Q3 2021 Martinrea International Inc Earnings Call

We're at the beginning we believe of a strong multiyear cycle, especially in North America, where we have most of our operations.

Not only will demand be high but it is going to be a long time before production levels will see inventories built up to normal levels.

Our view on demand is buttressed by many economic indicators on growth and stimulus but.

But let me give one stat that shows the power the purchasing power of consumers and likely pent up demand.

In Canada pre pandemic Canadians held approximately $40 billion in their savings accounts today that number is something like $310 billion.

In the U S. The savings number is something like 4% to five trillion.

In addition, People's Holdings of real estate and stocks are appreciated overall in all of this portends well for the economy for growth and for auto purchases.

Let us recall that autos are depreciating asset.

Overtime people, both need and want to replace vehicles and there is pent up demand to do so.

Many are holding on to vehicles, they want to replace when they have supply and choice and hopefully some cheaper prices.

We have just finished our board approved budgets, which support our targets in 2023 of four six to $4 $8 billion in revenues are greater than 8% operating margin and $200 million plus of free cash flow unless we have another pandemic or supply shortages extending beyond <unk>.

Census predictions.

2024, it looks better than 2023.

Our budgets don't go out further than that the value proposition remains intact.

A lot of value in our company.

From an equity perspective, we are up over $200 million based on markets and equity raise values since the beginning of the pandemic.

In sum despite the chip shortages in the quarterly loss.

Our net present value and equity value have been increasing in a real sense.

Indeed, our company is seeing the same experience in a way is a lot of individuals in the pandemic income has been hit to a degree long term prospects remain good real estate value has gone up and our equity portfolio has gone up.

I think we're undervalued and over time I am bullish that as the supply shortages lesson, we will see our equity value increased to meet intrinsic value with that I will turn it over to Pat.

Thanks, Rob and Hello, everyone as noted in our press release, we generated an adjusted net loss per share of <unk> 21.

And an adjusted operating loss of $16 million in Q3. This was on production sales of $797 million, which is down 15% year over year as chip and other supply shortages continue to weigh on our industry volumes.

While we didn't provide guidance for Q3, given the uncertainty in the industry results ended up being worse than what we had contemplated at the time of our last call.

The drag on our results has four components volume reductions mix loss cost and most notable the inflation of wages materials and energy that are weighing negatively weighted.

Wage inflation is more of an issue in the U S and Canada, while material and energy costs are having a wider global impact compounding. The issue is the recent practice of holding labor implants are scheduled production from our customers, who then call off the schedule at the last minute based on a diminished Atlanta site.

From their supply chain.

In normal times when customers call off production.

There is time to flex labor. However, the labor market is hot so if you lay people off even short term, there's a good chance to land another job and not return.

In order to protect the customer of the supply base in many cases is not flexing labor due to the probability of not having enough people to support the customer when production resumes.

This issue weighs heaviest implants with new model launches, new launches mean high investments and training team members it.

It is important to hold onto these new train team members to ensure a high quality product.

Silverado uplift at our Oshawa, Canada facility and the news there among others.

At any given time in any given year, we have launch activity and associated costs.

They have been abnormally high this past year, given the heavy launch schedule.

And a slower than planned to ramp ups as I mentioned earlier.

Despite these short term launch costs. These programs will ultimately drive strong sales growth it healthy margins in the years ahead. The demand for vehicles is high the inventory is almost nonexistent and the outlook is still very good as.

Okay and are taking advantage of the downtime where possible to improve the operation. So that once the spigot is turn back on we will be able to take full advantage of what will likely be a multiyear tailwind starting at some point in 2022 strengthening in 'twenty three and beyond.

I am pleased to announce that we have been awarded $40 million of new business. Since our last call. This includes approximately $30 million firms that us and $10 million from general Motors, both in our propulsion systems group.

New business Awards for 2021 to date are now about $200 million.

A number of new programs that were expected to be awarded by the Oems in 2021 or.

We're migrating into 2022 there.

Our Volta and explore JV with nano explore in a minority equity position in a limbo power a private company that is developing and aluminum are battery technology for a variety of end markets, including automotive.

<unk> is also evaluating a number of other initiatives such as additive manufacturing intelligent robotics and software can aim a few these initiatives may involve equity investments, but not necessarily regardless and then each case Martin ran provides operational and strategic support to its partners, including manufacturing excellence.

Development supply chain support and other areas in order to advance exciting technologies that.

We believe can change the world we live in.

From an investment standpoint, we've done well in fact, the value of our investments is multiplied more than fivefold, which demonstrates that we are adding value to our shareholders in areas that are strategic to our business.

We're excited about mind and its potential and we believe it will be a key differentiator for us as we move forward.

With that I'd like to thank the entire Martin <unk> team for their continued dedication and commitment in these challenging times challenging, but exciting nonetheless with that I'll pass it to Fred.

Thanks, Brett and good evening everyone.

As Pat noted Q3 was challenging.

More so than anyone expected at the time of our last call.

Mmm product mean more to us than others from margin and contribution perspective.

With the various and ever changing puts and takes regarding production and production volumes during the quarter.

We came out of the court on the short end.

There was a perfect storm to some extent with lower margin product up during the quarter.

The higher margin products were down resulting in this high an abnormal flow through effect.

Now all of this is being exaggerated by this complicated labor market, which is ultimately to us carrying more costs than we otherwise would under normal circumstances.

The good news here is that when the volumes do come back to more normal levels in particular with our core customers the mixed factor should adjust.

In addition cost inflation on materials labor energy and other inputs is Pat discussed with another $7 million quarter over quarter impact will launch related cost subtracted another $6 million.

As Pat outlined earlier or Lynch launch activity. This year has been especially high which will ultimately AD sales in the future, but as damping margins in the moment.

Lower COVID-19 subsidies and some other items amount to approximately $5 million made up the remainder of the quarter over quarter variance.

The accumulation of these factors resulted in and adjusted operating loss of $16 million for the quarter.

Inflationary pressures Pat talked about are real and currently costing us approximately $40 million on an annualized basis of.

A big impact no matter, how you slice it.

Labour availability remains an issue and we've had to adjust wages and cycle occasions in response.

As Pat mentioned, we are engaging with essentially all our customers commercially and how to deal with these cost increases.

Ultimately some of these costs normalize for someone like me stick soft setting. These costs headwinds is currently an area of focus for the organization.

We've had some success here and and we expect to have more going forward.

Turning to our balance sheet net debt increased quarter over quarter to $860 million in Q3.

Our net debt to adjusted EBITDA was 2.5 times at the end of the quarter and.

An increase from approximately 1.8 times last quarter, but still below our covenant maximum of three times.

An increase in non-cash working capital both production and tooling related has contributed to the increased debt levels.

Non cash working capital has increased by approximately $120 million since the beginning of the year.

The disruption caused by the global semiconductor shortage and specifically the short notice or low lead times, you are getting on production releases from our customers and.

In other material shortages is forcing us to carry a higher than normal level of inventory.

That pays for that increased this fall in the third quarter.

Ultimately the elevated production inventory levels should reverse over time as production volumes normalized.

We would like to see some level of us on the fourth quarter dependent on volumes and volatility.

Should the chip shortage and corresponding lower and volatile production volume environment continue which seems likely at this point.

There is a risk the company could be outside with financial covenants at some point in the future.

Given the pressures in the industry, we don't think will be alone in that regard.

In response and as a proactive measure we initiated discussions with our lenders on an amendment amendment to our covenant structure.

Similar to what we did last year during the Covid shutdowns in order to provide the company with flexibility as we navigate our way through these challenging times.

We are comfortable with our position in this regard.

Our banking relationships are strong and we're confident in our lenders will be there for us if and as required they.

They to see the current supply chain bottlenecks in overall charge challenging environment is temporary given the strong demand for vehicles.

Turning to the longer term melnick, we remain as confident as ever meeting or 2023 objectives, which calls for total sales, including tooling sales of four $6 billion to $4.8 billion.

And adjusted operating a margin north of 8% more than $200 million in free cash flow.

All consistent with our recently completed board approved budgets as Rob noted.

We are committed and motivated to achieve these targets and have skin in the game.

A few things to consider when looking at our longterm outlook.

First chip shortages and other supply chain initiatives should improve over the next year.

Don't know exactly when.

We have seen some recent customer announcements, indicating the things should get incrementally better, albeit perhaps slowly.

Second while.

While IHS recently cut its 2022, North American production forecast materially by 2 million units.

The 2023 forecast and I changed my much it actually went up.

The industry is currently dealing with a supply issue with inventories at an all time low.

Meanwhile, demand demand as as high as it's been in years and is expected to remain high for several years once production normalizes.

This is the assumption underpinning the longer term forecast of IHS and others and few would argue to the contrary.

Third while we are launching a substantial amount of new business. This year. The cadence of our launches is expected to normalize in 22 23 as Pat mentioned.

With this should come a reduction of costs and better margins.

We're also continue to execute on Arlene journey, which should bring further margin enhancements.

All told the potential to rebound historical margin levels or even exceed them remains once production bottlenecks worked up.

Finally, we continue to expect our capital spending to normalize to arrange approximately depreciation as a percentage of sales.

Again this too is consistent with our recently completed board approved budgets.

The two main drivers continue to be second generation programs on our flexible well lines, which require less capital than their first generation.

Getting past their heavy investment cycle and aluminum.

We have been winning a lot of business in recent years and this is required investment but ultimately this is really good news given a strong return profile.

In closing it is clear that the industry is currently in some challenging in volatile times.

The good news here is that it is temporary.

Once you get past these near term supply challenges, we expect a multiyear period of rising production volume sales margins free cash flow and a rising stock price.

We encourage all our investors remain patient and to focus on the long term.

Track record of delivering on our financial targets speaks for itself and we are confident that this will continue to be the case as we deliver on our 2023 outlook. Thank.

Thank you for your support.

And with that and I'll turn it back over to Rob.

Thanks, Fred and Pat and with that we conclude our formal remarks. Thank you for your attention. This evening now it's time for questions. We see we have shareholders analysts and competitors on the phone. So we may have to be a little careful with our answers, but we will answer what we can thank you for calling.

Thank you we will now take questions from the telephone lines. If you had a question and you're using a speaker phone. Please just you had said before making your selection.

If you had a question. Please press star one on your device keep that you may consider your question at any time they person starts.

Please press star one a design if you had a question.

And the first question is from Michael Glean women James. Please go ahead.

Hey.

Good evening so.

At maybe.

On the caller activity from the Oems are you seeing a clearly street.

They were dealing with some.

A unique situations. They didn't have visibility is that behavior improving at all as you tracks are cute.

Well.

Our expectation you recall earlier in the year was it would get better by Q3 and it actually got worse.

So far in queue for we've seen some unexpected call ups, but the next that drivel test will need. This next month, because some of the Oems GM in particular is announced.

Their expectations for the month that all starts to grind up next week.

So.

I think over the month of November will really get better judgment.

But if you took a look at the deterioration at the end of Q3 versus how we started off I'd say, we started off better then we ended in Q3, but it's still.

Volatile for lack of a better term.

And Israel wait for the Oems and SaaS in the question like can they pace the volumes more steady versus calling it off is that something that can take place to help you plan better about that.

It's a really good question because we've had those discussions at if.

If you built the the inventory so to speak of chips parts with the chips and this isn't as easy as I'm, making it sound so.

And sort of held off until you had enough and then when you said I'm going to go.

Go and they say we're going to go for weeks and then we're going to run out again, yes that would be a lot easier because part of the problem is.

And are you expecting to run Monday, it's Thursday, and you'll get a call in the evening or the next day and <unk> and a pulled to schedule by that time, what little flecks and you can do.

It's pretty much.

It's pretty much lost.

So certainly if they if they had a method to say, let's let's build up enough chips and wait until we can really rock yeah that would make a difference for the supply base certain.

Okay, and then can you just talk a little bit about.

What's the <unk> what is the outlook for the plant in the GM Platen, Ingersoll and and how you see things evolving at your all fields Platte over the coming year.

Well the.

Planet CAMI is to run one shift I think for the rest of this year. There are plans to continue to run it the first quarter of next year portion of that will be shipped dependent.

We'll supply as we have in there is some new business, we've won and put into all field.

There is a potential to put some more and if.

If we can make this space so it's kind of an interesting dilemma.

That we have where we could possibly put some work in there if we can coordinate things with our customers.

So the plant will be.

Open regardless, but how many people work there could definitely be impacted depending on what GM does.

Next X quarter.

Okay and.

Maybe just one on the balance sheet so.

Just a question regarding the dividend.

I guess with the balance sheet at two and a half and Fred you may be talking about the risk of a preaches littlest dividend put into a big conversation this quarter maintaining it.

No.

<unk> kept our dividends going through Q2 last year, we've got a strong balance sheet strong value and we will maintain so it was pretty easy discussion.

Okay.

I'll get back into cute. Thanks.

Thank you very much and the next question is from David Acampo Calmark Securities. Please go ahead.

Thank you and good evening everyone.

Hi.

Fred I really appreciate the color that you provided on the quarter over quarter breakdown in and the one time related costs of the elevated costs that you're seeing.

And you guys may have talked about this in the past, but I'm not I'm not too sure but in Europe. There. There is an inability to flex flavor compared to here in North America. So just curious what was the impact proportional between between year divisions between North America, Europe, and the rest of the world or was there one one segment that.

Higher elevated costs because of your inability to flex.

Yes, I think North America has been the region has been impacted the most.

On chips and other headwinds as well and it is our largest segment.

We did see some chip related shutdowns in headwinds in Europe as well.

But not to the extent of North America, So I would characterize the impact there is less.

At the same time, we're making some progress there with our facility and Berg noise that it came from a Tulsa acquisition. So.

That improvements kind of be masked by some of these other costs and headwinds and so forth.

But.

All in North America was by far the biggest impact in the third quarter.

Just supplemental for that I mean, everyone is trying to get Labour everywhere, particularly United States, Canada. So you cannot simply lay people off they may not come back and so the reality is.

You've seen this on a macro level a lot of people have not re entered the workforce in part because they've been paid not to work for a long period of time it kind of.

It used to that a little bit and we're seeing.

Wage inflation in the United States that we're dealing with as well so.

We trained people we have good people, we want to keep them in the plant back to what passed set.

It's easier to do that type of labor flexing in North America. When you know what the production schedule is.

Last year at Q2 overall shutdown it was actually in many ways easier to deal with your labor situation labor cost is now and so am access.

That's that's the reality that's.

That's out there.

Okay, and then just thinking a little bit more long term here.

Guys noted that you're speaking with your customers now to potentially get some some price increases to offset some some of those more permanent inflationary pressures whether it's labor.

But can you guys also fine cost cutting initiatives and if so what does that look like.

Well.

Certainly.

While we're down.

So it's kind of a double edged sword, you can't lay them off as Rob said, because you lose people, but if you're not running you got to have something to do so we do use people work on lean activity. So when.

When the scheduled to return to normal will be able to go forward with less labor scrap scrap cost improvements those types of things with also take.

People and put them in our plants, where we're launching where he could use an extra hand that type of thing.

And then certainly the more you can progress on a launch the quicker you can bring lending to the bottom line on one thing <unk> of the launch currently is that we're not getting a steady launch schedule and that's really critical.

But almost at every launch we're having right now we're being inhibited by again.

<unk> call ups, so it's made it difficult.

Just as a supplement to that you recall last year Q3, we came out of basically a lockdown situation and we talked up really quickly and we had a really profitable quarter. So this can turnaround really quickly and last year, we get a lot of activity that talked about this year, we're doing the same thing.

It's important that when <unk>.

MS are ready and they can provide steady production that we're ready to.

So we're taking a hit right now by having to hold people and it's not going to be sustainable forever by any means but.

Being prepared for when the volume is go up is going to be key because this could look like 2010, all over again, where.

They want to run every vehicle on every plan as much as they can.

Because everything is empty and I would almost guarantee that's going to happen as long as there's chips and other supply.

So we really the industry really needs to be ready to provide.

Parts of it are very high production level.

[laughter].

Right and I guess, asking the question a little bit more specifically as it relates to numbers.

Price increases be required to get to your 8% or is that something that you guys can do with just finding efficiencies.

In some cases you'd have to find a lot of efficiency, especially when it comes to material materials very basic and a product that always gets covered so it makes sense that will get covered and we have a lot of confidence that it will.

Labor.

Expect 2% to 3% labor raise it increases every year, maybe more on a good year.

And you cover that with efficiency. So this is your truck in 2025% Labour increases so it's a little bit more work.

Can we achieved a high margins with with all of this I would say we are going to have to have some help how much we really need to dig in and see.

But over time will improve at the same time as well.

Okay, that's perfect I'll hop back in the kitchen.

Thank you.

Thank you. The next question is Peters color BMO capital markets. These glass.

Fred when you gave that rolled forward from Q2 EBITDA to Q3 EBITDA.

One of the reconciling items was 25 million and with that the combination of sales mix and the and these labor issues, you're referring to I just want to make sure I understand what's at $25 million.

Yes, it's a combination of both.

Sales product mix as well as some of these challenges are having with labour in excess cost as it relates to that.

Okay, and what's the large.

Just curious why you lump them together like because they're not related but what was the larger issue was a mix or labor.

I am not going to get into a little detail and I'm sure our customers elect and all of that.

So.

Just leave it at that for now is that.

Okay.

So you would have.

Leasing preliminary numbers for October is.

It was October any better than what you experienced in Q3 or is it kind of more of the same.

I would say October.

Was.

Better than probably September, but still some room to to improve their as Pat alluded to earlier I think the key for the fourth quarter is to make sure that general Motors falls through on their current production schedule.

That's going to be key if you look at the OEM shutdowns during the third quarter, we've been tracking it since the beginning.

Jen.

Was hit by far the most.

Detroit three in particular.

So.

A scale up in the fourth quarter to some extent that will definitely help.

In November and December production schedule will be key today.

Yeah, and then Pat.

You refer to the GM truck program in Oshawa, what exactly is GM doing on the truck and I'll show up and.

What what have you got on the trucks there.

Well.

It's the.

If you recall I don't remember it was a couple of years ago, GM announced they're going to start building silverado's in Oshawa I can't sit here and can remember the volume Dr number.

For 100000, I think over 100000, or so a year, maybe it's more than any way we provide the same parts on the truck in Oshawa as we do in the U S.

In Mexico so.

It takes some additional capacity, which we're putting in a Canadian plant and then other parts will come from other places in North America.

Okay.

The volume move on Gm's part they see a need for more volume so they decided to put it back into the asphalt plant.

Okay. Good for US we are excited about it.

Okay and then just lastly, this program you are rewarded with from that asks what are you doing for setups.

Transmissions.

So is that F as a big transmission providers for.

Just about every automaker around the world and and.

And it's one of their main transmissions transmission cases, it's volume up.

So.

Oh, so this is aluminum.

Yes. This is aluminum correct alter an increasingly large customer for us.

You're doing the aluminum case correct yeah. Okay.

Got it okay. Thank you.

Thank you.

Thank you once again please.

On your device keep that if you have any question.

And the next question is from has been.

H.

Hi financial please go ahead.

Hi, Good evening, just have one question.

Can you hear me.

Hello.

Yeah, Yeah, okay.

One question is just with regards to the 2023 guidance and.

And maintaining the 2023 guidance.

I'm, assuming and if you could share of sort of.

There are any numbers to be shared like what what is space. What do you base your confidence about 2023.

On and is it.

Is it cheap back from Oems, some some internal estimates or is it.

I'm, assuming it's not just what they call escalation of commitment.

As it relates to 23, I think you're asking about potential with volumes environment, where it seems so we essentially projected budget based on.

And.

Calling for a fairly robust.

2023 volume environment I think their numbers right now is north of $17 million for 2023.

Higher than 24th.

So they are anticipating that the supply chain bottlenecks full.

Will be behind us by the end of 22, and 23 should be a very strong your volume. So our outlook is predicated on that.

Just to get just to give us a sense of the IHS volumes in the auto news last last week earlier. This week they posted what they anticipated Ravi volumes of 2023, $2024 25, 26 2027, each of those numbers was about $17 million and that would be very robust long periods.

Turn then we look at that and say okay.

Why is that going to happen because the slaughter by activity and also with respect to the rebuild of inventory is not going to come very fast.

Cause inventories are very low we lost don't forget.

Almost three months of production last year. So that's 3 million plus vehicles, it's very hard to catch up when you are pretty well at full production as Oems and demand as hot so.

So we're going to see a number of tailwind so that's almost.

Not quite analogous, but it's almost like vehicles that aren't made and sold today are going to be made and sold and added to what's going to be done in the next five years and so that's a very good position to be as a supplier.

Gotcha.

Okay. That's perfect. Thank you.

Thank you.

Thank you. The next question is from Michael Glean Raymond James. Please go ahead.

Hey, Fred.

Fred you talked about the Matassa Platen, Mexico that real estate opportunity. There can you give some insight into what the entire Martin Gray a real estate portfolio looks like.

We haven't necessarily have done a full in-depth analysis and that but needless to say we've looked at some properties as potential opportunity, we haven't decided where we're going to do there yet but.

Clearly, there's quite a bit of values sitting out there just based on the work that we've done so far on that on that matter.

I think they give you a process.

Don't know the exact number but we probably rent to both have our real estate in one or both the other half crux solemn silence on a real estate is not necessarily great areas for arrived with summit someone's really good and if you go back over Mccall So transaction.

Million dollars for the whole business, it's nice to have a real estate asset worth $36 million.

Okay choir, Franklin, we did that acquisition.

Kind of figure that would be some some value with the real estate, but.

She'd gone up quite a bit since then so we've actually done well in that perspective, or Sadat appraisal were smiling.

And.

Just in terms of the capital commitments your cap you're near term capex it.

Is there any abilities that you'd have to scale back on any of the capital or are you fully committed to such spending at this time.

At this point in time, you're just the book.

The majority of it is program capital.

And throughout this semiconductor situation.

Continue to work on their new program cadence.

Normal course, so they're not slowing down.

And they are expected to supply base cost a slowdown as well.

So we have some ability to different delay in some areas, but for the most part it's big fan.

At the core of our sales projections as well as pastel you put all this together, it's like $800 million annual business, which is huge.

Besides a lot of companies.

Sorry, you May have said this but what's to capex number for this year should should.

It should be what it's going to be about 325 million give or take that's been.

Well of course.

Okay. Okay. Thanks for taking my question.

From.

Thank you, yes, or no fight that question is just define it would know lakes the remaining over to them. So Rob will dubord.

Well. Thank you very much for all your tenants. This evening. If you have any further questions or would like to discuss any issues concerning us please feel free to contact us at the <unk>.

And the press release, thanks, very much have a great evening.

Everybody.

Thank you Nick offerings has now ended.

Please disconnect your lines at this time, we thank you for your participation.

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