Magna International Inc. (NYSE:MGA) Q2 2023 Earnings Call Transcript

Magna International Inc. (NYSE:MGA) Q2 2023 Earnings Call Transcript August 4, 2023

Operator: Greetings and welcome to the Q2 2023 results conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question and answer session. At that time, if you have a question, please press the one followed by the four on your telephone. If at any time during the conference, you need to reach an operator, please press star, zero. As a reminder, this conference is being recorded Friday, August 4, 2023. I would now like to turn the conference over to Louis Tonelli, Vice President, Investor Relations. Please go ahead.

Louis Tonelli: Thanks Rita. Hello everyone and welcome to our conference call covering our second quarter 2023. Joining me today are Swamy Kotagiri and Pat McCann. Yesterday, our board of directors met and approved our financial results for the second quarter of ’23 as well as our ’23 outlook–our updated ’23 outlook. We issued a press release this morning outlining our results. You’ll find the press release, today’s conference call webcast, the slide presentation to go along with the call, and our updated quarterly financial review all in the Investor Relations section of our website at magna.com. Before we get started, just as a reminder, the discussion today may contain forward-looking information or forward-looking statements within the meaning of applicable securities legislation Such statements involve certain risks, assumptions and uncertainties which may cause the company’s actual or future results and performance to be materially different from those expressed or implied in these statements.

Please refer to today’s press release for a complete description of our Safe Harbor disclaimer. Please also refer to our reminder slide included in the presentation that relates to our commentary today. With that, I’ll pass it over to Swamy.

Swamy Kotagiri: Thank you Louis. Good morning everyone. I appreciate you joining our call today and I’m happy to kick off today’s call with an update on our progress, and following a financial update from Pat, I look forward to answering your questions. Before diving into the details, let me walk you through some key highlights. We successfully completed the acquisition of Veoneer Active Safety during the second quarter, solidifying our position as a global leader in active safety. There is a lot of excitement and energy around Magna as a result of this acquisition. Our organic sales grew by 17% year-over-year, surpassing rate of production by 5% excluding completed vehicles and 3% including complete vehicles. Our second quarter showcased strong Q2 operating performance with high organic sales contributing to robust earnings.

These results represent a significant improvement both year over year and compared to the first quarter of this year. We have raised our 2023 sales, adjusted EBIT margin, and adjusted net income outlook ranges for 2023. This upward revision in our EBIT margin range demonstrates solid operating performance even with the inclusion of Veoneer Active Safety, which is launching significant new business over the next 18 months. We are highly committed to executing our strategy and remain confident in our ability to achieve our long term growth and margin outlook, and we continue to win business across all product areas which supports our go-forward strategies. It is important to note that the industry has seen some positive developments, including reduced supply constraints, stronger and more stable production schedules, and resilient order sales in a number of markets; however, the global economy continues to face some interlocking challenges, including continuing elevated inflation, higher interest rates, geopolitical risks, and slowing economic growth.

These challenges are impacting our entire industry. In North America, there are concerns about upcoming OEM labor negotiations when union contracts expire in September, which may have short term impacts on production. Rest assured, efforts to contain costs and improve our margins remains a top priority for us. This is being achieved through ongoing operational improvement initiatives, recovering costs from our customers, and executing flawless launches across Magna. Earlier this year, we estimated about $100 million of incremental input costs net of recoveries over 2022. Based on our initiatives together with improvements in market prices for energy and certain commodities, we now expect to mitigate about half of the incremental net input cost.

We also continue to take proactive measures in various other areas. We have executed or initiated consolidation, restructuring and cost containment activities at different levels across the company. We are engaged in ongoing commercial negotiations with our customers to recover costs, transitioning to various index programs and address pricing on challenging programs. At the same time, we continue to intensify our efforts in areas that are core to our daily business, including hedging activities and our enterprise-wide global purchasing initiative. Automation installations in smart factory initiatives with a digital ecosystem implementation are also well underway. Lastly, I’m pleased to report that our underperforming European BES facility is tracking to our expectations supported by a number of these initiatives.

All of these efforts are yielding positive results, enabling us to generate strong earnings on our sales growth and reinforcing our confidence in delivering on our expectations for margin expansion in the coming years. In early June, we successfully completed the Veoneer Active Safety transaction, and I would like to thank all those involved for their efforts. This transaction has expanded our active safety portfolio by incorporating complementary products, customers, geographies, engineering and software resources. The response from both the acquired business and our existing active safety unit has been overwhelmingly positive. There is a great deal of excitement surrounding the immense potential of the combined business. The business is on track with expectations as outlined when we announced the acquisition, including being neutral to earnings before purchase price amortization in 2024.

We hit the ground running and are fully dedicated to ensuring a smooth integration and realizing the $70 million in synergies identified at the outset. We are excited to share more insights about our combined active safety business and to update our 2025 outlook to reflect the acquisition during our upcoming virtual investor event in early September. We continue to execute our strategy aimed at accelerating our growth in mega trend areas. Recently we were awarded the battery enclosure for Ford’s next generation F-150 Lightning EV pick-up truck. To support this exciting new program, we are adding capacity in Tennessee. This award further strengthens our competitive position in the rapidly growing market for battery enclosures. In power train electrification, we are actively supporting our customers with a combination of components and systems.

We are proud to have recently won an award for our first-to-market modular standalone decoupling unit for electric vehicles. The innovative unit contributes to an increase in electric drive range by up to 9%. We have already begun launching this product on multiple vehicles of a German-based premium OEM. We recently announced a long term supply agreement with Onsemi. This agreement allows Magna to integrate silicon carbide-based technology into our future e-drive systems. The advanced technology will enhance our ability to deliver better cooling performance as well as faster acceleration and charging rates, which contribute to improved efficiency and increased EV range. These activities highlight our commitment to driving innovation and positioning ourselves as a leader in the rapidly evolving field of electric mobility.

Our success in winning business across all product lines continues to drive growth. In addition to securing the contract for the battery enclosure, we were pleased to announce that we have also recently been awarded the frame and seats for the next generation F-150 Lightning. The seating award represents yet another seat complete program for pick-up trucks in North America following our previous seat award for GM’s pick-up trucks to be produced at Lake Orion. We were also recently awarded the replacement vehicle assembly business for the iconic Mercedes Benz G-class. This award allows us to maintain our 40-plus year history as the exclusive producer of this off-road vehicle. We produced over 45,000 G-class vehicles in our Graz, Austria facility in 2022, bringing our lifetime total to over half a million.

The next generation G-class is expected to launch in 2024 and continue to run towards the end of the decade. We were awarded significant new fascia business on multiple programs from a Europe-based global OEM. We will supply the OEM’s assembly plant in North America from an existing exteriors facility beginning in 2026. With that, I’ll pass the call over to Pat.

Patrick McCann: Thanks Swamy, and good morning everyone. As Swamy indicated, we delivered strong second quarter earnings and free cash flow both above our expectations. Now comparing the second quarter of 2023 to 2022, consolidated sales were $11 billion, up 17% compared to a 15% increase in global light vehicle production. EBIT was $603 million and EBIT margin increased 170 basis points to 5.5% and was also up 140 basis points from the first quarter of 2023. Adjusted EPS came in at $1.50, up 81% year-over-year, and free cash flow used in the quarter was $7 million compared to $52 million generated in the second quarter of 2022, in part reflecting our higher capital spend to support record program awards in 2022. During the quarter, we paid dividends of $129 million and in addition to raising our sales outlook, we increased our adjusted EBIT margin and earnings outlook.

Let me take you through some of the details. North American, European and Chinese light vehicle production were up 14%, 13%, and 21% respectively, netting to a 15% increase in global production. Our consolidated sales were $11 billion, up 17% over the second quarter of 2022. On an organic basis, our sales also increased 17% year-over-year for 3% growth over market or 5% growth over market excluding complete vehicles. The sales increase was primarily due to higher global vehicle production and complete vehicle assembly sales, the launch of new programs, price increases to recover certain higher input costs, and the acquisition of Veoneer Active Safety on June 1, net of divestitures. These were partially offset by the impact of foreign currency translation and contractual customer price give-backs.

Adjusted EBIT was $603 million and adjusted EBIT margin was 5.5% compared to 3.8% in Q2 2022. Our focus on operational excellence and performance on cost initiatives helped drive strong earnings on higher sales. This was partially offset by the impact of the acquisition of Veoneer Active Safety. Adjusted EBIT margin was also positively impacted by about 25 basis points of net operational items, including productivity and efficiency improvements at certain facilities and higher tooling contribution, partially offset by higher program related engineering spending and launch costs, and higher equity income which benefited margins by about 10 basis points. EBIT margin was negatively impacted by higher net input costs, primarily lower scrap prices and higher labor costs, partially offset by lower costs for energy, commodities and freight, which combined to about 45 basis points, and non-recurring items which subtracted about 5 basis points.

Interest expense increased primarily reflecting the senior notes issued in the first quarter, increased borrowings and higher interest rates, partially offset by higher interest income. Our adjusted effective income tax rate came in at 21.8%, largely in line with our 2023 expectations but lower than Q2 of last year, and adjusted net income attributable to Magna was $430 million, up 77% over the second quarter of 2022, reflecting the higher EBIT and lower tax rate partially offset by higher interest expense and minority interest. Adjusted diluted EPS was $1.50, up 81% compared to Q2 of last year. The increase is a result of higher net income and fewer shares outstanding. The reduced number of shares outstanding primarily reflects the impact of share repurchases during and subsequent to the second quarter of 2022.

Turning to a review of our cash flows and investment activities, in the second quarter of 2023, we generated $879 million in cash from operations before changes in working capital. We invested $332 million in working capital, primarily reflecting the higher sales in the second quarter of 2023. Investment activities in the quarter included $502 million for fixed assets and $96 million for investments, other assets and intangibles. The $502 million capex was higher than $329 million in Q2 of last year to support our record program awards in 2022. Overall, we used free cash flow of $7 million in Q2, better than we had anticipated. We also acquired Veoneer Activity Safety for $1.48 billion and paid $129 million in dividends in the quarter. Our balance sheet continues to be strong with major credit rating agencies recently reaffirming our ratings.

At the end of the second quarter, we had over $4.6 billion in liquidity, including about $1.3 billion in cash. Currently our adjusted debt to adjusted EBITDA ratio is 2.19 times. Excluding approximately $400 million in cash we are holding to pay down our euro debt set to mature later this year, our ratio would be 2.08. These ratios are tracking better than our previous expectations as a result of our improved operating results. We anticipate a reduction in our leverage ratio by the end of this year and a further decline through 2024. Next, I will cover our updated outlook, which incorporates slightly higher than expected vehicle production in both North America and Europe, mainly as a result of better production in Q2. Our assumption for production in China is unchanged from our previous outlook.

We also assume exchange rates in our outlook will approximate current rates. We now expect a slightly stronger euro and slightly lower Canadian dollar and renminbi for 2023, relative to our previous outlook. We have increased our expected sales range largely reflecting the acquisition of Veoneer Active Safety, higher North American and European production in Q2, as well as the higher euro. As a result of our strong performance so far in 2023 and expectations for continued operational execution partially offset by higher costs to launch new programs, we have also increased our adjusted EBIT margin range. This is despite the short term 20 basis point impact from the Veoneer Active Safety acquisition. We are increasing our equity income range mainly reflecting lower spend and expected commercial items.

As a result of increasing the ranges for our sales and adjusted EBIT margin, we are also raising our range for adjusted net income attributable to Magna. Our capital spending outlook has increased to reflect the Veoneer acquisition in line with our previous expectations. Our interest expense and tax rate and unchanged from our previous outlook. In addition, free cash flow expectations are unchanged, even after incorporating Veoneer Active Safety for the last seven months of 2023. Note that beginning in Q3, Magna’s adjusted EBIT will exclude the amortization of acquired intangibles, the most significant of which is associated with the Veoneer Active Safety acquisition. In summary, we are pleased with our strong operating performance in the second quarter.

Once again we outgrew our end markets by 3% on a consolidated basis and 5% excluding complete vehicles. We continue to win new business across our portfolio, supporting our go-forward strategy and, largely as a result of our continued strong execution, we are raising our earnings outlook for the year. Thanks for your attention. We’d be happy to answer your questions.

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Q&A Session

Operator: Thank you. [Operator instructions] Our first question comes from the line of John Murphy with Bank of America. Please proceed with your question.

John Murphy: Good morning guys and thanks for the time. A first question – you know, as you look at what went on in the quarter, obviously volumes were up big time on a year-over-year basis but there was also a stabilization in schedules, right, so you knew what you were doing and how to plan for it. Swamy, which do you think was–I mean, obviously the rise in volume is important, but how important was the stabilization in schedules and how should we think about that going forward for the business?

Swamy Kotagiri: Good morning John. For sure, both of them, but I think if I had to prioritize, if you look at all the initiatives that we’ve been talking about, they play a bigger role in getting the flow-through that we would expect. But definitely the stabilization of production schedules is what helps those efforts in a big way, right, to get to the bottom line and get the intended effect of all the activities that we are going through. The big variable would be the stable production. Obviously the [indiscernible] in the high volumes helped, but the important thing is once you get the higher volumes, can I get the flow-through the way we expect, so definitely it helped both of them this time.

John Murphy: Then just a second question on the battery enclosure business for the F-150 Lightning. The fact that you’re getting the frame as well–you know, seats as well is good, but the frame and the battery enclosure seem like they might be interrelated, Swamy. How interrelated was that bidding process, how much of part of the structure of that truck is that battery enclosure business, and does that set you up well for future wins on other trucks, but maybe other unibody–that’s not unibody, but on unibody structures as well?

Swamy Kotagiri: John, I’ll answer the question from a Magna perspective, and we talked about highly integrated systems and the value that Magna brings when we look at not individual components but more how we bring things together, and I think this plays a role. I won’t comment specifically on the architecture of this vehicle because I don’t think it would be right for me at this point, but that expertise of knowing the frame, knowing the body enclosures and the whole vehicle definitely comes into play. As we look forward, we see in some cases, like you talked about, a framed vehicle with a separate enclosure today, but as you go to the next iteration, there is definitely a thought process of how you can get the synergies for structural performance for safety and efficiency and so on, so us being in the program now on actually multiple truck programs, I think definitely gives us, I think, a big advantage in not only addressing what’s needed today but taking this product line and evolving into the future.

John Murphy: If I could sneak just one last one in, commercial discussions with your automaker customers seem to be a little bit more amicable and conciliatory than they have been in the past. Is that a correct interpretation, and has something changed here where they are partnering a lot more on cost sharing, particular as costs are inflating, or is it more just more of the same and you guys are just doing a better job with these discussions?

Swamy Kotagiri: It’s a difficult one, John, but I definitely think–I think we had a gritty six months, is how I would put it. The reactions and the interactions are somewhat mixed, but I can tell you we are laser focused on it. It’s just not a person but a team and cross-functions across finance and sales and commercial and operations. The entire organization is around this topic. I cannot–I won’t be able to explain in a few sentences the effort that goes into this. I would say there is an openness to have the discussion in different forms. Like I said, some are a little bit tougher than the others, but it is–I mean, we cannot afford not to do this. It’s a must for us, right? I think the conversations are tough, but I would say they are fair.

John Murphy: Okay, thank you very much, guys.

Operator: Thank you. Our next question comes from the line of Tamy Chen with BMO Capital Markets. Please proceed with your question.

Tamy Chen: Hi, good morning. Thanks for the question. First, wanted to talk about Veoneer. I saw you’ve given the impact it had on your guidance. Could you just talk a little bit more about how you expect that to trend through the year, and you’re expecting it to breakeven before the incremental amortization next year. Could you just remind us the steps or the path for the business to get to that next year?

Swamy Kotagiri: Good morning Tamy. I’ll give you a few key points and Patrick can jump in. As we said, we closed the transaction. Happy to say that we hit the ground running on the integration efforts, and I think I could summarize by saying that we are comfortable with what we talked about when we did the acquisition announcement. Some of the facts that we talked about at that time, 2023 sales about a billion dollars, and we said it would have a 20 basis point impact on consolidated EBIT margin. Capex was roughly around $100 million. EBITDA positive in 2023. We expect the $70 million in synergies by 2025 – I think we are tracking very well and there could be tailwinds going forward. EBIT neutral in 2024 ex-PPA, and a little bit more color on 2025 impacts, we should be able to do that in our virtual investor day update that’s coming up, Tamy, in September.

Tamy Chen: Okay. Can you talk specifically, though, about next year, the business going to EBIT neutral from now being a drag? Can you just outline some of the steps to get there?

Patrick McCann: Good morning Tamy, and congratulations on your new role. When you think about the Veoneer business, it’s quite similar to our existing electronics business, and they’re experiencing rapid growth, so really the driver of what’s happening is a combination of two things. One is a lot of their launch costs are being incurred this year and they’re going to continue through next year, but what’s happening is as that business launches, it’s driving a lot of contribution margin, and that’s going to benefit as the volumes ramp. To be honest with you, that’s really the inflection point we’re seeing in their business, and it’s similar to what we’re seeing in our business and that’s what’s going to drive the dollar growth and the margin improvement.