Okay, good morning, everyone. We're very happy to have the management of PHINIA participating in the 22nd Best Ideas Conference at CL King. I'm David Silver. I'm Director of Research, Equity Research Analyst here. And you know, we'll be having a 35-minute Fireside Chat. Just to comment about the format, I am gonna turn it over to Brady and Chris for some opening remarks, and then I will pose a series of questions. If you do wanna ask a question, please use the box on your webpage. Alternatively, if you prefer anonymity, you can send me an email with the question. My email address is dsilver@clking.com. So that's D-S-I-L-V-E-R at C-L-K-I-N-G.com. Okay, with that, I'm gonna turn the floor over to the management of PHINIA for their opening remarks.
Brady and Chris, take it away.
Great! Thanks, David, and thanks for having us, and thanks for joining the call. It's our pleasure to introduce you or share some information on PHINIA. We're just over a year old now from being spun off from our former parent, and although we're relatively new as an independent company, we have over a hundred-year history of being in the industry and a very seasoned leadership team. We're focused on two main segments, our fuel system segment that provides, you know, fuel injectors, rails, high-pressure pumps for both Light Vehicle, Commercial Vehicle, Industrial, and Off-Highway applications across a variety of fuel types, including gasoline, diesel, biodiesel, ethanol, hydrogen, and such.
That's fully supported also by our Aftermarket segment that does both our independent Aftermarket and services, as well as our starters and alternators under the Delco Remy brand for both OE and Aftermarket Systems. We have a global footprint, and so we're able to design, develop, source, manufacture, and produce, and sell to our customers in the region where they need it. That allows us to really have a very adaptable organization that's very, very close to our customers to meet their specific needs without the need to have to ship product all around the world.
About 44 locations across 20 different countries and over 13,000 employees that are then supported by our brands that are hopefully recognizable, including the Delphi brand, the Delco Remy brand, and the Hartridge brand on top of the PHINIA organization as the parent company. So that's kind of a quick intro for us on PHINIA. So, Chris, anything to add?
No, I think you, Brady, pretty much covered it. As he said, there are two segments that we have that we're very proud of. They're very complementary segments, especially when you're looking at an automotive and Industrial landscape. The automotive is certainly a good balance to the entire portfolio of product, but I think Brady hit most all of it.
Okay, great. Thank you for that. So first question, I call this kind of a report card on your spinoff, maybe look back, look forward a little bit. But Brady and Chris, you know, your company was spun out by your parent, BorgWarner, just over a year ago on July 3rd, 2023, and I really like that you gained your, quote-unquote, independence one day before the 4th of July. But you know, unlike some recent spinoffs that I've looked at, I mean, your company already had in place experienced management with intimate knowledge of your products, markets, and technologies, a large core of profitable revenues, a clear business focus, you know, and other positives.
I personally think many of those strengths, plus maybe some underestimation by investors, have contributed to your very strong stock performance to date amongst the best of any domestic auto sector stock for the relevant time period. So, if you just discuss your top two or four, two to four priorities upon spinoff, what would you cite amongst them as being largely completed or successful? What areas has progress been somewhat slower? And, you know, how successful do you think you've been in establishing that separate corporate culture at PHINIA that's distinct maybe from that of your former parent?
Sure. Yeah, I think probably the most important thing for us was to make the transition from the former parent as smooth and seamless for our customers and our employees as possible. So in the last 12 months, we still had to transition, I think it was a 150 different transitional services agreements from cash management to IT systems, product line systems. We're very proud that over the last, you know, 12 months, we're now completely, fully independent from all services and support from our former parent, and are fully independent from an operational standpoint as well, from all material contracts. There's still a little bit left, and we're doing some services for them.
But all of our plants are pretty much all independent now at the year, gonna be at the end of Q3. And so that went extremely, extremely smooth, where customers, you know, really didn't even notice a difference with that transition. So that was kind of number one. I think number two was to deliver strong quarterly performance, 'cause as you mentioned, I think the original expectation was, "Hey, there's something hidden. These guys are gonna spin out, and they're gonna go down." And what I think the team has been able to deliver with that independence is deliver on all our commitments, but also deliver four strong quarters that I think have given investors confidence now that we're good stewards of their capital, that we're gonna invest it wisely.
And our performance makes sense as the market continues to soften a little bit. We're managing the downturn as well. I think from a challenge, yeah, you know, we'd hope the market was a little bit stronger out there right now. We have both the CV and Industrial markets are down on a year-over-year basis, and Light Vehicle is coming in softer than originally expected. But, you know, I think the team is continuing to manage, you know, that softness well and ensuring that our downside conversions are kind of within reason.
I think we are still continuing to work on messaging to investors, in the fact that I still think the predominant following that we have are Light Vehicle OE-focused investors at this point, 'cause they just assumed that we were a smaller version of BorgWarner, but as we continue to get that messaging out there, I think they're realizing the benefits of our large Aftermarket and our CV and Industrial exposure, and the fact that Light Vehicle OE only makes up 44% of our revenues, and so I think that was... Still, people are kinda digesting it. They're still saying, "Well, Light Vehicle OE is still your biggest segment right now," but we don't see it being our largest segment kind of longer term. We continue to see opportunities in that area, but we see growth...
Our growth, focus is gonna be more CV Industrial and Aftermarket-focused.
I'll just add on to some of the things Brady said, 'cause yeah, definitely the LV focus, but the other one was we wanted to change our focus and our employees' focus from being a totally P&L-based focus for bonuses and how they were assessing things in the business to an EV base. A return on invested capital and then making sure, I mean, even prior to BorgWarner, we were measuring all of our new programs, any new processes or anything else against an ROIC, but we wanted to move that even to our bonuses.
So we changed the entire bonus structure so that not only is the management team's bonus structure based on economic value and cash flow, but it goes all the way down to our operating units, so that we're all saying the same thing and doing the same thing and kind of rowing in the same direction. The other thing is, you know, the things that have been slower for us than we really wanted it to be was when we spun out, we spun out with some debt that had some interest rates and covenants that were not entirely favorable, and some of that had to do with the timing of the spin and just trying to get everything done. And so we changed up, and we did a bond issuance, a secured bond issuance that was announced in April.
That got us part of the step or part of the way, and then we just finished up another bond issuance that's unsecured, and that was announced last week, and so that was the second piece of it, so we corrected the covenants that were a little bit unfavorable, interest rates that were a little high, so we just had to redo the whole structure. That took us longer than we sort of expected to do, but I think we're pretty happy with where we're sitting right now, and then the last item for me was, you know, because we came out and everybody thought of us as a Light Vehicle and a smaller version of BorgWarner, which we're really not. I think it's taken us longer to pick up analyst coverage to get our story out there.
So that's been a little bit of a journey that, you know, we've been working through, but we're getting there.
So you're saying you're that rare company that's looking for additional sell side coverage instead of complaining you have too much?
Well-
Or at least that-
You know. Yeah.
I'm sorry, I had to jump on that.
Yeah.
Sorry. Next question, I'd like you maybe to, you know, walk through the fuel systems market outlook, and I'll stipulate you could probably spend the entire session here talking about this, but maybe if we could kind of break it up. But as a leading global supplier of fuel injection systems for mainly ICE or internal combustion engines, you know, your demand outlook is sensitive to a range of both cyclical and secular factors. At the risk of oversimplifying things, you know, your current demand environment reflects potential negative impacts from weaker near-term vehicle production and sales forecasts, but also potential incremental positive impacts from a slowdown and maybe a rethinking in the pace of the EV transition.
So I'll break up these questions, but the first one, you know, how does PHINIA assess the overall demand environment for its major products? Could you share your thoughts on both the Commercial Vehicle outlook vs Light Vehicles, also for both your OEM markets and Aftermarket?
... Sure. I think the first is longer term, as you kind of highlighted, both the CV Industrial and Light Vehicle markets are cyclical, and will kind of go up and down, but the nice thing about it, it is balanced with our Aftermarket business. And so as the OE is down, our Aftermarket tends to kind of pick up a little bit. So it gives us a little bit better balance than most of our peers. As we break down the fuel systems group, I'll break it up into a couple different chunks. The Light Vehicle OE business that we have, although hybrids are good news for us, extending the use of hybrids is great. I think it's just become rather than a tailwind, it's less of a headwind.
And so we do still see EV penetration rates continue to decline, you know, throughout the decade. But it may slow down and plateau at 30% rather than 40% or 50% that people were expecting before. And so it's a little bit less of a headwind. Overall objective for the Light Vehicle side is that we'll continue to invest in the technology to ensure that we can continue to win new business and gain market share to offset those declines due to EV penetration rates, even if they are slowing. EV penetration rates are still increasing. And so our goal is to keep our Light Vehicle OE business at roughly that $1.5-$1.6 billion level.
And so our goal there is to continue to pick up share to allow us to keep those plants full and generating a strong amount of cash flow from those assets without, you know, expanding capacity in Light Vehicle, you know, that Light Vehicle OE business. We've also been in the process of transitioning some of the excess capacity that we did have into the Commercial Vehicle and Industrial space. As an example, some of the Light Vehicle lines that we had, we've already converted them to hydrogen for Off-Highway applications using the same human capital as well as equipment. And we've also converted one of our gasoline GDI lines to diesel for Off-Highway applications that was just recently announced for our customer, Kohler.
It's kind of a low pressure, fully electronic direct injection diesel system, but at a much lower pressure, and therefore at a much lower cost than our high pressure, diesel direct injection systems. That's really helping them significantly improve fuel economy, fuel efficiency, as well as reduce emissions for Tier 4 emissions. That's where, that's what I then kind of lead into, is that's where on the CV Industrial and Off-Highway applications, we actually see good, strong growth with increasing content per vehicle, as well as, you know, just a good solid market over the next few decades. The CV and Industrial and Off-Highway markets aren't going to be affected by EV penetration rates to the effect of Light Vehicle.
We do see some EV penetration, but it's going to be more, you know, fork trucks, bus applications, school buses, and those are applications that we generally don't have a large exposure to. We're primarily more medium, heavy duty on highway trucking, and we're starting to increase our exposure into the Industrial and Off-Highway applications. By adding those markets to our focus, that should actually add significantly to our total addressable market and give us opportunity to grow on the CV side.
Okay, great. And just, you, you did touch on some of these, but some of these points, but just drilling down on a couple of subsectors now. But can you just discuss the opportunities for PHINIA in plug-in hybrid electric vehicles? And also, you know, the world, all the world isn't converting to EV just yet, but also, you know, the opportunity in GDI or gasoline direct injection engines that, you know, are replacing port fuel injection systems in certain regional markets.
Yeah, I mean, on the port fuel side, our exposure there is relatively low, primarily some legacy products still in China. As they convert from port fuel injection to gasoline direct injection, we see the average content that we can supply just for the fuel systems without the ECU going from maybe $40 a vehicle to $110-$120 per vehicle for a typical 4-cylinder application. Most of the new engines being developed, a lot of them are GDI, because they're trying to drive as much fuel efficiency and performance, and it's more some of the legacy applications that are still using port fuel injection. Whether it's a plug-in hybrid or just a standard combustion with a direct injection, the content is the same for us.
So for us, whether it's a plug-in hybrid or just a standard hybrid or just a GDI combustion engine, the content itself is about the same. And so as we see more hybrids and plug-in hybrids, that's good news for us as well, 'cause a lot of them, or probably about 65%-70% of those are direct injection applications, which is good business for us. And that was a few of the announcements that we had recently for a Chinese OEM using our GDI system for their plug-in EV application. We'll see that also in some of the range-extending EVs. And so we see some good opportunities there. So for us, both plug-in hybrid range-extending EVs is good for our GDI business and good for the combustion engine long term.
... Okay, great, and then one more. What is a realistic time frame and maybe a market opportunity for your fuel systems for use in either, you know, carbon neutral or ethanol fueled vehicles, as well as carbon-free or hydrogen-based application?
Sure. I mean, what's great about our transition is that it's the same human capital, our engineers that we have on diesel, are the same ones that can then rotate over to gasoline, are the same ones that have developed and we're launching our first E100 application in Brazil. A 100% ethanol, which would be considered a carbon-neutral tech fuel. And we've actually converted a port fuel injection line and a GDI line over to hydrogen for Off-Highway applications as well. And so we've got a full range of fuels, whether it's dual fuels with diesel and hydrogen, to natural gas, to ethanol, to methanol, biodiesels, gasoline, and full diesel.
So from our perspective, we can adapt our product, both our equipment, as well as our engineers, to adapt to wherever the needs may be in the industry. And as you mentioned, different regions of the world are going with different strategies, so there's not gonna be a one-size-fits-all. So you have to have the flexibility to adapt to where the customers are going and what those markets are demanding.
Okay, great. I have a question here kind of in two parts, but it's kind of gonna be the competitive landscape. So, assuming that the EV share of the total vehicle markets that you compete in continues to grow, albeit maybe at a somewhat slower pace than previously forecast, it's likely that PHINIA would need to raise its market share of the fuel injector systems market in order to maintain its revenue and profit trends. Could you share your views about the competitive landscape for your major products? Is the overall market consolidating as smaller or less committed competitors exit? What are your general expectations for market share gains over, let's say, the next two to three years, both for OEM and if relevant, the Aftermarket?
What, you know, in this kind of market, what tends to be the main value proposition PHINIA can offer to attract, you know, the new customers and, you know, in, I guess, in the recent or the current, you know, competitive environment?
Okay, great. I think we'll start with the overall competitive environment. As you know, both the OEMs and many suppliers have been going down a path of exiting combustion as best they can, so the first and easiest one was those players that had 1, 2, 5% market share said, "Hey, it doesn't make sense for them to continue to be in it," so they've been exiting the market on a consistent basis, whether it's the smaller players, the older technology that says, "Hey, we're gonna reallocate our technology or our R&D dollars to other areas," and they've been slowly kind of exiting, some have even been selling off and closing plants, so that's kind of one side of it. Then there's two. What I see is we have two major competitors.
One is Bosch on the Light Vehicle side that has over 50% of the market share. So as the consolidation occurs, many OEMs don't wanna consolidate down to them because they already have a more than dominant share, and they wanna have some greater diversity. The second largest player is Denso, and Denso is primarily supporting the Japanese OEMs on the Light Vehicle side. And they've already announced that, hey, they're not gonna be developing the next generation GDI technology for Light Vehicle. And so, and they're not really looking for additional business. So from our perspective, you know, we've been able to gain market share over the last few years, and maybe about a point and a 1/2 a year.
And we've got good visibility on that continuing through the rest of this decade in order to support our strategy of continuing to gain market share to offset any market dynamics. And as you know, you know, we have good visibility in the fact that we're gonna be awarded a program today, that's probably not gonna launch until eighteen to twenty-four months from now, depending on which region it is from. And it's gonna have a length of anywhere from four to six years long. So we have a good visibility of what the new programs that we've been awarded and how we've been able to gain market share. And so we've had a kind of a win rate on incumbent programs, so the carryover programs that we're already on, you know, north of 95%.
We've been winning conquest business against some of our top competitors and our smaller competitors at over 50%. And so that gives us a very good indication that we'll be able to continue to gain market share. Do we get an RFQ on every single application? No. Which is why we're not going towards 50% market share. We've got pretty good visibility on how we're gonna be able to support growing our Light Vehicle market share from the low teens earlier in the decade to now we're in the mid-teens and then trending towards, you know, 20%+ by the end of the decade.
And we think by doing so, that will allow us to keep our Light Vehicle fuel systems business around that $1.5-$1.6 billion number. From a value proposition standpoint, customers are still driving for fuel efficiency improvements and cost improvements. And if some tier one supplier stop developing next generation technology, that's gonna put them at a competitive disadvantage. One great example of that is the 500 bar technology that we just launched in China with the Chinese OEM at Changan, and we've been announcing several new wins with customers against our competition with that 500 bar technology, because it actually not only is it better performing for them, but it allows them to reduce the gasoline particulate filter, which saves them a tremendous amount of money.
So even though they pay a little bit more for the five hundred bar technology, they're actually saving money on the after-treatment side, and that's a good value proposition for us to win vs our competition.
You know, I'll just make a comment, but one advantage of spinning out in a market that you serve is that you don't have to convince your customers about your commitment, right?
Yeah. Absolutely, and believe me, I think that's a great point. A lot of them really appreciate our focus. They know that we're not spinning our combustion business to support electrification. And there's a lot of companies that they've got their feet in two buckets, and so in order for them to continue to meet their financial numbers, they have to. They're starving one to feed the other. And it's only a matter of time, that's similar to what I mentioned on Denso, they're starving their combustion side to make sure they're investing in autonomous and infotainment and battery electrics and everything else, because those are struggling from a profitability standpoint. And so they're starving kind of their cash king, and it's only a matter of time before we can chip away at some of that and take over more of that business.
I'll risk making one other comment, but, you know, I follow. There are analogous situations in some of the electronics and electronic materials, specialty materials sectors that I follow, and I would just add speed and responsiveness tends to be dramatically better, you know, with the, quote, unquote, "with the clearly committed supplier." So, and that tends to attract, you know, a certain type of customer.
I think it also attracts a certain type of employee, 'cause now they're super excited. They know that we're all on the same team, we're all going in the same direction, and there's not this conflict between, hey, if I'm making all the money, and then all the money gets taken away from my business unit and given to somebody else to invest, as an employee, you're not exactly excited about that either. So I think the level of motivation and excitement around the organization has also gone up tremendously, which then leads to even more excitement going after customers and giving, you know, being more responsive and supportive to our customers' needs as well.
Okay, great. This next one would be maybe you have touched on this a certain amount, so maybe just we'll flesh this topic out a little more, but it would be new wins in what you consider your strategic growth markets. But during your second quarter conference call, you highlighted several new contract wins in strategic areas, including multiple types of fuel delivery modules, as well as your first full system package utilizing PHINIA's, you know, complete hardware, software, and calibration products with a leading Chinese OEM. So could you provide an overview of what comprises that full system package? What are its most important benefits to the customer in terms of energy efficiency, safety, reliability, or other factors?
Looking out, you know, a few years, what is your best estimate for, you know, the full system market opportunity, and does that opportunity break down significantly differently by vehicle type? I'll stop there. Sorry.
Sure. I think a lot of the overall system that we're talking about will start from the high pressure fuel pump, to the rail, to the injector, and so that's gonna be kind of the wet side of things, of everything that's touching the high pressure fuel. What's then added to that is the ECU or the engine control unit, which is the brains, and where all the software is on how to control that engine to make sure it runs optimally. And then the final side of it that not only do we bring the electronics that controls it, the software and how to control it, but then we're also seeing more customers outsourcing all the calibration work.
They'll actually send us their complete vehicle, and we'll have our own calibrators that they'll pay us for upfront to dial in those vehicles and optimize them for fuel efficiency at high altitudes, low altitudes, hot climates, cold climates. As the OEMs have shifted more of their resources to autonomous and electrification and infotainment, they have a lacking amount of resources on the combustion and development side. Customers are also gonna be looking to rely more on a complete system solution that they can have a turnkey solution. They have one supplier to go to that can deliver all those things and ensure they are operating at an optimal under an optimal condition. Some of that involves it, and we'll actually help them ensure that their vehicles are emission-certified, operate well under all conditions.
There's also a lot of, you know, software and protections that we can put in there for them, from a cybersecurity standpoint, and so they're really kind of outsourcing a lot of that calibration work. And so we see, if you look at our numbers, about $80-$90 million of our charges that we have to customers for that non-recurring engineering, for those calibration services, that further embeds us in their organization and makes them, you know, extremely reliant on us for a lot of those applications. So I think it really creates a very collaborative relationship with those customers, as well as a long-term relationship with those customers.
And we see that trend kind of continuing to grow, as time goes on, and we think that's gonna put us, again, in a very strong position to where we become, you know, very integral to the customers', programs and strategies.
Okay, great. And then, I'd like to ask you to maybe prioritize things a little bit, but in terms of your... You have a lot of opportunities and a lot of, you know, approaches to serving customers a little bit differently over time. But, well, in terms of newer market opportunities, what are really the top couple of, you know, things that you're prioritizing? And by that, I mean, applying, allocating cash or, manpower, or R&D or development opportunities. You know, if you could-
Yeah, again-
- Prioritize the top couple. Thank you.
Yeah, I think it's the two main areas for growth is gonna be that CV Industrial segment and their Aftermarket business. Those are the two key areas that we wanna continue to grow to a larger % of our business. As I mentioned earlier, our Light Vehicle OE, it's a key part of business, we'll continue to invest the necessary dollars in it to keep us in a market-leading position, but we're not looking to grow that substantially as a % of our business. So for us, I think some of the announcements that you've seen are gonna be on Industrial applications, like the Kohler, construction, marine. We announced our first aerospace application and continuing to win new business in that space.
And so we see, and going from, I guess, historically of people thinking of us as a Light Vehicle OE, to more a Commercial Vehicle, Industrial, Off-Highway, aviation-type component provider, that has a substantial Aftermarket, that's gonna have just staying power and good consistent cash flows for decades to come. So I think, you know, those are expanding our CV Industrial, customer exposure and portfolio, and continuing to grow our Aftermarket and distribution network.
Got it. Next question would be on capital deployment. So your company's been a consistent generator of free cash flow, including several years prior to spin-offs as well as after, and to date, you know, you've utilized that cash flow mainly to refinance your debt for your initial dividend payments, and most recently you did make some meaningful buyback. Assuming, you know, your operations perform largely as expected over the next two or three years, how should we think about your capital deployment priorities? Can you discuss maybe briefly the M&A target funnel, what types of strategic assets or technology are most interesting to you currently? I'll stop there.
Sure. I think one of the things that restricted our capital allocation policies was the Term Loan B that got refinanced in April, and so there were a lot of restrictive covenants in that. Once we got that refinanced, it really kind of opened up our ability to do share repurchases. And that's what you saw in Q2 with nearly $90 million of share repurchases on top of the, you know, $11 million of dividends that we provided back to our shareholders. The way that we're looking at, you know, going forward is we're always gonna compare what our current stock price is and our multiple to potential acquisitions. Most of the acquisitions that we're looking at are gonna be smaller in nature and in many ways what we would consider subscale.
And so it becomes a very difficult proposition to acquire somebody that we think is not as strong as we are in subscale, and pay a multiple that is higher than ours, and higher than the market is recognizing for us. And so we're gonna continue to be very conservative in the application of that capital, and if we continue to think that our share price is below fair value, we'll continue to allocate the bulk of our free cash flow to share repurchases. We're trading at roughly, you know, just over five and a half times EBITDA right now, enterprise value. You know, we can find an acquisition that is at or below that, that is interesting, that we think it will fit with our portfolio and where we can drive synergy.
It's gonna continue to expand our CV and Industrial exposure and has a nice Aftermarket part of it. Those are things that we'll look to continue to add to our portfolio. But we do want them to have a heavy Commercial Vehicle Industrial exposure, and a heavy Aftermarket exposure. And you know, so we'll continue to kind of focus on those areas, and it should also be somewhat, you know, synergistic with the rest of our capabilities from a manufacturing footprint, manufacturing capabilities, our customers, as well. So we want it to fit, and so us getting into, you know, tires, probably doesn't... Not a whole lot of synergy there. So we're gonna be looking for items that are, you know, highly engineered, precision machining, system integration capabilities, and the such that we can add value.
Okay, great. You know, with that, I do think we're a tiny bit into overtime here, or extra innings, whatever. I really wanna thank Brady and Chris for participating in our conference and especially sharing their insights and perspectives on their company and the industry they serve. With that, you know, I now... Excuse me. I also wanna thank the audience for their participation in our conference and listening in to learn more about PHINIA. With that, I'm going to call an end to the meeting. Have a great rest of the day, everybody, and a great rest of the conference. Thank you.
Thank you.