or negative impact on margin as well as the level of engineering. But overall, I think we're in a really good position with some of the actions we took to rightsize the business moving along to 2020 that's going to continue to benefit us beyond 2020.

If we could just drill that -- that's helpful. If we could just drill down on some of those items. First of all, I mean, let's just zoom out. You're going to have IHS, I think, is forecasting production up, call it, 13%, 14%, whatever it may be for 2021. What type of incremental margin might we expect on that volume recovery?

Yes. I mean, I guess, Dan, we're in the middle of business plans right now and kind of lock in on final estimates for production volumes across the globe. But I'd say generally, if volumes are higher and sales rise, as mix remains the same, I'd expect that incremental margins will be higher than our average margins on higher sales. So that should help on the margin side from a percent perspective and also absolute dollars. But again, you've got to look at all the puts and takes, but generally, that should be a positive for us.

Right. And then as far as some of the more discrete items, and I think you had mentioned them, the discretionary cost controls that returns, but you have the restructuring. I think you talked about $200 million of the program. Could you maybe just highlight how much you've gotten year-to-date? And then do you get the full $200 million benefit in 2021?

Dan, we -- on an annualized basis, we'll get to the full $200 million in 2022. There's still some -- even though we booked some costs in [ Q2 ], by the time we implement all those actions, it may take a year or so for that to happen. And so I think by the time we get to 2022, we'll have that step down in our structural costs of about $200 million. We'll get a substantial amount of the way there in '21, then it's a smaller amount, obviously, in 2020.

Good. And then lastly maybe just on the R&D front. How are you -- obviously, you're pushing forward on a lot of new technologies. But at the same time, we have, for instance, the ADAS programs and the spend has moderated there. So directionally, how do we think about R&D?

Yes. If you think about the engineering costs as opposed to R&D, and I look at the engineering and I kind of bucket them in a couple of categories. The first is development of technology, core development technology, platform technology, something that it's an asset that you have that you could then apply to a number of customer programs. And unlike a fixed asset when you buy it, you put it on the balance sheet and then you generate the revenue. With an asset like that, you're expensing things. So again, we've got to get through the business plan. But the level of core technology spending in areas like ADAS and electrification, I think it's pretty well at a rate that we're going to be able to sustain going forward. I don't see some big movements up or down but kind of akin to maintenance appreciation. What's going to fluctuate is application engineering, and that's really a level of -- a function of the level of new business awards. And typically, you're doing engineering a year or 2 or 3 years before program starts. And in the case of both ADAS and electrification, we see that hurt margins. And I guess as we get into '21 and even '22, some of that ADAS application engineering spending is going to tail off because we have been working on this through advanced technology programs. It's going to be -- I mean, really to think about the level of new business awards and how that impacts our ongoing application engineering. Again, I'll give you some more color when we give guidance in February. Those are the 2 pieces that I usually look at to determine the level of engineering across the organization.

And then just a last one, maybe we can directionally think about some of the items on the cash flow line, specifically. Is there -- after this year, is there any more rebuild of working capital? Or is there deferred CapEx into '21? And then restructuring, have you completed the majority of the restructuring actions or the cash restructuring spend or is there more of that to come?

Yes. On the working capital side, we had a big build already in -- you remember in Q2, we recovered some of that working capital in Q3. I think as we look at Q4, we're probably -- look at Q3, we're probably in the normal range. It's kind of hard to determine exactly where we're going to end up. And part of it depends on payments from customers of last year, if I remember, we had about a $200 million more than we had anticipated in Q4. So we started off with a pretty low working capital number. So that's kind of reversed. But working cap is going to be a function of sales. I don't think there's anything there that's unusual as we get out of this year. From a capital perspective, we start off the year with capital being significant or higher than where we think we're going to end up. And we're thinking right now, cap, it's going to be about $1.3 billion. I think some of that capital has been deferred into '21 as we just look at what do we really need to do and what can we push out a year? Some of that capital has gone away. There have been some, in some cases, some program cancellations that are going to impact capital. And we did look at some productivity capital that we didn't put in place in 2020. I'm not sure with the year going by, whether we get payback, whether it makes sense to do all that spending. So in summary, I think you're going to see some spillage from '20 to '21, some things going away in '21 that we thought we were going to be there. But capital probably is going to be higher than where we're ending up our expectations are for 2020. On the restructuring front, we're -- expect to have some more charges in Q4. We talked about that when we talked about the restructuring in Q2. As we look into '21, too early to tell, but as I think about the discussions with the organization of that continuing to shift our manufacturing footprint to best-cost country, they're probably basing some restructuring in the years to come. But that will be attributed to a really good payback and improvement in margins longer term.

Great. Let's change gears and let's talk broadly about the strategy side. Obviously, you have a big change in management. Don Walker, after many years at the helm, is retiring from the CEO post. Swamy Kotagiri taking over. Swamy's obviously a veteran to Magna. But help us understand what -- as we zoom out, what are the elements of Don's tenure that we should expect Swamy to continue? And on the flip side, are there any strategies or aspects of the business where Swamy may change course? What's the same? What shifts?

Yes. That's a really good question. I've worked with Don for 31 years so I'm certainly going to miss him in the organization. He's done extremely well and I'll continue my friendship with Don and his family. And Swamy, I've known for a very long time. Swamy's been with us for about 20 years, and I've been working closely with him for the last 8 or 9 years. I'd say some of the items that aren't going to change yet. I mean, and where do I start? Our entrepreneurial culture, I think it's a unique advantage and Swamy is a big believer in that. Our relationship with our employees, I mean, Don was a big supporter of our employee charter, employees, diversity, sustainability. That's going to continue with Swamy. And as you think about Don's buzzwords, world-class manufacturing, innovation and leadership development, Swamy's been working on world-class manufacturing on the automation side for quite some time. Obviously in innovation, completely aligned and people development is really critical as we continue to grow and move in a bigger way into some of the newer areas of ADAS, electrification and usability. So I don't think that's going to change at all. It's going to continue with Swamy. In terms of kind of you asked me what may change or Swamy's emphasis going to change and is that going to impact Magna? I think back at Magna and how we have evolved as an organization ever, I don't think that's going to stop. The industry evolves. I think we're going to continue to evolve. We've been investing in some of the emerging areas in electrification program and usability. I don't really think that's going to change. And we've been putting, I could say, a disproportionate amount of our capital and engineering relative to sales and profitability in these areas. I don't really see that changing because that's a growing and big market among that. And we think we've got a good spot to be in. Yes, I just think of -- what really sticks out in my mind from Swamy is the work that he did years and years ago when we started to think about the car of the future and how we position Magna from a product area perspective, from a technology perspective. And I just think that Swamy is the right person to continue to lead Magna as we continue to think about the evolving industry and how we position ourselves with the car of the future.

And that's actually a good follow-up. Listen, he came from the CTO post. How does tech development or tech positioning shift under his tenure? I mean, is it possible that you're going to more aggressively highlight or make inroads into new technologies? I mean, how does that shift?

That's been happening. I just think it's going to become more evident as those businesses grow is that they're relatively small in the big scheme of Magna. So as we get out and talk about our business and do investor days, I think we're going to highlight that more because it's more focus and bigger -- it's going to become a bigger part of our company. So I think in terms of -- [ as we continue ] to talk about electrification and software capability, electronics, autonomy, these are areas we're going to continue to focus on and you'll hear us talk more about that. And again, I think about Swamy's background and what he's done, it's purposely aligned towards those trends and Swamy's sort of in the lead role as CEO of our organization.

Good. And then just maybe one last one, and I guess this relates directly to you. I mean, you're still the CFO. So how does capital allocation change? I mean, is there any -- obviously, you've, I think, managed a good balance, a lot of shareholder-friendly actions. But R&D, does R&D spend accelerate and share buybacks pull back? How does capital allocation shift and the pace of R&D?

In terms of balance sheet strategy, that isn't going to change. We've just gone through COVID-19, and it was a good sort of test of our overall strategy and I think it proved really well for us. So I don't see that changing. We're still going to look at investing in the business organically. We'll do some M&A as well, continue to invest in innovation and return on capital by way of dividends and to the extent we have excess liquidity, buy back stocks. So that isn't going to change. Are we going to put more money into R&D? In my earlier comments about some of the core development spending in ADAS and electrification, so I think we're at a level that's sustainable, is a good level for our business to maintain our technology and continue to evolve it. Obviously, as the company grows, we'll put more money into R&D, but I don't see it being a big step function that's going to have a negative impact on overall reported margins.

Good. Let's talk about the segments quickly and then we'll wrap up. Have a number of questions on electrification. If you could maybe -- let's just start actually with Seating. I mean, I think most of your segments are actually operating pretty well. That's the one where I think there's still a little bit of residual underperformance. So maybe you could just talk about where that stands, the path to improving launch efficiencies. And how does JIT mix play into this? Is that now normalized? Do we still need to see more JIT mix that normalizes and that weighs on the margins a bit? So comments on Seating and the operations there.

Yes. Well, certainly, you're right, margins in our Seating business are impacted quite meaningfully. By the level of vertical integration, we might have on a program versus another. We talked about winning a considerable amount of business with BMW, which was a new customer for us in the Seating business, both in North America and Europe. And is the only -- JIT-only business, no critical integration. So that negatively impacts margins. And I mean, from a return on capital perspective should be neutral but it's, certainly, from a margin perspective, dilutive. But when I think -- sorry, I'll just continue on vertical integration and I'll come back to the BMW program. One other issue we've had this year that's hurt our margins is that 1 program, the Chrysler minivan, which is our most vertically integrated seating program, has suffered from lower-than-anticipated volumes. So that also negatively impacts overall Seating margins, dilutes the reported margins. And then in the case of the BMW program, we had talked about some of the operational challenges that we've had there, underestimating customers' requirements and some of the customer-driven challenges on the program in North America. And we've been plugging away to improve those results. And despite COVID-related volume declines, results are better year-over-year. That's what's contributed to some of the growth in Seating margins in Q3. And based on what we've got in plan today and some of the actions we're taking, we're expecting to see the improvement in that facility continue to contribute to margin enhancements in our Seating business. And that will carry out in Q4 and into 2021. But I'll give you some better guidance again once we get through the business plan and understand the mix of business. We've got Hungary now coming in. Next year, we should be able to consolidate that, which gives us some more capability and presence in China. There's a lot of moving pieces but we're heading in the right direction in our Seating business.

Good. And then let's pivot to complete vehicles, which obviously, we're seeing margins the last couple of quarters of 5% or close to it. It was like 2% in 2019. And I think you've talked about benefits from mix and cost initiatives. So can you just give us a sense of how sustainable these robust margins are in complete vehicles and how much of that carries over beyond this year?

Got it. Actually, I think, Dan, there's 3 things broad based. There was actually a fourth. We did have an engineering impact that we booked in Q1, which helped to elevate margins in Q1 and so far, year-to-date. But putting that aside, I think there's 3 things that you should be thinking about. One is mix, the other is the cost initiative program that we've undertook that Magna started to kick off at the end of last year and then engineering revenues. So on the engineering side, we have been seeing more revenue and better utilization of our staff and more productivity, and that's really helped increase margins. And if the level of business maintains itself, that should carry on. In terms of the cost initiative that we did undertook at Magna Steyr, that's still underway. It's called Project Focus. We've been seeing quarter-over-quarter some improvements in cost structure. I think our President at Magna Steyr, Frank Klein. came up with some [ down there ] has done a really good job. I think that just positions us for the future, and that's actually carry on. Mix is a more difficult one. And I look at the mix of programs we've had so far this year at Magna Steyr and we've had some good volumes on the G-Class that they've been higher-end vehicles on the G-Class. Even within a program, you could have a mix of what you're assembling for the customer, which impacts overall margins. But all that has been pretty positive this year, and that's contributed to the growth in margins. So we're pleased with the performance and 2 of the 3 things will continue. The third one, I hope continues, but it really depends on mix of programs that we're settling at in Magna Steyr.

Let's wrap up with a couple of questions on your opportunity in electrification, which I think is accelerating. And I want to start on complete vehicles, continue line of questions. Obviously, you have Fisker launching in Europe late '22, Arcfox in China. So maybe zoom out, help us frame the magnitude of discussions that you're holding now or are the discussions on the EV side more significant with start-ups or with automakers? And should we just -- what are the things we should be watching for to come? Should we anticipate more deal announcements or manufacturing or engineering announcements on the EV front?

I think when I -- you should be looking at whole bunch of things on the EV side, whether that's on the Magna Steyr side as we work with a handful of customers on either engineering and/or manufacturing and you look at some of our even our Magna Powertrain business. When you think about eDrive systems, I think about what we're doing in China, for example, with HASCO or some of the other programs that have been awarded to us and in some of the technologies that we've been working on, we got the [ blade], the design systems to provide key components. So I think you'll see more and more awards in that area. When you look at even our Cosma business, for example, the opportunity in battery frames. Battery frame is a large, highly engineered product, pretty considerable [ costing ] per vehicle. We've got a couple of [ probable ] awards already that we're launching in the next few years. I think over time, as long as we pick up in this area, cost comes down. But certainly, that's incremental to what we've been doing. So I think you should see more e-mobility type awards from our part. And should also continue to see awards in other parts of the business that are not impacted, by the way of [ propeller ] vehicle whether it's an internal combustion engine or a complete electric motor.

Good. And continuing on the complete vehicles side, maybe just give us a sense of the deal with Fisker. What did you offer them? Or I don't mean the specific terms, but broadly, what attracted them to you versus other options that they have? I mean, I think they publicly talked in the past that they have been evaluating BMW. So I think that's a powerful statement that at the end of the day that they went with you. And I guess I would just weave into that. It sounds like engineering is a key opportunity here. So how much does engineering play into the deal with Fisker. And more broadly, how -- what's the opportunity for engineering revenue, which I think is roughly 10% of business now and is probably pretty margin accretive.

I mean, I'm not going to comment on kind of what other options they looked at and kind of look, well, I think what we bring to them is a base vehicle architecture, the ability to support them certainly on the engineering side, working with them on sourcing, ability to produce the Ocean in a time line that they desire. I think having a base vehicle architecture that we can build on certainly speaks up to time to market, which I think is a benefit to them. I think about our organization as entrepreneurial culture, with lots of flexibility, lots of ownership. And we have a lot of capability outside of Magna Steyr and outside of Magna Steyr of engineering which I think are -- I view it as an asset for Fisker when they look at some of the capabilities that we have.

Good. Let's wrap up and I know we're over time. Thank you. I just want to -- 2 quick final ones on the EV side and I'll just put them out there. One is we look at -- we think about what's happening in Europe right now, we've seen a much heavier EV inflection, EV penetration than other regions. What is the impact to your business and specifically the Powertrain side? And then as we think about your offering on Powertrain, I think you've talked in the past about potential for vertical integration within your eDrive business because right now, I think you're bringing in outside elements from outside supply for motors or power electronics or ECU. How much incrementally are you evaluating opportunities to increase vertical integration and bring some of that capacity in-house? So Europe EV and then in-sourcing on Powertrain [ future needs ].

Yes, I think when you look at EV penetration, I guess, I think given our sort of previous expectation, EV penetration has been growing. It'd be interesting to see what happens in the United States. When I think about our business and in-sourcing versus outsourcing and kind of where we sit, I think it's going to depend on the customer, the program, the sourcing strategy, the time line. We're predominantly a driveline supplier with certain products, customers and programs around the globe, including Europe and we do have the drive and capabilities to support our customers. So I view this as an opportunity [ route ] for Powertrain so we are investing some money there, and we're going to continue to invest some money there. And we do have some business awards and that's going to continue. And the opportunities we're looking at today are pretty interesting, for sure. Dan, I don't remember the second part of your question. Hopefully, I answered it.

In-sourcing in terms of motors, power electronics, something of that...

Yes, absolutely. I think that's an opportunity for us to continue to build our bench strength in this area. It's an area of focus from technology, in alliance, inorganic growth. Those are areas that are of interest to us. And this area of the industry continues to grow. You'll see our capabilities continue to expand so we get deeper in terms of what we can offer the customer on a complete product.

Great. Well, we're over time so you've been very, very helpful, Vince. Thank you, Vince, Louis, Jim, and we look forward to hearing more of the narrative as it unfolds. So thank you.

Okay. Great. Thank you. Thanks, Dan. Thanks, everyone, for listening.

Thank you. All right. You can now open and change your mic and that now close the call.