Martinrea International Inc. (MRE) Earnings Call Transcript & Summary

Good evening, ladies and gentlemen. Welcome to the Martinrea International First Quarter Results Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Rob Wildeboer. Please go ahead, sir.

Good evening, everyone. Thank you for joining us today. We always look forward to talking with our shareholders, and we hope to inform you well and answer questions. We also note that we have many other stakeholders, including many employees on the call, and our remarks are addressed to them as well as we disseminate our results and commentary through our network. With me are Pat D'Eramo, Martinrea's CEO and President; and our CFO, Fred Di Tosto. Today, we will be discussing Martinrea's results for the quarter ended March 31, 2023. I refer you to our usual disclaimer in our press release and filed documents. Pat will speak, then Fred, then me, and then we will do some Q&A. And now here's Pat.

Thanks, Rob. Good evening, everyone. As noted in our press release, we generated an adjusted net earnings per share of $0.54 and an adjusted operating income of $75 million in Q1, up approximately 7% over the previous quarter and 70% year-over-year compared to the first quarter of 2022. Production sales came in at $1.24 billion, up 6% over the previous quarter and 12% year-over-year. Adjusted EBITDA of $153 million was another quarterly record for the company. Adjusted operating income margin came in at 5.8%, a step-up from the 5.5% we generated in Q4, reflecting a lower level of tooling sales, which typically earn lower margins for the company. Overall, our Q1 performance was solid in the face of some ongoing challenges. Most notably, production volume and stability continued to be an issue in the first quarter as we experienced production disruptions with some key programs having long periods of unplanned downtime due to supply issues affecting multiple plants and multiple locations. While our overall production sales improved, sales and margins were below what they otherwise would have been in a smooth environment, thereby delaying progress to an extent. Of course, we continue normal improvements in our operations despite these ongoing supply chain disruptions. We also continue to face inflationary cost headwinds, although improved in some areas of the business compared to last year. Efforts to offset these inflationary costs commercially are ongoing and will likely continue for the foreseeable future as we try to find ways to counter the headwinds being created by the instability in the current environment. Looking forward, we continue to expect 2023 to be better year-over-year with higher production volumes, margins and free cash flow compared to '22. And what we expect are the early stages of a strong cycle with most of our plants running at capacity. As such, our 2023 outlook is unchanged. As a reminder, this outlook calls for total sales to be between $4.8 billion and $5 billion, adjusted operating income margin to be between 6% and 7% and free cash flow be in between $150 million and $200 million. As you know, we are particularly focused on free cash flow, and we're excited about the prospect of ushering in a new phase in the evolution of our company, establishing ourselves as an effective and consistent generator of free cash flow. Looking at our global operations. In North America, our adjusted operating income margin improved by 190 basis points quarter-over-quarter in Q1 on higher production sales and favorable commercial settlements with our customers as well as a lower level of tooling sales in the quarter. We are operating at a healthy margin level in North America, and we are seeing the expected benefit from the normalization of launch activity and ramp-up of volumes on new programs, although OEM production volume instability continues to be a challenge. Turning to Europe. Adjusted operating income was essentially at breakeven in the quarter, a notable decline from our prior quarter, reflecting a lower level of commercial settlements, uneven production schedules with key customers and some operating issues, partly due to launching multiple programs concurrently. You will recall that in Q4, we concluded several commercial agreements in the favorable terms related to the recovery of 2022 energy costs, which had a positive impact on our margins in this segment in Q4. While the expected recovery in our European results has been somewhat uneven, we expect volumes to level and results to improve in the coming quarters. In our rest of world operations, a small portion of our overall business, representing approximately 3% of our Q1 production sales, adjusted operating income declined quarter-over-quarter given lower-than-expected production volumes in China with 2 key customers. This was partially offset by indirect cost recoveries in Brazil. At this point, production volumes in China are not trending as expected. As a result, we are working with our customers to address the issue. I'm pleased to announce that we have been awarded $70 million in new business since our last call, consisting of $50 million in our lightweight structures, commercial group on GM's new electric pickup truck and $20 million in our Propulsion Systems group with GM and Tesla. Since the beginning of 2022, we have secured approximately $250 million in new business in addition to being awarded another $250 million in replacement business. We are winning an increasing amount of work on electric vehicle platforms and have launched or will soon be launching programs, including the Mercedes-Benz EVA2 platform, GM's New Bed 3 and the EV pickup truck and the Audi PPE among others. Some of this work is complex as it involves combining unlike materials using advanced joining methods, what we refer to as breakthrough technologies. This offers a high degree of value add for our customers. Over the next year, we expect 1/4 of our sales to come from EV or hybrid programs, and we see this potentially growing to half of our sales over the next several years. At the same time, we continue to see internal combustion engine vehicles as an important piece of the market in the foreseeable future. As those who have been following our story are aware, our business is largely agnostic to the propulsion type, which means that whatever pace the transition is to EVs, our products will remain relevant. Lastly, I wanted to touch on the recently completed Volta Explorer transaction, where we sold our 50% equity stake in the VoltaXplore joint venture to NanoXplore for an aggregate equity consideration of $10 million paid in NanoXplore shares, resulting in a gain on disposal of $5.3 million as reflected in our financial statements. Post-transaction, NanoXplore now owns 100% of the equity in the intellectual property in VoltaXplore, and we increased our equity ownership in NanoXplore from 21.1% to 22.7%. We also extended our existing graphene supply agreement with NanoXplore by another 5 years or to 2033. Over the last 2 years, Martinrea and NanoXplore partnered to construct and launch a demonstration facility showcasing the value proposition of graphene-enhanced lithium-ion batteries. Together, we created value within the joint venture. Now as VoltaXplore looks to take the next steps towards building a battery facility, including securing financing commitments, the JV partners decided that it is in VoltaXplore's best interest to engage with partners that can offer a deeper level of financial support. From Martinrea's perspective, we concluded we are not interested in building a battery plant based on our capital allocation strategy being focused elsewhere. We continue to believe in graphene and all its benefits. While we have decided not to actively participate in the construction of the battery plant, we will still see a benefit from any success at VoltaXplore through our enhanced equity position in NanoXplore, and we will also continue to work with NanoXplore to develop graphene-based solutions within Martinrea. True to the mandate, we have set out for Martinrea innovation development or mind, we have helped VoltaXplore flourish through the incubation phase with operational support, manufacturing know-how and financial commitments that has enabled the joint venture to establish a demonstration facility and prove its technology. With the VoltaXplore demonstration facility now established, we wish the team the best as they continue to capitalize on this exciting technology. We are happy to continue to be along for the ride through our equity stake in NanoXplore. In closing, I'm very happy with the work our team is doing. The challenges our industry continue to face from supply chain shortages, production disruptions and cost inflation have persisted for longer than anyone could have reasonably expected. Our people have persevered keeping focus on doing the hard work that needs to be done to continue to progress toward better days ahead. I want to sincerely thank and applaud our people for all of their efforts. With that, I'll pass it to Fred.

Thanks, Pat, and good evening, everyone. As Pat indicated, our financial results in the first quarter were solid, with adjusted EBITDA setting another quarterly record. While our company and the auto industry in general continue to deal with ongoing challenges from uneven production schedules, supply chain issues, cost inflation and tight labor market conditions. We have made and are making progress in offsetting these headwinds, improving our margin profile through strong operational execution and commercial activity. We expect further improvement over time as supply chain disruption subside, inflation normalizes and production volumes smooth out. As Pat noted, our outlook is unchanged and which calls for higher year-over-year production volumes, sales, margins and most importantly, free cash flow in 2023. Taking a closer look at our performance quarter-over-quarter. Production sales increased 6% on higher production volumes. As Pat noted, we continue to experience production-related volume disruptions in the quarter, impacting results. Although overall volumes are up quarter-over-quarter, volume and stability did not really improve. Volumes and volume instability are expected to improve in the coming quarters, and production should continue to trend higher, although given the continued volatility in the environment, it is unclear what pace and shape that expected improvement will take. Adjusted operating income margin came in at 5.8%, better than the 5.5% we generated last quarter, due, as Pat noted, to a lower level of tooling sales during the quarter, which tends to earn low -- to low margins. Adjusted earnings per share was $0.54 in Q1, lower than the $0.58 generated in Q4 and reflective but unusually low tax rate and a $3 million foreign exchange gain in the fourth quarter, which is not repeated in the first quarter. Normalizing for FX and the tax rate, adjusted EPS in Q4 '22 would have been $0.52 compared to the $0.54 generated in Q1 of '23. Free cash flow was negative $32 million, reflecting an increase in working capital. This was not unexpected as we typically build working capital in the first quarter and release it through the remainder of the year. We expect to generate positive free cash flow in the coming quarters as our '23 outlook implies driven in part by lower CapEx in line with depreciation and amortization as a percentage of sales. We note that cash CapEx was essentially in this range in Q1 and a significant improvement over Q4. Looking at our performance on a year-over-year basis. First quarter adjusted operating income of $75 million was up 70% over Q1 of '22 on production sales that were 12% higher. Recall at this time last year, we were just beginning to dig ourselves out of a low point in our industry when supply-related production disruptions were at their worst. Still, the strong year-over-year performance is nice to see, especially free cash flow, which was negative $52 million in Q1 of '22 compared to negative $32 million in Q1 of '23, a nice improvement. We expect further gains over the balance of the year as we deliver on our '23 targets. Turning to our balance sheet. Net debt increased by $47 million quarter-over-quarter to $956 million in Q1. The increase was driven by a seasonal increase in working capital, as noted earlier. Our net debt-to-EBITDA ratio continued its downward trend ending the quarter at 1.9x, down from 1.95x at the end of Q4 of '22 and 2.43x at the end of Q3 of '22. We are at a comfortable level, well below our covenant maximum of 3x. Our leverage ratio should naturally improve in the coming quarters as we generate an increasing amount of EBITDA and free cash flow. We expect to continue to trend towards our target range of 1.5x plus or minus over the coming quarters. A portion of our free cash flow will go towards debt repayment. We have noted publicly, we also put a normal course issuer bid in place late last month, and our expectation is that we'll be buying back some stock at these levels over time. And with that, I -- now I turn it back over to Rob.

Thanks, guys. I have only 2 points to cover, and I'm going to be brief. I know it's Stanley Cup season. There's some good hockey to watch tonight. So let's get to it. One is the resilience and strength of our Martinrea team. I want to talk about hockey. Last Thursday, I was at the league playoff hockey game, a 4-2 loss by the Maple Leafs to Tampa Bay in an elimination game for Tampa. I was disappointed. I came home and there were my 2022 tax forms for me and my family members. And before I went to bed, I reviewed them. I know what you're thinking, what a loser. But I got the work done. The next morning, I was reflecting, I told my son, "You know son, there are 3 certain things in life: death, taxes and Maple Leaf playoff collapses" -- it even rhymes. By the way, I'm very happy that leafs then broke the traditional collapsing in the first round. But then I was thinking, hockey is a sport, played by men, at least in the NHL, who're really grown up boys playing a game. There's work and sacrifice and challenges and tough losses and sometimes great results. There are losers, and there are winners, and frankly, there are many more teams that don't win their final game. Success in this sport comes from teamwork working together to achieve results, learning from mistakes, resilience, et cetera. And then I was thinking about our team at Martinrea. Last year, on this call, I spent some time talking about the world we live in and 2 characteristics of our team, resilience and entrepreneurship, 2 of our leading qualities. Entrepreneurship means ownership. We own what we do. So then I thought about us as a sports team. I believe someone has said, business is the ultimate team sport, whether it's the ultimate sports, I don't know, but it is certainly a team sport. And we at Martinrea are really, really good at our sport. We excel in what we do, industry-leading safety statistics, tremendous growth over the pandemic, we can make anything well. We are really, really good at making things. Industry-leading employee satisfaction. Coming out of the pandemic and industry supply shortages, high levels of sales, earnings, operating income margin, EBITDA margin, leading many of our peers. Pat and Fred went over the results and frankly, they're really good. Our team at Martinrea is resilient. Our team culture is outstanding. We find ways to get things done. We do not have playoff collapses. We don't choke. When the going gets tough, we dig in and perform. Our people show up every day, every game. You will get our best. We are winners. I'd put the character of our team at Martinrea up against any sports team. If you don't believe us, ask some of our competitors if we're good competition. I believe we are very tough to beat at what we do. And 1 more thing. We love this game. We love what we do and we excel at it. You know our history, time doesn't permit, but I'm happy anytime to give a blow-by-blow of our history over the past 20-or-so years, where we've been one of the fastest-growing companies in our industry, and we are stronger today than we have ever been. We are winners, in the infinite game of sustainable business. The second area I would like to address briefly is our upcoming shareholder meeting. Our AGM will occur on June 6 and proxy materials will be posted shortly. The message to shareholders is to me, an important one. It reminds all of us of our culture and its strengths, highlights of the past year and our approach to governance. These are important messages for us all to reflect upon. Please read the message. Now it's time for questions. We see that we have shareholders, analysts and competitors on the phone, but also employees. So we may have to be a little careful with our answers, but we'll answer what we can. Thank you all for calling.

[Operator Instructions] Our next -- first question is from David Ocampo from Cormak Securities.

You guys talked about and I touched on that you guys are still experiencing production issues or disruptions with the scheduling. I was just curious if you guys can quantify if we are 10%, 50% or 75% of the peak that we saw last year? And I guess I'm just trying to get a sense on when you guys can start reinstating your quarterly guidance numbers?

Quantifying the impact of the volume and stability is actually quite tough to do because it's in various places, various programs. It's not necessarily 4-week shutdowns anymore, which is -- which was a common theme back in '21 -- parts of '22. It's also just lower volumes. We enter in the week thinking that the customer will pull X and they end up pulling X -- less certain percentage. So I'm not going to go there. But needless to say, it's been an impact on us and continue to be one in Q1.

And I guess you guys don't have enough visibility for the Q2 to provide any quarterly numbers there?

We actually like the idea of not doing quarterly guidance and seeing what you guys are doing with your -- so you guys are good at it. So in that context, there's -- it's not just chips, there are some other things, and we may have a UAW strike in the second half of the year, whatever. I think we'll probably resolve that. There's always something. But overall, the trend line, as we say, is "up and to the right", and despite what we're seeing with the interest rates, which we think was ridiculous for the Fed to raise the rates in the U.S. again. I think at some point, they're going to realize that. But the underlying economy in the United States is good. There's pent-up demand. The April SAAR numbers were really quite good. So there's a lot of positive stuff. And as there is demand there and as we work through production issues, we'll smooth out a number of those things. But it's better than it was before. We think it's going to get better and we'll see that as we go month by month.

Yes. I would say that most of the disruptions are not chips. There are other supply issues that were below the water during the chip issues. And we discussed that this is probably somewhat predictable, though it seems to linger longer than we expected. But it's not -- I would argue it's not primarily chips anymore, at least not what we're seeing.

Got it. That makes sense. And then Fred or Pat, I mean you guys have at least for the last few quarters, have been announcing quite a bit of EV awards. I guess I'm curious the content per vehicle on those platforms, are they greater than what you would have otherwise experienced for ICE? And just curious about the margin profile on those awards as well? Are they consistent with the overall business of the 6% to 7% or are they materially higher?

I would say, in our lightweight structures group as far as the type of parts, the assemblies and those types of things are very similar. Differences in design a little bit, more unlike materials, more aluminum, more castings, more high-strength steels than we would see otherwise. But the basic design, if you look side by side are very similar until you get close and realize one is a lot lighter.

And I think from a margin perspective, broadly speaking, of course, there's always some anomalies, both up and down, but our expectations are that the margin profile and returns are going to be similar for these investments in EVs. so going forward, we shouldn't expect any huge variation. As Pat noted, some of these products are a little bit more complex. So in those types of situations where you got more value add, you potentially can make more money. But ultimately, generally speaking, we're targeting similar margins and returns.

Our next question is from Michael Glen from Raymond James.

So Pat, if I'm circling back to the last conference call, the 4Q conference call, you described Q2 during that call as a real test of everything that you've been put in place and all of the efforts you've been putting together. So as I think of the way Q1 transitions into Q2, are you still expecting us to see some of these -- some more significant contributions come in to play in terms of how we progress towards that 6% to 7% margin?

I think we'll see some progress, but the fluctuation from the customers, I can't predict, unfortunately. I would tell you it was greater in Q1 than I anticipated, I think than most anybody anticipated. So if production smooth, certainly, I think Q2 is going to be a good quarter. If it continues to be bumpy, we'll have to adjust based on that bumpiness. Now also, what I had said, if you recall, is prior to the pandemic, Q2 was always the high-volume quarter annually. But during the pandemic, that was not the case. So one of the questions or thoughts was, you know what, at some point, it's going to start to look more normal again and Q2 will be a higher -- be the highest quarter out there. I don't think it will necessarily be the highest quarter this year. based on what we're seeing, but I think it will be a better quarter than what we've seen as far as the customer goes. And we've seen some more consistency in some of the plants that were disruptive in the first quarter already this quarter, but we're not even halfway through it. So we have to wait and see.

Yes. It used to be Q3 was the weakest quarter. That hasn't been the case in the recent past. And I don't think you can predict that this year. We think Q3 could be quite strong too.

Yes. I do think in time, it will start to look more like it did before the pandemic. But a lot of these disruptions that are being seen when you start to whittle away boils down to, in a lot of cases, manpower, Tier 2 and Tier 3s, in particular, don't and in a lot of places, U.S. being one of them, have enough people to keep up with some of the demand. So the demand is there, but it's getting disrupted some.

Okay. And then the second question, just -- you talked about the potential margin profile on these [ ICE ] EV platforms ramp. But on the other side of that, can you talk about visibility do you have on what your margins on the legacy platform?

Well, they would obviously be dependent on volume and so forth, but the thought would be that they would be strong and there'll be mature products. We're anticipating some of these ICE platforms will likely get extended, which we view as a positive because, again, they're mature platforms on which we're making some good market margins on. So it's hard to tell how that transitions and takes shape, but we're comfortable with our current margin profile and we expect it to be similar, if not even better, as we get into the next transition to EVs and so forth.

Yes. I think you'll see the industry running parallel quite a while. And if you look at the strategy behind a number of the OEMs, they're running EVs in some plants and they're continuing to run ICE in the other, and they're kind of -- they know they're not going to both hit the highest volume, but they're going to shift over time, and we're seeing that. So if the ICE products last longer, I think that that's -- I don't see that as a negative at all.

Our next question is from Brian Morrison from TD Bank.

I just want to circle back to that last question. When you talk about the margin profile, should we expect sequential improvement throughout the year? Is that the message?

That would be the expectation. As supply chain disruptions subside and normalize and inflation starts -- getting more relief on inflation and so forth, that would be the expectation. Again, as Pat noted, it's really hard to predict where we're sitting right now, how that kind of takes shape, but the expectation is we progress throughout the year as some of these challenges improve.

I can say it's getting better quarter-over-quarter. It's not getting as good English necessarily, but it's not getting as better as fast as we thought it would. It's taking longer.

And we're not necessarily the same because we got to work through the quarter and some of these things are lumpy, including when there's downtime and that type of stuff that Q2 will be better than Q1, Q3 will be better than Q2, Q4 will be better than Q3. We think the trend line is up, as we've said. And there's a little bit of lumpiness in our industry and everyone is experiencing the same thing. We think we're in a good spot. And we might have a quarter that surprised to the upside and one that's a little down because of the timing of some different things, but trend line is in the right direction.

Yes. And some of the downtime we saw from some of our customers this past quarter were down right head scratches. Nobody saw them coming, including the customer, but some of the supply base has got some issues still.

Did the Escape have a major impact on the quarter? And is that up and flowing for you again?

The Escape we supply from multiple plants in different parts of the world even and definitely it was down longer than expected. And we've seen better performance from that product this quarter already.

And you'll note in our investor presentation, it is a top 3 platform for us -- there is a significant platform.