Q2 2022 Martinrea International Inc Earnings Call
All participants please stand by, your conference is now ready to begin.
Good evening ladies and gentlemen and welcome to the Martin Rea International Second Quarter Results Conference Call.
Instructions for submitting questions will be provided to you later in the call.
I would now like to turn the call over to Mr. Rob Wildemore.
Please go ahead sir.
Good evening everyone.
Thank you for joining us today. We always look forward to talking with our shareholders. We hope to inform you well and answer questions. We also note that we have many other stakeholders, including many employees on the call, and our remarks are addressed to them as well as we disseminate our results and commentary through our network.
With me are Pat DiRaimo, Martin Reyes CEO and President, and our CFO , Fred D'Etosto.
Today, we will be discussing Martin Maria's results for the quarter ended June 30, 2022.
I refer you to our usual disclaimer in our press release and file documents. I will speak briefly, Pat will speak, then Fred, and we'll do some Q&A. I am going to be very brief today and focus on one takeaway point for you, and one only.
Better times are ahead for us and for automotive suppliers. Write that down, embrace that concept and brand it on your foreheads.
Despite all you read about, war in Ukraine, interest rates, inflation, recession, house prices, supply chains, labour shortages, erratic production schedules, cyber, pandemic, climate change, tariffs, Joe Biden, Donald Trump, whatever. So much doom and gloom. Despite all that, better times are coming for us.
As this quarter shows, we had a good quarter, making decent money even today, and will continue to improve.
I went into this outlook in detail in my speech at our Annual General Meeting in June . You can see it or read it by accessing our website. I won't repeat it here. It's fairly lengthy with a lot of data.
The fact is that automotive parts suppliers, not OEMs or dealers, have been in a recession for over two years.
We are hit when production volumes are down. We were hit badly in 2020 when the industry stopped for three months. The second half of 2020 we came back strong. But since that time we have been hit by supply shortages, inflation and so on. But things are looking up.
For us, production is going to increase from here and that will help us. Even if there is a general recession next year, production volumes are up.
There's a lot of demand for what we make. Inventories are low and people gotta buy vehicles.
Sales are down these days because production is down. Sales will go up as production does and production will go up.
Pat and Fred will talk about our company, operations and financials, and you can see the strength of our company and what we are doing in so many ways from them. But once again, my point is this, things are decent now and they are going to get better. I believe the company and our outlook have never been stronger.
And now here's Pat. Thanks Rob. Hello everyone. As noted in our press release, we generated an adjusted earnings per share of 32 cents and an adjusted operating income of 46 million in Q2, up 17% year-over-year. Production sales came in at 1.1 billion, up 25% year-over-year.
Adjusted operating income margin came in at 4.1%. Much improved over Q3 and Q4 of 2021, and better than Q1 of 2022 on lower production sales.
While the production environment has improved compared to the back half of last year, we continue to deal with supply related disruptions with our customers.
At the same time, we've made good progress on recovering inflationary costs through commercial negotiations.
I'm proud of the team. This is a cumbersome activity and they have worked diligently throughout the year with our customers.
We have concluded a number of agreements on favorable terms and will achieve more inflationary adjustments before wrapping up these discussions.
The negotiations are ongoing and we expect them to be substantially complete.
by the end of the year.
Keep in mind, commercial discussions tend to be a normal part of the business, though at a much lower level.
We are making good progress on margin recovery. Having said that, margins are still below our potential and our outlook for next year as we continue to be held back by cost inflation, program launches, primarily where customers have not achieved ramp volumes due to chip and other supply shortages.
as well as continued production disruptions.
On the cost side, energy remains a significant headwind in Europe . Natural gas prices continue to move higher, which impacts our overall operations in the region.
As discussed earlier, we are looking for our customers to share this inflationary burden.
Other commodities, such as steel and aluminum, are beginning to normalize from very high levels.
Of course, a large portion of our input costs, but not all, are protected from price fluctuations in these commodities through OEM resale agreements, in the case of steel, and other pricing pass-through mechanisms in the case of aluminum.
Overall, while the environment remains challenging, our Q2 performance is where we expected it to be.
and our results are expected to improve in Q3 and beyond as these challenges subside and customer production smooths.
This should set the stage for a multi-year period of strong production volumes, margins, and free cash flow, with the majority of our plants essentially running at full capacity as vehicle inventories remain historically low and demand still high. As such, we expect 2023 to be a strong year for us.
Turning to North American operations.
Our Q2 operating income performance was generally consistent with Q1 on lower production sales.
As mentioned, we are still seeing disruptions from the customers, though better than we saw last year, particularly in the back half of last year. And as I mentioned earlier, we are making good progress on recovering inflationary costs.
We continue to launch on the largest book of business in the company's history, worth $800 million in annualized sales once these programs reach mature volumes.
As I've said over the past year, this record program activity has resulted in higher than normal launch costs.
which has been compounded by the volatile production environment we're experiencing. The good news is we are now hitting an inflection point where you should start to see these costs decline more meaningfully.
resulting in better margin performance.
This of course assumes that customers are meeting ramp up volumes, which so far is hit and miss.
Post-pandemic, with continually improving supply issues,
We are picking up progress on our lean for Martin Raya operating system activity.
Resource constraints inhibit speed, but as the workforce stabilizes, we continue to see great potential. This, along with continued commercial settlements, will improve our margin profile as well.
Turning to Europe , operating income turned positive this quarter, given the recovery of inflationary costs and continued operational progress.
Energy cost remains a significant headwind in this segment and as such we are devoting a lot of time and effort to recovering our fair share of these extra costs.
We are still a long way from where we need to be in Europe , but I'm happy with the progress being made in the face of some pretty significant challenges.
In our rest of world segment, we continued to perform close to break even given weaker volume and mix year to date, as well as the strict COVID lockdown measures in China, which made it difficult for people to come to work in both our facilities as well as our customers' plans.
I'm pleased to announce that we have been awarded $85 million in new business since our last call, $70 million in our lightweight structures group, which includes additional volume on the Ford Mach-E and additional content on the GM VEV3 electric vehicle program.
In our propulsion systems group, we have a $15 million addition in volume.
As you will note, we continue to win meaningful work on EV platforms with key customers.
Now I'd like to look forward and take a moment to talk about the great progress we are making on our project breakthrough strategy.
Launched in 2019, Project Breakthrough is both a product strategy as well as a commercial strategy.
It involves the company marketing itself to customers through three major product groups.
lightweight structures, which includes body and white, suspension, and other structural applications, primarily steel and aluminum.
Propulsion systems, which relates to products that propel or stop the vehicle.
products like engine blocks, transmission housings, battery enclosures, electric motor housings, as well as fluid system products, including thermal management solutions. And last, our Flexible Manufacturing Group, or FMG, which includes automotive module assembly and components for various industrial applications.
In essence, Project Breakthrough is intended to grow our revenue and margins by providing more value-added products to our customers.
It represents an evolution in our business model from being a supplier of components that are more commoditized in nature to one that provides highly engineered systems and assemblies that often contain multiple unlike materials. This involves combining different types of steel and or aluminum using complex joining methods.
a capability in which we are quite advanced.
Project Breakthrough also is intended to forge deeper long-term partnerships with our customers by providing them with a reliable product engineering source.
an area that we have grown and have strong capability.
We've introduced a number of breakthrough products to our customers since launching the strategy in 2019 which are unique in the marketplace.
We spoke about a number of these products at our AGM back in June , and we have published an investor newsletter called Project Breakthrough, Progress to Date.
outlining these products.
I'll touch on a few of these, but I would encourage you to check out the newsletter and the video from our Annual General Meeting, both of which are available on our website.
First, the Stellantis Jeep Grand Cherokee front rail assembly.
This is a front rail assembly on the new Grand Cherokee. It contains multiple materials as well as advanced technologies and joining processes, and therefore has a high degree of value added to our customer.
The assembly has a hydroform upper tail and a die cast shock tower that involves joining Gen 3 advanced string steel with aluminum using a combination of structural adhesives and advanced fastening and welding techniques.
We provide these assemblies for both the ice and plug-in hybrid variants of the Jeep Grand Cherokee.
Next, we have the front and rear subframes for the Ford Mach-E.
On this, we are fully responsible for design and development, as well as validation of these products.
on a very tight timeline.
They consist of multi-material front subframe that has a lower pressure die cast hollow aluminum rear attached to a welded steel front structure.
and a one-piece low-pressure die cast hollow aluminum rear subframe.
Moving along, we have the Lucid Air front subframe, which is made of hollow low pressure die cast and extruded aluminum components.
What makes this product unique is that it is joined by using only structural adhesive and rivets. There's no welding involved, which is a first in my experience.
The rear subframe is a one-piece hollow aluminum die cast structure.
Last for today, but certainly not least, we have our Graphing Enhanced Brake Line that we introduced in late 2020, which has recently been named a 2022 Automotive News PACE Award Finalist.
GrapheneGuard is a patented technology that coats brake lines with graphene in order to provide industry-leading abrasion protection, a rate reduction of up to 25% compared to a standard brake line through the elimination of components, and improve chemical resistance and high temperature performance.
The brake line is currently in production on three programs of Ford, the Ford Super Duty truck, the Ford Explorer and Lincoln Aviator, and the Ford Edge and Lincoln Nautilus.
as well as the Sierra and Silverado heavy duty trucks with General Motors.
We have made some great progress in both product and process innovation since launching Project Breakthrough in 2019.
We've introduced some truly unique products to the market that are complex and value-added, in that they solve problems or deliver superior attributes to our customers.
Some of these are in industry first.
I'm excited about the work our team has done to bring these innovative products to market.
Innovation is ingrained in the Martin Raya culture, and project breakthrough is a cornerstone of our innovation efforts.
It is a key aspect of our organic growth story and is expected to help drive sales growth and margin expansion well into the future.
Lastly, I'd like to thank the Martin Rea team. I'm very impressed with the work we have been accomplishing, especially over the last few months, and I applaud your efforts.
With that, I'll pass it to Fred.
Thanks Pat, and good evening everyone.
As Pat noted, our second quarter financial results were generally consistent quarter-to-quarter, as the impact of lower production sales was offset by better operating margins.
We continue to face a challenging environment on several fronts, including supply-related disruptions from our customers.
as well as inflationary cost pressures, including more recently increasing natural gas and electricity prices in Europe .
Having said that, we have been successful in recovering some of these costs through commercial negotiations with our customers.
I would personally like to applaud our team for their efforts on this front.
They have worked tirelessly on these agreements with the aim of protecting our margins.
We expect more positive results to come from this commercial activity in the coming weeks and months.
Overall, our second quarter results are right where we expected them to be.
I also believe they demonstrate that the worst is behind us operationally and that the progress we have made during the first half of this year is in fact sustainable.
And there is more to come.
We expect our Q3 financial results to be better than our Q2 results.
As supply chain bottlenecks improve, our launch activity normalizes, and we drive further cost recoveries through commercial negotiations.
We believe our results over the next couple quarters will set the stage for a multiyear period of strong volumes, sales margins and free cash flow starting with 2023.
Taking a closer look at our performance quarter-to-quarter, production sales were about 5% lower and slightly weaker mix.
We continue to work through supply-related production disruptions from our customers, though the environment is much better than what we experienced in the back half of last year.
Adjusted operating income margin came in at 4.1%, better than the 3.8% we generated last quarter, despite lower production sales and inflationary cost headwinds in energy and materials.
The positive performance is the result of favorable commercial settlements for their customers and operational improvements as Pat noted earlier.
As such, adjusted operating income and adjusted EBITDA were about flat in Q2 compared to Q1.
Free cash flow was a positive $23.5 million compared to negative $52.1 million in Q1.
The increase primarily reflects the timing of working capital flows.
We continue to expect free cash flow to be approximately breakeven to slightly positive for the full year 2022.
Looking at our performance on a year-over-year basis, second quarter adjusted operating income was up about 17 percent.
and adjusted EBITO is up about 15% on 25% higher production sales.
Recall that Q1 2021 was the first quarter we began to feel the impact of CHIP and other supply shortages on operations.
While higher year-over-year operating results are always nice to see, operating margins are still well below what we know we can achieve.
It takes time, but ultimately we do expect to get there.
Turning to our 2023 outlook, we continue to expect total sales, including tooling sales, of $4.6 to $4.8 billion.
An adjusted operating income margin exceeding 8%, and more than $200 million in free cash flow.
We're off to a good start in 2022 as our first half performance demonstrates.
We expect further improvement as we progress through the year, starting with Q3, which we expect to be better than Q2, as supply conditions and launch activity normalize,
and we get some more commercial relief on the cost side.
As Pat mentioned, demand for vehicles remains robust and vehicle inventories continue to trend near an all-time low.
which should support strong industry production volumes for years to come.
As part of our outlook and consistent with what we have said in the past, capital spending is expected to decline to range approximately in depreciation as a percent of sales in 2023.
The two main drivers continue to be second generation programs in our flexible weld lines, which require less capital in their first iteration, and getting past their heavy investment cycle in aluminum.
This continues to be one of the key drivers underpinning our strong free cash flow outlook for 2023.
Overall, we are right on track with where we expect it to be at this point.
And we continue to view 2022 as a transition year towards much better margin and free cash flow performance in 2023 and beyond.
Moving on to our balance sheet, net debt was about flat quarter-to-quarter at $931 million during reviewers
As we announced earlier this year, we have an amended covenant structure for the lenders.
Where adjusted EBITDA on Q3 and Q4 of last year is ignored.
and the remaining quarters in the trailing 12-month period are prorated when calculating net debt to EBITDA for covenant purposes.
Our leverage ratio is also subject to higher limits to the third quarter of this year.
On this basis, our calculated net depth EBITDA under the revised terms was 2.38 times in Q2, down from 2.43 times in Q1.
A comfortable level and well below the covenant maximum of 4.5 times for the quarter.
Overall, we are comfortable with our balance sheet position and expect to remain well within the covenants stipulated in our amended credit agreement.
This ultimately is a byproduct of going into the pandemic with a strong balance sheet as a starting point.
A strong balance sheet gives you the flexibility you need to manage your way through the tough times, like the last two years for example.
Our leverage ratio should naturally improve in the coming quarters as we generate an increasing amount of EBITDA and free cash flow.
a portion of which we will use to pay down some debt.
Our first half results were a step in the right direction and we expect more to follow.
We have strong relationships with our lenders, and we thank them for their continued support.
And with that, I now turn it back over to Rob.
Thanks Fred and Pat. Now it's time for questions. We see we have shareholders, analysts and competitors on the phone, also some employees. So we may have to be a little careful with our answers, but we'll answer what we can't. Thank you all for calling.
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The first question is from David Ocampo from Comark Securities. Please go ahead, your line is open.
Thanks. Good afternoon, everyone.
Fred, maybe this is something that you can answer. In the previous quarters, you've provided the annualized impact from the inflationary pressures. I think it was quoted at 100 million last quarter. Has that changed significantly? And probably most importantly here, how much has that been mitigated from your price initiatives with the discussions that you have with the OEM partners? b
At this point, I wouldn't say it's changed significantly. I think maybe on the energy side, it's probably gone up since the last call. We are starting to see some relief on material just in the marketplace. I think broadly speaking, it's probably in line, maybe slightly higher than what we talked about the last quarter. I think it's probably in line, maybe slightly higher than what we talked about the last quarter.
As it relates to the commercial sediments, we're not going to get into specifics on how much we're recovering there. Needless to say, we're definitely making progress. We're spending a lot of time and effort on this. And the commercial activity is not just related to customers, it's also related to suppliers. So there's two facets to it. And these agreements are multifaceted, very complex, and pulling from various different issues and buckets of monies.
So I'm not going to specifically say it, we're continuing negotiations with customers and suppliers. But needless to say, we're starting to chip away at the headwind.
No, that's very helpful. And then I don't know who wants to take this, but is there a leverage ratio that you guys are comfortable with before we start to see shareholder returns, whether that's through a buyback program? Just curious, just given how much free cash flow you guys are guiding to for 2023.
I'll answer that. I think the focus right now is to go towards our 2023 targets. I think right now as you get extra cash you pay down the debt, we've got revolving lines and we'll see where we are but it's premature to say where we are. I do think that the key focus is let's get to the free cash flow and strengthen the balance sheet. There's two ways to do that of course. One is to lower the debt. The other way is to increase the EBITDA and we're seeing good improvement on it.
Raymond James. Please go ahead. Your line is open.
Hey, good evening. Thanks for taking the question. So just again on I just want to circle back to the free cash target. In the past, when you've talked about free cash, you've characterized it as it could always be something that is offset if you win your business because you have to invest with that business. So,
You know with you are right with where you are right now looking at 200 million
knowing what the pipeline of new business potentially looks like. How confident are you in that $200 million? Is there any large new business that could provide, that could need investment upfront that might delay that $200 million?
The way I would answer that question is as follows. We've gone to the organization to rally around this free cash flow target and guidance we've put out there. And we've aligned our capital programs over the next couple of years to align with that objective. So we're working within certain limits and constraints of the organization to allow us to generate that free cash flow that we're talking about. So I think at this point in time we have a good line of sight. We have next year lined up quite nicely.
what type of business we go after versus a number of years ago we needed to go after a lot of business.
And just you highlighted the lucid business when
You know and I imagine there's others in the portfolio with with some of the emerging
emerging new entrants into the market. How do you price that business versus others? Is it priced to recognize there might be some inherent risk in what volumes may ultimately look like for a company such as that? Yeah, without getting too specific based on, especially in the EV market because of the, you know, no one's really sure how fast it's going to take off. There's a lot ofHeadache.org
media hype, but when you really boil down to it, it's going to take time.
the way you approach pricing or investment.
I'll say is in many cases adjusted and depending on the model and the company and the new company versus an old company those adjustments may vary some.
So, you know, we wouldn't go into something high risk without us believing that we had a big benefit at the end of the day. And that doesn't just apply to EV startups or any startups for that matter. We apply that risk-adjusted thinking to all our codes. Where it is, what it is.
You know, we wouldn't go into something high risk without, you know, us believing that we had a big benefit at the end of the day. And that doesn't just apply to EV startups or any startups for that matter. You know, we apply that risk-adjusted thinking to all our quotes. Yeah. Where it is, what it is. Programs, regions, and so forth. Yeah.
Thank you. The next question is from Peter Sklar from BMO Capital Markets. Please go ahead. Your line is open. Fred, I just have a question on how you account for these...