Nemak, S. A. B. de C. V. (NEMAKA) Earnings Call Transcript & Summary

Good morning, everyone. This is Marcelo Motta from JPMorgan. And in the name of the bank, it's a pleasure to have with us Armando Tamez, CEO of Nemak; and Alberto Sada, CFO of Nemak, for this panel of the U.S. Auto Conference. I would like now to pass the word to Armando. Thank you very much, Armando.

Yes. Thank you. Thank you, Marcelo, and thank you to the JPMorgan team for inviting us to participate in this conference. What we would like to do is basically start with a short presentation in which we would like to share for the benefit of the audience a short profile of the company and then talk a little bit about the recent developments with the Nemak, share briefly our 2030 strategy, and last but not least, Alberto will talk about our financial performance. If you can go to Page 3, please. Just -- the company was established in 1979. We have been operating for a little bit more than 40 years. We started with producing cylinder heads, aluminum cylinder heads for the internal combustion engine. Our company size is about between $3.9 billion, $4 billion. And we have about 38 manufacturing facilities in the world and approximately 21,000 colleagues working for us. If we move to Page 4. Basically, those are the main products that we are producing. You can see that on the powertrain side, certainly, Nemak is very, very strong leading player in the production of aluminum cylinder heads, engine blocks and transmission housings. And since 2013, we started identifying the trend of the industry that was moving more to electrification, and we decided to enter into vehicle structures. And after that, certainly, we have been able to capture a significant portion of the market on the vehicle structures as well as on the electric vehicle side. If you go to the next page. You can see also our customer portfolio. We started based on our geography with the Detroit 3. And as you can see here, we are supplying almost every single OEM in the world. And we're very proud to be one of the most important suppliers for many of our customers that have been very loyal. And certainly, we keep very close relationships with all of them. If you move to the next page, Page 6. You can see our footprint. We are based in North America, and we have a very strong presence in Mexico, U.S., also in South America. We have also a lot of manufacturing facilities in Europe and as well as in Asia, China and India. We have 38 plants operating 15 different countries. We are very proud to say that we have 10 product development centers around the world, basically very close to our customers. And we support out of our 38 facilities in approximately 12 plants the new components. The new components are basically structural components as well as electric castings or assemblies for electric vehicles. If we move to Page 7, talking a little bit about the recent developments. We're very happy to share with the financial community that recently we issued 2 sustainability-linked bonds. The 2 of them were EUR 500 million and $500 million. Those were to refinance existing facilities that we're planning to mature in '24 and '25. Both bonds came with very competitive interest rates and a lot of interest by the financial communities. In addition to that, for the people that have been following Nemak, it was announced that the Controladora Nemak, which was originally part of the shares that Alfa put in that, was approved already by the authorities and Mexican authorities as well as by the shareholders to merge the companies. So we will have a single unit and it will be listed in the next few weeks, only one entity, which is going to be Nemak. We also, based on the strong financial results that we saw during the first half of the year, made an upgrade on our guidance, especially on EBITDA for the year. And certainly, we are also very proud that we are getting a lot of new orders. We were able to get, over the last couple of years, business worth approximately $1.8 billion. A portion of that is replacement business, but approximately 1/3 out of that is new and incremental business. Moving to Page 8. And this is, in a nutshell, part of our strategy. Nemak basically is a company that, since the beginning, has always been focusing on efficiencies. Cost is very relevant for us, especially operating efficiencies and also working with a very lean organization. Last year, based on the pandemic, we demonstrated, again, back to the financial community as well as to our customers and all our shareholders that we did the right thing to reduce our cost structure significantly to adapt to the new market reality. And we are performing. We're performing very well. We are reaching levels that we had before the pandemic in spite of the fact that volumes have not recovered completely. And we are generating enough cash flow to basically fund our future, which is basically investments in electrification as well as structural components. I think we have a very solid company. And we are reusing existing assets that we have today, for instance, that we were using to produce cylinder heads and engine blocks to produce some battery trays and also other structural components. If we go to the next page, Page 9. You can see that we see electrification as an opportunity. For some people, they have indicated, well, you have a company that is producing a lot of components for the internal combustion engine. How do you see the future? Well, certainly, we see an opportunity. And basically, we are increasing the content of the products that we can produce to our customers. If you see on the left-hand side for the internal combustion engine, we can have some content up to about USD 500. If we move more to electrified and talk about hybrids, we can increase that by approximately another $100 up to $600. And if we'll go to full battery electric, certainly, we are enhancing the opportunity for our company to increase our content in excess of USD 1,000. So basically, those are some of the main products that we are producing. If we go to the next page, Page 10. You can see that Nemak, since the beginning, has been very selective in the products that we choose to produce for our customers. On the left-hand side, you see complex castings such as cylinder heads and engine blocks and also transmission housings. We have been asked by many customers to produce other castings that are less complex, and we have said politely, thanks but no thanks. We prefer to use our state-of-the-art technology know-how and concentrate in challenging products, difficult to make, in which you see higher barriers to entry. And that's the philosophy that has been very successful for us. And moving to electric mobility and structural components. As you can see in the examples seen in this picture, we are selecting as well a few components of the structure. Some of our customers are moving more to aluminum alloys to reduce the weight of the vehicle and certainly complying with all the specifications related to [ crash ]. And this is something that has proven to be very successful for us. And we're making those components as we speak in many of our facilities as well as, for instance, the e-motor housings, the e-motor housings, some of them very complex, using actually our patented process. The CPS is a process that we use to produce engine blocks that are very sophisticated, very difficult to make. We are using that process as well as high-pressure die casting, which is another technology that we're also using. On the flowing hybrids, we're also making battery trays with high-pressure die casting for some of our customers. We are happy to tell you that we cannot keep up with demand. Demand is extremely high. So we are happy. And on the right-hand side, also very important components, battery trays that we are producing, not castings. But we're using multi-material, not only aluminum but also other type of materials that are requested by our customers. So we are developing, as we speak, these capabilities and moving very fast to get a significant market share. One of the advantages that we see on the electrification side is certainly that the addressable market is going to increase. It's going to increase. And certainly, as I indicated, the content on a per vehicle basis also is increasing. If we move to the next page, Page 11. And you can see that so far, Nemak has been awarded approximately $900 million worth of new business on the e-mobility side as well as structural components. And you can see some of the examples of products that have been very successful so far. And this is just a small sample. You can see the vehicles that carry our products such as the Porsche Taycan; the Ford Mustang Mach-E that has been very, very successful; the Jeep Wrangler, which is a flowing hybrid; and so on. On the structural component, also to reduce weight, our customers -- and improve range on the vehicle, they are also using lighter materials. And certainly, this is our main expertise in producing this type of components. If we move to the next page, Page 12. You can see that also taking advantage of electrification, Nemak is gaining track and winning some new contracts to develop battery housings for light commercial vehicles. They are becoming very popular in the market. And certainly, this is something that we are taking advantage. In addition, and this is for the first time, we have also been awarded a contract to produce parts for heavy-duty trucks. And we are seeing this especially in Europe becoming more relevant. As you know, the emissions standards in Europe are becoming stricter than in any other region. And we are seeing customers in Europe requesting our company to quote new parts that we see very, very important. One important point that I want to mention related to heavy-duty trucks is the following. Certainly, volumes are lower, but the content is significantly higher. For instance, one of the contracts that we got just last year will require that this truck that is shown on the right-hand side will have approximately 23 battery trays. So you can multiply the volume by 23, and you will get a nice volume similar or in some instances higher than for the light vehicle production. If we move to Page 13. We're very happy to you that in spite of the fact that we are moving fast, we are already getting approximately 20% of the EV market in the products that we produce, and that is for North America and Europe. We're expanding capacities and capabilities in different regions of the world, mainly North America and Europe. And certainly, we are considering some opportunities also in China. And also, we're very proud to tell you that we are the largest independent producer of battery trays in North America. So this is something very relevant. If we move to Page 14. This is something that we are also very proud and committed. We think that this is very important not only for our customers but also for the society in general. And this is our commitment to reduce greenhouse gas emission by 28% by the end of the decade. We signed this, and we are committed to continue working in improving our environment. I think we have that responsibility. And certainly, our customers, especially in Europe and in North America, are also very keen. And we see that this will become a competitive advantage. We believe that we are moving at a much faster pace than some of our competitors and peers, and we're very proud to be in that area. And now I will let Alberto to continue with the material.

Thank you, Armando, and good morning, everyone. Let's move to Page 15, please. Here, you can see our financial performance for the last quarters, where you can see that our revenue share, first, has been consistently above pre-pandemic levels right after the quarter where we experienced a lockdown last year. So you can see that our volumes having averaged close to 10 million equivalent units on a quarterly basis. And our top line has been averaging close to $950 million for each subsequent quarter after the lockdowns. So certainly, a very positive development on the revenue side, but most importantly, thanks to the very strong measures that we took during the lockdowns last year to improve our overall cost position, tapping every single element on the cost side, both the discretionary as well as most of the fixed cost structure, we were able to adjust it to the point that immediately after the lockdowns, we were able to improve our net margins significantly versus where we were post-pandemic to the point that our EBITDA on a -- consistently on -- each quarter after the lockdowns have been above where we were prior to the pandemic. If you see our average margins based on sales, our margins are on average close to 16%, from averages of between 14.5% to 15% last year. But most importantly, when we look at this on a per unit basis, so this is taking away the raw material prices, you see that our average EBITDA per unit currently stands close to $16 per piece versus the $14 per piece that we had before. So this has been very positive for us as we have been able to improve overall our profitability on a marginal basis, thanks to these cost reduction improvements but also because of the addition of the new product mix that Armando just highlighted. Certainly, it's becoming more and more important for us, and it's becoming a more -- a higher relative share of the dollar revenue of structurals and EVs, which are coming with better margins than the average product. So if we move to the next slide, Slide 16. So going forward, as Armando highlighted, we see the total market increases significantly for us way more than what we were expecting prior to the intense introduction of electrification in the industry, where currently the total addressable market stands at about $28 billion between what's available on the EV and structural side versus -- and the powertrain, which is our [ base business ]. But going forward, we see the total market increasing by 70% to reach close to $40 billion. So definitely, this is a great opportunity for us that we are working very actively, as Armando highlighted. The first $900 million worth of annual revenue of new business, I think, is a good evidence of what we will be able to achieve. Our expectation is that going forward, this new segment of our business will grow its share from the total sales from 10% that represents right now in 2021 to close to 30% by the end of the decade. And for sure, given the performance of this type of components and the complexity that is in place, we're aiming that these products will have margins that are better than our base business, at least 10% to 15% higher on this new type of components. So this is not only going to affect -- will have a positive effect on our top line, but also it's going to be having an accretive effect on our bottom line. So moving on to Slide 17. This is our last slide. We just want to give you here a summary of what is the current situation on Nemak. Certainly, given all that was indicated both on the financial performance side as well as on our overall balance sheet perspective, which we were able to improve significantly, thanks to these new issuances of almost 1.1 billion in bonds, puts us in a very strong position to fund growth. Certainly, our relationship with our customers as well as our position overall in the auto industry allows us to capture a big portion of the growth. Quite successful so far, as has been highlighted by Armando. We certainly want to strengthening -- or continue strengthening our leadership position on these new highly engineered components. We are, as Armando highlighted, very selective on what we want to get into. And for sure, the component that we just described fit perfectly to our product strategy. So for sure, as many -- as we can see, electrification for us is a great opportunity rather than just a threat. And thanks to this improvement in addressable market and our ability to develop the skills required to develop these type components, we see this as a very promising opportunity for us going forward. But we expect, again, to grow it in relative terms versus our base business but also grow it in absolute terms to achieve our long-term expectations. And with that, we conclude the material. Marcelo, if you can help us with the questions, please.

Perfect. Thank you very much, Armando and Alberto. [Operator Instructions] So while we collect the questions, I will start with the first one, which is regarding how Nemak can use its existing capabilities on the powertrain segment to grow on the EV and structural components.

Yes. Thank you. Thank you, Marcelo. Certainly, there are a lot of similarities. For instance, on the structural parts, we are using the same processes to produce this type of castings. Those are, as I indicated, sophisticated, difficult to make and complex castings that would be made out of a single piece. One of these main advantages that our customers are seeing is that in the past, they were using, for instance, steel or other materials that require certain assemblies. And by using a single piece made out of aluminum alloys reduces weight by approximately 40% with the same -- in geometry. And those are some of the capabilities that we're offering. Our expertise goes back more than 40 years. We have, in our industry, our best talented engineers and people that know a lot about materials so they can join forces with our customers. So we are using this type of processes as well as a patented process to produce, for instance, battery trays that we -- or e-motor housings that certainly will give our customers additional benefits similar to the engine blocks in which they could have cooling in the immoral e-motor housing as well as complex geometry that will add additional components to this to improve efficiency. One example is, for instance, the e-motor housing for the Porsche Taycan. Everybody knows that Porsche is a leading sport vehicle producer and always go for the best possible technology. And certainly, they selected us. So those are examples, Marcelo.

No. Very clear. Following with the Q&A here, just wondering how -- or what could be the strategic changes in the company after the merge between Nemak and Controladora Nemak. And if you could just give us a little bit of the background of the transactions for the investors that are not familiar with what happened in the past 6 months.

Yes. Please go ahead, Alberto.

Yes, for sure, Marcelo. I think -- I mean, just to give you some context what's happened, Alfa was a major shareholder of Nemak, holding 75% of the shares. And Alfa decided last year to start the process in which they want to untap value from the existing business. Alfa is a large conglomerate that has 4 major divisions. And they decided to start with Nemak. So the decision was to spin off the share of Nemak, giving each Alfa shareholder one share of new created entity called Controladora Nemak, which was created only for the purpose of performing the spin-off. So that entity did not -- there was no pushdown of debt or any other assets or any of the shares. So that took place in December. And just recently, we got approval to merge Controladora Nemak, making now Nemak just having one single entity trading in the stock exchange. So this is going to help certainly on the stock side because now we will have way more ample liquidity on the stock. The floating of the stock is expected to be around 70%. So certainly, there's a big change versus the floating that we had back with only Nemak having close to 20% of the shares floating in the stock market. So for sure and going forward, certainly, the strategic agenda of Nemak doesn't change. I think to the contrary, we are fully committed to our long-term plans to get strongly into the -- put selectively into this new type of components. We have, as we said, a very strong balance sheet. So our balance sheet didn't change from the transaction of the merger and quite committed, again, in general to perform towards our long-term expectations. So all in all, there is no change in the strategic agenda. To the contrary, I think we will continue pushing for that and now as almost fully traded company in the stock exchange versus having one large controlling shareholder.