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

Good evening, ladies and gentlemen. Welcome to the Second Quarter 2026 Results Conference Call. I would now like to turn the meeting over to Mr. Rob Wildeboer. Please go ahead.

Hi, everyone. Thank you for joining today. We always look forward to talking to our shareholders, updating you on our business, answering your questions. We also note that we have other stakeholders, including many of our employees on the call, and our remarks will be addressed to them as well as we disseminate our results and commentary to our network. With me are Pat D'Eramo, Martinrea's CEO; our President, Fred Di Tosto; and our CFO, Peter Cirulis. Today, we will be discussing Martinrea's results for the second quarter ended June 30, 2026. I refer you to our usual disclaimer in our press release and our filed documents. On this call, Pat will touch on some key priorities for the business over the next few years, discuss operations and outline some key highlights for the quarter. Fred will provide an overview of our operating segments and highlight some new business wins and growth opportunities. Peter will discuss the Q2 results and 2026 outlook, and I will conclude with some brief comments on trade, geopolitics and capital allocation. To kick things off, here's Pat.

Thanks, Rob. Good evening, everyone. I want to start by providing an update on how we see our business unfolding over the next few years. We have a three-year strategy that we update annually where we lay out key priorities. These include focusing on margins and free cash flow, growing our core automotive business, partnering in regions that have more risk or where we don't have scale or other competitive advantages and limiting our investment in those regions, growing our nonautomotive business and ensuring our investments are successful. I'll take a moment and elaborate on each of these, starting with margins and free cash flow. We continue our strong focus on operational excellence, driven by our lean manufacturing principles. This continuous cost reduction and AI machine learning installations across the plant network will be key in driving margin expansion. As we enter 2027, we'll be intensifying our plant-specific performance targets with a view on consolidating or exiting underperforming operations where appropriate. We are targeting an adjusted operating income margin of 6.5% to 7% by 2028. And these are the levers we will pull to get there by also getting some help from projected better volumes and the move to next-generation programs where we can reprice the business to meet our expected hurdle rates. We will maintain our capital discipline in line with our previously communicated framework of CapEx roughly in line with depreciation and amortization. Improved capital efficiency should flow naturally through better operating performance, resulting in even stronger free cash flow. Moving on, we foresee good growth in our core automotive business based on recent new business wins and strong performance at our customers. We are seeing a high level of quoting activity where we can be selective while growing at a faster pace than the overall market. Fred will elaborate on recent new business wins in his remarks. As always, we have a relentless focus on quality, which is a big part of what's helping us win new business. We are being recognized for this as evidenced by more than 30 awards we won from customers and industry organizations last year alone, in areas, including quality, delivery, sustainability, workplace excellence, communications and industry leadership. We have won awards from multiple customers, including the most notable General Motors Supplier of the Year Award, along with Ford, Toyota, just to name a few. As we've indicated on prior calls, sales growth will be focused on North America, but we will look to maintain our book of business to open capacity and expand margins in Europe. We will limit our exposure in other markets that comprise our Rest of the World segment. Aligned with this strategy, we reached an agreement to sell 85% interest in our fluids plant in China, partnering with a local Chinese supplier, and we're looking at other potential dispositions of noncore assets. Turning to nonautomotive markets. We continue to see growth in our industrial business with both our core customer base as well as new customers and new market verticals such as power generation and defense. We also recently entered the school bus market through our acquisition of Lyseon North America, which we now call Martinrea Tulsa and see strong growth prospects in this business. In addition, we have a meaningful book of heavy truck business. We spoke on the last call about TruNorth Kaizen, our lean consultancy business that we recently launched. We've already won a few contracts in defense and aerospace, including one worth USD 5 million from Raytheon to work with them on improving manufacturing throughput on some key defense products. Thus far, in a short period of time, we've had a lot of success helping them, clearly demonstrating our strength in how we approach operations. This success is expected to lead to more business opportunities for TruNorth Kaizen. We expect to sign more contracts at TruNorth, which could expand the business by as much as 4x by the end of 2026. The business has significant room for growth, and we believe that over time, the relationships we forge through TruNorth could lead to opportunities to participate more directly in the defense manufacturing business. Importantly, TruNorth is a higher-margin business and was profitable in its first quarter of operation. Similarly, our MiNDCAN software subsidiary continues to see steady growth with an expectation to be profitable in 2027. This is great progress for a new software start-up. As you can see, we are diversifying the business into markets with attractive growth prospects using existing skill sets, capabilities and equipment and for very little to no incremental capital investment. That dovetails nicely into our final pillar, which is to ensure investments are successful. The strategy here is to invest in new technologies and capabilities that can be a differentiator for our business and support those investments with resources, including human capital. The strategy also involves monetizing certain investments that have completed their incubation period and are self-sustaining. Now let's shift to the quarter. I'll be brief, and Peter can fill in the details. We're pleased with our Q2 performance, considering the impact we had from lower volumes, including lost sales from the Ford Escape program, which ended at the end of last year, negative foreign exchange and higher aluminum costs, which is expected to reverse at some point. As we have articulated before, aluminum costs are a pass-through to our customers, though the pass-through occurs at about a 90-day lag. Given the spike we saw in the aluminum prices because of the Iran conflict, we had to absorb some extra costs in Q2. We expect to recover the amounts in the coming quarters as prices normalize with the timing dependent on how the Iran conflict plays out. The good news is volumes were up quarter-over-quarter, and we were able to offset cost pressures, including aluminum costs through operating improvements and commercial recoveries. This allowed us to also improve margins quarter-over-quarter. Overall, based on our performance in the first half of the year and considering the various puts and takes, we are confident that we will meet our 2026 outlook. We're on track. Peter will elaborate on our financial results and our outlook. With that, I'd like to thank the Martinrea team for all their hard work and ongoing commitment to make this business better every day. With that, here's Fred.

Thanks, Pat. Good evening, everyone. We continue to execute well, both operationally and financially while navigating through industry dynamics pertaining to trade, tariffs, electric vehicle volumes and the Iran conflict. We are doing well, managing what's in our control and pursuing growth opportunities in a prudent manner, as Pat outlined. Turning to our segments, starting with North America. Q2 adjusted operating income margin came in at 8.3%, 20 basis points lower than the 8.5% margin in Q2 of last year on production sales that were 1.2% lower. We continue to consistently perform at a high level in North America, the main growth engine in our business where over 75% of our business resides with a solid margin profile, a good place to be. Europe recorded a CAD 7.5 million operating loss in the quarter, which compared to a CAD 1.8 million operating profit in Q2 of 2025 on production sales that were down about 8% year-over-year. The weaker year-over-year performance was a function of decremental margins on the lower production sales, higher aluminum prices, which is expected to reverse at some point, as Pat pointed out, and a lower level of commercial settlements. Clearly, this is not where we want to be in Europe. However, we have actions in place that should improve European performance in the second half with a path toward breakeven for the full year 2026, including anticipated commercial recoveries related to the significant shortfall in electric vehicle volumes. From there, we are planning for and expect 2027 to be better in Europe year-over-year. As we've said on prior calls, our results in Europe reflect the volume environment that remains well below expectations. The European volume environment has been challenging across the auto supply base. Our disciplined approach, maintaining a presence for customer support while avoiding aggressive growth is the right strategy for this cycle. Over time, we believe Europe can return to a mid-single-digit margin profile as volumes recover, particularly given the operating improvements and restructuring actions we have taken. While the reality of our performance in Europe is not lost on us, our approach remains disciplined and deliberate. Our strategy is to maintain a presence and fill open capacity rather than pursue aggressive growth. We think it's important to be there to support our customers globally and to win business with German OEMs in both Europe and North America. This is demonstrated through some considerable new business we were recently awarded from BMW in North America, which wouldn't have been possible without our manufacturing presence and capabilities in Europe. Next, adjusted operating income in our Rest of the World segment was approximately breakeven compared to CAD 1.4 million in Q2 of 2025, reflecting decremental margins on lower production sales. As we have stated before, this segment is small, representing less than 3% of our consolidated sales and results can vary quarter-to-quarter. Our strategy in this region is to maintain only the footprint required to support our global business. As Pat noted, we sold a majority stake in our fluids plant in China during the quarter, further reducing our presence in the region, and we are exploring other potential divestitures. Moving on, I'm very pleased to announce that we have been awarded a new business worth CAD 110 million in annualized sales and mature volumes, consisting of CAD 55 million in various structural components in our Lightweight Structures Commercial Group with Ford and Volkswagen Scout, CAD 40 million in our Propulsion Systems commercial group for Volvo, BMW, Rolls-Royce and Volkswagen Scout, CAD 10 million in our flexible manufacturing group with Isuzu and John Deere and the CAD 5 million consulting contract with Raytheon through TruNorth Kaizen that Pat mentioned earlier. New business awards during the last 12 months totaled CAD 440 million. Quoting activity remains robust, and we continue to be awarded program extensions and takeover work from financially troubled or underperforming suppliers. We're also seeing opportunities from OEMs localizing or onshoring production to North America, some of which we have already benefited from. I'll end it there. Thanks for your time. I'll now turn it over to Peter to discuss our financial results and outlook in more detail.

Thanks, Fred, and good evening, everyone. Before we dig into the financials, I want to frame our second quarter results through the two lenses that we use to evaluate the performance and running of the business; how well we are operating and our effectiveness in deploying capital. Each is a leading indicator of the value creation arc that we are on. Regarding operations, Q2 adjusted operating income margin was 40 basis points higher than last quarter despite the temporary aluminum cost headwinds. Our operating performance continues to demonstrate the strength of our lean and continuous improvement mindset. The improvements we are making through the scaling of our AI, machine learning and other initiatives as well as the positive flow-through impact from higher production volumes should provide meaningful operating leverage as we advance towards our 2028 targets. Our capital allocation priorities remain unchanged: invest in the business, maintain a strong balance sheet and return capital to shareholders through dividends and share buybacks at appropriate times. On the balance sheet, net debt ended the quarter at CAD 801 million, down from CAD 819 million in quarter 1. Our net debt to adjusted EBITDA ratio was 1.63x, roughly the same as last quarter and broadly in line with our target of 1.5x. We did this while repurchasing approximately 919,000 shares for CAD 10 million, consistent with the amount we spent last quarter. This is a disciplined approach. We continue to balance share repurchases against maintaining balance sheet flexibility, funding organic growth and pursuing strategic acquisitions. Looking closer at the results, adjusted operating income margin came in at 5.9%. This is a decline from the 6.8% margin we generated in quarter 2 of last year, which was a high watermark for us. Let me be clear. The year-over-year margin decline is driven largely by temporary factors, the aluminum cost spike from the Iran conflict, which we expect to recover with a 90-day lag, and the production from the Ford Escape program and negative FX on our Mexican labor cost base. Strip those out and our underlying margin trajectory is improving as evidenced by the 40 basis point sequential improvement from quarter 1. Reported free cash flow before principal lease payments under IFRS 16 was CAD 52.8 million. After principal lease payments, free cash flow was CAD 36.9 million. Free cash flow came in somewhat lower than expected given the timing of certain trade and other receivables, which we expect to collect by the end of the year. Overall, we remain on track to meet our 2026 free cash flow outlook. We are generating a healthy level of free cash flow from the business, and we expect this to continue. I'll have more to say on our 2026 outlook in a few moments. Year-over-year, reported earnings per share increased to CAD 0.61 compared to last year's reported Q2 EPS of CAD 0.52, primarily because restructuring charges were lower, finance expense declined and the effective tax rate was lower. From an operating perspective, however, adjusted EPS of CAD 0.61 decreased compared to CAD 0.66 in quarter 2 2025 as a result of the aforementioned lower sales and compressed margin, which is primarily attributed to the Ford Escape program ending as well as the decremental margin impact of lower production volumes, mainly Europe. Moving on, we are reaffirming our 2026 outlook, which calls for total sales of CAD 4.5 billion to CAD 4.9 billion, and adjusted operating income margin of 5.5% to 6% and a free cash flow of CAD 125 million to CAD 175 million, with approximately CAD 300 million in CapEx. The outlook is indicative of strong operational execution in a relatively flat market. Recall that our guidance assumes a modest decline in sales compared to 2025, reflecting the end of the Ford Escape program and lower tooling sales. Based upon our performance year-to-date and what we currently see in front of us, we believe our full year 2026 results will fall within the range of our guidance. Our focus remains consistent execution and free cash flow generation through cycles based upon the elements of the business that are within our control. Q2 is one data point in a multiyear transformation. Since 2023, we have expanded margins, generated record free cash flow, restructured Europe toward breakeven, won more than CAD 1 billion in cumulative new business, are deploying machine learning at scale and have returned capital to shareholders through share buybacks. By 2028, we are targeting CAD 5.3 billion to CAD 5.5 billion in sales at a 6.5% to 7% adjusted operating income margin with an improved return on invested capital profile. That is the arc. With that, I now turn you back over to Rob.

Thanks, Peter. I'll make a few takeaway comments on where we are at with USMCA and trade and geopolitical issues as well as capital allocation. As you've heard, there are many great things happening in our company. We had a good start to 2026 despite much noise on geopolitics and trade. Regarding the USMCA and trade discussions, while there's always a lot of noise, it seems pretty clear to me that we will be very likely not seeing any tariffs on North American-made auto parts. Scott Bessent himself told me tariffs on auto parts is a very bad idea. He's right. This is good for us, but this is a consensus view in Washington, Mexico and Canada. I also foresee no tariffs ultimately on Canadian-made autos. That's what we are negotiating for, and that's what the entire industry wants. Meanwhile, as to timing, who knows? We did not expect a deal on USMCA by July 1, and that should not be a surprise to anyone. But let me repeat an observation I made on the last call. Over 97% of our sales are made to assembly plants that are not in Canada. That is less than 3% of our revenues worldwide are made from sales of our products to Canadian assembly plants. Most of what we make in Canada is shipped to U.S. assembly plants already, tariff-free. Our U.S. footprint is much bigger than Canada. It's clear to me that our North American auto parts sales are likely not materially impacted even if, for example, Canada faces a tariff on assembly or USMCA discussions don't go well between Canada and the United States. I do believe there is huge consensus in our industry, OEMs and suppliers alike for a tariff-free North American auto industry, autos and parts makers. See, for example, the industry submissions to the administration and Congress, and I think we'll get there. But even if we don't, we'll be fine. In terms of the USMCA and other negotiations, we are heavily involved in the consultations. Like all of you, we would like to see clarity and a good result, but we are patient, and we will deal with. I believe that the U.S. tariffs on other jurisdictions on parts and vehicles in whatever form they take, will, over time, encourage more manufacturing in North America, again, good news for suppliers and Martinrea, and we have seen some of this already. The tariff issues are really part of the overall geopolitical environment we face and are impacted by it. For example, the various conflicts in the Middle East and Ukraine as well as broader areas are clearly a primary focus of our largest trading partner. The USMCA is not the or even a top priority item for the U.S. at this time in my view. That's not to say it isn't important, but the fact is the tariff issues are much more in the news here than in the U.S., and that's just the way it is. At the same time, I believe the geopolitics of the U.S. and China ultimately favor a fortress North America approach. This industry supports it even if for this industry only. And I think it is in the best interest of the U.S. to have a good deal with Canada and Mexico. And in my view, both Canada and Mexico should hold out for that. Now let's turn briefly to capital allocation. Our framework is shown on this slide. We've consistently followed it over the years. First, to be profitable and sustainable for the long term, you have to invest in your business. Over the past decade, we have grown organically with some tuck-in acquisition activity. Some of our recent growth includes takeover work, as Fred noted. As a result, we're extremely well perceived as a supplier in our industry. As Pat noted, we are better operators today than we were in the early days. We have not made any large acquisitions, but have invested in our footprint and frankly, brought up the high standard in number of plants we acquired over the years. As our history shows, we've been very good at buying distressed assets and fixing them up. We have also invested in R&D and made some strategic investments. We're not venture capitalists. We invest in relationships that make us more competitive and that bring us something, Graphene being one example, additive manufacturing using Equispheres Powder being another. And we bring them something, too, maybe a customer relationship, expertise in scaling up or customer access. Remember, we were a start-up at one time and still have a highly entrepreneurial culture. Our focus on improving operations and the use of leading edge technology in our business has brought us opportunities through consulting, which are already bearing fruit. These investments have led to better operational performance and are paying off. Second, we maintain a strong balance sheet. This is paramount and something we will never compromise on. It's important to our customers. It enables us to win takeover business from other suppliers and take advantage of opportunities when they come along. This is a business that fluctuates and you want to be able to be nimble as we are. We've seen many competitors lose the value of their equity over the years by being overleveraged. As we've stated, we've won significant new business and our strong balance sheet has been a key enabler of this. Third, we returned capital to shareholders. As noted, we bought back some shares in the quarter. We renewed our NCIB. We've now bought back about 20% of our company in the past decade or so and over 2.5% this year-to-date. And we paid a consistent dividend for years. This chart is interesting as it shows how we deployed our free cash flow over the past 3 years and illustrates what has been a balanced and prudent approach. In the three years from 2023 to 2025, we generated close to CAD 600 million in free cash flow. With this, we reduced our net debt by over CAD 200 million, strengthening our balance sheet in some trying times, as you know. We repurchased approximately CAD 100 million of our shares, representing over 10% of the company's outstanding shares, which is now approximately 13% with share repurchases we've made year-to-date. We also paid CAD 45 million in dividends over this time. That's a balanced approach. Our shareholders vary in their views on how to spend the cash, and I'm sure you can appreciate when we talk to them and listen to them. So where are we today? We continue to invest in the business. Peter talked about capital expenditures, and you have our outlook for this year and our 2028 targets. We must invest to grow in a prudent and profitable manner. We intend to maintain leverage at our target of 1.5x net debt to EBITDA or better, and we'll buy back some shares. In terms of capital allocation, we have divested our fluids plant in China, as Pat noted, and we're involved in discussions on other potential asset dispositions that we generate cash to fund our business and other capital priorities. Now it's time for questions. We have shareholders, analysts, employees, even some competitors on the phone, hello. So we may need to be a little bit careful with our comments, but we will answer what we can, and thank you all for calling in.

Thank you. Ladies and gentlemen, we will now begin with the question-and-answer session. [Operator Instructions] With that, our first question comes from the line of Ty Collin with CIBC.

I appreciate all the commentary on the call so far. I guess to start, just wondering if you could share any sort of high-level expectations around cadence for sales and margins in Q3 and Q4 and any sort of timing factors or unusual items to take note of.

Okay. Thanks, Collin. Good to hear from you again. Yes, I'll refer back to what I had said in the last couple of calls. What the shape of the guidance, if you will, for this year is kind of like I've said before, a mountain shape. So we started off with a 5%, 5.5% quarter 1, a good quarter 2 and quarter 3 should be similar, I would say, to last year and then a little bit of a more sluggish quarter 4, similar to last year. I wouldn't say that quarter 4 is similar to last year, only that the shape is low in quarter 1, low in quarter 4 and the best quarters of the year for us would be the second and the third quarter.

Okay. Got it. Appreciate that. And then you called out a couple of factors within your Q2 margin performance, aluminum on the negative side, commercial settlements being favorable. I'm just wondering if you could help us kind of quantify those impacts to your Q2 results and what your expectations are specifically around both of those pieces in the coming quarters.

Sure. So as far as the aluminum is concerned, right? So on a year-over-year basis, it was substantial, if you will, it's about 50 or so basis -- a little bit less than that, maybe about 40 basis points because of the Iran conflict, which obviously wasn't contemplated at the time of guidance at all. So it's about 40 basis points on a year-over-year basis. As we move forward through the remainder of the quarters, you should expect that it will get slightly better in quarter three, but not completely reverse itself on the lag since the peak let's say, that we experienced was around CAD 3,800 per ton. It's come down now to the low CAD 3,000s, but not to where it started out the year, what we had planned for, if you will. So that reversal probably wouldn't take place until starting in quarter 4, maybe bleed into next year, just obviously dependent upon the trajectory of the Iran conflict.

Okay. And the commercial settlements, any sense of how meaningful that was in Q2?

Yes. We talked about as well in quarter 4 last year, quarter 1 this year that we were expecting a significant commercial settlement with one of our customers in North America. That did happen. However, it didn't take place in terms of, let's say, the timing or the lump sum. So let's say, format because it can take multiple formats. When you move forward here, so that's behind us. But moving forward, we still are working on several other commercial settlements, primarily in the European segment.

Okay. That's great. And if I could sneak in one more, maybe for Rob, just around USMCA and specifically the proposed 50% U.S. content requirement that has been put forward. I would take it based on your comments that your view is that this maybe isn't likely to get implemented, but that has been a long-standing ask for the U.S. So if something like that were to get implemented, is there a possibility that, that could disproportionately impact Mexican vehicle assembly and maybe have some sort of outsized impact on your footprint there?

Yes. A couple of comments. I mean the comment was raised in Mexico. Mexico told the U.S. to pound, so I'll tell them that one. The 50% requirement is actually kind of there right now in the context of -- in order to qualify for rules of origin, you've got to have a labor value content of USD 16 per hour absent benefits, which is basically an anti-Mexico provision, right? Like if you recall back in 2018, that was the original ask by Lighthiser, Canada and Mexico says, no, we're not going to do that. And they kind of backdoored it in the context of the labor provision. So you've kind of got that there anyway. And then I think in the context of whatever your overall rules of origin, the 50% application goes toward the calculation of the overall rules of origin, which are in flux as well. So the interesting thing is that we aren't that far away from effectively that level anyway. It's how you play it. But in the context of the discussions from both the Canadian side and the Mexican side as well as basically every market player in the U.S. OEMs and supply folks is that's a problematic proposition, and it shouldn't take place. So I think we're going to basically be okay there.

And your next question comes from the line of Brian Morrison with TD Cowen.

Peter, can you maybe just start with the aluminum commentary you just had? I understand that there's the lag the 60, 90 days. But I would have thought with aluminum prices having come down substantially post the end of June that it would have been a benefit in Q3. Can you just walk me through what your budgeted amount was and how the recoveries work?

Yes. So the budgeted amounts were slightly less than CAD 3,000 a ton. So when they're approaching CAD 3,100 right now or so, right? So we're still not where we had planned it to be. So they've come down recently, but they're not where they -- let's say, where we'd expect them to be relative to the planning of our financials.

Sorry, but call it, CAD 3,500 or CAD 3,600 a ton in the last quarter, I thought you would have recovered that differential from the OEMs in Q3, no?

Let's put it this way. It's more on the 90-day lag than on the 60, right? So when we reprice at the 90-day mark on the average, it's always on an average now that will start to come back. So it depends on the timing of when the prices go down. And obviously, when we buy at the higher price, that also has an impact based upon the volumes at the time. So there's going to be the impact of what you buy, when you buy based upon the volumes of the releases and then the averaging of what that is relative to the lag on the contract, the lag language on the contract.

Going into Q4 with a better run rate.

Yes. Quarter 4, you should see a bigger impact. Like I said with Ty's question, I would think we would have some improvement, but it won't be completely, let's say, negated. So I think the kind of the scenarios we're running based upon the amount of material that we purchased based upon the releases would be -- some of that comes back, let's say, half of that deviation comes back, but not the entire amount won't come back.

Maybe the way to say it is the second half of the year is going to be -- its trend line is moving in the right direction for the second half. The material index is trending in the right direction, correct, barring we are going to another war.

Understood. You've been a little bit more open with respect to forthcoming noncore assets. Specifically, you mentioned China. I assume that real estate might be in there as well. Can you maybe just frame potential magnitude of some of these divestitures that you're alluding to?

I think that -- I mean, we talked about the sale of Anting. That's not a big ticket item. We have a few things in the hopper that we'll consider. Obviously, you got to get the right pricing. But I would say, looking at my colleagues, CAD 50 million to CAD 100 million maybe.