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

Thank you, everyone, for joining us as we continue the Barclays Global Automotive Mobility Tech Conference. I'm Dan Levy. I lead Autos -- U.S. Autos research coverage at Barclays and very pleased to have with us Magna International, who you all know as one of the top 3, 5 largest Tier 1s. -- #4 -- right now, you're #4. Okay. Very pleased to have with us Pat McCann, Magna's CFO; and Louis Tonelli, who leads Magna's IR efforts. I'm going to go through a series of questions, fireside chat style. But anyone in the audience, please raise your hand if you want to ask questions. We want this to be interactive. And also for those on the webcast, you want to ask questions anonymously, please feel free to e-mail my colleagues, Trevor Young, [email protected] or Jason Stuhldreher and they can ask questions for you. So with that, Pat, Louis. Welcome.

Perfect. Thank you Glad to be here.

I think a good place to start is on the near-term production environment because we're hearing from several of your competitors or peer suppliers that a lot of the choppiness that we keep on hoping and thinking will dissipate is still in place. And so I guess first question is, what are you seeing on the production schedule choppiness?

Yes. I'll add to it, Louis as well. But I think on the choppiness, it is getting better. I think that's the #1 thing. And -- we think where we started really 18 months ago when the chips really hit and it accelerated into Q3 of '21. I think that was the trough that was the worst. And our data, which we're missing about [ 3.5 million units ] of production. If you fast forward 12 months, we were down to about 700,000. There's still stop starts with the choppiness in it, but it's getting better. That being said, we expected it to be behind us. To your point, I agree. Tomorrow is never going to come. Everybody think it's going to be a little bit quicker. Some of that slack starting to build up. I think it's probably delayed and we're going to see the end of it this time next year as we get through it.

And what is the primary constraint that you're hearing from your customers? Is it still chips? Or is it issues with Tier 2 or Tier 3 suppliers or issues on the transportation or logistics side?

My belief is chips. So if you go back again over the last 12 months, they would say, yes, we couldn't build because of chips. They've been more silent now. I think it's more of a reflection of there's not as many units coming out of the system. So my belief is still dominated by a chip issue. There's probably normal stuff that would happen over time, but the big numbers are chips. Great.

Regionally, are you seeing any difference in these dynamics?

Not significantly. I would say we see a little bit more in China per se, just on the volume sets of some of the units lost, but that's not as impactful for us just because we're underweight in China.

Let's pivot to the near term on the cost side. You talked about $580 million of incremental cost headwinds on a net basis this year. It stems from commodities, energy, labor. Just walk us through the different magnitudes of -- different components of these. Any magnitude around that? And then what's sticky?

I'm glad you're the first person to ask that question.

I'm sure no one else thought of it.

I think in terms of the numbers, we started the year, we expected about $275 million in costs, of which about $190 million was commodity and the remainder was labor. We came to May, we can move that number up by about $290 million. The bulk of that was related to energy. And we've really held that over the last couple of quarters. I think the last quarter, we moved it up about, let's say, $20 million or so. That was mainly just the impact of lower scrap steel prices on our overall number. And so if you look at it, really the 3 biggest categories would be energy, commodities and labor. And I'd say roughly, in rough numbers, let's say, $300 million of it is energy, $200 million Commodities, $100 million is labor roughly. Are there some other things in there. I'm just rounding, but those are the biggest buckets?

Okay. And then obviously, the follow-up is on the recovery. So what has been the tone and tenor of the discussions that you're having with your customers on recovering that?

The numbers Louis, we're referring to is the net number. So our numbers are gross, that roughly $600 million would be on a net basis. They're never easy discussions. Let's be honest, nobody wants to reimburse costs. When you think about what we're seeing how -- we're seeing those lines, sorry -- we're seeing those conversations accelerate. And I think the customers are coming to the realization that we have an industry issues to see inflation costs -- I'm sorry, energy costs go up by eightfold is an industry issue, and you have to put some support into the system. And it's not just Magna, the table looking for reimbursement, it's Tier 2s, Tier 3s that need to be reimbursed basically to stay solvent. So I think one of the benefits of being at Magna, we have a very strong balance sheet and strong liquidity. The flip side to that argument is we're last in line when you come to these discussions, not last, but like a well-capitalized companies are being dealt with in Q4. And Dan, I think that's reflected in the cadence of those costs. And as Louis was saying, of the $580 million, $550 million of it has already been in Q1, 2 and 3. So we're starting to see some of the recoveries be back ended.

One of your competitors, peers, another Tier 1 mentioned today, historically, when we think of the index agreements or the recovery agreements, it's purely on raw materials. There wasn't indexation or agreements for labor, for energy. Your customers are going through their own cost increases as well. So what is the willingness for your customers to recuperate you or make you whole on some of these other costs that they themselves are having issues on and that historically, they never covered?

You talked about this forever. But if you think about some of our Steyr contracts where we do vehicle assembly, we have had indexing really to labor, energy in certain areas. But they're not the norm. I think where we have other pockets of success with these types of negotiations would be in emerging markets where we've had operations in Brazil, Turkey, India, where you have high inflation. So we have been -- it's not necessarily indexing, but you have an economics discussion 1 to 4 times per year to recover inflation. It's just a significant number. I think where we're a little bit different from the OEMs and absolutely they have input cost, the flip side is they have record selling prices as well where we're somewhat in the middle, right, absorbing Tier 2 and Tier 3 costs in to supply the customer with a fixed contract. So all that being said, when we look at our quoting, we are looking to derisk. So to your point, can I get on an index? Maybe. When do you want to get on to the index is #1 question. If it's at a high, do you want to ride the curve? But when we get into new quotes, what else can we index? So we have 70%, 80% of our steel is already indexed. 20% of our resin, can we start looking at indexing? Still more commodities, but energy and then you get into labor. But I think labor is more sticky, and I think some of that's on the supply base as well to be more efficient and implement more automation.

Great. Let's talk about 2023 to the extent that you can. Just firstly, I don't know if you can share with us any views on the broader LVP environment that you're seeing. IHS, I believe, is low single digits. But do you have -- I think you were saying just on the choppiness, some of that continues into 2023?

We're not -- we're still going through that whole process, Dan, of what the volumes are going to peg going through our business plan. So it's really a bit early to talk about what '23 looks like from production or margins or any of those factors. We got to really wait until we get through ours. I mean we're just going to start in the next few weeks. And I think we get to February and have our outlook, we'll have more detail on '23.

As far as maybe some of the -- your typical flow-through, maybe you can give us a sense if we're just comparing against 2022. I think you said your incremental margin historically has been sort of 20-ish percent -- low 20s.

That's what we had seen when we had gone down in [ 2020 ], but it depends on segment, Dan. So our incrementals, decrementals the lowest in Steyr than Seating and then the heavy industrial ones at BES and [indiscernible] would be at that bear end.

Right. So maybe just help us understand under what circumstances we would see sort of normalized incrementals versus if we have an environment of continued choppiness, your incrementals are pressured.

I think what we have -- I kind of disassociate them, Dan, to be honest with you, because I'm thinking as we have sales with pull-through, that is -- we are seeing those normal pull-throughs that we've had. What we have on this flip side is this is an operational issue, which is the stop start. I guess when you put them together but when we're seeing new business come on, that's running at a stable platform, we're seeing normal incrementals on that business.

Okay. Maybe one more on the near-term operational sort of this culture. When Don Walker was CEO, he talked a lot about world-class manufacturing. How have we seen that at play in the last 2 years where manufacturing has been -- I think prior to 2020, we all sort of took in the industry broadly, manufacturing supply chain for granted. It was just very smooth and issues got sorted out very easily, and that's been the exact opposite the last 2 years. Do you see world-class manufacturing? Is that something that's played out in the last 2 years that maybe helps to mitigate some of the impacts.

My view is absolutely -- Louis jump in. If you think about what happened in March of 2020, when we started seeing COVID come through China and then was spreading into Europe. The ability of our operations to react. And the way we came down, organized employee safety and the way we came back up and you're coming back to your incremental margins, those margins at that time, Dan, were significant. And it was really a reflection of Don's view of world-class manufacturing that you -- we have to be world-class to be able to be competitive and survive long term. I think when you come to Swamy, with Swamy coming in -- Swamy has a different background. He's more on the technical side. And -- but his -- one of his main pillars is innovation, but also it's manufacturing innovation. So how do we build from Don's base and again build on world-class manufacturing. So some of the things we would be looking at, for example, would be master data and how do you use master data, machine learning, AI to be more efficient and predictive maintenance, automation in the plants. So these are the things where we have such a great culture of people being responsible and accountable. Don's foundation now if you can start putting a lot of the data into it, that we can build off that. I think that's going to really make us much more competitive as we move forward.

Great. Let's pivot to megatrends, which was the core focus of your Investor Day earlier this year. And I think the vision that you were pitching is that you have all of these expertise areas in a wide set of products, which is quite different than a number of your competitors that have sort of narrowed the focus. So hey, maybe it gives us a sense of what is the mix of your awards that are for a wider mandate. And maybe you can give us some examples of some awards that you've won where you won that award because it's leveraging your expertise in another product area, there's building blocks that you've talked about.

Yes. I think we believe that it's our systems expertise and our complete vehicle expertise that inherently makes us -- we can see the vehicle and all the systems that go into it in a way and optimize the vehicle in a way that really -- no one who -- other suppliers that don't necessarily do the complete vehicle that we can. So I think there are areas like driver monitoring where we're connecting what we do on the meter side and what we're doing on the electronic -- the ADAS side, front integration panels, we're looking at a facia and how do we integrate the sensors into that or liftgate where it's a liftgate plus lighting integrated into that our connected powertrain, where it's our powertrain systems or either our system but also bringing in information from ADAS. So we've been kind of demonstrating over the last little while some of the newer areas. And some of them we have program awards, some of them don't, we're -- this is early days, but those are the types of things where we're showing that we can integrate better than really anyone can do, and that's really what we bring to the table. Even if we don't necessarily have -- I think even if we're not necessarily doing something across different segments, I think just the understanding of a complete vehicle makes us -- allows us to do a better powertrain system because we understand how it connects with the rest of the vehicle. So that's really our pitch, and we believe that's going to continue to matter. I think optimizing systems and reducing cost is not going away. It's going to continue. And I think because of our position, we're going to be able to benefit from that.

Does the size create any -- does it inhibit you at all in terms of some of the share? And maybe you can give us a sense also how the customers look at as they're adding new content that maybe they haven't ventured into as much. Do you have a bit more of an advantage because you have that track record with them? Or is there maybe a little more caution about not wanting to give too much share to the very large suppliers?

My impression on what we're seeing, Dan, is that our -- a lot of the -- you're going to have a strong tariff supply going to be core to the OEMs -- and they're going to look to Magna for various factors is going to be what Louis covered as far as we can deliver a product that maybe our competitors can't because we have the various technologies. The other reason might be, if you think about a battery trade, we're launching a significant battery trade. They can come to us with our engineering expertise, and we can -- if you want to roll form it, if you want to stamp, if you want a hot form, if you want a cast that, we can provide a whole suite of services that we can solution for them. And I think the last thing that they look to us is when the OEMs are moving from a traditional business into these BEVs and it's critical that they execute. They want to partner with suppliers that know can execute. And that's going to be what we're talking about on the technology manufacturing side. But the flip side of it as well, what we bring is a solid liquidity basis, too, right? We're proud that we haven't shut down a customer because of COVID or chips in 3 years. And I think that goes a long way to be a core supplier.

Great. Before we go into some of the products that you've talked about megatrends, maybe we could just look at this from a growth over market standpoint because I believe the -- your latest 3-year outlook implies it's low-single digits growth over market. So help people understand. When people think of megatrends, they think of a larger growth of the market. Why are we not seeing that play out in numbers as much? Is it more of an opportunity beyond the forecast horizon?

And there's a few factors. So if you go back to our Investor Day, you would have recalled we have basically, 70% of our products are agnostic. So they're going to grow with market or slightly above as we move forward. And we're always trying to add content into the various seats or facials, or stampings. We have a portion of our business that is ICE or mechanically driven. That's going to -- whether it's manual transmissions or all-wheel drive or 4-wheel drives. And then we have a growing piece. What we're seeing on some of the all-wheel drive, 4-wheel drive in particular, is that product is being replaced with an electrified version of it. So we're still going to be transitioning that business, and we're going to grow in the BEV space, but we're not going to have the sales growth because it's basically replacing one for the other. I think the other and bigger factor is when you think about the way we're trying to grow our eDrive business, a large portion is coming through joint ventures, which are consolidated. So it makes it a little bit the math a little bit harder. So you're not seeing the growth over market. The flip side would be when you look at our equity income, our equity income is growing significantly from our '22 to '24 period. So you have a growth over market, I would say, on earnings related to it.

I think there's room for us to continue to grow faster than market going forward, no doubt about that. But we are a big company. At $40 billion, it's hard to grow 10%, 15% every year. Those numbers are big and to do it every single year is hard. So just the fact that we continue to grow fast in the market, and we believe we will continue to grow faster is I think significant.

Okay, let's unpack some of those products. Let's maybe start with ADAS. You've targeted $2 billion plus of ADAS revenue by 2027, up from $0.5 billion last year. So maybe give us a sense of what product specifically it is that's driving the growth. You have vision-based products, you are expanding with an HD radar. What's driving this? And do you believe you have scale, right? We know you pursue a certain acquisition and it didn't work out, but do you think you still have sufficient scale even without acquiring?

I think -- so I'll answer the scale piece first. So when I -- when we look at the scale, I think we have the full suites and capabilities to do. We want to play up into a level 2 plus 3. That's really our range. So whether it's radar, cameras, vision, even into the LiDAR type space, we're able to deliver that today. And actually, the other piece we'd bring down is just all the fusion of the various pieces, right, on the ECU portion of it. So do we have the scale? I think where we are now is we're at $0.5 billion. We have the products and we have the expertise coming up into the $2 billion, we start to build the scale. And there's financial scale in the sense that we're expensing x amount of money to grow this business as we start to grow revenues by $1.5 billion over the 3-year period, that contribution margin is going to start dropping to the bottom line, so we become much more efficient in that piece of it. As far as where we're growing the $0.5 billion up to $2 billion, the vast majority of it is in vision-based ADAS type systems. And as Louis mentioned earlier as well, we also have the DMS, Driver Monitoring Systems.

Another question on ADAS and this has come up recently as it relates to one of your Tier 2 partners who have made some claims or hopes of taking on more of a Tier 1 role. Maybe remind us why you think that your position as a Tier 1 or as an integrator is secured that it's not something that can easily be taken by a Tier 2 jumping to be a Tier 1 as well.

Yes. So it really depends where you want to play in the stack. So at the base, you're going to have a perception where the supplier you're talking about plays and how do you move up the stack and as far as you're going to have drive policy and you're adding all your function and features. We have the sensor suite that we're trying to pull into the drivability. At the end of the day, I think it really drives around how does the OEM want to source that work. And you have to be competitive and have complete vehicle know-how for the drivability piece of it. So the perception is going to say, hey, that's a stop sign, how do I make the car react and the drivability? That's the expertise we bring to it.

Drive units. You're taking 3 different approaches at this. You have your own wholly-owned business. you have the JV with LG, and you have a JV with HASCO, yes. How are you -- what's the value proposition of each of these? Are there synergies across the businesses? Is there a way to maybe have a more unified approach across each of these offerings?

We view it as unified, when we think about it, Dan, in the sense that the LG joint venture -- so if we break it down into buckets, the LG joint venture was -- so we have our existing business and what we bring to eDrives is we have a gear expertise, a gearbox expertise. But the big thing we really bring is the design and engineering of a vehicle, like the actual -- the unit, whether it's mechanical or eDrive. You have to have that skill set. When we entered into the LG joint venture, they have an expertise in motors and inverters. So how do we take those 2 strengths, put them together, and then at the end of the day, you're able to -- it's cliche, but how do you make 1 plus 1 equal 3? So you put the 2 pieces together. So if they're able to provide scale and you need a lot of scale when you're making motors or inverters, and we can buy those system components and put them into a full system that we sell to basically any place outside of Korean OEMs and Japanese OEMs in the Asia space, if we can take that business and we have the joint venture, we benefit on the component side, that's a win for us. On the -- from LG's perspective, they have the benefit that we bring the vehicle know-how, the automotive know-how that we can grow in that space. So when you put together, that's a great benefit. Then the third pillar to it as some OEMs are looking at doing this work internally, maybe in the short-term anyways. In the long-term, our experience has been they tend to move it back. So just every supplier you've had here today is great at driving costs out of the system. So the third pillar is those OEMs in the near-term had a minimum need components. So we can sell components in at that as well. So when you put it all together, it might look divergent, but we really have 1 approach to how we're trying to attack eDrives.

Great. Let's talk about complete vehicle assembly. What's been the discussions with automakers to bring more EV content in? And we hear about most established OEMs generally wanting to own a manufacturing. What's the value proposition for an OEM giving you the manufacturing for their EVs?

I think traditionally, you would look at a traditional OEM and a new entrant probably a little bit differently. In both cases, I think what we bring to our potential customers is our engineering capabilities which other assemblers or suppliers can't provide. The other piece we bring to it is an incredible high quality. We have -- we've been building high-end vehicles. We've won J.D. Power awards for -- or best quality in all European operations. So that's a given for Magna. I think when you look at the new entrants, the other piece that we bring to it is speed to market and capital and know-how. So if -- when we're working with Fisker, the ability for us to bring that vehicle to market as quickly as we can with the quality we expect to launch it at, that's an extra. That's something that other suppliers can't do.

How should we think of the magnitude of your engagements with newer entrants? Because on one hand, it is a more challenged environment. So I think some of the companies that some may have thought could have been your customers initially maybe aren't doing financially as well, and you're probably evaluating those companies. But at the same time, the start-ups were the ones that were theoretically to approach you more. What types of engagements are you seeing?

We've been -- I don't want to use the word cautious but thoughtful about dealing with customers. We've had the benefit of dealing with a handful of customers that are financially strong for decades. So when we've gone into the space of dealing with new entrants, and I'm talking, Dan, now more broadly than just Steyr because our system groups are also -- you might be selling a seat into a new entrant or a body panel, whatever it is. So we were much more cautious or thoughtful when we approach them. So you have to look at what obviously what's their financial wherewithal, what's the product going to be, what's their long-term viability? So you get into all these analysis. We've talked to every single one. Then the question is how many do you want to deal with and how much content do you want at any given vehicle that where it's balanced? So I say we have a balanced approach to dealing with new entrants.

When I see headlines like we saw yesterday that VW is looking to potentially work with Foxconn. Does that -- gets back to the question of building out your footprint because you have Graz, you have the plant in Slovenia as well. Does this -- when you hear headlines like that, is there -- where are we on enhancing or growing the manufacturing footprint?

I would view them as unrelated. If VW has -- it's news, right? I read the same article you read. And if they're going to look to grow with Foxconn in their Lordstown facility, that's their prerogative. I don't think what we bring is low cost. We have to be competitive. That's a given. We bring things as far as like I said earlier, engineering and quality. That's our sales pitch. And not -- I shouldn't use the word pitch. That's our reality. That's what differentiates us, and we're going to continue to focus on that. And that's been our real-world experience in Europe because there were competitors that were more low cost, strictly just put cars together. And we've shown with our track record of 4 million units that we build -- we're able to win work even when there are other low-cost competitors out there, right?

I'll pause here. I don't know if folks in the audience have any questions, or if there are any no questions.

[indiscernible]

Yes, absolutely. It'd be the business case. You're going to go through the logic we just went through, what's the product, what's the partnership, what's their financial wherewithal? So we go through those things because it is a significant investment to put up a facility, to launch and there's a lot of lead time, so you can do brownfield, greenfield, but it's a significant investment. And you'd have to look at what's the -- it's not a 5-year commitment. This has to be a real viable product that we're going to continue for 2 cycles, you would think, minimum.

[indiscernible]

Yes. We launched 2 weeks ago. So I think it's a little premature to be honest. It's a slow launch. So the launch we're ramping up into a regular production in Q1. So I think maybe if we're here next year, we'll have a better answer for you.

Is it fair to say [indiscernible] America, which we be manufacturing [indiscernible].

I agree, and I think the other piece of it is when you do the engineering, you're more efficient on the manufacturing side. So you want that benefit that you have way more -- and that applies beyond Steyr. So we have way more success where even if you're designing a battery tray or a seat, the more you're involved earlier in it, the more efficient we are long-term. And then what we also find is we have more or higher probability of being awarded replacement work because it reflects a lot of our manufacturing processes.

Further on the megatrends, I mean, you talked about $900 million of annual engineering expense. I think when you gave that target, it was a very different macro environment from what we're seeing today. Does the macro environment make you think differently about the pace of your spend?

I think the short answer is no. We're obviously cautious where we can defer and delay. We're always going to do that. When you think about the $900 million, it's basically made up of 2 components as a core engineering, and this has all being expensed, right under the accounting rules. So we have to expense it. So we're expensing a core portion, and it's related to your earlier question of how we're going to launch ADAS from $0.5 billion to $2 billion if they go together. But there's an application spend related to all these pieces, and that's what's buried in that $900 million on average. My preference, Dan, would be if we can maintain our core and resell that core over and over. I would like to see our engineering spend increase for the application portion. And if I increase my application portion on good dollars, not wasteful dollars, but good dollars, I know I'm continuing to grow the business. That -- it's virtually a start-up. I was saying earlier today a couple of times, it's almost like you're looking at a start-up business, where you're expensing a whole bunch of money. And then once you start launching that business, you get economies of scale into it.

And folks, ask questions if you have them. Maybe why don't we talk about some of the segments and the margin dynamics. Let's just start with complete vehicles actually because those margins have continually held in much better than what you've guided to. What is driving that?

I'll start. I think relative to kind of where we started the year, volume and mix has kind of held in there pretty well. I think engineering margins have been strong in the business. I think those 2 have really kind of helped them to maintain their position. And there's a little bit of input cost impact that's negative. But I mean they have a lot of -- I think as Pat mentioned earlier, there had a lot of protection on the cost side, but they do have a little bit of energy cost that's coming through. But I think just relatively strong, stable program volumes and mix has really helped them.

And as far as Power & Vision because I assume that's where the majority of the engineering spend is hitting as far as ADAS. You're getting the spend related to LG. What's the path to getting ADAS margin to be breakeven or to be neutral or accretive? When does LG start to contribute more meaningfully?

Yes. I mean we're growing pretty rapidly in well both businesses, in fact. So there's lots of sales growth there. We haven't -- we're not talking about margins by product areas, so we can't get into that. But definitely, as we grow the sales, we're going to have more contribution. That's going to be a contributor to the margin expansion. We expected that. So certainly, some of the, let's say, electrification spending that we have right now, as we have more sales coming through, that's going to be additive to the margins, right?

Seating margins.

Yes. Seating has been impacted by a few things. Mix has been negative for seating. A couple of the key programs have really been an impact. The question is there's a big program for them, most vertically integrate program, and volumes have been pretty weak on that just as -- I guess, just impact or allocate less ships to that program. That had some just regular launch costs for new programs, significant new programs. I think that's been a net negative for them. Input costs have impacted the business. And they've had some operational issues, a couple of facilities, one in particular that they've been struggling with. So I think in that, you've got a few things. Mix can turn. I think the operational issues will contend with that. And then we have to kind of deal with the input cost side.

Great. And just to close, you've had on the cash front, had pretty healthy share buybacks in recent quarters. Should we interpret this as less opportunity for M&A going forward?

No, I don't -- we don't look at it that way, Dan, internally. So when we look at our #1 priority is foundational to us as having high investment-grade balance sheet. That's our foundation. Once we get past that, it's -- we want to grow. So our outlet is the NCIB. So it's a combination of growing organically or inorganically. And so we're trying to balance the cash that we had on our books, that we don't have dead assets sitting there. And if we can't use the cash to grow currently and we're still generating cash, right? That's the other piece. We've got to stay ahead of it. So we have been share buybacks during the year, but it's not a reflection of just lack of opportunities. It's -- I think the M&A market is taking time to reset to what our appropriate levels would be, I would say, as value.

Great. All right. We'll leave it out there. Great. Perfect. Thank you. Pat, Louis thank you so much.

Thanks, Dan.