Everyone, as we continue the Barclays Global Automotive and Mobility Tech Conference. I'm Dan Levy. I lead U.S. Autos Research Coverage at Barclays, and very pleased to have with us American Axle & Manufacturing, leader in driveline products. We have with us today David Dauch, Chairman and CEO, and Chris May-
Good afternoon.
the company's CFO. So we're going to have a conversation, fireside chat style. Anyone who has any questions in the room, feel free to raise your hand. If you have questions on the webcast, please email my colleagues, Joshua Cho or Daniel Lai, first name.last name@barclays.com, and they're glad to ask your questions. Now, with that, David, Chris, thank you so much.
Great. Glad to be here.
Okay, let's jump right in, and let's go straight into sort of the near-term environment. Strike's over. Maybe you can give us a sense on how the environment has looked post-strike. To what extent have we seen some normalization and recovered schedules emerge?
Yeah, so let me go first, and, Chris, you can add in. You know, clearly, we're all very happy that the strike is over. Obviously, we were dealing with a lot of uncertainty and volatility before the strike. The strike just compounded matters, especially with the rolling strike that took place there. We are seeing the OEMs, you know, start to get their assembly plants back up and running. Once you shut down an assembly plant, it's not easy to start them back up. It takes, you know, days, and sometimes weeks, to do that. Most of our customers are getting their assembly plants back to where they need to be. Some of the limiting factor is still the supply base at this point in time.
Great. Is there any opportunity—I think you had guided to $70 -100 million of lost revenue from the strike, any opportunity to make that up in the Q3, or is that—that's probably more of a 2024 opportunity?
Yeah, I would think about that more as a 2024 opportunity. You know, our guide for impact for sales lost was $70 -100 million, as you mentioned. Only $15 million of that was inside of the Q3. The balance was the Q3, which the bulk was October and the ramp-up pace that David just articulated. So we don't, we don't see recovery off of that here in 2024 or 2023, sorry.
Yeah. Yeah, I'd agree. I think it's going to be hard-pressed for the OEMs to make up some of those units right now.
As far as production stability, I think one of the themes that we saw in the Q3 was T1XX volumes were choppy down in Silao. You know, what are you seeing in terms of production stability more broadly? Obviously, the environment is a lot better today than where it was the last couple of years, but what do you think it takes for us to get back to maybe a pre-COVID type level of stability that we've seen on the production side?
I personally-
Especially for-
... I personally don't think we'll get back to 17 million units an hour for some time. You know, this year, production-wise, we are going to be around 15.5, which was going to be a good year. With the strike, we'll probably finish around 15.2, 15.3. Next year, we think that number is between 15.5 and 16. I think it kind of levels off at that area for a period of time. You know, inventories on many of the vehicles are at the desired state that the OEMs want to be at. They're not going to go back to the historical levels. There are still some, especially the full-size SUVs, that are below the desired levels, so they need to still build that.
I think interest rates right now are going to curtail, you know, some of the demand for a period of time, but at the same time, we are seeing an increase in schedules, but I don't think it'll go beyond that 16 million level for several years.
As far as the health of the supply base, is that still a limiting factor, the Tier 2s, Tier 3s?
Absolutely, and we've experienced some of our own issues as a Tier 1 with labor availability or labor scarcity. That's, you know, throughout the supply chain at this point in time. That's limiting some of the recoveries of some of the assembly plants right now. It's just suppliers' ability to provide product to meet the customer schedules, but it's largely driven by labor. I've been saying it for three years. I thought labor was going to be one of the biggest industry issues that the industry faced for the years going forward, and that's only got compounded with the cost of labor going forward now because of the labor negotiations.
Thank you. Just to pivot off of that, Q3 Metal Forming saw a number of issues, but I think one of the core issues here has been labor, labor availability, and this is something that's been elevated all the way to the top of the organization to address sort of, you know, better efficiency within that sector. So maybe you could just talk broadly. Help us appreciate, you know, what it's going to take to... I mean, we could talk about Metal Forming specifically, but then broadly, what it's going to take to get, you know, a better level of labor stability for you. What are the things that you are doing?
Okay, let me just touch just in regards to in general, when you look at pre-COVID, you obviously there was plenty of workers in the workforce at that point in time. During COVID, you had a lot of the baby boomers that retired. You had a lot of two-thirds of the childcare in this country went away, so you have a lot of parents staying at home to look after kids or elderly parents. At the same time, our government was paying people not to work. Some of those people never went back to the workforce, and others have decided to stay out of the workforce altogether. So what was once readily available isn't as necessarily readily available from a labor standpoint. You know, we're not immune to it, meaning American Axle.
We have several facilities that we do not have a labor issue, but we have select facilities where we have a labor scarcity or labor availability problem. That's led to some of our metal forming issues. Some of our powdered metal facilities were impacted based on labor availability. So we've had to, you know, unload certain plants and reload them at other AAM plants or have the supply base supplement some of our capacity. That, you know, at the same time, customer schedules prior to the strike, they were trying to build inventory, so they were running at maximum capacity levels. Post-strike, they're now trying to make up where they can, so they're keeping the demand there. You know, we're running six and seven days a week.
At the same time, once you get into six and seven days a week, you're not maintaining your equipment the way you should. Your people burn out. At the same time, you have quality issues and scrap issues and premium freight issues, and that's exactly what we experienced at a few of these Powder Metal, Metal Forming facilities. And we're highly confident to get the issue resolved. We put a chart together that we covered in our earnings call, saying that most of these issues would be behind us by the end of the Q3, but some of it would carry over into the Q1 of next year. But we're confident that we can get it contained within that. And, you know, we're unloading the facilities where it makes sense and reloading other plants where we do have labor.
We're making permanent structural changes where we're, you know, doing plant loading, and we're looking at automation and robotics where it makes sense as we go forward. And that's not just at the troubled plants, that's across the board now, because we think this labor issue is going to continue to fester for a period of time.
How much of the solution is just higher wages? I mean, wages are going up regardless, but how much of it is just, you know, you just have to flow through more, more to your labor base?
Well, that's obviously part of it as well, and we've done that. You know, throughout the year, we've been increasing our wages and our benefits in order to attract it. You know, providing signing bonuses or even recommendation bonuses to our personnel in order to attract talent to the organization. But at the same time, you have to have a desire and ambition to work, too.
One more on what we were seeing in the Q3, and I think back to... it was the late 2018 timeframe, there were a number of operational issues as well that you worked your way through. So maybe you could just talk about, you know, in the past, the company's ability to tackle when there are operational challenges, to put out a roadmap and get through it. Just how are you leveraging that in terms of getting smoother operations? Because the labor availability issue, that seems to be the larger one, but there are a number of other one-off issues that seem to pop up in the Q3 as well.
Mm-hmm. Yeah, I mean, we're essentially using a similar playbook that we did in 2018. If you remember, we acquired MPG in 2017. We inherited some launch problems. We were very transparent with the investment committee in regards to what those launch problems were. We identified the corrective action plan to address the issues and the timetable to do that. We're doing that exact same thing here with the Metal Forming plants. And like I said, we're highly confident that we can put these issues, you know, to bed and resolve. I mean, those that know AAM and have followed AAM know that we're known for our operational excellence and our performance. That's one of our differentiating features as a company.
So it's very unusual for us to have to call out the issue we did in the Q3, but we experienced it, and as always, if we have an issue or a mistake, we highlight it, but we also tell you what we're doing to fix the issue, and we're not trying to hide behind it.
Right.
So...
Let's pivot to maybe some of the considerations on 2024. And I wanted to start with maybe you can give us some comments on what you're hearing on T1 schedules. You know, I think most of us assume, even though GM volumes may be up, that could be closer to flat, potentially down. How are you planning for that?
Yeah. Today, if you think about looking, using some, I'll call it, third-party providers of volume projections, you'll see year-over-year it's flat. Generally speaking, you know, obviously, we're very bullish on that platform. We believe there's strong demand for that platform, especially all three segments of that platform. The full-size SUV, which, you know, is running red-hot, low days of inventory on hand. The heavy-duty sub-segment of that platform continues to be in high demand, not a lot of inventory, and the light duty is sort of transitioned now to, it appears to us, anyway, the inventory levels at once, and still good demand for that vehicle. So we felt that way here in 2023. We could see that same level of demand and interest for that platform next year in 2024.
Great. Let's unpack some of the other drivers. FX, you actually held in fairly well on not seeing transactional headwinds this year. You know, you have hedges in place.
Correct.
Explain to us the dynamics of these hedges, at what point they expire. You know, can we maybe frame the magnitude of potential headwinds we could be seeing?
Sure. I think when you refer to FX, the largest impact from a cost element for us on FX is the Mexican peso. As you know, we have large operations in Mexico. We consume somewhere between MXN 5 billion-MXN 6 billion a year. We are on a 3-year rolling hedge program, so if you think about the next 12 months, we typically have anywhere from 70%-80% of that hedged. But really, over the last, I would call it nine months, the peso has strengthened in a meaningful fashion, right? It was 20X about a year ago from a conversion rate. It's closer to 17 today.
We did benefit, obviously, from our hedge protection through the course of 2023, but inside, if you look even inside our Q3, the drag of the peso versus the prior year, where it was running 20+ from a FX rate conversion, was $5 -10 million. So you're starting to see that impact settle in on us here in the back half of 2023. If it remains flat from here on out, you know, you'll continue to have some year-over-year pressure in the H1 of next year as it relates to the peso FX, and then it'll settle into sort of the run rates you see here in the back half of this year.
Great. Is there a way to frame the amount of labor inflation that you're gonna have? And just, you know, how should we think about, given the timing and structure of your labor agreements, the path to those costs increasing? I assume it's gonna be on a rolling basis over the next couple of years.
Yeah, that's, that's a fair way to think about it. But just for context, if you think about our cost of sales, 60% of our cost of sales is associated with material purchases from our supply base, about 5%-10% is D&A. The balance of the two is split between other overhead elements, you know, tooling, coolants, things of that nature, and then labor and benefits are that other piece. So that's really where when you talk about inflation from a labor perspective, where that cost-- that inflation would, would center into. For our UAW contracts or union contracts inside the U.S. they're in place today. They start to renew and expire in 25 and 26, with the larger one being in 26.
But as David mentioned in some of his comments a few moments ago, we've been giving some wage increases around the board to continue to attract and retain labor. Labor inflation is real, and we'll continue to work our way through dealing with that to make sure we have labor availability inside of our facilities, and obviously, productivity to help mitigate some of those costs as well. But again, next contracts are really about two years out.
There's no master agreement like we see-
No master agreement. No, we eliminated the master agreement in our labor negotiations in 2008, and for those, again, that have followed us, know that we had an 87-day work stoppage in 2008 with the UAW, 'cause we needed a market competitive Tier 1 supplier agreement, not an OEM agreement, which is what we had at the time. And ultimately, we, we achieved that market competitive agreement. Each of our plants are now on a standalone independent agreement. All those plants are staggered in regards to their contract durations. And then we also look to backup supply capabilities across our enterprise.
Great. We could just wrap one on inflation, and maybe we could just talk about the broader cost recovery environment, right? And I think the question is, automakers, and we just see Ford, the D3 are each absorbing at least $2 billion of incremental costs off of labor over the next handful of years now. EVs are a challenge. Pricing, you know, is probably going to be a headwind. What is the recovery environment or the tone and tenor of discussions you're having? Is it incrementally tougher, or is the answer it's always tough, and it never changes?
Well, it's always tough, but you know, if you compare last year to this year, last year we had much better success earlier in the process at a lower level in the negotiations, meaning lower level in the organization to deal with. This year, you know, with the European and the Asians, we've worked our way through the majority of those issues. Our biggest challenge has really been with the Detroit Three, and clearly a lot of it stemmed around where they were from a labor negotiation standpoint and just trying to curtail costs. We're making you know, we're having you know, meaningful discussions with them. We're making progress there, but we don't have it completed yet. We called that out in our Q3 earnings call, but we expect to address that here in the Q3.
Are there any other discrete costs on the inflationary side that you would call out? Anything that's normalizing, that's getting a little better?
Well, you know, we saw through the course of this year, utilities get better, right? That was a very, significant cost for us last year, early part of this year, and has gotten better through the course of this year. But from an inflation standpoint, you know, labor is sticky. That's gonna continue around. You know, we have seen metal market indices. These are our pass-through mechanisms, which are also align a little bit with inflation, but also some commodity pricing. Those have come down, since last year, though they seem to be sort of plateauing and stabilizing. And we probably have a little residual pressure yet from our supply base that we have to work through, but that is starting to come down a little bit as well, as some of these other cost pressures are coming down on our suppliers.
I'd say some of the freight and logistics costs-
Yeah.
Have come down as well, along with the energy side.
Yeah. Can you just remind us of the dynamics on metal markets, just given, I believe your steel purchases are partially indexed, partially annual buys?
Correct.
You know, how do we net out... You know, steel has been erratic, and how do we net out, like, where we stand today, how that could impact you next year?
Yeah. So the cost structure for our steel and other elements inside of our purchase buy as well, that are generally metal-based, really come in the form of two fashions. Number one, there's an index component. So, think of the ingredients used to make steel, for an example, right? You have. They melt down scrap. You have nickel, moly. We buy aluminum, things of that nature, are traded on exchanges. The prices change every 30, 60, 90 days. The change in those prices, we have arrangements with our supply base to compensate them for, and generally, a back-to-back arrangement with our customers to pass any of that commodity-like exposure up through the chain or any price decreases as it goes down, also up through the chain. We retain about 80%-90% of that transaction, whether either favorable or unfavorable, depending on the price change.
As it relates to base costs, where we are in negotiation with our supplier for what the base cost of that component would be to purchase, whether it be a pound of steel or other, other structural component that we buy, generally, are on annual or biannual contracts, and those come up for renewal from time to time. A lot of our steel contracts will be coming up here in 2024, and we're working through those now. You know, and they face some of the challenges that we have, but obviously, it's a, a robust negotiation with the supply base.
For those of us who are less in tune with SBQ versus-
Yeah.
hot-rolled coil steel
Correct.
- any differences to highlight?
No, I mean, hot roll seems to bounce around a lot more, and you see that traded, and obviously, the rate for hot roll moves around. We don't have that level of exposure. SBQ, we're also one of the largest buyers in the world, frankly, for that component, so we have some leveraging elements there from a buying power. But it's really the commodities that go into that SBQ that drives a lot of the price up and down that we pass through in the metal market mechanisms.
... Great. Let's pivot to the EV slowdown, because I think that's been the central theme that's been in discussion. You've laid out a plan to, you know, transition your portfolio. A year ago at CES, there was a very attractive play. You're going to be at CES again this year?
Mm-hmm.
We'll make sure you can plug your, your presence there. How has this shift in environment changed the way that you're approaching your portfolio, or has it not?
Curiously, it really hasn't. I mean, we never totally believed what some of the prognosticators were saying in regards to the adoption rates of electrification over the period of time. They were saying 40% in the US by 2030. We obviously have to have a plan in case it does happen, but we also have a plan if it doesn't. Now, I think the rubber's hitting the road, and reality is starting to settle in, that things are being pushed out or delayed, especially because the labor negotiations that cost the OEMs a lot of money. They can't fund everything they wanted to do in the past. What we've always said is that we want to be agnostic to the market. You know, we've got a full portfolio for ICE products.
We have a full portfolio for hybrid products. We're developing that portfolio right now for electrification. We've been in the electrification business, making electric axles since the 2017 period of time, but we got into the electrification business in 2010, but the market just wasn't ready yet. Like I said, we've been making products since 2017 for the Jaguar I-PACE. We make the front and rear axles there. We're doing work for Mercedes and AMG on multiple variants for their portfolio. We're doing a lot of work in China today. It was really the U.S. market, the North American market, that was lagging behind. That's our biggest market, and obviously, we're going to do what we need to do to procure. A big win for us was Stellantis, so that's very encouraging.
For us, it's also proved our capability and our relevancy and our technology there. Each quarter thereafter, we've announced other wins, both in the component form or sub-assembly form, I think of like differentials, gearbox form, but also in the electric drive unit and the e-Beam form. And we've picked up work in India, we've picked up work in China here in the second and Q3, and we're quoting on $1.5 billion of new and incremental business. Now, our concern is that how much of that, you know, $1.5 billion that we're quoting today, of which about 75%-80% is electrification-based, how much of that's going to slide out because of the retiming of the programs that are going on?
That might impact us a little bit in regards to our win rate and the timing of that win rate, but we're going to, you know, historically deliver. We're going to deliver what we historically have won before in the past on those. I mean, the big thing for us is just we're going to continue our R&D to get our portfolio where it needs to be, so that when the market does ultimately, you know, move faster towards electrification, that we have the products ready to support it. But we're a big believer in electrification. We've been making investments, like I said, since 2010. We're going to continue to make investments in that area there.
It's just we thought the adoption rate would be low or slower than what was being originally communicated and forecasted by many and accepted by many, and like I said, I think reality is really setting in.
The core of your business, your driveline exposure on T1XX trucks, Ram HD, I assume that's perfectly intact, and to the extent that tail is extended, that's great news for you, yes?
A- absolutely.
Absolutely.
I mean, EVs make up probably less than 2% of our business today. We're a very strong ICE producer. We generate strong cash flow from our business, strong EBITDA margins, you know, top quartile. For the business, the longer ICE stays, the greater cash generation we can realize, the more optionality we have to strengthen our balance sheet, fund additional electrification growth, and fund additional profitability growth, you know, both on the ICE side and on the EV side.
Over the last year or two, you may have noticed, we've made announcements that we have secured the next generation of some of our most critical ICE programs, and I think the value of that will continue to shine for many, many years to come.
Yeah. I mean, if you go back and look at what our priorities are, and we've been very consistent on this, is, one, we want to secure our next generation business. Majority of that's done. We got a couple programs that we're working on, but we expect that'll be done in the, let's say, the next couple of quarters. So we're hopeful to get that done. We want to make sure that we're optimizing our business to generate cash from the business. We're doing that. We continue to generate positive free cash flow every year for the last 10+ years. We're using that cash flow to pay down debt. We've paid over $1.4 billion in the last five years, paying it down just to strengthen our balance sheet.
We've overcome Murphy along the way, or a lot of adversity, between the GM strike in 2019 and then COVID, and then the semiconductors and the other issues that we're all dealing with. Meanwhile, we've been spending $35 -40 million a quarter on R&D, with the majority of that being dedicated towards electrification. All those priorities are really set so that we can ultimately position ourselves for profitable growth, both on the ICE side and the EV. But there's really two things that are the boss: our customers and the market. And right now, the consumer is really speaking, that they're not fully ready for the EV at the rate that the government would like to, you know, politicize it or try to drive it to. And the OEMs now are having to respond because ultimately, when it's all said and done, the consumer's the boss.
If we could double-click on the Stellantis e-Beam axle-
Mm-hmm
... win. You know, I think most people would probably say that's probably the, the most impressive-
Mm
- win, the best proof point you have on the electrification side. You know, well, you haven't said which vehicles, but we can imagine which one they are, and you've said content is, like, 2,500 plus, plus, I think, has been the-
Yeah, plus, plus, plus.
A lot of pluses. So what led you to that win? And maybe, you know, as a follow-up, if some of the automakers are maybe pulling back on some of their efforts on volume, and this changes the dynamic around vertical integration and how the math works, are you seeing any more increased conversations with automakers that would have otherwise insourced and say, "Okay, maybe it doesn't make as much sense now?
I think it's too early to answer that question just now. I mean, what I would say is this, is that clearly, every OEM is going to have to go back and re-evaluate their electrification strategies. As far as the timing, the amount of money they're going to spend, both from an R&D standpoint and from a CapEx standpoint. At the same time, they're also going to have to go out and re-evaluate their make-buy strategies. And when they have reputable companies like ourselves and other qualified suppliers in the marketplace, they're going to find the right balance that's good for them, while at the same time being supportive of their partners. And, you know, we've got excellent relationships with all of our customers. Our largest customers are the Detroit Three. You know, obviously, they've got some big decisions to make.
Their cost structure just got a lot more expensive with these negotiations. Clearly, there's a cascading effect, so we'll all feel a little bit of that, but we won't feel the magnitude that they're feeling. But with that, we're going to continue to, you know, invest in electrification. Really, what differentiated us in regards to our portfolio was our engineering, creativity, and innovation is outstanding. And we're, you know, we always are known for our operational excellence, but we also have tremendous technology leadership, and we deliver, you know, quality, excellent quality products on time, every time.
So, you know, we feel really good about where we are, and like you said earlier, the delay in electrification is only going to benefit American Axle as far as stronger cash generation, profitability, and, and performance, while allowing us, you know, more time to develop the portfolio on EV.
Okay. Well, I want to wrap with, with a couple more questions on, on, you know, one on EV spend and another just on cash and, and the balance sheet. EV spend, you're running at $35 -40 million.
A quarter.
A quarter.
A quarter.
Just remind us, how much of that is sort of hard spend that you have to do on future product development versus application engineering that's going to vary depending on the timing of programs? So, to what extent should we, if things slow down, will we see you pull back on some of the spend?
Yeah, keep in mind, a piece of that spend is still to support our internal combustion engine business, right? Because that still continues to grow for us, and we also have launches coming up. But think about, you know, probably 50%-60% of that is sort of base spend, where you are in current programs that you're supporting or getting ready to launch future support. And then, you have the balance of that's really building out our new electrification programs and supporting some new electrification program quotations coming at us. That's how I would think about it from an R&D spend perspective.
And then, just final on cash flow and the balance sheet.
Mm-hmm.
Maybe you can give a comment on CapEx, which has, it's been running at roughly 3% of sales, which is, like, really low, below what you've done historically. You know, and it seems like spend pushed out, but maybe there's something structural here. Can you just talk about what's happening on the CapEx side? And then, maybe, you know, an update on the path to get to 2 times and how the capital allocation evolves.
Yeah, the past couple of years, we spent closer to 3%. You know, as you know, previously, we've been spending much higher than that to launch programs. But we put in, several years ago, a very conscious effort to reduce our CapEx spend, and attacked it from many different ways: reuse the capital, redeployment of capital. We continue those themes. But as you know, CapEx also ebbs and flows with program launches. So as we have program launches, that will also increase, potentially, if there are large programs coming at us. But our goal here, I would tell you, in the near to midterm, would be keep our CapEx number at 5% of sales or less.
You may have a period of time, if you get a compressed year or so or 18-month period, where you're launching a lot of new programs, you could have a spike over that. But that means you're launching big, new programs, so which, of course, in from our view, would be a good thing. So, I mean, that's sort of how we're thinking about CapEx. I think we got a good control over that. It'll be subject to programs going forward. That's sort of our line of sight going forward.
Yeah. But, but we're going to spend 1-1.5% minimum every year just on maintenance capital. At the same time, you know, when, when we historically, we spent 4%-6% for legacy AAM business. When we took over MPG in 2017, they were in the midst of some major launches as well, so that CapEx, as a percentage of the sales, swelled up to 6%-8%. But to your point, and Chris's comment, you know, we've been able to bring that down to that, you know, around 3%. But, but as we launch electrification programs and some of this replacement next-generation ICE business, the capital demand isn't as great on the ICE, but there's still some changes because of horsepower and torque and engineering changes that take place, that we need to be able to fund and support.
But as Chris said, we made a conscious effort to bring that down and keep it at a disciplined level. And we're reusing a lot of capital where we can, but the majority of our ICE capacity is in place and was only going to come down, you know, as EV penetration increased. Now, as EV penetration goes out a little bit longer, it's just going to drive a little bit more maintenance capital for us, but it's not going to be the big program capital until we really get to the electrification programs. And even then, we're going to try to use as much as we can from ICE to EV, but there's select components, and even some assembly, that we'll have to put in specialized capital to support the EV requirements.
Great.
Great.
We're going to cut it off here.
Great, appreciate it.
Thank you.
Okay.
Chris, David, thank you so much.
Yeah.
Very insightful.
Appreciate it.
And look what, CES, do you want to give a one-second plug to CES?
Well, go ahead. Oh, we'll be at the CES show here early in January. Come stop by our booth. I think you'll see a lot of these great technologies that we've been talking about. You've got some thoughts and questions on our technologies, we'll be happy to answer anything on your mind and, of course, walk you through and so you can touch and feel some of this stuff.
Thank you.
It'll be a great show.
Great.
Great. Thank you.