Magna International Inc. (NYSE:MGA) Q4 2022 Earnings Call Transcript

Magna International Inc. (NYSE:MGA) Q4 2022 Earnings Call Transcript February 10, 2023

Operator: Greetings, and welcome to the Q4 and year-end 2022 results and 2023 Outlook Conference Call. As a reminder, this conference is being recorded, Friday, February 10, 2023. I would now like to turn the conference over to Louis Tonelli, Vice President of Investor Relations. Please go ahead.

Louis Tonelli: Thanks, Chris. Hello, everyone, and welcome to our conference call covering our ’22 results and our 2023 outlook. Joining me today are Swamy Kotagiri, Vince Galifi and Pat McCann. Yesterday, our Board of Directors met and approved our financial results for 2022 as well as our financial outlook. We issued a press release this morning outlining both of these. 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 claimer. Please also refer to the reminder slide today included in our presentation that relates to our commentary. This morning, we’ll cover our 2022 highlights as well as our Q4 results. We’ll then provide our 2023 outlook and lastly, run through our financial strategy. And with that, I’ll pass it over to Swamy.

Swamy Kotagiri: Thank you, Louis. Good morning, everyone. Today, I’ll recap 2022, comment on our results and address our outlook. 2022 was another difficult year for the automotive industry and for Magna. The year started with continued supply chain disruptions, most notably the lack of semiconductor chips, which was expected to improve considerably during ’22, but instead remain an issue throughout the year. Although vehicle built recovered from the 2021 levels, OEM production schedules remained volatile throughout 2022, which drove significant inefficiencies in our operations, including tapped labor, overtime and staffing availability issues to name a few. It also had an adverse impact on our ability to achieve our continuous improvement plans and optimize our cost structure across the company.

We also started 2022 expecting net input cost inflation of about $275 million year-over-year. The conflict in the Ukraine created additional input cost pressure, particularly in energy, and China’s zero COVID policy resulted in lockdowns and further supply chain pressures. These factors drove an additional $290 million of net cost headwinds, primarily energy-related. Despite significant cost volatility through 2022, we were able to slightly improve from our revised $565 million in net input cost from our April Q1 call. We ended at $530 million for the year. In the context of this industry environment, a tremendous amount of effort was expanded by our team to manage through the challenges, launch business, negotiate customer recoveries and resolve commercial items.

We were also successful in booking a record amount of business for Magna. So, while we are not happy with our 2022 results as a whole, and especially with underperformance in some of our facilities, I am appreciative of the tremendous efforts made across the company. Unfortunately, we ended a difficult year with disappointing Q4 results relative to our expectations entering the quarter. Although our sales of $9.6 billion in the fourth quarter of 2022 were up 5% year-over-year compared to our outlook, Q4 sales were lower and mix was negative with our operating segments down almost $400 million, excluding complete vehicles and the impact of foreign exchange. Turning back to year-over-year. EBIT margin for Q4 declined to 3.7%. This was due to both internal and external factors.

Internal factors included higher warranty expense, which cost us about 35 basis points, provisions against certain balance sheet amounts about 30 basis points and operating underperformance at a facility in Europe by approximately 25 basis points. External factors included continued inefficiencies caused by ongoing last-minute reductions in OEM production schedules and a customer footprint decision that resulted in our having to take asset impairment charges, which was about 5 basis points. These were partially offset by higher commercial resolutions, which positively impacted us by about 25 basis points. Our adjusted EPS was $0.91 for the quarter, ending the year at $4.10, and mainly as a result of lower EBIT, free cash flow in Q4 was $340 million, which was below our 2022 outlook.

I recognize that we have operations that have underperformed our expectations this past year. However, operational excellence remains core to Magna, a key differentiator and a fundamental element of our strategy going forward. Although we incurred additional cost to do so, we once again managed to minimize disruption to OEM production despite continued supply chain challenges and volatile schedules. Our customers continue to recognize our efforts in operational excellence and innovation. Last year, we received 107 customer awards, and our progress continues towards net carbon neutrality in our operations. Part of how we address operational excellence is through a focus on people. We developed the operational management accelerator program to enhance the technical breadth of our future general managers and leaders.

This will ensure we can fill the pipeline of future leadership across Magna. And I’m proud that Magna received 14 leading employer recognitions this past year, including from Forbes for the sixth consecutive year as world’s best employer. Turning to sales growth. We outgrew our markets in 2022 by 7%. And once again, we achieved this outgrowth in each of our major regions, North America, Europe and Asia. We were awarded a record amount of business, about $11 billion annually for 2022. This represents more than 30% above the average of our last five years of awards. We expect this to drive strong sales growth over market and improved returns as these programs launch. And we signed an agreement to acquire Veoneer Active Safety. This will further accelerate our growth and position us as a leader in the fast-growing ADAS market.

We have begun planning to ensure a smooth integration of the business once the transaction closes this year. Finally, we remain committed to innovation. We were awarded substantial new business in a number of core innovation areas. This includes battery enclosures, eDrives, Driver Monitoring Systems and SmartAccess power doors. We won another automotive news PACE award, our sixth such award in the past eight years. Our commitment to innovation continues. As we communicated last year, we increased our R&D investments in mobility megatrend areas in 2022 to support awarded programs and opportunities. With that, Pat, I’ll pass it off to you.

Patrick McCann: Thanks, Swamy, and good morning, everyone. I’ll start with a detailed review of our financial results. As Swamy indicated, our 2022 results were impacted by continued significant disruptions in OEM production schedules, mainly due to supply chip shortages and input cost inflation in our primary markets to levels we have not experienced for decades. Overall, global light vehicle production increased 6% in 2022 or 5% weighted for our geographic sales. Our consolidated sales rose 4% year-over-year. On an organic basis, our sales increased 12%, driving a 7% weighted growth over market for the year and partially customer recoveries. However, our adjusted EBIT margin and EPS declined during 2022. The single most significant factor being input cost headwinds, net of customer recoveries, which reduced our consolidated EBIT margin by about 150 basis points.

The start-stop production impacts, while difficult to quantify, were also a meaningful headwind, negating some of the positive impact of higher sales. In addition, operating inefficiencies at a BES facility in Europe cost us about 35 basis points. Entire engineering to support our activities in electrification and ADAS negatively impacted margin by 25 basis points. Partially offsetting these favorable was favorable commercial resolutions that benefited margin by about 45 basis points. For the fourth quarter, global light vehicle production increased 5% as North America increased 7%, China increased 3%, while Europe declined 1%. On a Magna-weighted basis, production increased 5% in the fourth quarter. Our consolidated sales were $9.6 billion compared to $9.1 billion in Q4 2021.

We had strong relative sales performance in the quarter with organic sales outperforming weighted production by 8%, again, in part due to customer recoveries However, continued OEM production schedule volatility negatively impacted our pull-through on the higher sales. We had disappointing EBIT margin performance in the quarter, which resulted in Q4 EPS that was also lower than we expected and lower than 2021. Let me take you through the specifics on our margin. Adjusted EBIT was $356 million, and adjusted EBIT margin decreased 190 basis points to 3.7%, which compares to 5.6% in Q4 2021. The lower EBIT percentage in the quarter reflects higher engineering spend for electrification autonomy, increased net warranty expense, higher launch costs, operational inefficiencies at a facility in Europe and provisions recorded against accounts receivable and other balances.

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These are partially offset by the impact of foreign currency translation, commercial resolutions and higher contribution on sales, although significantly hampered by OEM production volatility. As we indicated in our early warning press release last month, some of these items were not anticipated when we provided our outlook in early November 2022. In particular, the net warranty costs, the provision against AR and other balances and the timing of net engineering expense. Turning to a review of our cash flows and investment activities. In the fourth quarter of 2022, we generated $501 million in cash from operations before changes in working capital and a further $755 million from working capital. Investment activities in the quarter included $750 million for fixed assets and $186 million for increase in investments, other assets and intangibles.

Overall, we generated $340 million of free cash flow in Q4. We also paid $126 million in dividends in the quarter. Growing our dividend remains an element of our stated financial strategy. And yesterday, our Board approved an increase in our quarterly dividend to $0.46 per share, reflecting the Board and management’s collective confidence in the outlook for our business. We have increased our dividend per share at an average growth rate of 11% going back to 2010. And now I will pass it back to Swamy for comments before I get into the specifics of our outlook. Please note that our outlook excludes the pending acquisition of Veoneer Active Safety.

Swamy Kotagiri: Thanks, Pat. Over the past couple of years, we’ve been highlighting our go-forward strategy to propel our business into the future. While it is still early days and despite the difficult industry environment, we are making progress in our strategy. You’re going to see that this progress is reflected in our three-year outlook, mainly through investments in megatrend areas. We start to see some results of our strategy over the next three years, but most of the benefits are expected to be realized beyond our outlook period. As always, our outlook reflects both tailwinds and headwinds. Now in terms of tailwinds, we’re launching content on a number of new programs, which is contributing to sales growth. Compared to 2022, we anticipate higher global auto production growth during our outlook period, although the growth rate is well below what we expected a year ago.

As I said earlier, we continue to increase our business in megatrend areas, particularly electrification and autonomy. This additional business is leading to increased investment. In terms of headwinds in our outlook, while we experienced some improvement in 2022, we expect continued OEM production schedule volatility, primarily due to semiconductor supply constraints. Our business is facing further inflationary input cost impacts compared to 2022, especially in labor and energy as well as lower scrap revenue. We expect incremental input cost headwinds, net of recoveries of approximately $150 million for 2023. However, I’ll tell you that we continue to pursue additional recoveries associated with ongoing input cost inflation. Our prices need to more closely reflect the cost environment we’re currently operating in.

Lastly, with the existing macro environment, there is a risk that auto demand may be negatively impacted. So how does all this translate in our key financial metrics? We expect continued strong organic sales growth in the range of 6% to 8% on average per year over our outlook period. We anticipate margin expansion of 230 basis points or more from 2022 to 2025. Our engineering investments in megatrend areas should continue to average about $900 million annually before customer recoveries. And capital spending is expected to increase mainly to support our significant business growth, particularly in megatrend areas. Lastly, we expect our free cash flow generation, which has been impacted by the industry environment over the past couple of years to significantly improve over our outlook period, as margins expand and get through our heavy period of investment for growth.

As a result of the increased investment spending and the pending acquisition of Veoneer Active Safety, we plan to increase our debt during 2023. As we continue to execute against our long-term strategy, our number one priority in 2023 is operational excellence to improve margins and returns as well as the seamless integration of the Veoneer Active Safety business once the transaction closes. Now I’ll pass the call back to Pat to take you through the details.

Patrick McCann: Thanks, Swamy. I’ll start with the key assumptions in our outlook. Our outlook reflects relatively modest increases in vehicle production in each of our key regions relative to 2022. For ’23, our global light vehicle assumption is up about 2%. In North America and Europe, our two largest markets, volumes in 2023 remain well below levels experienced in 2019. However, we expect the increased production in both markets through 2025. In China, we expect a modest decline in ’23 and growth from 2023 to 2025. We assume exchange rates and our outlook will approximate recent rates. This reflects a slightly weaker Canadian dollar and Chinese RMB and slightly stronger euro in each case relative to 2022. Net-net, the impact of currency to our outlook is expected to be negligible.

I will start with our consolidated outlook. We expect consolidated sales to grow by 6% to 8% on average per year out to 2025 reaching almost $45 billion and potentially as high as $47 billion. The growth is largely driven by the higher vehicle production and content growth, including as a result of the launch of new technologies across our portfolio. These are partially offset by the end of production on certain programs and the disposition of a manual transmission facility. On an organic basis, we expect consolidated sales growth to also be between 6% and 8% on average per year out to 2025. Excluding complete vehicles, we expect our organic sales to grow between 8% and 10% on average. For 2023, we expect organic sales growth of between 5% and 9% compared to global production of 2% or weighted growth of about 3.5%.

You’ll see that this growth requires additional capital. In addition, we are expecting significant sales growth from unconsolidated joint ventures over the next few years, including our LG JV for electrification components and systems, our integrated eDrive JV in China and a new seating JV in North America. We expect our consolidated margin to be in the 4.1% to 5.1% range in 2023. As Swamy noted, we expect continued input cost pressures in 2023 but we are focused on mitigating higher manufacturing costs, via operational improvements and additional inflation recoveries. Relative to 2022, our ’23 margin is expected to benefit from contribution on higher sales, operational improvement initiatives, lower warranty costs and the impact of certain AR and other provisions incurred in the fourth quarter of ’22.

Offsetting these are lower expected commercial resolutions compared to 2022, higher net input costs of about $150 million, including $50 million related to lower scrap sales, lower license and royalty income and higher launch and new facility costs. While we do not provide a quarterly outlook, we do expect ’23 earnings to be lowest in the first quarter of ’23, in fact, below the Q4 level and improve sequentially as we move throughout the year. We expect a step-up in margins from ’23 to 2025. This is largely driven by a contribution on higher anticipated sales, continued execution of operational improvement initiatives, higher equity income and lower launch and new facility costs. Many of the same factors that are impacting consolidated sales and margins out to 2025 are also impacting our segments.

In the interest of time, we will not run through the segment detail. However, we are happy to discuss any questions. Next, I would like to cover some of the highlights of our financial strategy. We have been consistent in communicating our capital allocation principles over the years, and I’d like to reiterate these. We want to maintain a strong balance sheet, ample liquidity with high investment-grade ratings, invest for growth through organic and inorganic opportunities along with innovation spending and finally, return capital to shareholders. As we begin 2023, our leverage ratio is just above the high end of our target range, substantially due to the recent impacts of the auto environment — EBITDA. As Swamy noted earlier, given our investment needs and capital spending, working capital and to fund the acquisition of Veoneer Safety, we plan to increase debt in 2023.

We expect to maintain high investment-grade ratings with credit rating agencies. And based on our current plans, we anticipate bringing our leverage ratio back into our target range by the end of 2024. We are entering a period of somewhat cyclical capital investment to support growth, similar to what we experienced in 2016 to 2018. We expect capital spending to be approximately $2.4 billion for 2023 and to modestly decline from these levels out to 2025. Compared to our 2022 level, about $1 billion of our incremental capital spending in the ’23 to ’25 period relates to our upcoming sales growth in megatrend areas during and beyond our outlook period. This includes almost $500 million in capital in 2023 alone. Based on our current plans, CapEx to sales will reach a peak this year before beginning to decline again.

The global and industry challenges have hampered our free cash flow over the past few years. And based on our increased capital spending in the near term, will impact free cash flow. However, based on our current plans, we expect significantly improving free cash flow throughout our outlook period. In summary, we expect continued organic sales above market, increased investments to support further growth and opportunities in megatrend areas, margin expansion over outlook period, including through ongoing operational improvement activities, and increasing free cash flow as sales and margins expand in our gross spending subside. As Swamy said, we are highly focused on the integration of Veoneer Active Safety and getting back into our targeted leverage range over the next couple of years.

Thank you for your attention. We will be happy to answer your questions.

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Q&A Session

Operator: And our first question is from the line of John Murphy with Bank of America. Please go ahead.

John Murphy: Good morning guys. Just a couple of questions on the sort of the near-term and midterm outlook. I mean, if we look at the ’22 to ’23 numbers, I mean, you can certainly argue that the small decremental margin, right, as earnings could go down, even the sales go up on the low end, but then you could get something to sort of 13% or sort of mid-teens, depending if you want to include the unconsolidated sales in there. It’s kind of a wide range. And I know you kind of highlighted some of the factors here. But I mean, if you were to think about sort of the extreme to the downside, what do you think would really drive that? I mean the upside seems, like it’s kind of more normal in the process, but the downside seems like it’s pretty extreme. What would take you to that low end of the range?

Swamy Kotagiri: Good morning John. I think some of the things that I mentioned, right, have been difficult to quantify. And the one significant that shows up in my mind is the production volatility. Just to give a context and put some amount of magnitude around it without naming customers or platforms, if I just look across the major customers that they have, there are some programs where the volumes are in the 50% to 60% of the contracted plan. On top of that, at these low volume numbers, the variability of the production schedule is hovering anywhere between 35% to 50%. And that is a significant inefficiency hit in terms of managing labor, looking at cap labor or just looking at the overall cost structure. I would say that is one significant impact.

The other one is energy in Europe, how it ends up and how it progresses. And obviously, the third one is a significant headwind in terms of inflation and input costs. And it’s a complex equation that we’re trying to solve here. And that’s kind of the reason why — and looking at the geopolitical and macroeconomic issues, I think are the reason for the broader range that we’re looking at. And I think we’ll be able to get a little bit more granularity as the year goes by.

John Murphy: And Swamy, the one plant — or it seems like there’s one plant in Europe that’s causing you problems. I mean this kind of happens from time to time, there’s one underperformer in the large portfolio. Can you kind of highlight or give us some details around what’s going on with that? Because it sounds like it’s called out as one specific plant and what the turnaround process is there?

Swamy Kotagiri: Yes, John. It’s a BES facility, and I think I talked about it in the last two quarters. And it’s basically the planning and efficiency, and I talked about a little bit in looking at the specifications and how it was underestimated, which led to a lot of constraints on production capacity and strike. But the good news is that over the last two quarters, it has been stabilized and the expected impact that we have planned in Q4 came as we expected. So, I think the facility is stable, and we are continuing to improve in 2023. But I think I’ve mentioned in the past, it takes a little bit of time to balance the capacity back to normal. Some of the outsourcing that we bring back in get the stability that is needed, put the capacity that was needed. I’m confident that we are on the right path in that one. But you’re right, that is the one facility that has had a significant impact in the numbers on the underperformance bucket.