J.P. Morgan Automotive Conference

Aug 12, 2021

Slides

Hi, good afternoon. I'm Ryan Brinkman, The U. S. Automotive Equity Research Analyst here at JPMorgan. Thanks for joining us on day two of the twenty twenty one JPMorgan Automotive Conference. Very happy to get going with our next presentation now, which is with Cooper Standard. I'm going to turn it over to Jeff Edwards, Chairman and Chief Executive Officer. He's going walk through some slides, and we'll have a conversation. Just want to remind the investors, they can submit their questions, too, via the conference website, and I'd be more than happy to ask them on their behalf. So Jeff, thanks for being here. I turn it over to you. Okay. Thank you, Ryan, and good afternoon, everyone. So I'm going to start with the first overview slide. I assume that most of you are familiar with this. But just quickly, Cooper Standard today, as we sit here, a $2,400,000,000 automotive Tier one supplier. We supply ceiling systems, fluid transfer systems as well as fuel and brake delivery systems. The message here on this slide, as you can see, we have significant market share across each of these. These are leading products for us. But on the flip side, you can see it's a very fragmented market when you look at the amount of share that we have. So a lot of white space, a lot of consolidation opportunities, we believe, still in this space. So as things get back to normal here, we're hopeful that by the time we work our way through 'twenty two and into 'twenty three, maybe we can have an opportunity to do some of the consolidation that still needs time. The next slide really gives you a chance to look at our diverse customer base. I mean, obviously, we grew up as a North America Tier one supplier. But starting in 02/2004, we began consolidating between Europe and Asia, along with our North American customer base. And you can see that we've transitioned quite well. The real key here is you see we've also included, companies like Lucid, Arrival, Rivian, Neo, the EV companies that I'll talk about a little bit, later on. And then at the bottom of the slide, you can see the Industrial and Specialty Product Group customers that are different from automotive. And that business today is about $200,000,000 in revenue of the 2,400,000.0 total. We're probably in a we've never been in a better position than we are right now with our customers. I think the amount of reward and recognition that they've given us over the last several years, we continue to execute on all fronts, quality, delivery, service, innovation. So we're about ready to have some challenging conversations with raw material costs and other inflationary challenges. So, the message here is, very good state with our customers, and we've received, I think, some of the most prestigious honors in the history of our company and certainly in the time that, this type of thing was being tracked. The next slide, really talks about our Fortrex chemistry platform and how we're recognized there. I think we've done a really good job externally of talking about the performance of value of Fortrex. So you're familiar with the lightweighting. You're certainly familiar with the improved resilience on rebound and the higher resistance to compression set and things like that. But what we haven't discussed a lot about is the impact that it has on greenhouse gas in the carbon footprint reduction initiatives that our customers have, for us and for themselves. And so we've given you a couple of data points here, that it's 53% lower from a carbon footprint point of view than our EPDM rubber processing, capital, and it's 22% lower than our TPV capital. So this now is starting to resonate not only with our automotive supplier but also with our nonautomotive customers. Everybody's interested in it, and I think it will have a lasting effect in the sustainability of our Fortrex and the penetration of Fortrex across all of our businesses. The next slide is important because it really talks about and reminds everyone of Cooper Standard's dependence on the largest growing segment in the industry, which is trucks and crossovers and SUVs. The data here shows over the next several years that the segment around trucks and SUVs is going to grow at a 7.4% CAGR. Our growth rate over that same period is approximately 9%. If you focus your eyes on the right hand side of the chart, a couple of important data points. You can see that within our global revenue, 73% of our global revenue is tied to trucks and crossovers. In North America, it goes all the way up to 88%. Also, from a content per vehicle point of view, we have 2.4x more content on our global platforms, trucks versus cars. Here in North America, it's 2.7 times the content, trucks versus cars. So as the mix continues to grow, as you know, customers happen to make most of their money in this space, we think that bodes well for our future. The next slide gives you a little bit more around electric vehicle. We continue to grow in this segment. We're outpacing the market. And more importantly, I think, is that we're expanding our content per vehicle. The bar graph on the left shows you the growth that's expected in the global light vehicle production arena. It's going from the $73,000,000 up to the 88,000,000 as we get into 2025, and that's certainly a nice growth rate. But for us, we are giving you information here regarding our EVs. So EVs, we have grown with the 20 of the 25 top EV platforms in the world. We are on 16 of those. We have strong new business. Last year, we booked $100,000,000 in revenue in 2020. In 2021, the first half, we're already at $59,000,000 That's up 41% versus the first half in twenty twenty. We expect growth rate of in excess of 15% I'm sorry, 50% CAGR over the next four years. The closing comment here is that our content per vehicle growth opportunity is 20% higher than ICE vehicles. And the next slide answers the question, well, why is that? And you can see that with ICE, there are eight part numbers. With hybrid, there are 28. And with battery electric, there are 20. More importantly, I think, is the level of engineering required to be part of the fluid dynamic solutions required to make the battery electric vehicle fluid do its job. And so our engineers are becoming expert in this area. Our customers are giving us additional business as a result. But this just gives you some, at least context to put in why the content per vehicle is up and why customers are willing to pay more for what you see in the center and on the right of the screen. Also, from an innovation point of view, as you know, we have a history of innovating for our customers across our product groups. And we've given you today just some key developments that are driving growth for us in the global EV market. And you can see our PlastiCool technologies. These are our multilayer tubes that are used in EVs. We also have invented an EZ Lock, which certainly, not only from a sustainability point of view, helps emission, but it also helps the leak and the foolproofing of the leak. And it also makes it easier for our customers to assemble the product in their plants. And then finally, you can see flush seal on the far right. This is an innovation that helps improve the aerodynamic performance of the vehicle, less drag, better fuel economy, or less drag, better battery life. And so these are three that we're showing you today that's helping drive some of the net new business that we talked about on the previous slide. In addition to the automotive business and the Advanced Technology Group, we're giving you a little bit more color here around the Advanced Materials Science business. And as we've said here about a year ago, we've focused our attention on footwear. We've completed the technical phase of development with two large footwear suppliers. We are now in the commercial phase, with them, in other words, negotiating price. And we hope to have both of those done here in the next quarter so we can announce that publicly. But making good progress, I believe, that we'll have good news to report here in the coming weeks. We've talked openly over the last couple of years about the driving value plan and our work along those lines. And we clearly are well positioned to return the company to double digit EBITDA performance as well as double digit ROIC performance. As we head through 2022, you'll see evidence of that. We've said all along, as we get to 'twenty three, that will be the first full year of the company executing back at these levels or better. Message here is we're on track, and we believe that we'll execute to the level that we've talked about and that 2023 will be the first year where we're operating at those levels. So what's all that mean? The investment thesis that we believe, in the one that we've been communicating with all of you is on the slide now. And it really is about leading market position in each of the three product groups. So customers want us. We've got a long history with the ceiling and the fluid management part of our business and the products associated with it. We're well positioned to help our customers. We've been an innovator in this space. We continue to be. I think the result of the growth in EVs is just another leading indicator of that, that's working. I talked about the growth trends around trucks and SUVs and how that drives content per vehicle for Cooper. And certainly, the growth trends in electric vehicles are positive, not a negative for our company. We've talked about the strategic diversification, meaning today, it's an automotive company. Tomorrow, we expect the Advanced Technology Group to grow and provide even stronger pathways to double digit, EBITDA and double digit return on invested capital. And then finally, the message to everyone is that we are on target. We're executing to the driving value plan, and we will return to double digit return on invested capital over the course of the next eighteen to twenty months. So that's the message from here, Ryan, and I'll turn it back to you for Q and A. Okay. Great. Thanks. And maybe good first place to start is the biggest picture, this recent ongoing semiconductor shortage that has impacted automakers and their supply base pretty significantly. Almost everybody has had some impact. Your 2Q results and adjustments to full year guidance suggested maybe a bit greater impact than for some others. I don't know if you agree with that. And if so, what are the drivers of that? Yes. Well, so far, I'll just talk about us. And in our case, it was about a $200,000,000 revenue impact, Ryan, and 75% of that here in North America. The slide that I had up earlier is a pretty good indicator of why it impacts us, the way it does. First of all, it's the region where we're making our money. Secondly, the trucks and the crossovers have a very high content and a very high profit associated with them. The other thing to keep in mind is that, that $200,000,000 of revenue was the impact. 75% of that was North America. There was also a $75,000,000 FX that affected the top line in a positive way. And unfortunately, that doesn't have anything to do with the bottom line. But if you were just looking at a revenue comparison and you didn't discount that $75,000,000 of FX that was in there, maybe you didn't quite understand all of that. But the 200,000,000 was real, and the profit associated with it had a big impact on Cooper. The good news is, as we head our way through the month of August here, we are seeing some stability from our customers creep back in. There's less volatility. It seems like the ability to predict what we're going to be building is improving, and that feels good as we get into midway through August. Great. And of course, another big trend impacting the industry this year is commodity cost inflation. I wanted to ask on that. How much of a headwind do you expect to face this year? I did get an investor question I want to weave in here. This investor observes, he thinks your cost pass through mechanisms may be less complete than for some other suppliers. Why would this be the case? And do you have any plans to increase the percentage of your raw material buy that's subject to, I guess, these automatic escalator agreements with customers? Yes, twofold. So I'll answer the first part of your question. So the headwind that we expect for the rest of this year is $40,000,000 on the raw material front. It was $15,000,000 when we started the year. So certainly, like everybody's reporting, we aren't immune to that. The second half of your question, it's a very good one. A lot of people are indexed, and therefore, this is potentially a simpler process. We are working with both our suppliers and our customers to get more of our product indexed, but that takes some time. We're making progress by the end of the year when our suppliers will probably be at our goal with our customers. It's more complicated because you're talking about product that's in production, not product that you're just quoting. The good news is the products that we're quoting, we are indexing. So going forward, this won't be an issue, but in the short term, for us, it is. Historically, we've recovered 40% to 60% of the premium or the inflation, if you will, related to raw material. You would think that would be a good enough number. Well, it is if your inflation is $10,000,000 But your inflation is 40,000,000 or $50,000,000 that's not enough. So that's why we're going back in and having the difficult conversations. The good news is if this is short term, then the price we receive the price increase we receive, we'll turn around and give that back when the inflation comes back down to a more normal level. In the meantime, we don't use our balance sheet to fund our customers' inflation or, for that matter, supply chain issues that they're facing around microchips. So it's going to be a challenging discussion, of course, because certainly we all know the dynamic of getting price increases in our industry and the potential long term impact that, that could have on your business. But I think we'll balance that, and I think we'll come out of it with a fair deal. In the meantime, 25% of our EPDM material is indexed, to answer that other question. We wish it was more, but it isn't. Long term, it probably will be. 75% of the $40,000,000 that I referred to is EPDM rubber. So once we get that part of the negotiation resolved, we're talking about a lot less inflation on the other products. And what percentage of your raw material buy roughly is EPDM? And what are your other commodities that you're exposed to? And are there any substitutions or alternatives for the more expensive materials that you could possibly make? I think round numbers, our raw material is our purchased products is 45 to 50% of the total cost of what we do. And within the inflation itself, it's primarily EPDM. It's 75% of the $40,000,000 is EPDM. 25% of that 75,000,000 is indexed. The other materials that you're asking about, simply for plastics with the TPV sealing business that we have and the other plastic hose business that we have. Steel, obviously, is also a component. But those are the primary ones that are driving the 40,000,000 Okay. Thanks. I wanted to ask, maybe there's, I don't know if it's the case, some investors might perceive that some of the products that you produce commoditized relative to some of the higher value add components other suppliers may make. I'm curious what your response to that might be. And does the nature of the products that you produce give you any less bargaining power with your customers when it comes to negotiating on price or on material cost recovery? And do you need to develop new technologies or expand into new product lines to be successful as a company? Yes. Several components to the question there. So first and foremost, our products are on every vehicle. The good news is everybody needs seals and everybody needs fluid management product that we produce. In the better news, as the industry transitions to EV, we've shown you that our content per vehicle goes up in our fluid business by 20% in those vehicles. Actually, if you look at the hybrid phase of the transition, we're up almost 50% content per vehicle in the fluid business. And I gave you a chart earlier to show you how the complexity versus ICE changes between hybrid and battery electric vehicles. So long term, the products that we produce, every vehicle needs. The second part of your question really gets at the fragmentation that exists within the products that we produce and that we sell to our customers. And you'd have to go region by region. So let's start in Europe. Clearly, the fragmentation in the ceiling business in Europe is a problem. When people can't cover the cost of capital, they put companies up for sale. Virtually every one of our ceiling competitors in Europe is up for sale today. We aren't, but they are. And that should give you some sense of that issue needs to be resolved. Customers need to get involved, get engaged with us to help us resolve that. And until that happens, it will be a challenging market in Europe. That's why we've decided to reduce the size of our company there and become more profitable, that's our strategy going forward. Whenever the customers realize that they can't keep people alive with bread and water in Europe, then maybe this will get resolved on the ceiling front. We shift back to North America. I think the market has plenty of competitors, and it proves that three or four is fine. But you start talking about five or six in a region, it just isn't sustainable. You move to Asia, you have a similar issue there in the terms of you go to the North, there's competitors. You go to the central part of the country, there's a different set of competitors. You go to the South, there's a different set of competitors there. So I think the fragmentation in China is also a challenge going forward. But we're committed, again, to rightsize the business in China, rightsize our footprint in China and do business on platforms and with customers where we can make profit and make a fair return on the investment. And those areas that we can't, we will exit, which we've proven with our ABS business as well as our European fluid business recently that if we are making money, we're out. And that's the strategy, make money or leave. Okay, great. Thanks. And your customer base has historically been quite heavily weighted toward the Detroit three, right? So how has this changed in more recent years? And does it need to change still more, do you think, in order to optimize the mix of business? Well, if you go back, let's say, back to 02/2004, really when Cooper Standard was spun off from Cooper Tire and you look at the the North American customer base there, it was 80%. So 80% of the revenue was tied to what you said, the North America Big three. So if we just fast forward to today and we still look at the North American Big three, even though there's some different names there, our percentage of revenue is down in the 50% range, so much better than it was fifteen years ago, but still heavily tied. And more importantly than the revenue is our profits are heavily tied within the North American business. So what we've done is spent a lot of restructuring money in Europe this past one years point and in Asia over the same period of time to get our fixed cost in those regions down to a competitive level. And think about 15% of that number, 15% of our revenue being fixed cost in those regions, we think, is a benchmark or world class performance. And so that's what we're doing in Europe. That's what we're doing in Asia. And we're already operating at that level or close to it in North America. When we do that, the return on invested capital is going to go up. The ability for us to respond to our customers in a way that still invests in innovation and new technology in our business is going to be very good and improved over what our competition could do. And at the same time, we're lowering the capital expenditure required to support that business, the amount of cash required on an annual basis to support that level of business. And therefore, it's a much healthier company. And it may be smaller, but it's more profitable. And that's the approach going forward that we're going to take. And you touched on it already, but to just sort of pivot over, and maybe there's some unrelated questions, too, from the customer diversification, geographic. I mean, really, North America is only the only region that's really sort of consistently turned to profit, right? I know GM exited from Europe, Ford exiting from Brazil. Just curious the extent to which you need to remain in Asia, Europe, South America from a capital perspective, from a profitability perspective, from a time focused attention perspective? What do you think? Yes. Well, the good news is in both Europe and Asia, smaller and more profitable didn't mean zero. So in the case of Europe, we're committed to the forward opportunity. It's going be less than $1,000,000,000 business, but that's okay. If it's $700,000,000 and we're making, 10% EBITDA, that's a whole lot better than 1,300,000,000.0 making nothing. And so that's our strategy, and we know that we'll be able to execute that. Same thing in China. We know that over time, that market is going to come back, and we're going to be in a good position to take advantage of that growth. We've put the amount of fixed cost in that we think we can fill up over the next three or four years in the targeted new business that we have. And we believe that business will be well, we know that business will be profitable because of how we're quoting it. And if we can't hit the hurdle rates on net new business opportunities, Ryan, we pass. It's just really that simple. And we have a global process to ensure that those hurdle rates are being met at the time we quote. If we're allowed to quote at that level, we take the business. If we're not, we pass. So the area that I would talk about real quickly is South America because it's a question that was embedded in there. We do believe that that's a region where we can make money. If we can't, we've said by the end of this year, we'll announce exiting. We'll really announce our decision whether we're going to stay or whether we're going to exit at the end of this year. But I have no doubt that our customers want us to stay in South America. I think it's clear that our customers know we have to be able to make money. We have to be able to cover the cost of capital in this business. We exited ADS because we couldn't, and we exited the fluid business in Europe because we couldn't. So there's credibility in the words. If we aren't making money and we can't fix it, then we're going to leave. I think Ford had set aside like $2,500,000,000 to facilitate their exit from South Park. That was their cash cost, compensating dealers, etcetera. I don't know if there's any sort of compensation for the supply base. Well, I can't get into the specifics, but you can rest assured that any money that we were owed as a result of, that exit, we've been compensated or expect to be. Okay, great. Thanks. And then just big picture, 2014 through 2018, there was a real nice run of improving profitability, the double digit margins in 2017 and 2018. What changed to cause the margins and the ROIC to compress so much off those earlier levels? Was there something unusual that was benefiting like twenty seventeen, eighteen? And what do you see as a sustainable level of return of capital or margin? How do you get back there? Yes. So I can assure you we didn't take stupid pills. So what happened simply was the revenue reduction in China occurred. Unfortunately, we were heavily tied to the Western joint venture companies. So when you look at the China, units, you see that they were down about thirteen percent two years ago. For Cooper Standard, that was a 33% revenue reduction because of the mix that we had towards the Western company. So instead of making $100,000,000 in China, that we thought we were going to make in the forecast because of the 33% reduction in those units that were ours, we ended up in a negative or close to a breakeven position in China. So that's what happened there. In Europe, we had three vehicles that certainly, from a mix point of view, were critical to our profitability in Europe. And unfortunately, again, those volumes went to almost zero because of the lack of demand for those vehicles. And they were big nameplates in Europe that went through a pretty tough period of time. In simple math, there was $160,000,000 of margin that left the company. Dollars 100,000,000 of it was due to the raw material issue that occurred. We were having tailwinds for the period that you mentioned, and then it turned into a headwind. And then we had a number of critical programs that were up for bid at the same time that we had to pay customers more money that year than we had normally. And so we had to give a 2% price reduction in that year of inflation in order to protect some very critical nameplates that are still with us today. So it was a good decision in the long term. But in the short term, that 2% cost us about $60,000,000 in price. So if you add up the $100,000,000 of raw, dollars 60,000,000 in price, that was 160,000,000 left. So what we did, we took a step back from the business. We created this driving value plan that said, look, we aren't going to be able to continue to invest in Europe. Europe is not going to be a $1,200,000,000 business for us, and we aren't going to be able to make money. So let's get rid of the things that we're not making money. So we exited programs and products in Europe. We got out of India, and we sold our AVS business. And that, for us, meant, all right, now we have to rightsize the company. Instead of being a 3,600,000,000 company making the returns that you talked about, now we're going to be a $2.5 to $2,600,000,000 company. We have to get the SGA and E down to that level. We have to get the fixed cost down to that level. And then we have to reinvest in the Europe footprint. So that means we have to spend $100,000,000 in cash to update and to restructure Europe. Well, we've done all that. It's done. It's behind us. The good news is 'twenty two begins, for Cooper, a year of significant growth. Over the next five years, we're going to grow at a 9% comp and annual growth rate. By 2023, we'll restore the company to 10% EBITDA or better, and we'll return the company to a 10% ROIC or better. In 2013, we had a 5% ROIC, and we had about a 5%, EBITDA. In the mid years of the decade that you're talking about, we were at 12% ROIC, and we were well above 10% EBITDA. We know how to do it. The driving value plan that we have in place today now will provide the platform for us to take advantage of the growth that's coming, both organic and inorganic over the next two to three years. So we're excited about our future. We've learned a lot in terms of how we need to manage raw material costs going forward. The indexing discussion that we talked about is a big component of that, but also being smarter quarters. I think we're definitely in charge of our costs. We're in charge of the prices that are going out everywhere in the world. It's now a central global process, And we don't take bad orders. If we can't make money, we don't do it. Maybe just talk a little bit in a few minutes that remain here about your nonautomotive business, four tracks in particular, and the degree to which you're looking at some other end markets, footwear, etcetera, what percentage of your business this could grow to over time and the degree to which nonautomotive factors into the effort to improve margin and ROIC? Well, Advanced Technology Group is a little under $200,000,000 of the $2,400,000,000 revenue. The good news is Fortrex, as a result of the product performance that I talked about earlier and the new approach on reducing carbon footprint that all of our customers are now excited about, I think Fortrex will improve its penetration not only in our automotive business but also in our Industrial and Specialty group. The big box stores that we supply Industrial and Specialty products to also have the same carbon footprint goals and objectives that the automotive companies do. So I think Fortrex will continue to penetrate. It will continue to improve the return on invested capital of the company. In terms of AMS that you talked about with footwear, we're focused on it. We've exited the development phase of it. We're now in the commercial negotiation phase, and we'll have a win to announce or a couple of wins to announce here very shortly. So I think on that front, it's going to take us a lot longer, but we're still committed to double digit EBITDA in that group as well as probably a 20% plus return on invested capital. Okay. Great. We are out of time, but thank you, Jeff, for your time and all of your insight. Okay, Ryan. All the best to you. Stay safe. You as well. Thank you. Thank you.