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

Well, thanks, everybody, for joining us again. Next up, we have Magna, which is the #2 or 3 largest auto supplier in the world depending on the year. Magna has always been a tech leader in numerous parts of the vehicle, but it's not been recognized as such, and instead, often been referred to as a great middleman, right? That's a misguided view, we believe. That view is slowly changing and the stock and the valuation are improving somewhat, but there really is a long way to go from here, at least in our opinion. Today, we are very happy to have Vincent Galifi, CFO; and Louis Tonelli, VP, Investor Relations, to discuss the company, current market dynamics and much more. And thanks so much, guys, for joining us. We really appreciate it.

Thanks, John.

Thanks, John.

So we're going to kick into Q&A here. And if anybody on the line has questions, there will be the opportunity on the right-hand side of your screen to send questions to us, and we'll read them off to Vince and Louis. But maybe just to kick off in a very short-term fashion and understand what's going on with the chip shortage, what are you guys hearing, seeing directly and indirectly on the chip shortage as well as what is kind of a developing some shortage and some other disruptions in the supply chain at specific locations like Mexico? Is -- how are you seeing production ending and flowing through the course of this year? Your customers are dealing with it. How are you dealing with it?

Well, John, we've been talking about this chip shortage. We talked about it during our call when we released Q4 and gave our outlook. Certainly, there have been some disruptions. We're in, as you can imagine, constant communications, with our customers and look at the supply chain of chips. We've been very fortunate today that we've been able to work through the issues and find solutions for our customers. So we haven't checked up any of our customers down. We've been juggling some things around sometimes. So there's been some inefficiencies, you start and you stop and you get going. Vehicle production, as you could imagine also in the industry has been impacted. But as I look forward and as we look forward, we think that we'll get through that, hopefully, by the end of sometime next quarter, the end of next quarter. And we'll see how things work out for the balance of the year. But so far, so good on our part, a little bit of juggling, but we've been able to make things work out.

And Vince, kind of ironically with this constraint last year, you saw your customers focus on higher mix, higher-margin vehicles, which ultimately was a very good thing for their profits. Your profiting for the whole value chain. I mean, do you think that is -- how are they going to approach this year in the near term? And potentially, maybe over the intermediate to long term, I mean do you think there could be a change in behavior that's developing? We've never really gone through this environment where there's been this very strong demand, but constrained supply is kind of the experiment we've all wanted the automakers to run for a very long time or they haven't. I mean, is this -- is there a change here? Maybe in the short term, it will still be positive for you and your customers and maybe something that's more developing -- more disciplined that's developing over time.

John, I think our customers that you're looking at sort of the supply side and the constraint or the demand side from consumers, they're going to try to balance out their own production to maximize the situation for them, and we'll follow along. As you know, the market is quite strong in North America for trucks and CUVs. So certainly, I got to believe our customers are going to be focusing on that, and we have a lot of exposure to that. So that should hold well for us. Longer term, I think your question is, there's a change to customers' behavior. I think in a material way, there's probably not going to be much change. I think people kind of -- well, the industry probably look at longer-term planning. But when you think about how efficient the supply chain is when you're purchasing globally, I don't see that change in any big way. I think that's the right way to do it. But we'll work through this hiccup. We have -- as an industry in the past, we'll figure this out and move on, and we'll make the best of times as we can given the constraints that we all face from time to time.

Got it. And maybe sticking on one other shortage, we get a lot of questions on -- obviously, raw material prices are inflating, and we're not going to get anything on guidance today, but if you could just remind us sort of mechanically, maybe contractually, how your raw material sharing goes with your customers and runs through your P&L. I mean, it's the 3 -- your rolling contracts, hedging indexing, all sorts of mechanisms by which you're getting with this. I mean, if you can really remind us, so we understand how this may or may not impact you over time.

John, I just -- as an industry perspective, as commodity costs are moving up, it's impacting the industry. Some of it's going to be very -- the cost of that, whether it's the consumer or the customer or the supply base agreement. It's not good. And typically, when you think over this a shorter period of time, supply and demand has a big impact on the price of commodities. Our biggest buy across the company is steel. And most of our sale, those were probably about 75%, 80%. It's...

Yes, about 75%, yes.

Customer resale programs, but we're essentially getting a pass-through on the price of steel. And there's economies of scale for our customers to buy steel from the mills. So it kind of makes a whole bunch of sense. Where we have some exposure there is the steel not on resale, and we certainly have index pricing and some shorter-term contracts, whether it's 6 months or a year. The summer, it's far. So that will have an impact, positive or negative, depending on what happens to pricing. And scrap is also another source of commodity impact. As part of our process, there is engineer of scrap as we're designing things. And we do sell that, some of that we share with our customers, but there could be an impact on the revenue side from the sale of scrap. And steel prices are going up. That's an offset if steel prices are going down. That will be a negative because we're getting less revenue. The other big commodity in our organization is resin-based, and we're -- we've been moving up on the resale side of this part of the purchase. We're probably somewhere between 20%, 25% today, John, on resale. And again, it makes sense for our customers to think about consolidating the purchase because of economies of scale from their perspective, but the rest of it is subject to price risk. And certainly, we're seeing the impact of that as resin is up, and short-term resin has been moving up. The impact on taxes is having an impact on resin and supply as well that we've been able to work with our customers to ensure we get supply to support them. But that will have an impact on us. At present, it's going up. It will have a short-term impact. You'll make that up over a period of time, but it is negative in the short term.

Got it. Okay. One of the things that we saw last year was your margins and other supplier margins were really, really great amidst the crisis and have been stronger than the automakers for some time. As automakers are going through this transition in their business towards EVs and making a lot of investment, is there anything changing in the relationship where they might get more aggressive on pricing, maybe on some existing products and a little bit more favorable on future product? I mean, is there anything changing the dynamic in sort of pricing and contracts with your customers that we should really think about short term and maybe long term?

Yes. John, I'd say that a couple of things on the pricing side. It's a pretty competitive environment in any time with our customer. They're always looking for the lowest price, given a certain set of standards that they're looking for. And we're dealing with that. And I think, ultimately, the price of a particular product is going to depend on a whole bunch of factors is what's the volume going to be, what's capital involved, who's paying for the engineering, who's paying for the [indiscernible]. And from our perspective, as we're looking at pricing things, we're always keeping the back of our mind, what's the appropriate return on the capital we're employing in the business. That's been the case for the last 30 years that I've been at Magna. I don't think that's going to change. I think what you're seeing is, as you look at some of the mega trend areas, as you look at electrification and you look at ADAS and there is [indiscernible] to some degree, there is a lot of interest in that by our customers as well as consumers. And both capital of engineering are into that. And I'd say from a pricing perspective, that's, for me, a little more challenging in terms of trying to figure out what the right price is going to be. It's a little bit more dynamic. Volumes are a little bit more certain. Technology is continuing to evolve. How do you recover your investment spending, your engineering spend or what set of volumes over how many programs do you think you're going to win to use that platform technology. So it's a different type of environment that we've worked in the past and will continue to work. But I don't think fundamentally that someone is saying, if it's not in the mega trend area, price is coming down because it's no longer relevant, and everything else relevant is electrification autonomy. 85% of what we do, John, is inside of our powertrain business, which is not impacted by out of whole electrification. And we're in any structure, we're in any seats. We need a whole bunch of things, whether the vehicle is autonomous, whether it's an electric vehicle, whether it's driven by diesel engine. Our products and systems, by the most part, continue to be demanded regardless of how our vehicles is being propelled.

And maybe we're jumping around here. We've got a couple of questions on the line, and we've kind of got into sort of EVs and strategy. But obviously, Don has done a great job of leading the company for a very, very, very long time, Don Walker. Yes, Swamy Kotagiri that's taken over as CEO. So I'm just curious, I mean, you've been in the business for a long time and you hopefully operate much more as an operating CFO than just a number cruncher. I mean have you and Swamy thought about any shifts in strategy now that there's been this change at the top or an acceleration in any way in AV or EV technology? Or is Swamy's vision fairly similar to Don's, and it's still focus on execution and the playbook as it existed?

Yes, John, I mean, you've known us for a long time. Actually, we've been an evolving company. And you can talk about Don, you can talk about Swamy, do they have -- what's their strategy, is it the same, is it not the same? Swamy has been around for quite some period of time. And as we -- we were talking about the car of the future years and years ago, which you use as well and some of the material that you're print. As we sat back and looked at where the industry goes, it was heading towards in some of the trends. We identified as a team, including Swamy, that some of the mega trends were important in the addressable market. It was going to become larger in margin. And if you go back even under Don's watch and you look at how much we were investing in areas such as electrification or autonomy, some of the things we've been doing with even Magna Steyr on the mobility side, I mean that investment has been ramping up. So I kind of used the words, we've been putting a disproportionate amount of our capital -- or cash or capital. It took engineering and capital in these mega trend areas because it's strong. I don't really see that changing. And Swamy will say the same thing. Can we say are we going to accelerate? Well, yes. Well, we've been spending a disproportion amount, I don't think that's going to change at all. So the strategy is going to continue. I think the -- with Swamy being CEO and he's got a more, I would say, technical background than Don did and probably more up to speed on some of these mega trend areas, we'll see continued growth in those areas. And some of the things we've done even in the last year, think about what we do with LG, for example, hopefully, we should get this transaction to the finish line next quarter. Supporting what we're doing on the electrification side are some of the partners we've been working with on the ADAS side, for example, [indiscernible] as an example [indiscernible]. I don't see that changing at all, John. Having said that, I don't also see the focus on operational or world-class manufacturing, ensuring that our operations are as lean as they possibly can be and as competitive. Swamy does believe just like Don, we're the low-cost producer and we've got the right technology, that's a real plus for us, and we should be able to continue the green content per vehicle in our company and gain -- continue to gain market share.

So almost continuing the continuum of evolution with the company is really the best way to think about it.

And John, we'll talk in 10 years. There'll be another mega trend, and we'll talk to you about what's happening different and...

I hope we'll all talk in 10 years. Definitely, I mean that really help you with our -- so when you look at some of the opportunity set that's developing now and changing a bit, obviously, there are a lot of -- quite a few, right, new EV OEMs. I'm just curious how you look them as an opportunity from parts to systems to really the great capability you have at Magna Steyr if that's different by geography. I mean, it just seems like it's a great opportunity set for you. You can help a lot of these companies ramp up because you've got a lot of capability. But I mean how do you think about that opportunity?

Yes, John, I think it's a great opportunity for us, and we're doing some things with a number of players. You think about what we're doing with this. I think we're really uniquely positioned to support some of these new entrants coming into the market. If you think about our overall capabilities across the company, you couple that with our systems or platform capability, our complete vehicle engineering, manufacturing vehicles, it's a big asset. And I look at some of these companies, and it gives us an opportunity to access the market a little faster than they otherwise, given our overall capabilities. So we have to -- as an organization, I also have to think of it where we allocate resources as well. And that's not just cash and capital in dollars, but it's also people. So as we're looking -- talking to some of these newer players, we're trying to assess kind of where they are, what's your mindset, what's your game plan, what's your level of maturity, where do you think you're going to be successful, how do we play, what's the risk we're taking as well and as with the rest. And based on kind of all of those factors, we decide whether it's something that we want to get involved in. But I think it's an opportunity as mobility continues to evolve. And we think outside of our traditional vehicle today, I think there's lots of opportunity for Magna given our capabilities to grow in this area.

In the same vein with your existing customers that are launching a lot of EVs, how do you see the opportunity set there? And I guess, one of the questions that we get a lot from investors on Magna and the industry at large is can the incumbents maintain or grow their position. So in -- what is the opportunity with your existing customers, I think, as you're going to market with new -- whether it be battery trays or inverters or whatever else you're going to market with? Are you running into new competition as you're bidding on product? Or is it the same folks that you've traditionally gone up against, particularly in powertrain? I mean is there all of sudden a flood of new folks that are new competition coming in? Or is it the usual suspects?

John, I'd say that, first of all, if I think about the customer side of the business before we get down below the supply side, I mean our customers have a different -- some customers have different strategies about what they do on electrification. And a customer actually has a different strategy depending on the geographic region that they're looking at. Some customers are looking at overall e-drive system and handing that over to the supply base where others are keeping that integration capability within, but are also seeing some of the components. So I think about Magna, I think we're well positioned in both of those fronts in terms of complete integration of an e-drive system. We're very good at that, and we've got some programs in plus with that. And to the extent that the customer is only buying components, whether it's an inverter, whether it's an e-motor or so on, with our LG relationship now and our joint venture, I think we're really well positioned for that.

Are we seeing competition in this space from players that we wouldn't have seen?

Yes, I don't think we would have come across a company like LG, for example, in the past and some of the other components that we're involved in. So there are different competitors in this space but I kind of look at it and look at our capabilities, and we have a lot of intellectual property as it comes to understanding how you take power from a power source and bring it to the wheels efficiently and noise and handling and responsiveness and what the consumer wants and you couple that with our capabilities on the electrification side, I think we've got a really good set of tools analysis to continue to grow in this space. We've been awarded and we were launching for -- in China with HASCO, another joint venture partner we have, a secondary e-drive for the NEV platform in China. We get another second launch going on there. And I know we're working a bunch of other things. I'm confident we're going to get some other business as well. So I think we're on the right foot. The industry is growing and evolving. We'll evolve, and I'm confident we'll get more than our fair share of that business. The real -- the question in my mind is how quickly it evolves? It's not when, but it's how quickly. And I think given the way our asset portfolio is positioned and the building blocks that we have, we have the ability to accelerate that to take a little bit more modest for growth. It really depends on what happens with the industry. And that's impacted by regulation, battery technology, consumer preferences and acceptance of electric vehicles. But I think we're in pretty good shape. In the meantime, as we move to hybridization, as we get to purely based, I think we're on the winning side there, given our products where you offer your traditional Magna products and custom electrification or the content of vehicle and just new stuff. It doesn't go down. So I think that's possible.

Yes. We're actually launching hybrid DCTs, pretty high-volume starting later this year, another program starting next year. So a lot of new electrification products that are coming to market for the next little while. On top of the program, as been said, we've launched with VW and HASCO in China.

Yes. No, I mean, it seems like people are missing the stuff that you're working on. I mean, I guess, Vince, as you look at the evolution of the technology, obviously, you have a lot investment internally, organically, but there may be an opportunity to go after some technology that you might want to acquire. How do you think about that right now as a lot of folks probably hunting that technology other than you, including the new stack investors that are probably inflating valuations a bit? But I mean, how do you think about rolling acquisitions into the business over time? How open are you? Like what's the thought process and the priorities there?

John, if you think about kind of [indiscernible] I've been talking about capital allocation amongst 3 years about Magna and balance sheet and leverage, and you've always heard me talk about our #1 priority is to invest in the business for the right opportunity, something that's aligned with product strategy, the car of the future. And we've been doing that. And the way we have been doing that is investing organically and inorganically over the last years and years and years and go back. I don't see that changing at all, John. I think when you look at -- if you look at some of these mega trend areas and you look at our portfolio, you look at where the industry is going, how fast it's going, what our capabilities are, what the gaps are, how do you fill those gaps, you do that internally, if you look at inorganic growth. And to me, it's going to be a combination of both. I don't think we're going to do that all organically, and I don't think we're going to do it all inorganically. I think we're going to do bits and pieces of it around our overall capabilities to position us well with the customer, given what's happening in the industry. So I don't see any change there. And when you've heard me talk about kind of investments inorganically, I've always said, well, our #1 priority is going to be looking at technology. Something that complements our capabilities, and we'll look at things where we want to maybe gain some mass in a geographic region or position that sits better with the customer, but you've -- always sure we talk about technology. I don't think that's going to change at all, John.

Got it. I think Doug Karson had a question on the balance sheet. Do you...

Yes. Great. So you guys are very strong at rating probably the only auto supplier that I know as an A- rating. I think in your recent earnings call, you talked about leverage around 1.9 turns and like the sweet spot between like 1 and 1.5. Just trying to understand how important is it to maintain like a single A rating. As you look at acquisitions over the next few years, how do you think about how much you delever the balance sheet?

Yes. That's a really good question. And it's something the Board periodically asked me and says how far, Vince, can you stretch the balance sheet if you had 1 or 2 or several opportunities. And I'd say it all depends really. I think when you look at kind of where I'd like to be on a balance sheet perspective, I'd like to be a high investment-grade. A- certainly qualifies, BBB+ certainly qualifies. You could suddenly notch down and still be in that sweet spot from my perspective. Yes, I think you have the ability to stretch leverage if you have to for some period of time. I think we've had discussions with the credit agencies for years on a whole bunch of what if scenario. As long as there was a plan to delever, I think you'd be comfortable with where we sit from an overall rating perspective. So the balance sheet has the strength to do a whole bunch of things. I think more -- and we had that for years. I think more importantly is, is there the right opportunity at the right value that make the things that we want? And I think if they are, we've got the balance sheet to support that. But it all has to kind of work together, and that's been the case. Like go back for 5 or 6 years, nothing has really changed. I mean we've had the balance sheet to do some pretty significant things. We just haven't found the things that, in our opinion, are right for our organization or the product strategy that we have.

That's helpful. All right. I'll turn it back over to John.

And maybe in that same vein, Vince, but I mean we're seeing companies raise capital at very low cost. And when you highlight EV, AV opportunity, future car, whatever you want to call it, the capital markets seem to dive in, whether it be on the credit side, as Doug was kind of just asking about. But even on the equity side and on the convert side, I mean given the right opportunity, I mean would you consider other slices of capital whether it be stock-for-stock or issuing equity to raise capital? I mean, obviously, it's all going to be situational. So I mean, it's probably TBD. But I mean, it just seems like the capital markets are there to support future car efforts in a way that it's pretty remarkable at the moment. So I mean, would you consider other slices of the capital?

Yes, John, it's pretty theoretical sort of hypothetical question. I mean, I guess the way I would think of it -- think of things is, yes, there's an opportunity out there and we're convinced that it creates value. That's a good thing, right? And it meets our product strategy. We kind of look and say, well, if you were to do something like that, how do you kind of fund it? And then you look at -- what I would typically do is look at my internal cash flows and look at my balance sheet strength. And with this overall leverage, Doug, we just talked about leverage and say, if you had an opportunity or opportunities, how do you deal with that? And if you need capital, how do you raise the capital? But it's all hypothetical, but that's kind of -- would be my thought process on how you kind of deal something like that.

Okay. And then maybe the same financial vein, if you think about margins over time and your free cash flow expectations, I know you've kind of laid some of this stuff out, but maybe you can remind us where you think things to be sort of mid to long term. And as you think about CapEx and R&D, how those will ramp to support future business over time?

Yes. Look, I'll just talk about engineering and capital [indiscernible] our cash flow over time. When you think about -- remember I talked about disproportion line of investment in some of the mega trend areas, over the next 3 years on average, we've got about $600 million on average [indiscernible] on engineering or the mega trend areas, electrification, autonomy and new mobility. That's a pretty big chunk of money for -- this is for program rewards, it's also for some top line technology. And we got capital that's at some decent levels. So if I think past the 3 years, where do those numbers go, I'd expect as we continue to win business in some of these areas that you're going to see engineering and capital continue to grow to support the growth. That to me, it wouldn't be something that will be out of the ordinary. I'd expect that. And does it impact our business in the next 3 years? Could be. John, when you think about it, our outlook is based on substantially book business. We get significant business awards that may start in year 4 or 5 from now that's not in our outlook period where we're going to be putting capital engineering in place. So if that comes, we'll have to come back and talk to the market about what we're doing and why we're doing it. But my anticipation is that, over time, we're going to continue to see engineering and capital grow as the business grows. I think what we -- I would expect that as the business gets to a certain scale in some of these mega trend areas, when you start thinking about engineering required to support that business, it becomes more of a maintenance capital. It's kind of normal. We're just growing. So you're seeing a big step function in your upfront investment. But that, as a percentage of sales or percentage of profits, however you want to look at that, will normalize as the business gets bigger. Louis, you want to talk about cash flow?

Yes. On margins, I mean margins, we're kind of in 7.1%, 7.5% this year. We said in last month in our outlook, we expect it to be north of 8% by 2023. So a pretty healthy expansion in the margins for the last few years. And on cash flow, we've said that we should generate in the next 3 years between $5.5 billion and $6 billion. So really nice healthy cash flow that we're continuing to expect for the next years.

John, you're on mute. You're on mute, John.

There we go. Can you hear me now? Sorry about that. Technology is still a challenge for me. The -- so I mean, to be a little bit repetitive in this last question, Vince, as we're wrapping up, I mean as you look at that great strong free cash flow, what we're seeing given the market reward is significant growth above market. And you're doing a good job, consistently hitting in the sort of low single-digits growth above market, even though you're -- right, once again, one of the largest -- second or third depending on the year. So I mean, it's really hard to outgrow the market just given your size, but you're doing it, right? And you're doing it year in, year out. If you were to look at that capital, is there any way that you could use it to maybe accelerate that growth above market a couple of points? Or do you think that returning it to shareholders through buybacks and dividends like you've done consistently, which is great, right, certainly not critical, it's actually fantastic stuff? So you could drive growth a bit faster. I mean you're not capital constrained, right? So I mean, it's just -- a theoretical question is that a CFO and a management team and a Board, what you go after. And it seems like these companies that have a couple of points of growth above market over yours get even -- I mean your multiple is creeping up, but it's [indiscernible] still got a long way to go. You have multiples that sometimes are almost 3x yours, and their business profiles are only marginally different. So I mean is that something that you would consider? And the higher multiple, your cost of capital goes down. So the business has fundamentally changed to some degree. So I mean, how do you think about that? It's a long-winded theoretical question as well. But it's important.

Look, John, I -- certainly, I think when you think about the management team or the Board, one of the things we look at is our growth rate and growth over market. We have been growing over margin. Outlook is growth over market as well. Could that be expanded, enhanced, accelerated or whatever word you want to call? I think, certainly, we have the balance sheet to do that. We have the financial strength. We have the cash flow to do that. And it's our interest to do that. But I want to caution you that, at the same time, for us, it's growth, but also with the discipline that we have, the appropriate returns in the business as well. So there's got to be that proper balance. It's not all about growth. We're not a start-up company where people just look at the revenue line. From my perspective, I certainly look at the revenue line, but I also want to make sure that I get the cash coming along to justify the growth and the investment that's required to support the growth in revenue. So I think that is an opportunity. And remember what we talked about in our outlook, what you saw in 3 years was -- did include any acquisitions and includes any dispositions to the extent that we may be doing some. And it was based on book business. So we continue to chug away and talk to a whole bunch of partners and talk to customers and yes, I'm hoping as we get out to kind of year 2 and year 3, that actually business continues to grow over and above what our outlook is. But that outlook is pretty solid outlook. I'd say it's a conservative way to look at the business today.

Great. Well, the clock is running down. As always, it's great to catch up with you guys and see you guys. And we appreciate your insights and very much look forward to seeing you in person and doing stuff like this in person very soon. So thank you very much for joining us today. And hopefully, we'll see you in person very soon.

Thanks, John.

Thanks, John. Thanks, everybody.

Thank you.