Magna International Inc. (NYSE:MGA) Q4 2023 Earnings Call Transcript

Magna International Inc. (NYSE:MGA) Q4 2023 Earnings Call Transcript February 9, 2024

Magna International Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings and welcome to the Magna International Q4 and Year-End 2023 Results and 2024 Outlook Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded today, Friday, February 9th, 2024. I would now like to turn the call over to Louis Tonelli, Vice President, Investor Relations.

Louis Tonelli: Thanks. Hello, everyone, and welcome to our conference call covering our 2023 results and our 2024 outlook. Joining me today are Swamy Kotagiri and Pat McCann. Yesterday, our Board of Directors met and approved our financial results for the fourth quarter of 2023 as well as our 2024 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 disclaimer. Please also refer to the reminder slide included in our presentation that relates to our commentary today. This morning, we will cover our 2023 highlights as well as our Q4 results. We will then provide our ’24 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. I appreciate you joining our call today, and let’s jump right in. Overall, I was pleased with our 2023 operating performance, including good launch execution that helped us to continue to drive organic sales growth over market and record sales of $42.8 billion. Great efforts at all levels to offset inflationary pressures and significant traction in removing costs and improving efficiencies across the company. We ended the year with solid Q4 results considering we were slightly hampered by a couple of discrete items relative to our expectations. Pat will cover those. Our sales of $10.5 billion in the fourth quarter of 2023 were up 9% year-over-year despite the UAW strikes that reduced sales by $275 million in the quarter and contributed to negative vehicle production mix for us relative to the comparable period in 2022.

Adjusted EBIT increased 52% to $558 million in Q4 and EBIT margin increased 150 basis points to 5.3%. Adjusted EBIT margin ended the year at 5.2%, up 70 basis points year-over-year and in the middle of the 5.1% to 5.4% range we guided to in November of last year. Our adjusted EPS for the quarter was up 41% to $1.33 and ended the year at $5.49. And free cash flow in Q4 was $472 million, up $132 million relative to Q4 last year. Turning to key accomplishments in 2023. We executed on a number of short and midterm operational excellence activities, which contributed about 75 basis points to margin expansion this past year and is expected to contribute a further 75 basis points combined over the next two years. Our customers continue to recognize our efforts in operational excellence and innovation.

Last year, we received 107 customer awards in recognition of quality and operational performance. One reason we continue to win business. And in 2023, we committed to achieve net zero emissions by 2050. Operational excellence is enabled by our ongoing focus on people development. This past year, we launched our operational management accelerator program aimed at identifying and cultivating individuals within Magna to become future leaders in our divisions. For the second year in a row, Magna has been named one of the world’s most ethical companies. And I’m proud that Magna received 16 leading employer recognitions this past year, including Fortune’s world’s most admired companies and Forbes Best Employers both for the seventh consecutive year.

With respect to sales growth, we once again outgrew our markets in 2023. We were awarded about $12 billion in new business, which will contribute to further sales growth above market as these programs launch in the future. And we are on track with integration and synergies for the Veoneer acquisition. Lastly, our commitment to innovation has helped us win business in core areas, including advanced high-volume front camera modules with a European-based global OEM and battery enclosures with four global OEMs and eDrive systems with a European-based and North American-based global OEM. With that, I will pass it over to Pat to cover our financials in more detail.

Patrick McCann: Thanks, Swamy, and good morning, everyone. I’ll start with a review of our results. As Swamy indicated, we were pleased with our 2023 operating results. Overall, global light vehicle production increased 8% in 2023 or 9% weighted for our geographic sales. Our consolidated sales rose 13% year-over-year. On an organic basis, our sales increased 11%, driving a 2% weighted growth over market for the year despite the negative impact of the UAW strikes in the third and fourth quarters. Our adjusted EBIT margin improved 70 basis points to 5.2%, reflecting earnings on higher sales including improved margins due to the impacts of operational excellence, cost initiatives, productivity improvements and lower costs at previously underperforming facilities.

These were partially offset by higher costs associated with new assembly business, the negative impact of the UAW strikes, the net unfavorable impact of commercial items, lower amortization related to the initial value of public company securities, higher launch costs and the impact of acquisitions net of divestitures, mainly as a result of our sales growth and margin expansion, adjusted EPS increased 29% to $5.49. For the fourth quarter, sales increased 9% to $10.5 billion. Adjusted EBIT improved 150 basis points to 5.3%, and adjusted EPS rose 41% to $1.33. I’ll take you through some of the details. North American, European and Chinese light vehicle production were up 5%, 7% and 12%, respectively, resulting in an overall 7% increase in global production.

Breaking down North American production further, while overall production increased 5% production by our Detroit-based customers, which were targeted in the UAW strikes actually declined 11% in the fourth quarter. Our consolidated sales were $10.5 billion, up 9% over the fourth quarter of 2022. The sales increase was primarily due to the higher global vehicle production, the launch of new programs, the acquisition of Veoneer Active Safety, net of the divestiture of our manual transmission plant in Europe and the net strengthening of currencies against the US dollar. These were partially offset by lower complete vehicle sales, mainly due to a program changeover in Graz, Austria and an estimated $275 million impact from the UAW strikes in North America.

On an organic basis, our sales increased 4% year-over-year or 7% excluding complete vehicles. This compares to a 6% increase in weighted global production. Once again, negative production mix, largely driven by the UAW strikes unfavorably impacted our year-over-year sales growth in the fourth quarter. Adjusted EBIT was $558 million, and adjusted EBIT margin was 5.3% compared to 3.8% in Q4 of 2022. Our continued focus on operational excellence and performance on cost initiatives in addition to higher volumes is driving strong earnings on higher sales. This was despite the negative impacts of a program changeover in complete vehicles and the UAW strikes in North America, which we estimated cost us about 50 basis points. The net effect of these generated 30 basis points of net improvement.

Adjusted EBIT margin was also positively impacted by about 80 basis points of net operational items, which include productivity and efficiency improvements at certain facilities and higher tooling contribution. Nonrecurring items, which together had a net favorable impact of about 30 basis points and about 20 basis points related to lower net input costs. EBIT margin was negatively impacted by lower equity income, which reduced margin by about 10 basis points. Earnings on higher unconsolidated sales were more than offset by the finalization of year-end tax balances and some negative product mix in one JV. In addition to these items, relative to our expectations, there were some retiming of expected customer recoveries into 2024. As Swamy alluded to earlier, relative to our expectations for the fourth quarter, the lower equity income together with a foreign exchange loss on the devaluation of the Argentinian peso cost us about $35 million or about $0.11 per share.

Turning to a review of our cash flows and investment activities. In the fourth quarter of 2023, we generated $660 million in cash from operations before changes in working capital, up $127 million or 24% from 2022. We also generated $918 million in working capital for total cash from operations of $1.6 billion for the quarter. Investment activities in the quarter included $944 million for fixed assets largely to support program awards and $189 million for investments, other assets and intangibles. Overall, we generated free cash flow of $472 million in Q4. And we also paid $133 million in dividends in the quarter. Growing our dividend remains an element of our financial strategy. And yesterday, our Board approved an increase in our quarterly dividend to $0.475 per share, our 14th consecutive year of increased fourth quarter dividends, reflecting the Board and management’s collective confidence in the outlook for our business.

We have increased our dividend per share at an average annual growth rate of 11% going back to 2010. And now I’ll pass it back to Swamy to cover our outlook.

Swamy Kotagiri: Thanks, Pat. Over the past three years, we have been highlighting our go-forward strategy to propel our business into the future. The key aspects of our strategy are unchanged despite continuing industry challenges, and we are making significant progress in our strategy. This progress is reflected in our outlook, and we expect to realize further benefits beyond our outlook period. As always, our outlook reflects both tailwinds and headwinds. In terms of tailwinds, we are launching content on a number of new programs, which is contributing to sales growth. Our megatrend business is expected to continue to grow significantly, which we anticipate will drive profitability as we leverage the sales growth. And we expect further traction in our operational excellence activities contributing to additional margin expansion.

In terms of headwinds included in our outlook, we anticipate further net input cost increases substantially related to continued elevated inflation driving higher labor rates and scrap prices are expected to continue to decline. The industry appears to be moving from supply constraint to demand constraint as macro challenges persist. And expected EV penetration rates have been pushed out, which is having some negative impact on our anticipated short and midterm sales growth. So how does all this translate in our key financial metrics? We expect continued solid organic sales growth over market in the range of 3% to 5% on average per year over our outlook period. We anticipate margin expansion of 180 basis points or more from 2023 to 2026. Our engineering investments in megatrend areas should average about $1.2 billion annually before customer recoveries.

This includes about $300 million related to the acquisition of Veoneer Active Safety. We expect a modest decline in megatrend engineering spend in 2026 relative to 2024 and 2025 levels while sales are increasing. Capital spending is expected to decline beyond this year and CapEx to sales is on a path to return to more normal levels as we have highlighted previously. Lastly, we expect our free cash flow generation to increase each year over our outlook period as sales continue to grow, margins expand and CapEx to sales normalize. We anticipate over $2 billion in free cash flow by 2026. Last year, we highlighted our significant expected sales increases in megatrend areas and the fact that our engineering spend in absolute dollars was largely unchanged through our outlook.

While our midterm sales in megatrend areas have been somewhat impacted by lower expected volumes, particularly related to EVs, the trajectory of our sales growth in these areas remains considerable, growing by over $4 billion in the next three years. Lower expected megatrend profits on the reduced sales is the most significant factor shifting our profitability inflection point from 2025 to 2026. While our outlook reflects a modest 2025 loss year, we continue to work to reduce or eliminate this loss. Regardless, we expect significant improvement in our results in these areas over our outlook period and solid profitability by 2026. Next, let me cover our consolidated outlook. In terms of key assumptions, our outlook reflects essentially no growth in weighted global light vehicle production and only modest growth of about 1% on average over the ’23 to ’26 period.

In other words, it’s our content growth that is driving our organic sales. We assume exchange rates in our outlook will approximate recent rates. Net-net, the impact of currency to our outlook is expected to be negligible. We expect weighted sales growth over market between 3% and 5% over our outlook period. From ’23 to ’24, sales growth substantially reflects the launch of new and replacement programs, a higher amount of directed content on the new Mercedes G-Class assembly program and the acquisition of Veoneer Active Safety. These are partially offset by lower sales in the remainder of our complete vehicle business, largely as a result of the end of production of certain programs and a higher proportion of vehicles assembled whose sales we account for on a value-added basis.

From 2024 to 2026, the most significant contributors to sales growth are the launch of new and replacement programs and increased directed content sales from the Mercedes G-Class as volumes ramp. In addition, we expect an 8% to 9% compounded sales growth from unconsolidated JVs over our outlook period, including from our LG JV for electrified components and systems, our eDrive systems JV in China and our Seating JVs. We expect another step-up in consolidated margins in 2024 to a range of 5.4% to 6%. Our 2024 margin is expected to benefit from contribution on higher sales and ongoing operational excellence activities. Partially offsetting these are higher launch and new facility costs associated with new programs as well as higher net input costs expected to impact us by about 30 basis points.

While we do not provide a quarterly outlook similar to last year, we expect our 2024 earnings to be lowest in the first quarter of 2024 and improved meaningfully in the second quarter. We expect a further step-up in margins to the 7% to 7.7% range from 2024 to 2026. This is largely driven by further contribution on higher sales, continued operational excellence activities, the reversal of launch and new facility costs as programs come on, lower engineering spend and growing equity income. These are partially offset by a 10 basis point impact from higher directed content on the G-class as volumes ramp. Many of the same factors that are impacting consolidated sales and margins out to 2026 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 on them. I’ll pass it back over to Pat to cover some of the highlights of our financial strategy.

Patrick McCann: Thanks, Swamy. We have been consistent in communicating our capital allocation principles over the years, and I’d like to repeat these. We want to maintain a strong balance sheet, ample liquidity and high investment grade ratings, invest for growth through organic and inorganic opportunities, along with innovation spending, and return capital to shareholders. Our balance sheet continues to be strong with investment-grade ratings from the major credit agencies. At the end of Q4, we had over $4 billion in liquidity including about $1.2 billion in cash. Currently, our adjusted debt to adjusted EBITDA ratio is at 1.89. We anticipate a reduction of our leverage ratio to be back within our targeted range during 2025.

We expect capital spending for 2024 to be approximately $2.5 billion. This includes about $100 million that will be funded by our customers. Under US GAAP, such customer funded amounts are included in deferred revenue, whereas previously they were netted against capital spending. In other words, this CapEx is cash flow neutral and capital spending would be $2.4 billion. Our ’24 to 2026 capital spending outlook also includes approximately $400 million related to recent program awards, from a high-volume EV OEM that were not included in our previous outlook. Despite these new awards, we expect CapEx as a percent of sales to decline over the ’24 to 2026 time frame, in line with what we had been indicating over the past year. EV volumes remain uncertain, and we continue to have discussions with customers about future plans.

We remain laser-focused on capital to assess where we may have the opportunity to stagger, delay or eliminate capital from our plan. As a result of growing earnings and declining CapEx levels, we expect free cash flow to accelerate through our outlook period. We anticipate over $2 billion in free cash flow by 2026. In summary, we expect continued organic growth above market with more than $4 billion increase in megatrend sales over outlook period. Further margin expansion this year and in each of the next two years, including through ongoing operational excellence activities and at least $1.7 billion and increased EBITDA over our outlook period through 2026. We anticipate that these increasing metrics will lead to accelerating free cash flow generation over the next three years.

We remain confident in executing our plan and continuing to drive our strategy forward. Thank you for your attention. We would be happy to answer your questions.

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Q&A Session

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

John Murphy: Good morning, guys. Thanks for all the info particularly on the 2016 outlook. If we think about on Slide 35 and then 36, it seems like you’re remaining very committed to your CapEx plans. Certainly, it seems like you are on the R&D side. But Swamy, there’s obviously tectonic shifts that are going on here very quickly in the way that sort of the expectations are evolving for EV penetration, program potential cancellations or at least pushouts. How flexible is your CapEx spending and R&D spending to potentially be pushed down into the right to deal with that and potentially even deal with potentially cancellations and programs?

Swamy Kotagiri: Good morning, John. Great question. If you just think through what’s happening I think one of the key things we’ve been focused on and have been discussing is the CapEx. If you look at the CapEx ratio, we have been — CapEx to sales, we’ve been talking about going back to the low to mid-4s, and happy to say we are on track to that. When we talk about this year, Pat touched on his prepared comments, that $100 million of the $2.5 billion that we are showing is really given by the customer. And we actually talked about a program for another about $150 million to $200 million spend, which was not contemplated, but we felt, given the program, it was a good idea to invest in that program going forward strategically, right?

So those were the two otherwise, it would have been around the $2.2 billion in CapEx. So that’s one part of it. The second part of the question that you asked regarding R&D, and we’ve always talked about the $900 million plus with the Veoneer $300 million is the 1.2 with the sales increasing, again, the ratio of R&D spend to revenue was going to decline. But having said that, we are looking very seriously into the spending of that. If it’s not related to the direct launch of their program, then everything is under scrutiny. And again, in the prepared comments, we talked about it. We are also looking at capital in terms of with discussion with customers, obviously, is how can we stagger given pushout of the date for the launches or just even in terms of the volume ramps.

So we are looking at staggering capital, looking at the modularity, having discussions with the customers, also a little bit in how we look at volumes on given programs by the customers, although we have to run at rate for them at PPAP and so on. We take into account the volume assumptions when we look at revenue on such programs. So we are looking all of that. So pushing out in terms of CapEx spend or R&D engineering spend, depending on the program cadence, absolutely, yes. Just to give an example, over the last three weeks, I, along with the senior management team, have spent at least about 40 hours line by line on all R&D projects, and we are looking at the value proposition of each project, what it brings to us. Keeping in mind, obviously, that it cannot hurt the future and cannot hurt the launch.

John Murphy: Okay. That’s very helpful. And then Pat, if we were to kind of suspend this belief and say you guys remain too conservative on your volume forecast. And let’s say there’s a 2% to 3% upside in global LVP in ’24 or maybe even just think about it sort of as 1% higher in a way being $450 million more of revenue. Do you have capacity? Obviously, this is kind of a generic question, but to take that on and what kind of incremental would we be thinking of, if all of a sudden, sales came in 2% to 3% higher than you were thinking because LVP was higher?

Patrick McCann: Good morning, John. In that scenario there, when I think that’s probably a best case scenario. If you go back to Swamy’s comments where we have capacity installed up to planning volumes, right? So if we flex up you might be — you could speed up the line or add another shift, and that’s where you have a lot of leverage in your model. So your incrementals on that scenario would be quite strong, and that would be what we’ve seen historically. They’re different by segment. But the 20s for BSP and V and then seating depending on the region, 12% to 7.5%. Steyr is a little bit different, John. It’s because of all the recoveries. But I think that would be the best case scenario for Magna. The worst case scenario is when you have to put in new facilities and that’s — when you go through our business plan and you look out into the future, some of the incrementals aren’t at that let’s say, 20-ish percent, and it’s because they’re coming through market corporate average where you’re adding bricks and mortar and new facilities and overhead.

So a long answer, but the scenario you’re describing is the best case for Magna.

John Murphy: And then just one last question. Can you comment on what region that high-volume EV manufacturer is domiciled in? Is it a North American manufacturer or a China manufacturer? And is that for battery tray or battery structure? Or is there something else that, that CapEx is allocated for the $400 million?

Swamy Kotagiri: John, under strict confidentiality, we are not able to give too much details, but I can say that this is a material investment in southern US and Mexico for a significant future product of Tesla.

John Murphy: Okay. Very helpful. Thank you very much, guys.

Patrick McCann: Thanks, John.

Swamy Kotagiri: Thanks, John.

Operator: Our next question is from the line of Chris McNally with Evercore. Please go ahead.

Chris McNally: Thanks so much, gentlemen. One really benign question on seating and then maybe on the capital and the buyback. So Seating, Swamy, could we take a step back — this has now been an underperformer for a couple of years. I mean, obviously, you have a different ROIC, so a slightly different margin compared to peers. But I know you can’t be happy with the margin that has perpetually been a target and so that 5% or 6% range. Can you help us walk through what are some of the issues? And then what will get us eventually to that 5% to 6%?

Swamy Kotagiri: Good morning, Chris, I think if you look at the last couple of years, the significant impact on Seating have been the mix and certain programs significantly underperforming the volume expectations compared to the planned volumes, right? And as you know, in Seating once you have the facility and you have the labor, it’s pretty much dedicated to the program. We do [indiscernible] to flex, but it is not possible to negate everything. So that has been one of the primary reasons. The one other thing that you will see in the dynamics looking this year and going forward a little bit, on the Seating, last year, we had assumed that we would exit a high-volume, low-margin program, and we were having discussions with the customer.

And during the process, we were able to secure a fair and good appropriate margin and return on the next generation. So we are maintaining the existing business now. So that having a negative impact in the short term. The new program, the next generation with the appropriate margins and returns is starting to launch in 2026. It’s a staggered launch, but it will start on the 2026. Also the Seating team has been extremely focused on all the items of operational excellence. So looking at all the details during our planning process minus the big program that I talked about going out into ’26, ’27, I feel comfortable that we are on the path to the margins that we talked about that is in the 5% to 6%.

Chris McNally: Okay. Super helpful detail on that problematic platform. Can we just now maybe move to capital allocation and the idea of the buyback? So I know you have sort of the debt-to-EBITDA ratios you’ve used in the past. Obviously, net debt is a little bit more attractive. And also given where your stock is, can you talk about what the potential for more of a historical buyback ratio could be? Obviously, the free cash flow goes up every year, ’24 to ’26. But sort of like your investors buying low rather than buying high as always sort of a favorable strategy. So just how you’re thinking about getting ahead of some of those better free cash flow numbers in years to come?

Swamy Kotagiri: I think the capital allocation strategy and how we are looking at that, as Pat talked about in the prepared comments, remains truly as an outstart for us, Chris. If you look at the leverage ratio in 2024, our first priority is to get back to the 1% to 1.5%, right? And we seem to — given the EBITDA profile and the sales, we see that in the early part of 2025. So once we start having the cash and the cash flow operational wise is on track to what we expect it to be. Then we go back to our priority being investing organically or inorganically for the appropriate returns that are accretive to value. And anything remaining, obviously, the preference is to go back to the share buybacks. So we’ll be looking at it towards the end of 2024 in the normal course of action and getting back and staying in the level ratio that we talked about.

Chris McNally: Okay. Thanks so much.

Patrick McCann: Thanks, Chris.

Operator: Our next question is from the line of Tamy Chen with BMO Capital Markets. Please go ahead.