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

All right. We'll try to speak over the -- with the noise outside. Our next presentation is -- our next fireside chat is with Magna. So during the earnings call last week, Magna's management team indicated that they see revenue climbing from $43 billion in 2023 to $50 billion by 2025. So $7 billion of growth. Of that $7 billion of growth, roughly 2/3, so $4.5 billion is coming from megatrend growth areas like ADAS, EV, drivelines and battery enclosures. That business generated $2.5 billion last year. It's expected to reach the low $7 billion by 2026. But I think even more notably, at least from my perspective, they anticipate significant margin expansion as those businesses ramp. The -- right now, those businesses, and you can just imagine a $2.5 billion business that's consuming $1.2 billion of R&D. So profitability is not very good right now. But as they start to generate revenue, that actually is very meaningful to the bottom line. Their margins at Magna have already improved from 4.4% in 2022 to 5.2% in 2023, they're projected at 5.7% at the midpoint in 2024 and then 7.4% in 2026. Another way to think about this is you're going to be a $50 billion company in that time frame. If you can achieve another 200 basis points of margins in this time frame, this is another $1 billion of EBIT, it's going to be coming through. And at the same time, it sounds like your CapEx is going to be coming down by about $500 million or so from where it's been running. So when we plug that into our model, we see a company that could accelerate their free cash flow to something like $2 billion a year. EPS in 2025, we think around the $7 range, then over $9 by 2026, even without buybacks, possibly a lot higher if there are buybacks here. So with that as an introduction, I'm very excited to have Swamy Kotagiri, the company's CEO; Pat McCann, CFO. Thanks for joining us.

Thanks, Rod. My pleasure.

Have a few questions, maybe to kick things off. Maybe first of all, I would say, all in, 2023 actually was a pretty good year for Magna. Earnings up 31% to $2.2 billion. Operationally, the businesses are on track, making good progress on margins. And I'd just like to ask before talking about the business and your outlook, just if -- things are looking good, but it's a big company. There's some things that are great and some things that are not great. But if you can go back in time and you can make strategic changes, it would have resulted in a better outcome than what we're seeing right now. Are there things like that? Just to give us a sense of the things that you're focusing on now?

That's a very good question, Rod. I think if you look at it from a strategy perspective, I think we've focused on the 3 big pillars. As we look at the last 2, 3 years, there have been a lot of, call it the black swans or events or whatever you want to call it, the COVID, the inflation, there's the supply chain issues and all. That pivoted, but I think they were all very tactical issue. The focus is on being very modular in the product and process helps staggering, for example, the capital investments and so on and so forth. Those were small pivots that came into play with all these incidents, but we still believe and felt, and we've been talking about it the secular trend of EV is there. The question of at what rate will it come has always been there. If you look at it over the last, I don't know, 6 years, we always felt in the low 30s was going to be the EV penetration. Obviously, different in different regions, China being the one leading and then followed by Europe and then North America. I wouldn't say we would have changed substantially any of that stuff. There is a lot of focus on the operational excellence, we call it back to basics, right? And we are starting to see the benefits of that. We've got about 75 basis points this year, 75 more to come in the next 2 years. So at a fundamental level, I think it's been proven that the strategy that we have, which is very simple, keep focus on the megatrend areas that are there for the long term and mobilize the investment in the right way, profitable growth. Go back to the basics, as we call it, the operational excellence, we started seeing results as the second pillar. The third one is just to see how we can leverage what we have in expanding our business, right? So I wouldn't say there's any shift in that.

One thing that I -- maybe this is correct or incorrect, but I do sense that there is an operational shift within the company. So you've faced your share of headwinds. There's been $600 million of inflationary headwind from '21 and '22, a lot of labor inflation. But I think that -- I mean, you've beaten -- exceeded expectations in 3 of the past 4 quarters. And I'm curious if something changed in the way that you're operating the business that you think is actually making an impact. It's not an easy business, tactically, things are happening. Is there something that changed within Magna that is leading us to see now exceeding -- meeting or exceeding expectations more regularly?

A couple of things, Rod. I think there were too many events that happened over the last 3 or 4 years in the industry, right? If you look at the COVID, I think we kind of were the gold standard, just as an example, our Graz plant was the first to come back online in 2020 then we had the supply chain then. Then something like the inflation because of Ukraine and the conflict that happened in our industry with the cycles that we go through, it's difficult to pivot that quickly, right? So all said and done, I think, over the last 18 months, we are very focused on looking at continuous improvements, comparing to the price givebacks, looking at our operational efficiencies, very deeply focused, very granular, obviously, sitting down with customers on recoveries, whether it's -- different types, whether it's commodity, whether it's energy, whether it's any of these topics, and add to that the program shifts that are happening are disciplined and figuring out how we're going to stagger capital, how are we going to build something that's modular. Even to the aspect of we take our own volume assumptions in terms of when we talk revenue. We still have to do the PPAPs and so on at the run at rate and all that. But all of that is -- there is a lot more focus on it. Pat might go through this every 2 weeks with our key management team. So every 2 weeks, we talk about all the tactical stuff. The following 2 weeks, we talk about all the strategic stuff, right? So once a month, we touch on all of these things. We have a regular, a very granular meeting every month. What happened last month? How does the next month look? How does the next quarter look, right? So I can't say anything more than that. It's just basically back to the basics.

Yes. But it sounds -- but there is something that changed, right? You had mentioned to me at one point that you had elevated to divisional incidents and operationally, even there's more intensity on sort of a COO role, is that right?

Absolutely. Yes. I think we got 2 gentlemen, John Farrell and Tom Rucker, both 25-plus years in Magna. So one of them is looking at the body structure system, the Cosma, the exteriors and the seating oversight. The other one is the mechatronics, mirror, sliding powertrain, electronics and Steyr. So there's a lot more granularity. The other interesting thing is when we go through this meeting, all the group presidents listen to everyone. So we are even trying to find the synergistic effect of you've gone through this, you've done this with this customer on this platform, how do we work together, right? So...

Let's talk about the drivers of growth. So of the $7 billion of consolidated revenue growth, we said $4.5 million was megatrend businesses. And I was looking at the components of that. Looks like the majority of that on a consolidated basis is the ADAS business is growing. So that was about $600 million in 2022. I think it was $1.8 billion, $1.9 billion something like that in 2023. Is that business still on track for something like $3 billion in 2024, maybe the mid-3s in 2025? If so, that's a big chunk of the consolidated growth.

Yes. I think you got most of the numbers. Roughly 2023, we ended up at $3 billion in ADAS, right? $1.8 billion, sorry, last year. And we're going to $3 billion this year and about 2027 will be $4.25 billion. That's what we've been talking about, and we still feel pretty comfortable holding to that. So that's a big jump that you talked about, Rod, about $4.25 billion to 2027 about $3 billion this year.

That's a lot of growth. And can you talk about the position that you have within ADAS? What kind of market share? Why do certain OEMs choose Magna? What's the landscape look like?

Yes. You have to define what's included in this addressable market and market share. We have always talked in terms of driver assist systems and full autonomy, and we are very focused on what I call the different levels of driver assist functions, right? Having said that, the 2 or 3 key aspects of being able to do that is providing the necessary sensors or the necessary compute or the software associated or the integration of all of them, right? So we are participating in all of them. And when you talk to the OEMs, there is something to be said about Magna and having the balance sheet that's necessary to go through once you have a program and how -- and the operational excellence, the launch discipline, right? And with software and the hardware and the integration of all the stuff and the discipline that you bring in of how to manage the change is something we feel the OEMs do appreciate.

What's the content per vehicle that you're typically seeing in these ADAS applications?

It depends on the type that you supply. It could be -- when you're doing just the sensors, let's say, you do the camera or the radar itself in the $50 to $100 range, all the way up to when you do an entire system $1,200 to $1,500, right?

So pretty advanced systems.

Absolutely, yes. Yes.

I'd maybe just ask also about how this fits into the margin story because it seems to me that investors don't fully appreciate how significant a driver this actually could be. So I know you don't disclose the profitability by business line, but just to use rough numbers, if it was $1.8 billion, $1.9 billion, let's use $2 billion as a number, maybe a 20% gross margin, making a number up to $400 million. I know that you spend 2/3 of your R&D on this area. So this could be $700 million or $800 million against just R&D, against maybe $400 million of gross profit if it was actually that strong at that point. So this is hundreds of millions of dollars negative, $300 million, $400 million negative now. You had said that this will turn EBIT neutral and then corporate average margins within your planning horizon. So maybe just talk to us a little bit about -- is that actually -- is the way I'm thinking about that right? That there is a few hundred million dollars of earnings growth from '23 to '24 and then more from -- into 2025 just from that business actually now starting to inflect.

So I think -- I agree, Rod, we talked about this on the call, right? I think your numbers are in the ballpark. The one thing I'd caveat is when you look at the corporate average of margins, it is going to come in somewhat below even in '25. So we referenced it to 2025, those numbers. But directionally, what we're seeing is the inflection point of now we're starting to bring the sales in, that we're holding our R&D is actually going to start trending down as we move out into the out of period. So we are seeing a pickup in our ADAS business as it comes in and it's driving margin. So I think your increase of doing your math of whatever, $400 million is probably not unrealistic. So then the balance comes in. So we have $7.2 billion of sales increase, to your point earlier, you take off, say, the $1.8 billion that we're seeing in ADAS space. And then the other piece we have to consider is the G-Wagen pricing. So you back off another $1.5 billion just on a bond change, no margin impact. So you're left with -- when you work through all the math, you're seeing a pull-through on the rest of our business, driven by a lot of stuff Swamy's talking about being the operational excellence and whatnot. And you're seeing a pull-through on the rest of that sales growth of 20% to 25%, and it's higher than our traditional number driven by your question earlier, like how are we driving it? It's launch execution, it's driving performance in the plant. So it is that growth. And so it's -- summary, it's ADAS coming through the leverage you back out the sales growth on the G-Wagen, it's nothing. And then it's strong pull-through on the rest of the business.

The investment that you're making, obviously, your -- you must be confident in that growth coming through. We're hearing mostly on the EV side about some delays of products and our impression is that some of these EVs have the highest content also on ADAS as well. So is that something that you're seeing? Or do you feel like that growth is generally on track at this point on the ADAS side?

I think on the ADAS side, I think it's on track. And I don't really see a big difference in our ADAS stack versus whether it's ICE or whether it's EV. And a lot of our awards are in the ICE space. So I'm reading the same stuff here, Rod. I don't see a lot of the decontenting that people have been talking about or [indiscernible] in the ADAS space. Really, when we look at our volume set and as Swamy said earlier, it's kind of a slower launch on the EV side, not necessarily on the ADAS side. So and it's very region specific, and it's primarily driven by North America.

So the rest of the consolidated revenue growth that we're talking about. Obviously, it's mostly on the EV side and mostly on the battery enclosures, right? Because most of the powertrain thing is unconsolidated?

There's still about $400 million actually in other stuff.

But there's a good $1.5 billion or something like that of battery and enclosure side. Could you talk about what you see happening generally in the EV market affecting this and as well as the powertrain business? Obviously, there's still a lot of debate we've been having with various CEOs and suppliers all day today. How is that business ramping? And specifically on that battery enclosure side, I think you have 9 customers. Can you just talk about what are the products that you're on?

I'll start, Swamy. So we're 9, 10 customers, where we have the new award we talked about in the call. So we're 9, 10 customers. It's in all 3 regions. And the battery trays, there's a whole gamut, but generally, we're trying to focus on the more complex, structurally difficult to make type battery trays. We don't want to be making a simple as an example, don't get mad at me, but basically a bathtub. We want to have a very complex part that we can differentiate, whether it's ADAS or even in our Cosma stamping facilities. We want to make the complicated, hard-to-make, higher content products, Rod.

So the other thing to talk about is when you do talk about battery enclosures, you got to keep in mind that the investment that we're talking about is just more on the assembly side, right? Most of the assets like stamping or roll forming or hot-stamping or casting, whatever parts that are required to make this battery enclosure assembly is normal course of business for us, right? So when we talk about assets, these are not dedicated assets for this specific...

You're leveraging...

Exactly, right. So the only exposure would be specific lines that are meant to build these enclosures. And that's where this whole modularity of how do you build it, how do you ramp it? Of course, it's a conversation with the customer, but that's something that we -- what Pat talked about is just not building a battery cover. There's a lot of complexity in what goes through there and how much joining technologies and so on. That's where we are differentiating.

So you're -- there's some protection because they -- it's all incremental to the existing structures business to -- as this grows, are you seeing your customers tapping the brakes a little bit on this? Or what have you heard from your customers in this area?

In terms of volumes, I said there is a two-pronged approach. One when the volumes come, we have our own viewpoint based on our own tribal knowledge or programs and so on, how much we think we should be making an assumption. So I think it's fair to say that the decline that we are hearing and seeing in the market is not proportionally what we are seeing for ourselves because we had made a different set of assumptions.

So you were more conservative on what the ultimate ramp would be. So from your perspective, it's fine. Maybe there's some of the euphoria is coming off?

Yes. That's why I referenced back to our own take rates towards 2030 being in the low to mid-30s for the last 6 years. They were not as exciting when we were talking about it a couple of years ago. But we kind of followed that.

Yes. I want to take a step back, maybe just to talk about the overall business. One of the other dynamics that we've been talking about all day is the shift in mix that's occurring within the industry and we were talking about how the Western OEMs, the Europeans and the Americans, lost 9 points of share since 2019. It's really a big deal. How should we be thinking about that for Magna? Have you incorporated mix shifts amongst your customers in your forecasting? Maybe we can just chat a little bit about that because historically, those were the OEMs initially that really provided the bulk of Magna's business?

Yes. I think we are still indexed in the North American production, right? But we are kind of looking at a flattish production scenario and -- which means the OEMs here in our set of assumptions are not taking back market share, they're kind of in line with what exists today, right? Is that fair? So that's kind of how we are going through our set of assumptions. On the EV side of things, just to add to my last comment, if -- we are indexed in North America because of our presence and so on. If North America slows down significantly, yes, it will have a little bit of an impact -- negative impact on us but it's something to work through.

But the megatrend growth business is more diverse than what you have in the base business?

It differs from one to the other. When you say megatrend like ADAS, I would say, it's pretty much across all regions, including in Europe with the German OEMs. On the battery enclosure side, I would say it's a little bit more indexed towards North America from a content perspective because of the type of the vehicle and the platforms and so on. So that mix you have to take into account. On the e-drives and the powertrain side of things, it's pretty global, including China and Europe and North America. It's actually more indexed towards Europe and China than it is towards North America from our consolidated business. From the unconsolidated business where our LG JV, there is lot of electrified components supply to North America, right?

It's the opposite of what I would have thought, but okay, that makes sense. The margin expansion going from 5.4% to 6%, climbing to 7% to 7.7%. Can you give us a sense of how much of that is factors that are within your control, the operational performance? What is that coming from. And if there is some volatility in growth, how do you manage that? What -- how should we be framing the range? Is it the low end of -- what frames even the range of expectations that you have?

That's a difficult one, Rod. I don't think we can capture all of volatility, right? Because it comes in mix. It comes in volumes and based on different regions. Certain amount of volatility -- that's what's captured in the mix, you go up and down, again, looking at the historical program history and the customer history. There is some amount that's in there, but it's very difficult to say we'll capture all the volatility. You're part of, I would say, visibility of the margin expansion or the road map that we are talking about going from 5.2 to 5.7 to the low 7s. That's a pretty clear path. It's pretty detailed when we make these plans. The 75 basis points over the next 2 years, I would say, is pretty granular all the way, not just at our level, but the COO level that you talked about doesn't stop that it goes to the divisional level, who is doing what and how we're going to get there. That we feel pretty good about. We talked about the booked business and looking at how that is launched, so there is good visibility on that, unless there is a drastic change in the industry. There is a very good path and look at how we are spending, for example, the $1.2 billion. How much do we need to spend on what program? What's the value proposition? Is there something that we should be looking at going forward? That look cuts across every function, right? So given all of that, I think we feel pretty good unless there is again a huge drastic change in volume, which is a big variable for all of us. We feel pretty good about that path.

The 75 basis points of operational improvement. Is that largely recovery of inflation? Or are there some specific projects that you were focusing on to get that?

It's not all based on recovery. There is, I mean, a huge list of things when we talk about continuous improvement that we go through as a process every year. So there is some amount of that because that ties back to the recoveries. We are not just going back and say, here's the number, you just need to recover that. Part of it is offsetting, Part of that is going back. Last year, if you remember, we offset what we felt were headwinds, but we are not stopping there. We are going back and saying, what's embedded with the year before that as the baseline, right? So we still have headwinds that are there right now in labor and a few other things. Production environment is pretty flattish, at least in our assumptions for volumes, but we still feel we are getting from where we ended up at 5.2 to 5.7 and 7, right? 7 plus. So we feel pretty good about -- and the plan that we have is realistic and bottoms up.

Sorry, just to add is the 75 basis points has not -- it's pure operational within our control. This is not related to -- it's not commercial. It's not recoveries related to inflation. It's us fixing our cost base. All the stuff Swamy's about making our plans more efficient, CIs and Factory 4.0 or all that digitization type work. That's where the 75 basis points is coming from. Inflation is actually still a net headwind as we go through '24. But as we see it, as we come through, it's about 30 basis points. Okay.

Any questions?

I really appreciate the detail on the ADAS business. I was just wondering, in terms of the big change in the ADAS business recently, it's been chip semi cost inflation. And I'm curious how the contracts are structured to account for the material upward reset in pricing if the pricing is effectively set on contract launch date versus when those contracts were sort of in initial planning stages, which could be multiple years before today?

So I would say it's a combination. When I say that contracts from the past, over the last 2 years, I would say, in the semiconductor side, we had recoveries of 90 plus, maybe even in the high 90s. So we didn't have to take that. We have arrangements in place to get that. The second part of it is the discipline of the allocation, like how much do we get allocated per year, so we can have the reserve that's needed from the chips. So we can keep the production going, which was a 3-party discussion. We didn't do it with the chip guys on our own. We always had the customer with us to say, "Hey, this is what we're signing up to, how do we work together?" While this was happening over the last 18 months to 2 years, anything that we quoted at that point of time, is exactly what you said. It's not the price today. It's a frame of reference, but we're going to reset at production. So it's a combination of...

Quick follow-up on the semis. Are you seeing pricing coming down on the semi side?

It depends on what we referenced. It's still not back to what it used to be, like I'm talking peak '21, but it's definitely off the peaks, right?

And in that case, how does that flow through? Whether they benefit to Magna? Or is that shared with the OEM?

No, this is about risk mitigation. When we talked about saying, hey, we're going to work through and pass on the costs, obviously, goes the other way, too, right? Yes.

There was an announcement this week at Tesla in Mexico is going to bring some of your Chinese supplier base here. And then we're seeing BYD expand in Hungary, South America and so on. As Magna is a fairly global company, how do you see this panning out, say, 5 years from now, 10 years from now, especially with the Chinese forecast to become -- they're the biggest exporter today, but they're looking at 10 million to 15 million units in under 5 years. So how is that going to impact not only Magna but the entire Tier 1 -- big Tier 1s like you?

Yes. I can't talk about the geopolitical situation. One of the things that we constantly are talking about is our presence in China. And when we talk, we are, what, $4.8 billion or so, right? And if you take the JV side of things, it's an additional $2 billion. And we -- on the consolidated side, we are growing at 5% or so, right? And -- so we have a presence is what I'm trying to say in China and roughly half-half is domestic Chinese OEMs to the other. So we hope to have that relationships and grow with them as they go to different places. But I also kind of look at what happened in the '70s, '80s when the Japanese expanded, they had their [ Koritsu ] base and so on. We work through it. We're not taking it likely, of course, but it's something that we try to keep the finger on the pulse.

And there may be some opportunities as a result of that. Maybe just one last one for me. You've given us -- we talked earlier about what the free cash flow could get to. Could you give us a sense -- I would expect it to be relatively modest, at least in this year. But how should we be thinking about the trajectory? And how should we think about what you will ultimately do with the cash flow? So does Magna's valuation play a role in whether you decide to buy back stock or look at M&A? How do you -- how should we be thinking about Magna's uses of cash?

Yes. I think the -- good question, Rod. One thing is like -- we have always looked at growth as profitable growth, not just any growth. That's one of the things we keep talking about a lot on the topline. As we get through our capital strategy, Pat and I talk about it all the time is the first principle is get back to the leverage ratio. We finished the Veoneer acquisition. The integration is going well, seems to be ahead. We get the synergies that we need and get back to the leverage ratio of 1 to 1.5. And once we have that in place, our first priority is profitable growth that's accretive, either organic or inorganic, right? That's the first thing. And any excess cash, then we said we're going to talk about share buybacks, right, dividends and share buybacks. When we look at an acquisition strategically, I think Magna's share price is just one of a variable. More importantly, we are also looking at what geography, what strategic gap is it filling, what's the state of the market at that point of time in terms of liquidity, cost of debt. These are some of the things. So Magna's valuation share price is 1 variable, I would say. You want to add something?

Great. Well, thank you very much, Swamy and Pat, for making the trip up here. It was great to see you again. Thank you.