PHINIA Inc. (PHIN) Earnings Call Transcript & Summary

Good morning. Thank you, PHINIA, for joining us at our Chicago Industrial Summit. We're excited to have Brady Ericson, Chris Gropp with us today. Thank you. [indiscernible] side, we got some prepared slides, They have got some slides [indiscernible] kick off from that, then we'll go to Q&A. We want this to be as interactive or good as possible. So thank you for joining us here again. And with that, I'll let you kick off on the slides.

Great. Thanks, Brian, and thanks, everyone, for joining. We'll flip through a couple of quick slides here kind of give you a quick overview of the company and our strategy and then go from there. First up, it's how we go to market is through product leadership. We continue to try to ensure that we have some of the best products that provide the greatest value to our customers. And we think we've got strong positions in all the product lines that we're participating in, whether it's fuel injection, starters and alternators, and aftermarket businesses. And we're leveraging a lot of that capability. And so we're not just -- we're not a what we consider a commodity. We try to win on our technology and our performance of our products. We go to market and we actually service all a bunch of different markets out there, and that's why we can really consider it more of a diversified industrial because of the variety of end markets that we serve. We then couple that with a lot of our financial discipline. We evaluate every single quote that we have out there, expectations on return on invested capital, our minimum hurdle rate is 15% is what we expect to deliver on any of our new programs and continue to drive that as part of our business. And then all of our decisions are really around how do we maximize shareholder return. And that's where our financial discipline and stable growth, our capitalization strategies is really going to shine through is where we're focusing on that shareholder return. When we talk about the diversity, I think this slide here really kind of goes through a lot of our strategy. Not only do we have diversity around the regions. We also have diversity in our customer base. Our top 5 make up 37%, our top 1 is in the high teens, 16%, 17%, 2 through 5 are all in the mid-single digits. So we have a lot of diversity in our customer base. And then finally, as I mentioned, a real diversity in our end markets, service, which will include original equipment service as well as independent aftermarket makes up 35% of our revenue. So that's actually the largest end market that we serve. That's followed by light passenger vehicle at 25%, medium- and heavy-duty on-highway commercial vehicle of 15%, light commercial vehicle at 19%. And then probably our fastest-growing segment is the off-highway industrial and other that will include the air based, gensets, the ag, the construction. And people will ask us a lot about going into all these different end markets. What's interesting for us, it's really the same engineers and the same manufacturing equipment. And so for us, we're able to leverage our human capital and our manufacturing capital to go to these different end markets. So we're not having to invest a bunch of money now in the hope of delivering additional revenue and profitability later because we're able to repurpose a lot of our existing lines. And so there's actually a light passenger vehicle diesel line that we repurposed to do some of the aerospace work because the processes, the material, the precision machining, the final assembly of the test is all similar. And the same thing with the engineers. We're not converting mechanical engineers and trying to have them do power electronics. We're having mechanical engineers, and it's a pre and post injector for a turbine engine. So it's fluid management. It's precision engineering. And so it's the same engineers that we have on aerospace, commercial vehicle and light vehicle because it's the same basic technology. It's just different flow rates, different pressures. And so we're able to shift our resources depending on where the growth is coming. And that's, in our view, is going to deliver a consistent growth rate and make us very resilient in a relatively volatile market. We did just recently announced the acquisition of stoba here at the end of June, gave a little bit of more insight in our latest earnings calls. And you'll see here, we see it as consistent with our strategy. It's going to add another aerospace and defense certified location in Germany, very precision machine components and they have a lot of intellectual property and trade secrets on how they manufacture the products, the type tolerances that they're holding. They are one of our largest suppliers and a critical supplier for us. And although their third-party or total revenues are about $200 million, $120 million, that was to us. So we see that as a not only as a way to get some critical technology inside, but also make our supply base a little bit more resilient, as we've seen in many of the European supply base and others, there's a lot of concerns with the financial viability. And so these small- to mid-sized companies are concerned. And so we saw this as an opportunity to not only expand our exposure into aerospace and into different customers, but also to solidify our supply base as well. And so we think it was a fair multiple at 6x EBITDA. We think that will just nicely kind of slide right into our organization. Their plants are close to our plants as well, and it gives us some ability to continue to optimize their manufacturing footprint with ours as well. Just a quick highlight. We did report earnings a few weeks ago as well, another good solid quarter, $130 million of EBITDA, $940 million of sales, another strong sales quarter for us year-over-year growth versus prior year. EPS continuing, I think, it was up around 20% adjusted EBITDA from prior year. We continue to maintain a strong balance sheet share repurchases continue even with the acquisition that's coming. And our leverage is pretty conservative at 1.3x. Our target is around 1.5. So we have a little bit of room there as well. And again, the 1.5 plus or minus, we think, is a good level right now. As we shared at the Investor Day as we continue to grow and as we continue to get our interest rates may be a little bit lower, maybe we go from 1.5 to 2, but we still want to maintain a relatively conservative balance sheet. We're not going to be levering up to 3x. And what we consider excessive because there are always going to be some cycles that we have to weather. I think this is, I think, a nice summary of our discipline and financial discipline and capital allocation discipline. Since we've spun, we just had our third anniversary back in early July. And in that time, we bought back close to 24% of our shares, returned $665 million to shareholders. We've increased our dividend. We established a dividend and increased our dividend twice already, maintain good leverage. We produce predominantly in low-cost countries. We've seen some nice organic growth rate and also now with SEM acquisition integration last year and now the stoba acquisition, we're finding those nice little tuck-in at reasonable prices that continue to support our business kind of longer term. So we think this is a really strong slide for us on how we have a good, strong foundation. We're investing for the future growth. We're disciplined in that area. And again, I think some of our capital return to shareholders has also been extremely strong over that period. And that thing kind of leads into kind of what our overall expectations are what has been for the decade, through the cycles, we'll see that average organic growth rate in that 2% to 4%. I think this year, we're right around 3%, 3.5% this year. Cash flow continues to remain strong. We still have some opportunities to continue to grow EBITDA, and we expect that to be solid in the 14% to 15% range. And then that target modest leverage at 1.5x. So I think if you take a look at what we've delivered over the last 3 years, I think it's -- our goal is to be consistent kind of in the ups and downs even with commercial vehicle market being really pretty heavy over the last couple of years, we still kind of held our numbers are relatively flat to maybe a little bit up, continue to deliver good, strong cash flows, and that's one of the benefits of the diversity of our -- of the markets that we serve. There's no one market that's going to really drive our one platform that's going to drive our revenues. And so I know people are more excited about light vehicle or more around CV. But again, CV is still only -- medium-heavy-duty CV still only 15% of our revenue. So yes, we'll see a little bit of uptick there. We're seeing a little bit of headwind in light passenger vehicle in China. India is now really kind of ramping up, and we're building a new plant there as well to support that growth. Alternative fuels is really growing well, whether it's natural gas, ethanol, methanol, both light vehicle and commercial vehicle, hydrogen as well. We think there's a lot of opportunities for us to continue to grow in these different markets and different regions of the world. So with that I'll pass it back to you, Brian.

Good. Thank you taking us through that Brady. Just some questions you get started as the Q&A session. You talked a lot about diversity of end markets and come here. So when you think about that end market exposures, it continues to evolve -- we talk about kind of the industrial aspects of that and again, getting away from -- and industrial, excess industrial state, but also on highway, on-highway from a commercial vehicle standpoint, other than [indiscernible] and then aftermarket. And as you position that from like kind of core growth and margin engine for the company. Talk about that just organically and inorganically as we should take it forward.

Yes. I mean, we're going to be disciplined on the inorganic. And so are we looking for opportunities on the aftermarket side from an acquisition standpoint? Absolutely. It's got to be at the right multiple and fit with our portfolio. From an organic standpoint, we expect our Aftermarket and our Service business to grow from roughly 35% to probably closer to 40% organically between now and the end of the decade. And so -- and that's primarily made up of kind of 3 major components. One, as we were talking earlier, the average age of vehicles continues to increase. The number of vehicles in operation continues to increase and as long as people are driving, our Aftermarket in general, the market itself is growing 1% to 2% a year. So that's just the overall market. Pricing is generally 1% to 2% a year on average as well. And then we've been kind of continuing to gain a little bit of market share as we continue to diversify our product portfolio and our offerings that's another 1% to 2%. And so that's where we see our Aftermarket in that 3% to 6%, 4% to 6% type of growth rate. And so if we continue to grow that, that's going to allow us to increase our Service and our Aftermarket business as a percent of sales. If you take a look at our recent earnings, our Aftermarket segment is already delivering roughly half of our profits. And so although the revenues may be a little bit lower, it's already about half of our profitability. The Aftermarket segment, I think we were just right around 17%, 17.1%, I think, in the quarter. It's a good solid number for our Aftermarket segment and our Fuel Systems is right around 11%. So our goal has always been for Fuel Systems to stay double digit. Hopefully, the new floor is around 11%. Aftermarket was, hey, at 15%, maybe 16% is now kind of the new floor, and continue to grow the business. And so we see these as real strong businesses, very profitable businesses and ones that deliver great cash flow, too.

And you push further on the industrial front. The great thing is that the industrial aftermarket tends to be more profitable and stickier.

Yes. If you -- I mean, if you look at the numbers, our Aftermarket as a segment, half of our -- of that 35% is more on the heavy truck and the other half is on the light passenger side. So I absolutely agree with you. On the commercial vehicle side, we may get 2 to 4 replacements over its life cycle. We're on a light passenger vehicle we may get 1 to 2. And so we do see a much larger just because of the miles driven and the severity of some of those applications that we tend to get more service parts over the life of the vehicle.

Just a little bit more on the Aftermarket side. When you think about just key operational levers there, the SKU expansion, brand conquest wins, what else is helping drive the outperformance there?

Well, I think the SKU is the overarching. But as we do this, we've continued to add different product lines into different regions. And we're doing it in a disciplined manner to where we'll launch it in one region, we get penetration, see if we can get some success in there. if it continues to grow well, we'll then take it to other regions. So steering, suspension, breaking was one of those things that has really been growing well for us. And now we're taking it to kind of all markets. I think having the OE pedigree and the quality, I think, also helps us. So we're definitely the premium product. And people know the DELPHI brand. The DELPHI brand is probably one of the top 5 -- in the top 5 brands out there in the aftermarket that people recognize it they appreciate it and they're willing to pay a premium for it because they know it's a good quality product. And so we leverage that. And the nice thing about the DELPHI brand is at some point, they probably made about every single component in the vehicle. So we have the flexibility to go into those different areas, apply the DELPHI brand to it, and really get a premium for that product and actually helping a lot of the mechanics and the shops. They put that DELPHI brand, they can sell the DELPHI brand easy. And they make more money because they're doing a markup on our product. And so a markup on $50 is not as good as a markup on $70. And so they actually make more money. And again, with many of our components labor is actually the bigger component. And when you start tearing apart the engine, if you see in some of the labor rates in some of these shops, they're probably going to spend more time and labor the than doing parts. And so they're going to want to ensure that they put the best quality parts on it. And so they're not going to go with a cheaper brand just to save a few bucks because if something goes -- if the mechanic is putting it on if something goes wrong, they're on the hook for their labor to replace it for the customer. And so that's where they really know they can rely on the DELPHI product and the brand, and they can easily upsell their customers to get the higher quality part.

And there's a similar dynamic on the DELCO REMY on the CV side, where you're literally spec-ed in by the fleets to sell the DELCO REMY. So whichever brands you're going with, whether it's DELPHI, which can go across both the CV and the light vehicle and the light commercial and you have the DELCO REMY, that's more skewed towards the CV side also [indiscernible] adds.

Any questions? I don't want to monopolize. I can keep going.

[indiscernible]

I don't think they necessarily will I want to get solidly into 14, 15 before I make a commitment to go 15, 16. That's probably more of the rationale behind it because it's -- the EBITDA aren't that much different, when we talk about the 17, that's operating income. There's not a lot of depreciation in the Aftermarket segment. So it only has maybe 1 or 2 where it's 4 to 5 on the Fuel Systems side. So the Fuel Systems is not that much different. It's only a few points less. But I think in general, as we continue to grow as we continue to expand into the off-highway industrial and some of the aerospace business. I think that will then allow us to kind of take that margin up a bit kind of going forward. It's really small. We launched our first program with [ Safran ] earlier this year. The second one launched in Q2. Third one launches?

In '27.

Yes. And then the fourth one, I think, is end of '27 as well. So that's kind of -- it's something we been working on for about 4 or 5 years now. our facility in France got their aerospace quality certification in Q4 of last year. And now we've been going to a lot of the air shows and now that we have a big customer credible customer and with our quality certifications. The doors are really starting to open up. There's probably a dozen programs that we're currently quoting on right now on supplying prototypes for. And then the stoba acquisition will add -- they have a number of aerospace, they have an aerospace certified location as well as well as customers that we aren't in right now. And so that will open up some more doors for us as well.

The key theme of conference is obviously how to build out a data center footprint in terms of what's there. Can you talk a little bit more about -- think about what fines doing of stationary power generation side of things. industrial applications, some of that lineage, you just talked about DELCO REMY [indiscernible] standpoint, the alternative fuel research that the team has been doing, how you're able to kind of capitalize on that macro.

Yes. Yes. I think some people kind of, I think, overhype the data center side of things if we're doing generators. I mean we work with the cats, we work with the [indiscernible], we work with a lot of the genset providers. But the genset market in totality is now increasing, but it's not doubling in size. Certain applications are doubling, but the volumes are still relatively small. We've been on gensets for 30, 40 years, whether it's [ Cat Perkins ], whether it's [indiscernible] others. And so yes, we do see some increase in it, but it's still a relatively small percentage of our overall business. Now what we can't say that the genset is going to a data center because it's just a genset. It could be going to a factory. It could be going to a hospital. And so really, what we know is, hey, it's a 20-liter genset, it runs on natural gas and is a design for prime power backup power. And so that's what we supply our parts to. And in general, our parts are going to be the same, whether it goes to a data center or whether it goes to a hospital or a factory. So we are seeing some tailwinds. We saw some tailwinds in gensets business a number of years ago when they were building out 5G towers. They needed a bunch of gensets backup power for the 5G towers, and we had a big surge in our genset business for a few years, and it came back down again in a cyclical market. I think with the data centers and some of that demand rather than being a cyclical business, I think it's going to turn into more of a consistent long-term growing business. And we do think there's opportunities there. The SEM acquisition is one of them that is benefiting from that because a lot of their ignition coils is for natural gas applications. And that's where a lot of these large prime power are going to be on natural gas. And so we do see some opportunities there as well.

Just picking up on the stoba acquisition, again, [indiscernible] the exposure on both off-highway and industrial, as you mentioned. As you think about just taking that and then first, the existing relationships you have in them, but how does that best further accelerate what you're doing into not about in terms of those industry. You talked about aerospace supply chain in terms of enhancing that...

Well, I think it opens doors to customers that we've been trying to knock on and haven't been able to get into. And so they're already working with [ Lever ] and [ Woodward ] and [indiscernible], and a number of different customers that we're not in right now. And so it's going to open up some doors there. with the build-out with the military spending increasing in Europe, having a certified location in France having a certified location in Germany we have locations that are working on the certification in the U.K. We think we're going to be well positioned to support those customers. And as people know, the military sector and the aerospace sector, not the best at managing their supply base, and there's a lot of challenges. And so us going in there, the doors have been kind of wide open. They're excited about it. Their main concern was always can you guys -- you understand our lower volumes. And we say, yes, we're doing gensets. We're doing off-highway. We're doing marine already. We know the low volumes, and we can support it. And as we're continuing to build a strong relationship with the customers, they're giving us more and more opportunities. And if you think about some of the manufacturing processes around the components in our fuel injection, we're talking about plus or minus 0.5 micron. We're talking about pressures in our injection systems that are in excess of 40,000 PSI close to 3,000 bar. Laser ablation, laser drilling, EDM drilling, the micron, the shapes that we're controlling the aerospace specs that we have are quite easy compared to what we're doing on commercial vehicle diesel injectors. So the capability, the types of materials we're using the super alloys, it fits directly in with our capabilities. And that's why it was easy for us to win these first couple of programs, one is a pre-injector, one post-injector for [ Turbinengine ]. For us, it was the same basic machining, assembly lines, and we're able to convert an existing line. And that's why we think this is a -- it's an area that we can we can shift into and allocate additional resources to without having to increase our CapEx without having to increase our R&D as a percent of sales and we're leveraging our same existing human capital as well, so we can move them from commercial vehicle to aerospace. And I think another couple of good examples of that is we also converted one of our light vehicle diesel lines because, obviously, Europe light vehicle diesel kind of went off a cliff. We actually converted -- we have a GDI for diesel. And so we actually converted one of our GDI lines for diesel applications for coal or for an off-highway application. We've converted some of those diesel lines down for South America and other locations. So now we're 100% ethanol applications. South America seems to be going more that way. You've heard a lot of different new business wins in natural gas in India. India is going heavily into natural gas, both light vehicle and commercial vehicle. So we're moving lines down there as well. And so what's nice about it, not only do we have flexibility on our human capital, but a lot of our manufacturing lines, one we can convert from gas to diesel and we can easily move them from Europe to South America or Europe to China, China to Mexico depending on where the demand is. So these are things that we can move capacity around where extended as well.

And just picking up on what you're hitting on from a nat gas standpoint. I mean, that fits into just some of what your capital is on in terms of alternative [indiscernible] in core markets. [indiscernible] different chapters share, ethanol, methanol, hydrogen, and can you talk about how you're being able to capitalize on that opportunity.

Well, again, it's -- from an engineering standpoint, it's just a different viscosity and different flow rates and pressures. And so you just have to make some slight -- whether it's nitriding, whether it's a coating, whether it's a diameter, you got to open up a lot more flow. It's the same basic technology. And so we were -- probably a few years ago, we were probably people were more excited about hydrogen. And so we're investing a little bit more there. I think the excitement has kind of leveled off a little bit and I think there's still a lot of work going on there, but they're not the overhype. So we backed off a little bit, move some more of that to natural gas and some of the lessons learned that we had on hydrogen, we're able to apply to natural gas and ethanol applications. And so for us, every time we work with a different fluid, we learn some new things, and we can then apply some of those lessons learned to other applications as well, whether it's a different type of coating, nitriding, a flow rate, corrosion, I mean, obviously, 100% methanol is a very corrosive fuel to deal with. And so getting something to live with methanol over the life of the vehicle is a challenge. But obviously, we learn a lot and we can apply some of those lessons learned to other applications.