Stoneridge, Inc. (SRI) Earnings Call Transcript & Summary

Hi. I'm Ryan Brinkman, the U.S. Automotive Equity research Analyst at JPMorgan. Thank you for joining us for the 2021 JPMorgan Automotive Conference. We're very happy to get going with our next presentation, which is from Stoneridge. We have here with us, Jon DeGaynor, President and Chief Executive Officer; and Bob Krakowiak, Chief Financial Officer. I'm going to turn it over to Jon for a slide presentation, and then we'll go through some Q&A. Thanks a lot, Jon, and Bob, we appreciate your time.

Our pleasure. Thanks, Matt.

And Ryan, thank you for the invitation. We're glad to be here. And for those in the room, if you forward to Slide 3, let me give you just a little bit of background on Stoneridge for those of you who may not know the story. So Stoneridge is a 56 year old company that -- we're global. We can serve our customers around the world. We'll talk a little bit about that split, but it's really -- it's a 56 year old company that has really significantly transformed in the last 6 years under this leadership team, and I'm really proud of the progress that we've made. A couple of things to understand about Stoneridge for those of you that might not know the story or maybe know a story from more than 6 years ago. Currently, you've got a business in Stoneridge that 85% of the business is -- by 2025 will be associated with, what we would refer to as, drivetrain agnostic. So the things that we make, not at all associated with -- not at all driven by internal combustion powertrains. And it positions us really well to be flexible for whatever that mix between internal combustion, hybridization and electrification is. We're -- we've worked really hard to develop our portfolio and drive growth. And what that does is it sets up a 5-year compound annual growth rate of more -- of at least 10% where expected revenue in 2023 of $925 million and $1.1 billion by 2025. And a strong backlog of awarded business with over $3 billion in backlog over the next 5 years, which represents more than 5x our 2020 OEM sales. So that backlog in and of itself, really supports our growth moving forward in our top line growth. If you go to Slide 4. Talked a little bit about the transformation of the company. Not only there were a series of key actions that were done since 2014, it started with the sale of the business that founded Stoneridge being the wiring harness business, the sale of that business in 2014. And we've really sought to reposition the business since then. So we've optimized our portfolio. We had a couple of key divestitures, one being our non-core switches and connectors business to standard motor products in 2019. And then most recent divestiture announcement, which was the sale of our soot sensor business also to S&P. At the same time as we've been rotating our portfolio, we've been adding in inorganic activities, namely the investment that we made in Orlaco, our partner in MirrorEye, as well as the remaining acquisition of our business in Brazil. PST now referred to as Stoneridge Brazil. And through this transformation, what we've done in order to drive all that is really to transform the leadership team to make sure that we have the capabilities to drive a forward-thinking, advanced technology organization that really performs at the top level of the industry and the best way to do that is with talented people. So that result of shift in our structure, shift in our product line portfolio and shift in our organization has allowed us to really focus on utilizing the engineering footprint and the operational footprint to drive our global capabilities, drive cost savings and accelerate our growth and the financial performance of the company. As we think about that diversification, if you go to Slide 5, this will give you a sense for how our product portfolio breaks down. So our Control Devices business is our largest segment. And in 2020, that represented 53% of our sales. And it's largely focused on passenger car and light vehicle applications. So it's focused on powertrain electronics and electromechanical actuation, but is, again, driving toward -- its technology alignment gives opportunities for the future. Our electronics business is 40% of our revenue, and it's focused on the commercial vehicle applications really in the vision and safety and connectivity and driver information in the vehicle communication space. And Stoneridge Brazil, was an aftermarket-focused business in safety and security. What we've been working over the last few years to transform that to support our global customers, particularly in our global commercial vehicle customers with OE product lines in alignment with our electronics business and also that gives us the ability to utilize the engineering and manufacturing capabilities in Brazil to support our growth. And on the bottom of that slide, what you'll see is the alignment of our business and what we use is sort of our North Star for alignment with the mega trends of safety and security, vehicle intelligence, fuel efficiency and emissions. So the things that we work on and where we're spending our time lead us to -- we judge it by, are we aligned with those mega trends and are we spending our engineering resources that way. And that's how we believe we can drive market growth or growth outside of market by 2x to 3x. Go to the next slide, Slide 6. What we're doing already is leveraging our technologies to really prepare for what's next. We take the market positions that we have and where they're strong and try to bring those things together, integrate the capabilities. That allows us to increase our overall content per vehicle throughout the product portfolio. So in order to drive that 2 to 3x market growth, it isn't by necessarily growing share, but it's really growing content. One of the areas is, expanding our connectivity capabilities and allowing and bringing more value to both the OEs as well as the fleets. Using those relationships in the CV market to drive growth in systems integration and really utilizing MirrorEye as this platform for additional growth with additional safety applications, driver awareness applications as well as integration of our connectivity activities, so that allows for data recording, data communication and other value-added features for the fleets and for the drivers by utilizing the core competencies that exist in the company. If you move to Slide 7, let's spend a little -- a few more minutes on MirrorEye and what that technology is. So MirrorEye, to boil it down, is a camera-based vision system that allows us to replace the physical side mirrors on a commercial vehicle, but to provide a lot better value-added systems. It's -- it really is an enhancement to what's out there today with integrated digital cameras and monitors inside the truck. Those high definition displays are mounted on the A pillar, which gives the driver the same experiences he's had with the mirrors mounted outside the A pillar. So the way they're trained, they don't have to retrain themselves with regard to scanning mirrors. They're just seeing things that are inside the A pillars as opposed to outside the A pillar. It provides them with a much greater field of view and eliminates a whole series of blind spots which improves safety. And then those -- then the camera system also provides much better visibility at night in low light conditions. You may hear the thunder lightening in the background, certainly in inclement weather, rain, like we're experiencing here or in snow. It's much better than with physical mirrors and also with no impact of spray. And then once you digitize the image, now you can do other things with regard to image processing and signal processing. And we've been able to do things called trailer panning which allows the driver to see the back of the trailer even if when the truck is articulating, allows them to make sure that they're avoiding, particularly on a right turn the risk of where that trailer goes up over a curve and not seeing what's there. And the other benefit for MirrorEye is taking the physical mirrors off the truck has significant fuel economy benefits and at least with one fleet they've demonstrated over 2% fuel economy benefit. This is a system that we're incredibly excited about. And not only do we have OE program awards that are launching, but there's also been award-winning for us with the Automotive PACE award, which in the industry is somewhat viewed as the Oscars, if you will. We turn to Slide 8 and spend a little more time on the technology features of MirrorEye. It's -- I won't go into every one of the details, but it should be clearly noted that Stoneridge was the first one to get FMCSA approval, Federal Motor Carrier Safety Administration approval to operate commercial vehicles without a mirror. We've been awarded 4 OE programs for global commercial vehicles. 75% of the CV OEM market in North America are associated with those awards, and really 1/3 of the European production volume is also associated with those awards, with not all of the North American or European market fully decided. What's in our backlog is $70 million worth of contracts at the OEM defined take rate, which is currently 15%. And we believe that the opportunities for this product line are a little bit like backup cameras and passenger cars in the past would go across 100% of the vehicles. And so then the awarded programs rather than being $70 million would be closer to $500 million. And we believe that the -- that these take rates will accelerate far beyond what the OEs have expected as fleet adoption, as fleets try these and see the benefits and these drivers hold this. And the timing for this is that the OE programs, the first OE program will launch later this year with the second one early in 2022. And the third and fourth one is then in subsequent years. We see the activities between fleets and the OEs working together that help us to continue to develop and improve our value proposition and drive the value both for the fleet customers as well as for OEs. So if I synthesize what's really going on at Stoneridge, you go to Slide 9. The -- from a shareholder perspective, Stoneridge is a organization that's focused on driving shareholder value really by using our core competencies and using our technologies and building upon those. We have an executive team that is comprised of industry leaders who know how to drive growth. As I said earlier, where we've got diversification from a global standpoint, we've got diversification from a product standpoint and diversification from a customer standpoint that allows us to react in the end markets. And this long-term strategy gives us the opportunity to outgrow the market on the top line 2 to 3x, and to achieve top quartile financial performance over the planning period. So with that, Ryan, I'll turn it over -- turn it back to you and turn it to a question and answer.

I wanted to just touch a bit more on the commodity cost situation. Everyone in the industry has obviously been greatly impacted. Can you talk about what your exposures are? And what incremental actions you might be taking to address these costs?

I think we lost Bob via a video, but I believe he's on via phone.

I am on, Jon, can you hear me?

Yes.

Okay. Great. Yes, Ryan. So yes, I apologize. We had a power outage here because of the weather, so I am on the phone. In response to your question, as you can imagine, as a result of the current supply chain situation, we have incurred for us, a significant amount of incremental cost about -- during the first half of the year. So for us, we spent about $8 million. We've recovered about $2 million of costs. And it's really for us, it's primarily in 3 different areas. We've had price increases due to spot buys. And we've been fairly aggressive there where we've gone out to our customers on spot buys, these onetime buys where we've asked them to basically pay for the spot buy if they're -- if they want the product, and we've been successful with that policy since we initiated it in late June. We're also incurring premium freight as well. We've also established a policy with our customers on outbound premium freight from our facilities to the OEM assembly plants that if they want the product expedited that they're -- we send them the invoice and they've been paying those charges as well. And then the third category for us has just been the overall price increases in the electronic components and commodities that are a really big part of our business. So as of right now, we've been taking the price increases from our suppliers. We have sent letters to all of our customers, negotiating -- and we're in the process of negotiating price increases to recover those costs. We've seen a significant -- and then in addition to that, of course, just given the volatility, we've seen a significant amount of market volatility in the OEM production schedule. So that's driven some decreased sales in our passenger vehicle end markets. And we've also experienced some labor and operating efficiencies as a result of that. So really, in summary, for us, to combat the price increases and the shortages that we've seen, we're continuing to actively negotiate a sharing of our incremental costs with our suppliers and our customers. We are also developing strategies to mitigate these costs as well, looking for more efficiencies within our overall supply chain, and then also looking at redesigns of our product, which will open up the opportunity to use some different components, which will mitigate some of the increases that we're seeing right now. But based upon the current market conditions last week in our earnings call, we had updated our excess supply chain costs last week to be about $9.1 million to $10.3 million for the full year. And as I mentioned earlier, to date, we've incurred about $6 million of net incremental costs.

I see. Are you able to review what have been your biggest recent program awards? And what are your most important launches coming up?

Sure. I'll take that. I would say we have a couple of really important launches and awards, one being PACCAR, our digital instrument cluster that is just launched in Q2 2021. That's $40 million with annual revenue. It's the largest instrument digital display program that we've ever won. And it's also the largest display in its class. So it's moving PACCAR into best-in-class with regard to both the capability of the display as well as what it enables from a vehicle integration through that display. So we're really excited about that. Smart 2 tachographs, which for many investors, particularly where they don't have European exposure, won't understand what that is, but that is effectively the government-mandated technology in every commercial vehicle in Europe that manages hours of service and speed and all of the above. We are -- we've been in that business as a key player in it and have some very important awards for the next version of that, the next mandated version of that, Smart 2 that starts in 2023 and allows us now to do -- bringing our connectivity technologies in there with over-the-air updates and other capability additions. So it brings some of the fleet management capabilities into this mandated device. On the Control Devices side, business wins, we talked about in our most recent earnings call with both our front axle disconnect product line and additional wins there. Our Park-by-Wire applications where we're seeing expansion not only with Ford Mach-E, but with other electric vehicles within the Ford portfolio, their E-Transit and the new Maverick truck. And then a couple of additional actuator as well as trailer connectivity awards. So both in the control devices and in the electronics side, we are seeing good business awards and growth. And that doesn't include what we see as the outstanding growth opportunities from here on.

Great. And I wanted to ask on MirrorEye a bit more. Obviously, super exciting, tremendous amount of growth potential. Just give us an update on the recent developments? Any additional color on how you plan to use MirrorEye as a broader platform going forward?

Yes. So thanks, Ryan. It's something -- I view MirrorEye as emblematic of the transformation of the company, where you use a set of core competencies and really look to put those things together in a system, develop a solution that has all the way to the end customer feedback, but then look at what do we do to utilize our additional capabilities going forward with additional features. So that's why the combination of OE business wins as well as the fleet trials and the expansion of those fleet trials gives us the opportunity to make sure that our product is well developed and is meeting the needs of the end customer, which accelerates the expansion in the pole to the OEs, but it also sets us up for what's next. So as an example, we see continued fleet expansion with the safety leaders, many of whom we've talked about publicly, Schneider, J.B. Hunt, Maverick. And we see some of those who have already made the decision even if they're not fully available from an OE standpoint to go 100% across the board because they see the safety benefit. What that has led to is OEs now -- before they put a MirrorEye system in production from an OE standpoint, doing what we call pre-wire, which is where they're preparing the truck and the wiring for a MirrorEye retrofit in the factory. Daimler is the first one to do it. They've seen a level of order pull already this year, 500 this year, but most importantly, 200 in the month of July. So we're seeing uptake that, obviously, the fleets are driving that. And then the launches with the OE programs, the expansion into buses using the MirrorEye technology in European buses first, but basically as a bus program, and 1,500 of those that have been installed already this year and a major OE contract with a European bus manufacturer to expand the application there. And again, it's both in retrofit and in OE applications. But what we see next is it's a gateway to bring a suite of solutions, whether it's recording, whether it's using our connectivity capabilities was how it ties into fleet management, but also then with other safety aspects where object detection, driver monitoring, trailer monitoring, other things. So we really see this as a platform that sets us up with building blocks. And as we've said to investors in the past, you've got to be in the conversations in order to be developing with the OEs on what they're going to need in the future as you see vehicle automation -- not all the way to autonomy, but automation will come and driver support will come well before autonomy. If we're in those conversations, it gives us the ability to continue to iterate our products and be part of that as the trucks get smarter and smarter.

Great. And on the earnings call last week, you mentioned your balance sheet was well positioned. The fact that you don't require significant capital expenditures in your business creates the opportunity for a strong cash generation with the amount of growth that you expect going forward. Can you discuss how you think about putting that cash to work then?

Sure, Ryan, it's Bob. I'm happy to do that. And we're extremely well positioned right now. We have relatively low leverage, significant amount of available capital. If you look at our LTM -- if you look at our LTM debt to EBITDA, we're about 1.4 turns right now. Our strategy on acquisition to grow businesses really hasn't changed since I've been the CEO over the last 6 years, and I've been CFO over the last 5. Looking for logical adjacencies, we do like our portfolio of products, where there are opportunities for logical adjacencies and then where there are opportunities to grow with new customers in our existing product lines. We're also looking at M&A opportunities. I had a very successful Orlaco acquisition a few years ago. And then we're evaluating all of our capital options, including the possibility of renewing our share repurchase authorization as well.