Leading off our companies is one that I am very fond of as an opportunity here. We have Garrett Motion, which is headquartered in Switzerland. It is a leading tier one light commercial and off-highway vehicle supplier, known most for its turbochargers. However, the company, I think, is best regarded as a technology company, investing in propulsion and also with a burgeoning industrial business that we will talk about. The company has 185 million shares, trading around $21 today for about a $4.1 billion equity cap, $1.1 billion of net debt for about a $5.2 billion total enterprise value. We are very fortunate to have Sean Deason, the company's CFO here, to talk about the financials, but also Nils to be able to talk about some of the technological advances that are coming from Garrett. Thank you both very much for coming, and we will kick off Q&A.
Okay. Would you like me to say some things about Garrett, or are you going to.
You know what? Yeah, let us start from a broad perspective, thinking about what Garrett has been and the transformation that you all are undertaking from a technological perspective, and what you see for the next five years, what the company is going to look like.
Sure. Garrett is known for turbocharging. Turbocharging is ultimately a technology that is derived from aerospace. We were a subsidiary of Honeywell. We have been making turbos for many, many years, over 70 years. The first turbo actually was sold to Caterpillar, so we were first and foremost a commercial vehicle company. Then turbo penetrated diesel, but more broadly diesel engines, went into passenger car diesel engines, and then to gasoline engines. We have been transforming ourselves over time in this turbo market. But again, always with the view of our aerospace roots. Over time, as the drivetrain has started to electrify, we have also created things like our E-Turbo, our E-Boosting solutions. We got into fuel cell compression over 10 years ago, developing it 15 years ago. That really started to push the envelope of our technologies and our compression technologies.
All that has led Garrett to really have five key building blocks of technology. Very, very fast, high-speed rotating machines, so we are talking about up to 300,000 RPMs, operating at temperatures of 800 degrees Fahrenheit. So, highly precise rotating machines literally turning faster than a jet engine. Along with that, electrical motors, because we had to figure out how to make an electrical motor that could turn a machine that quickly for the fuel cell compression. Along with that, we had to figure out how to control that electrical motor through the power electronics and the inverter, as well as the software. On top of that, as it relates to the fuel cell compression, we had to figure out a way to make it very efficient, and we did that with our airfoil bearing.
Again, a technology derived directly from aerospace, and we did all this at automotive scale and quality. So, when you put all that together, that leads us to what we are really, really excited about. Again, we love turbocharging. We are going to be here to make turbos until we are the last man standing. We love it, and it is great. It is a great business. It has a great cash flow profile. But taking these five building blocks and moving them into these new technologies, and Nils here is with me. He is actually our Head of Strategy, Business Development & New Technologies, so he can answer some of the more technical questions you might have.
But as we move into these new platforms and technologies, we are putting all these components together to really bring something unique as it relates to not only E-Powertrain, so propulsion, but also cooling. Okay?
That is really becoming a big theme for us, because we see a real step change in performance in providing compressors for refrigerants for the HVAC industry. That is not only for mobility, but it is also now branching into cooling needs for industrial and commercial needs. On top of that, if you take the fuel cell compression, it is basically an air compressor. We also signed a deal with Ingersoll Rand to provide industrial air compression. It is also very, very efficient. It is really, really getting a nice amount of traction for what it provides. Again, when I talk about air compression, why is it interesting? It is interesting because we are using an airfoil bearing that has no organic lubricants in it. It is floating on a cushion of air. So that provides very, very clean air in a highly efficient manner.
So it saves the end user energy at the end of the day. So that is, I think, a summary of where we are going from a technology transformation—
Yeah, no, I think—
—standpoint.
I think it's great. Talk a little bit more about the compressor business. You are going up against incumbents for whom compressors are the core business. What makes you think that you're structurally advantaged to earn that business against some of these incumbents?
I'll let Nils answer that one.
Yeah.
Sure. No, look, I think multiple aspects. I think the first and most important one is we have a different technology than several of the incumbents, but a technology that is super well-suited to these industries and the challenges everyone faces, right? If you look at data centers, but also at many other HVAC applications, Sean was also alluding to some of the air compression application, it's all about energy efficiency. If you can bring a new technology that is superior in the energy efficiency, and we're talking about a step change, right? 10% efficiency gains and more in several applications, that's a major saving. That's something that brings you a unique edge over some of the incumbent suppliers.
Now, if you combine that technology edge with the ability of Garrett to produce at automotive scale and quality, I think important in this context is to understand it is a lot of building blocks that we already have in production that we are really reconfiguring to bring about some of these new compressors. That is really where a lot of the credibility also for us, compared to some of the other players trying to enter this space, is coming from, because we can show we know how to produce these technologies, and we can be quick in also introducing them to the industry. I think that is how you can take it together, and how you see that we have a very credible play in this industry, and you have seen that from many of the announcements we have made.
We have convinced some of the industry leaders that this technology works and brings the benefits that we are talking about.
I think it is one of the core pillars of what GTX is from an investment perspective. I want to potentially go back to the industrial business later on, but let us talk about the auto industry. We have seen on a couple of my slides that we have seen a pullback, I think, in Battery Electric Vehicle adoption towards hybrids and range extenders. What does that mean for Garrett from a content per vehicle perspective? Talk about your E-Turbo as kind of a bridge technology for the next decade there.
Sure. Well, I think you are right in that there has been a pullback, in particular in the U.S., as it relates to BEV penetration, Ryan. You also said something important too in your earlier comments, which was that it is still growing. We realize that, and so we are really focused on, again, always providing a turbocharger, but also looking at applications where they are much more resilient in terms of battery- electric penetration. Think about commercial vehicles, off-highway vehicles.
Yeah.
On highway. We see that growing for the foreseeable future. Even light commercial vehicles are going to need turbocharging for the foreseeable future. The use case just isn't there. On the pure pass car business, yes, it is increasing to the extent that you're seeing more interest in hybrids to alleviate range anxiety. That's a good thing for us because hybrids tend to be a bit more turbocharged. Overall, we like the business. We like the pass car business very much, and we think the pullback makes sense, but it is still growing, to your point.
Yep.
It's not like it was a few years ago where people thought it'd be close to 40%-45% BEV pen by 2030.
Right.
We don't see it going there.
It was a much bigger topic a few years ago, but one that's going to obviously be important, and in particular important, I think, on a global basis in China. Maybe just kind of shifting to that Chinese market where we have OEMs becoming more vertically integrated on the OEM side. How do you think about investing within the Chinese auto market and avoiding becoming subscale as it relates to some of these OEMs going more vertically integrated on the powertrain?
China is a very tough market, but we are competing successfully there. We continue to win business there, both on traditional turbo ICE engines, but also on hybrid, and in particular on engines that will be used for export. What we are seeing more and more is, and this is across the board, but a lot of new Chinese companies coming in, stepping up. Traditionally, you thought of BYD, but now you are seeing companies like Seres and others, and they are looking for global partners because the Chinese companies are expanding. But most importantly, is you have to be able to compete in China, and we are successfully competing in China. It is an important part of our business, and we really feel that if you cannot, as a company, compete in China, you are going to have a really big problem in the future.
We are able to do that, and we are successfully doing it, and there is going to be more and more opportunity as these companies look to export and actually put brick and mortar down in other parts of the world.
Yeah. And maybe just to add to that—
Please.
I think the other thing that you are seeing is, especially if you look into Europe more, the Chinese are starting to realize that also the European Union will start to require more local content, right? So, they are really starting to localize more and look for global suppliers that can also support their engine programs and their vehicle builds in Europe, right? So, that is something where global suppliers like us that are successfully competing already in China and known to them in China have a particularly well or particularly good position from my point of view.
If we are thinking about the core markets within turbo, we have seen light vehicle diesel penetration drop. What are your thoughts? Gas has risen. What are your thoughts on turbo penetration and how that looks for the light vehicle market for the next several years, maybe relative to where it was a couple of years ago? If I am thinking ahead of what you are going to say, I think it is probably going to be better than what you might have otherwise been expecting, more of a flat market.
Certainly compared to a year ago.
Yeah.
That is absolutely true. As we said in our Investor Day, turbo is going to be stronger for longer.
Yep.
We still believe that we will have as much revenue from turbo sales in 2035 as we had in 2025, but the mix will be different. The mix will be different because we see lots of growth in commercial vehicles, both on and off highway, and on the industrial turbo side as well. We see that growing tremendously, as we mentioned on our last earnings call. Mainly driven right now by just the need for power, which is a macro trend. Think power generation, whether that is for backup or prime power. All those machines have turbos on them, and they are growing at a rate that is actually much, much faster than we even thought back in May when we had our Investor Day.
Which regions do you think anchor this for the long term?
I think it's going to be global, but right now, the demand really is North America and China. Europe will be right there. We see it globally.
Yeah.
Again, it's a play not just on data centers, and I want to make sure that's clear too, because data center helps, but the macro trend we're seeing, and we will continue to see, is that there is going to be a need for power. When you have that need, regardless of what the driver is, you're going to need backup power generation and prime power generation. That'll be both diesel-fired at the moment or natural gas-fired. Our product makes those engines, those very, very large machines, more efficient. That's, again, where the Garrett technological advantage comes in, and that's where we're seeing lots of pull. It's tremendous. We came out and said, "We're going to do about $230 million of revenue this year just from industrial turbo, and we'll do $300 million next year.
Oh, please, go ahead.
Just to add to that, I think what also is important in this context is the more of these generators are installed, the bigger also the aftermarket opportunity for us gets, right? Because obviously, that's long-term capital equipment that has more than one turbo over the life of these power gen sets. So, it's really building up also a nice aftermarket play for us that we are very much looking forward to.
And just to remind the audience and those on Zoom, aftermarket as a percentage of revenue is roughly?
10%, 11%.
Yeah.
Yep.
But nice.
Some of our highest- margin products.
Thinking about Garrett, I think you properly term it as a technology company that has helped you defend mid-teens EBIT margin through a lot of change, through mix shift, through cyclicality. How do you think about your ability to defend what is among the more profitable supply margins in the industry, and where do you see your ability to kind of take that as the business mix shift towards industrial continues?
Okay. One, a turbo is a technologically differentiated product. In the auto industry in particular, if you're commoditized, you're going to get single-digit margins. Really, there are two major players, that's us and BorgWarner, and then five or six other smaller companies, all of which we are, both us and Borg, are taking share of demand from. The industry is effectively consolidating as it relates to ICE turbocharging. That puts us in a very good situation because our customers can't make their own turbos. They don't know how, and it's very complex and difficult. It's taken us a long time to get to where we are, and it's not something that can be turned on. The product is not a commodity.
Even the base passenger car for the light vehicle industry, those tend to be our lower- margin products in our portfolio, but still very high margin compared to the rest of the tier one suppliers. But as you mentioned, our focus now is on further turbo applications for commercial vehicles, both on and off highway, and the industrial applications we were talking about earlier. And then that creates the aftermarket opportunity which Nils mentioned. All of that just steps up our margins. Short answer to your question, yes. As those existing traditional businesses, our core turbo business continues to grow, especially in those areas, you will see our margins gradually start to expand. As you look to the new portfolio of products, the electrified products, as we build that out, it's about getting the scale.
Because we have the equipment being installed as we speak, in some cases, to launch all of them next year in one form or another, but it's going to take time to get to the scale because that's industrial, so it doesn't scale like automotive. I think I've said in the past, post-2030, that'll then help, you'll have enough material revenue then that that should help further the margin expansion from the new category of products we're making.
Yeah. So, some launch costs, but all for the better as we get towards-
It's not so much a launch cost as it is a scale.
Yeah.
It's about getting the scale up, because the products, once we start producing them, will make very, very good margins. That'll be some of the best margin products we have, especially for some of the industrial cooling opportunities. But the volumes are lower, so it takes time.
I should remind our audience, or actually introduce the idea, we are an interactive symposium, so if you all have any questions for our management, please raise your hand, and we'll get a microphone to you. It's been one of the better parts of this conference for five decades. I want to talk about your cost structure, which I think is unique and far more variable than many give you credit for. Talk about the last couple of years and what that has taught you about your variable cost structure as far as it relates to your footprint, automation, AI usage, et cetera.
Okay, that's pretty broad, but—
Yeah.
I'll take the finance piece, and I'll let—
Start wide, and then we can narrow down.
Nils, talk about the use of AI, where we're really using it, in particular for some of our IP and our R&D. Look, we operate in the automotive industry, we know it, and it's cyclical. That's always been an issue. Very early on, I'd love to take credit for this wonderful capital structure that we have, but it was already built. I think it was that way because we were part of Honeywell. Honeywell was basically an aerospace company serving industrial customers, and they demanded a very high level of performance from an automotive division, if you will. So, how do you weather cyclicality? You make sure that you are highly variable. We do that by not having a heavy capital allocation to capital equipment. We work very closely with our suppliers. Our suppliers are doing all the casting.
When we buy inverters, we're buying the inverter, we design it, but we're not picking and placing chips. That's something someone else, or there are many other companies can do that at scale more than we can. We have about an 80% variable cost structure, whether that's regarding labor or supply base, and we're able to flex that very efficiently as the industry ebbs and flows. On top of that, we have a very nice working capital structure as well that's effectively neutral to slightly negative, which is something you really don't see. I can't think of any other company automotive sector that has something like that, where basically our customers will pay us before we pay our suppliers.
We keep our inventory extremely lean because we're basically doing all the quality- critical assembly processes, and we have several different trade secrets in our manufacturing processes, and even certain patents on manufacturing technology such as laser welding that gives us a competitive advantage.
Yep. Let's talk about tariffs. Let's talk about your ability to pass along costs. Also, let's talk about footprint. Have the last few years taught you anything that you didn't already know about where you want to have your footprint relative to where your customers are?
I think that if we talk about automotive, it really depends on what the customer wants. But in the end, we are making a product that is fairly heavy and robust, so we produce regionally and source globally. That is the way to think about how we work. But we do not necessarily need a big footprint per se, because we are doing assembly. We are not casting, we are not placing the chips and things of that nature. As our business scales and we do more larger assembly, maybe we will need some additional footprint. But for us, putting up a plant is not a big expense, and it would fit into our framework if we need to expand. The real expense is the lines.
Yep.
A lot of times with certain customers, the lines and the tooling is actually funded in part or in full by them. That is another aspect of our business. When we talk about RD&E, which we did not address regarding AI earlier, but you look at our, what you are seeing is our net R&D spend, but the reality is our gross spend is north of $220 million per year. But a lot of that we get funding for, because again, we are a technologically differentiated company, and so we are able to leverage these strengths that differentiate us from all the other supply base because we offer something that is ultimately valuable to the end customer.
I think we should probably go back to the AI question, talk about how you are incorporating it not only into your technological development, but maybe into your cost structure as well.
Yeah. On the technology side for us, it is fairly straightforward. AI is helping us tremendously, especially on the simulation side. It makes us faster, and it reduces the cost that we have for hardware tests. That is something we are very actively pursuing. It also helps us to get to more robust products, and ultimately, of course, there is the aspect of incorporating AI into some of our offerings as we move forward. That is something we are fairly actively looking into. On the overall side, on the cost structure, obviously we are implementing AI in the different elements of the business.
Probably, Sean, you want to add to that.
No, we see it across the board. Certainly, the administrative functions, whether it's legal it's finance, we see tremendous opportunity, but we're also being cautious. There's also some aspects to it that we have to understand better to make sure as we roll it out and it starts making decisions on our behalf, that we're able to monitor that and encapsulate it in the right security structure. But really, where we see a lot of excitement is the area where Nils is referring to, because it's really helping us be faster to market with new technologies, and in a more cost-effective manner. That's again, and all that comes back to staying within our financial framework, which is no more than 5% of sales spent on R&D. But again, I remind everyone, that's our net spend.
We actually have a spend that's quite a bit higher on a gross basis.
As long as someone else is willing to pay, then it certainly makes sense.
But again, that's why you have to—
Yeah.
—you have to be the technological leader. You have to be able to differentiate.
One of the areas, pursuant to that net CapEx number, one of the areas that I think Garrett doesn't get enough credit, and certainly isn't getting enough credit in its stock price now, is just your ability to generate cash. And you are industry best from really any sort of free cash flow metric. Talk about how you think about the stock now, how you balance buybacks versus dividends versus going out and being acquisitive, given all the variables that you see ahead.
Okay. I want to make one thing clear too. First and foremost, we fund the business. We are very, very comfortable with the level of investment we have for R&D and capital equipment within our framework. But the framework, again, doesn't limit us. The framework is there to ensure that we remain nimble and flexible through cycles. But we will always fund the business first, and we are going as fast as we can on every opportunity we see. But yes, as you stated, the core business throws off a tremendous amount of cash, and that's great because that allows us then to repurchase shares. And we've repurchased 44% of our stock count since Q1 of 2023. We continue to do so. We just authorized a new $250 million repurchase plan for next year.
We're on track to meet our framework this year, which is returning 75% of Adjusted Free Cash Flow to the investor base. We also have done a little bit better this year than our forecast, and so we've even repaid debt. We repaid now, with this last tranche, $100 million of term loan B this year. Our leverage ratio is in a very good place. That's just sort of how we operate. First, fund the business, but then from there, with the excess cash, we don't really want to hold it on the balance sheet. We don't think that's a very good use of that cash for our investors, and so we return it in the way we just mentioned.
If you were looking externally, which may not be something that you're all that interested in, what capabilities would be most attractive to a Garrett as you think about your end markets and your growth within the industrial area?
I think if you're talking about inorganic—
Yes.
—opportunity. First, you need a very solid organic strategy, which is, I think, something that Garrett has. We are the last man standing on turbocharging across all industries, across all different verticals. Also, we are very interested in growing commercial vehicle , and industrial, and aftermarket, and that's where we do see a lot of the growth. We see passenger, at least on core, coming down over time due to electrification. But with some of our new products, the electrified products, we see tremendous opportunity to really recast Garrett to more of an industrial play than a traditional automotive play. That, I think, is a very important aspect. Then Nils, maybe you want to say a few words.
Well, I think that the important message is that we have the capabilities that we need to really bring about that strategic execution that we're looking for in the new technologies internally, right? It is not that we are lacking capabilities in order to execute what we want to execute. I think whenever we would be looking at an inorganic, it would need to be something very, very compelling and convincing to us in terms of helping us to further accelerate and meeting our requirement of technical differentiation, so making sure that we are really remaining that technology leader.
But it is nothing where we would say we have a huge gap today in our portfolio on the technology or capability side that we need to close in order to be successful to bring about the growth that we are also committed to since the Investor Day and that we have publicly announced, right?
I would imagine too, and we spoke about it before, given where the shares are now and how they somehow got caught up in, from a negative perspective, in a data center trade over the course of the last couple of months, it is fairly attractive to be buying. Maybe the best acquisition you can make is yourself sometimes.
Yeah. Look, we were a firm believer in returning shareholder value through buybacks, and you can see it in our numbers. We have been buying back throughout the whole year.
Yeah.
At any given point this year, we felt the stock was undervalued.
Well, I concur. That bumps us up on the half hour. I want to thank you for being the first company to speak at the 50th. We have a small token of our appreciation here. Nils, thank you very much for coming as well. I look forward to seeing what Garrett has in store over the course of the next couple of years.
Excellent. Thank you.
Thank you so much for having us.