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

Okay. All right. And I think we are very live. Okay. Great. Thank you, everyone. Thank you for joining, as we continue the Credit Suisse's 9th Annual Industrials Conference, the auto track. I'm Dan Levy, I lead research coverage of the auto sector at Credit Suisse. And very pleased to have with us Magna International, who you all know quite well. Magna is the world's third largest auto part supplier. We have joining us today a full lineup, Vince Galifi, Magna's CFO and soon to be President; Pat McCann, who is Magna's current VP of Finance, but soon to the Magna's CFO; Louis Tonelli, who leads Magna's IR efforts; as well as Jim Floros from the IR team. So we're going to go through a series of questions here, fireside chat style. Anyone who has questions, please feel free to e-mail me, dan.levy, D-A-N dot L-E-V-Y @credit-suisse.com. I'm glad to weave in your questions as they come in as anonymously. So with that, Magna team, Vince, Pat, Louis, Jim, thank you so much for joining.

Thank you.

Good morning, Dan. Thanks for inviting us to be part of this today.

Great. Okay. Well, why don't we kick off here? And maybe you could just give us a sense, let's just start with the current environment today. I know it's been a choppy environment in terms of the auto production build. But maybe you could just give us a rough feel for how production schedules are trending today. Is there maybe a little more stability, a little more consistency, just a bit more visibility, better volumes? So just roughly how things are shaping up today versus maybe where we were last month or even before that?

Yes, Dan, I'm not going to talk specifically about last month to get into the quarter, but maybe give you some color. As you know, Q2 and Q3 were tough quarters for the industry and for ourselves. And we were getting into kind of the end of the year, Q4. And we were seeing -- we were expecting some better visibility and marginal better visibility. I'd say when we look at what we're seeing and what we're expecting is consistent is that the semiconductor supply chain is a little more stable, but they'll still monit the levels that we really need to be to run smoothly. I think as a result of that, we'll probably see less last-minute start and stop impacting Q4. But supply is still tight, so a small disruption anywhere can have an impact on production. But the kind of last-minute call-offs are less, just a risk there. But planning up overall seems to be a little bit better. So I think it's easing. We start to see light at the end of the tunnel, but the tunnel is still pretty long, and we're -- we don't expect to kind of get over this until second half of next year. But more positive than kind of I would say our actual results were in Q3.

Great. So better trajectory. Great. And then maybe we can just take a look, an early look at '22, and I know you'll be giving your guidance and the fourth quarter update a few months from now. But maybe we could just start by saying, okay, as we look into 2022, just broad strokes, what are the things that we -- I think we know industry volume has an opportunity to be better, but what other broad stroke parameters should we be considering as we're bridging from 2021 to 2022?

Yes. Let me start with the kind of sales, right? And I think about growth over market. We gave some guidance in early February about where we thought we would be kind of a '20 to '23 time frame and -- for the market. I don't really expect a big change in that. I mean there could be some mix changes there. Still we're on the right sort of path. Obviously, volumes are going to have an impact on what overall sales are. But I think if you look relative to the market, we should be faring pretty consistent to what we talked about earlier. I kind of look at '21 and say what's impacted us and is that going to kind of reoccur Into '22? Because we certainly have a lot of plans to improve or grow margins over our 3-year time frame, and some of the things that we did in 2020 are going to positively impact us in '22. They're impacting us in '21 in a positive way. I think the biggest inefficiencies we've had in '21 is this stop and start up production unexpected start to stop. That, as we just talked about earlier, should ease up. So I think that's going to be a sort of a positive '21 -- '22 versus '21. I think when you look at freight costs, and we've incurred some premium freight costs to get raw materials where we need to be, I think that's going to subside as per option turns more into normal levels. But there are certain inflationary items that I think are going to continue to impact us in Q2, the impact -- or sorry, in '22. They're impacting us in '21. I think you're going to see commodity costs are still going to be probably a headwind versus kind of the expectations that we've had a year ago. And we're seeing some pressure on labor, which I think is going to flow into '22. That's all negative, but I think the offset to that is the success we may have in recovering some of those pressures from our customers. I'm not sure we're going to recover all of it, but I'm hopeful that we'll see some offsets as we work through our customers through the balance of this year and when we enter '22.

Okay. Maybe to try to put like a slightly finer point on it, if we're just using -- I know there's always the risk of extrapolating from a quarter or 2 quarters to a full year. But if we're just looking at what you saw in the third quarter, which was quite weak margin even when you back out that ever-growing write-down, was there something in the third quarter or the fourth quarter that we shouldn't extrapolate? Is that largely -- is that pace largely being determined by the start-stop nature of production? And so the big -- that's the opportunity to improve from where you are in the third and fourth quarter?

Yes. I think if you look at '21 versus '22 in second quarter, third quarter and as we get into the fourth quarter, the biggest impact on decrementals/incrementals is really the start-stop and the inefficiencies that we have in our facilities. And I expect that's going to go away as we work through '22. And that's the biggest item order of magnitude against some of the inflationary pressures are -- will have -- I expect will have an impact. Again, those will be mitigated through some of the actions that we're working with on the customer side.

Great. Just a question on cash. As we think about that, you've been building up some inventory. Maybe you can give us a flavor for how that inventory unwind may unfold in terms of the working capital impact?

Yes. So typically, working capital has a direct relationship to sales. And you really, Dan, shouldn't be looking at kind of full year sales. Obviously, that's going to drive it, but internally, we're focusing on what happens more in that quarter. And you're typically building up inventory in the first half of the year -- sorry, you're building up working capital in the first half of the year. And as things start to slow down at the end of the year, we start to recover that. That's pretty normal, so I don't expect that to change. The change to me is how we move back to normal inventory levels. Our inventory levels are higher than what they should be. Part of that is safety stock. Part of that is just supply chain disruptions. Part of that is a start-stop where you've got work in process or finished goods that you shouldn't be having on the floor, that you're not shipping out that's going to impact us. So yes, I don't really start to see kind of our inventory levels move back to the right levels. It is going to be just probably the second half of next year that we'll start to lean down that inventory as we move into '22 and production becomes a lot more normal in the industry.

Great. Look, just one more as we're thinking about '22, and I think you alluded to it, just the types of commercial discussions that you're having. I mean you're looking at your customers. They have very robust margins. I think they would argue that those margins maybe could have some more near-term benefits just because of the unique supply constraints that they're facing. They might also argue they have to invest a lot in EVs. But at the same time, you're facing this very unique cost inflation. So maybe you can give us a flavor for the types of dynamics that have shaped the commercial discussion. What you think the ability could be to offset some of these cost headwinds?

Dan, certainly, our customers have a huge investment program as they look at autonomy, they look at EV. And I kind of think of the positive side of it given our capabilities and our strengths, our systems confidence, how do we work with them to support them and move them a longer track, and I think that's a big advantage to us. But at the same time, we are facing some cost pressures. We've seen some significant inefficiencies with this unpredictable production schedules. We've had some discussions with our customers. We continue to have discussions with our customers. I think time will play out, and we'll look back and figure out how successful we're on recovering some of the cost pressures we've been seeing over the last little while. And I'm hopeful we'll get something. But if you think about it, Dan, recovery, and it's not just I'm going to get a price increase. Part of that could be an offset to future givebacks or program awards you're going to get and sometimes there's some compensation itself at the beginning of the program. And that could be an offset to that. So it's not necessarily one-for-one black and white, it's how you manage the entire relationship with the customer. I can say, Dan, over the years, and I've been around in this industry for a long time, there's periods where it's pretty tough up on inflation where you stopped dealing with your customers and kind of look at what we've done over the years in terms of maintaining margins and growing margins, I mean that's really the success we've had. It could be tougher 1 year, a little bit better than the other year. But longer term, we've been able to manage through beyond these cycles. I'm so confident we're going to be able to do that.

Okay. Okay. Why don't we just transition to the organization? So I think we know -- we see -- we saw some change at the top last year with Swamy taking over after an extended run by Don Walker as CEO. Now I guess, in the next few months, Vince, you'll be transitioning even at the company over 20 years, from the CFO role to President. Pat, you're transitioning from a leader in finance to the CFO. So maybe we can just start. First of all, Pat, I don't think we've heard from you in a public forum. So you could just introduce yourself frequently and maybe some of the approaches that you're going to take as you're transitioning to the CFO role?

Yes. Thanks, Dan. Sorry. So I've been -- so I'm Pat McCann, for everybody's benefit. I've been at Magna for just over 22 years. I started back in '99, working for Vince as Controller. And I was eventually promoted up to VP of Finance in 2008. Throughout that time, I really worked on financial reporting, a lot of market transactions, M&A. And then I went out -- what's interesting, Vince thought it was a good idea and Don was to go to a group and get some group experience. So I went out to Cosma, our biggest group metal stamping facilities and came back as SVP of Finance in 2019 working with Vince. Obviously, a lot of our plans got derailed with COVID, I would say, over the last 2 years. But it's been interesting times. I think on a go-forward basis, Dan, Vince and I are going to work together on a transition over the next 1 or 2 years and keep moving the ship forward, I would say, I think we have a good company and its tweaks as we go forward.

Great. And Vince, your new role, maybe you can give us some sense on what your new role as President is going to entail? And what approach you might be taking as you transition in what the work with Swamy is going to take?

Yes. Dan, I've been spending more and more of my time on corporate strategy, whether that was Don, or more recently with Swamy. And given some of the changes in the industry, the megatrends and the investments we're making, it just, for me, is spending more -- all of my time essentially working on corporate strategy on close service with Swamy. So that's what I'm going to be doing. It's -- so I view it as just a natural progression. I mean lose directly some of the things I've been doing on the CFO side and amplify what I've been doing on the corporate strategy side. I'm comfortable with Pat taking over the role. I think he's going to a really good job in the organization. A good leader. He knows our company. He's going to have to get involved with our investors. He hasn't seen a lot of that. And I'll spend some time with Pat on the IR side so that we evolve a little bit in that area. But it's really corporate strategy and trying to figure out where we're going to steer the ship, whether it's on the ADAS side, whether it's on electrification, product strategy and all that, I'll be involved in.

To that point, so we are coming in on 1 year of Swamy's tenure. Maybe you can give us an appreciation? Obviously, a lot of the same approaches, a lot of the same frameworks are still in place at Magna. But maybe you can give us appreciation for what are the ways that things have pivoted a little bit? Is it more -- it seems like there's more of a focus on increasing your exposure to megatrend. So in the past year, maybe what are the areas, even if ever so subtle that have shifted at Magna?

Yes. So I think there's -- in my mind, there's probably one thing that really stands out from a shift perspective. I'll tell you what, it continues to move along, and that is really a fundamental Magna strategy, which Swamy has been instrumental. I think about car of the future, we plan the car of the future for a long time. Swamy was really the creator of that car of the future concept years and years ago and figuring out kind of what we wanted to be in, what we want to get out, where do we need to shore up some technology capabilities, geographic footprint. And as part of that strategy, we've certainly been investing in a heavy way in the megatrend areas, so just proportionate amount of our capital compared to the scale of our business. That's just continued with the acceleration of, in particular, electrification across the organization, across the industry. So he's spent -- so he's been spending a lot of time there. I'm not surprised. It's a continuation. I think we're, I would say, for me, it's kind of a little bit different. I'm pleased with that, and Swamy and I can put the line on that. It's really the accelerated focus on the capabilities of Magna as a whole and how we work across the organization to bring unique solutions, strategies to our customers. We received some business awards this year that we've had and we've talked about. And I think that really differentiates us. I've been talking about this for years. Swamy is a big believer in that. And I'm seeing a big step forward in that area, which I think is going to position us well for the future. Given all the changes in the industry, given the new entrants coming into the space, I think that really sets us apart as a supplier.

Great. Well, why don't we pivot to the segments before we go to the megatrends you've been talking about here. Just a quick sort of segment rundown of question here on each of the segments. Maybe we could just start with BES. Slow margins in the third quarter, roughly 3%. What drives the margin recovery in BES going forward? Is it just volume recovery that drives the margins from where we are in the third quarter?

Dan, I'm going to have some of these questions answered by Louis. I'd see that you're going to have to deal with this going forward in '22 directly. So go ahead, guys, you split it up.

Yes. I'll jump in first. I think on the BES side, Dan, Vince spoke about this earlier. It's a combination of volumes coming back, and I think we'll have our incrementals that we're expecting. And I think more importantly, it's just the stability of the volume increases and avoiding that stop-start. That being said, we'll have to see where commodity costs come in because this group is a big user of raw materials.

Great. Power & Vision. I know there's a lot of underlying pieces in Power & Vision, but my question on Power & Vision is going to be on DCT. So maybe you can help us disaggregate what the underlying trends have been in DCT. To what extent is that driving outperformance, where we'll be seeing some better growth over market? How much of that is this BMW program that was rather large that you won a couple of years ago? Maybe just some underlying color on the DCT trends that you're seeing within Power & Vision?

Yes. DCTs have been performing well. They have been contributors to our growth outperformance. This is we've launched new business in that product area over the last few years. I think more recently, we've been talking about a transition to hybrid DCTs that are supporting our customers' electrification strategies. We did talk about that BMW contract a couple of years ago. We're now in to launch DCTs, including the hybrid DCTs to that platform. We're also launching just the next little while, an additional hybrid DCT program for another European-based global OEM. And then, of course, in the last quarter call, we talked about the -- another electrification award. It's both, it's transmission, traditional DCTs as well as hybrid DCTs for Daimler. So that's our third high-volume DCT program award. So it's been going really well. And what we can really provide as a benefit is obviously, the fuel efficiency that comes with the hybrid option, but just offering the flexibility with our package neutral system. So using the same space in the transmission, the OEM has flexibility whether they want to go through traditional DCT or hybrid DCT. So it's been a good success story, I think, for Magna.

Great. Seating. Sort of same question as BES. At Seating, we've seen some margin pressure beyond just the volume issue. So what is it that drives margin recovery in the Seating segment?

I think on the Seating side, what we're seeing is not only we have in the stop-start, which is impacting all of, not only Magna but all our competitors. The issue we're seeing with Seating at the same time is negative program mix within JIT facilities dedicated to one program generally. And we've had negative mix, specifically on a couple of North American programs. I think we're going to have to win some awards, backfill those programs and get back to normal levels in the longer term.

Great. And then let's wrap up with Complete Vehicles before we go to the megatrend piece. There you've actually seen really strong margin outperformance, and that's continued. I mean we saw that really in 2020, and that margin outperformance has largely been in place. So maybe you can just give us a sense of what is it that's driving that? Is it just more engineering mix? Is it favorable program mix? Because these factors that we would have thought would be sort of temporary seem to be remaining and you are getting that better margin performance in.

Yes. It's really been a combination in that business. Frank Klein is a new President there, and his team is really -- they've really done a good job. They were ahead of the curve. It was really pre-COVID where they were looking at a program to take out costs out of the whole organization. So that's definitely been a benefit we've seen throughout the last couple of years. We've had strong operating performance from the engineering team. Even when COVID hit, they were able to keep up strong sales and productivity was very high. So engineering definitely helped, and program mix has been favorable for that business. So all those things, I think, have contributed to strong margins over the last couple of years.

Great. Let's -- we're going to ask some questions on megatrends. And by the way, anyone who has questions, please feel free to email me, [email protected]. Let's just zoom out first. I think one of the things -- one of your approaches that you've talked about is a building blocks-based approach, very systems-based approach. So as automakers are moving more to EV, there's more software-defined vehicles that automakers are approaching shift in architecture. To what extent are you seeing sourcing patterns changing that all of a sudden, they may look at that building blocks approach or that systems-based approach that you have, and that gives you inside edge on winning more business than you've had in the past? Are there any early reads that you are getting those benefits?

Yes. There's a number of examples, Dan, certainly from our building blocks approach. And I got to tell you that our OEMs really differ on approach. How much they kind of in-source versus they build out or they design in-house or design outside. And if I think about -- and let me look at electronics in our mirrors business, right, and get a strong base of electronics -- strong base on the mirror side, so you put both of those building blocks together and you come up with a great product, maturity product. We've got some awards on it, for example. So that's really good. Look at what we're doing on the EV side. And again, customers have different approach on what they're doing there. So if you think about what we're doing from a capability side, so we've got software capabilities, we've got full integration capabilities, we've got e-motors, inverters, we've got gearbox manufacturing capability. And you kind of put that all together, depending on the opportunity with the customer to deliver something. And as you're moving to some of the new entrants, if you look at Fisker and our capabilities across the organization, we're able to help Fisker get to market faster given our expansive capabilities. Even our fascia business, for example, we're really good at fascias, we're really good at making them efficiently, styling, good, classy surface, great painting. And now what we're doing with some of our capabilities on the sensor side is how do we integrate that all together into a grub to reduce the cost for our customers improve how a patient walks, or how do you integrate a battery frame and enclosure into a frame with their [indiscernible] building? So we're seeing a lot of opportunities that sort of, I would say, go beyond just one product area, lots of opportunities as well even within a product area to talk about ADAS notification, for example. And I think that's just going to continue to move forward and should benefit us. And that was my earlier comments about Swamy embracing all our capabilities across the organization. Even though we're leaders in a lot of the areas, as you kind of put it all together and we can offer a full integrated package to our customer on all the building blocks we have that really sets us apart from a supplier perspective. It can provide our customers what we think is an optimal solution.

Let's talk about Fisker because you raised an interesting point there. First of all, a question from the audience. What's your confidence that Ocean is going to be shipped on time or ahead of time? I think Fisker has been very, very positive about these things are trending as planned. So maybe you can just give your side of it as well. It sounds like things are going okay. And then just zooming out, is the Ocean going to be -- should we look at that as a signature program for you, a one program where all of your capabilities are really being put to work and something that could bring in other start-ups as well?

Yes. So you got a couple of questions there. The vehicle has unveiled at the LA Auto Show, I think there's some really good reviews on [ very nice set of vehicle ]. The teams are working collectively to launch this program like '22, and I say the teams do business, our team and Fisker's team. I think we're working extremely well. And our team is more than just Magna Steyr, it is across the organization. Is it a signature program for Magna? We built over 3.7 million vehicles on Magna Steyr. So it's another program, but we've had some really good programs. It's a good program for us. It has a number of our capabilities in there where we have complete systems. It doesn't have all of our capabilities. So I think this is a good example for our customers as well as new entrants to show what our capabilities are in getting the vehicle to market on a more timely basis and a good vehicle to market on a timely basis. But I don't -- it's a great program for us, and I think it's going to lead to small business for us across the industry.

Great. Battery frame. You have the content on F-150 Lightning. You have other content as well. Maybe you could just give us a sense of what the competitive landscape is. And would you talk about your moat versus others? And we look at that F-150 Lightning win, how indicative is that of potential future commercial success for that product?

Yes. I guess competitive landscape, I mean, there's always going to be a lot of competitors when we're looking at our new product areas. So there's always a lot of competition in all of our product areas. They are pretty important program awards that we have with GM and Ford. And there's -- I can tell you, there's a lot of additional opportunity with a lot of other OEMs that we're considering. It's a high-content product. Think about a truck frame being at, let's say, $500 of content. Content on a typical battery enclosure is going to be a little higher than that. So large, highly engineered system that's acquired on every EV. There's a lot of considerations, thermal consideration, structural elements, and we have the expertise and scale. And we think that's going to give us an opportunity to really grow this business and really stand out from being highly engineered, I think, for Cosma is an advantage, and it's an attractive growing market for us.

Great. I'm going to ask you a question on AVs and then one on capital allocations, and we'll wrap up here. AV, I think people largely forget that you own a stake in Waymo. You collaborate with Waymo. So maybe you could just tell us, where does the collaboration stand? What are the opportunities to expand that collaboration?

Well, Dan, we've got a couple of things going on with Waymo. We have a contract that integrates the Waymo drive rule into vehicle platforms as to our Magna Steyr operation. Then we were also offered the opportunity to invest in Waymo, which we took up. And I think it's a good way to just continue the dialogue with them. I think Waymo has got a leading position development of autonomous driving technologies, in particular, kind of Level 4 and Level 5. Our focus has been on Level 2 Plus 3, Level 2. So being involved in the investment side could just, in communication with them, gives an eye to what's happening on the L4, L5. Because it's a market that, at some point, is going to be important and that I want to participate. So I think it's a good relationship. And we'll see where that kind of leads us down the road at some point.

Great. Let's wrap with a couple on capital allocation. You maintained your capital allocation framework, but you also have fairly high cash balance. I think it was $2.7 billion at the end of the third quarter. So maybe you could just give us a sense of, a, what normalized cash level should look like? And given the Veoneer deal did not work out, should we expect elevated share buybacks to work down some of this cash?

Do you want to take that, Pat?

Yes, I can jump in here, Vince. So I think the first part of the question, Dan, is just what's our regular levels of cash we'd expect to see on our balance sheet. And typically, we'd be looking at about $900 million number, in that range. It's going to bounce up and down. But just pick $900 million, I would say, generally. When you think about the $2.7 billion we have the cash on the balance sheet at September 30, part of that was related to the Veoneer transaction, where we were damming up cash in the anticipation of closing. Obviously, that transaction's moved. So absent investment opportunities, we would be looking at doing share buybacks in the future, and we did renew our NCIB in mid-November.

Great. And as far as other portfolio areas, you talked about -- obviously, you thought you were going after active safety with Veoneer. But what are the core -- the bolt-on priorities for you within the portfolio?

Yes. Personally, I would look at any of our segments as for bolt-on opportunities. If it's going to attract a technology, a customer or a region, and it's accretive and it's going to create value, this is something we're going to look at. It's something we've done for 20 years, and I don't see that changing, Dan.

Okay. Well, we're over time. We'll leave it there. Vince, Pat, Louis, Jim, thank you so much for your participation, and we look forward to hearing more from you.

Thank you, Dan.

Thank you.

Thank you.

Okay. OpenExchange, we can close out the session.