TI Fluid Systems PLC

LSE:TIFS

Earnings Call Transcript 2021-Q3

[Operator]

Hello, and welcome to the TI Fluid Systems plc Third Quarter Trading Statement Conference Call. Today's conference is being recorded. And at this time, I'd like to turn the conference over to Mr. Hans Dieltjens, CEO and President of TI Fluid Systems plc. Please go ahead, sir.

[Hans Dieltjens, CEO, President & Executive Director]

Well, good morning, everyone, and welcome to TI Fluid Systems' Third Quarter 2021 Trading Update Conference Call. I'm Hans Dieltjens, CEO and President and I'm joined today by our CFO, Ron Hundzinski. I would like to thank everyone for participating over the phone today as we all continue to deal with the travel and the health, safety protocols for all of us, given the ongoing challenges presented by the COVID-19 ongoing pandemic. I truly hope that each of you and your loved ones remain safe and healthy. And I'm confident that we are getting closer to resuming a more familiar and safer way of life and look forward to soon come to London. Now this morning, I will be taking you through the key highlights for quarter 3 of 2021 before handing to Ron, who will take you through the update and outlook. Following that, we will be happy to take your questions. But let me first comment that we continue to demonstrate the company's resilience despite these ongoing supply disruptions, the volatility in customer releases, global light vehicle production volume reductions, as you know, and the inflationary increases. So additional to the benefits arising from the restructuring program we started in 2020, we have further reinforced our structural cost adjustment program with an additional program adapting to these lower volumes and business environment. Secondly, resulting from our successful electrification strategy to a great extent allowed us to outperform the market by 500 basis points in quarter 3. We continue to target full year revenue to outperform global light vehicle production and target a high single-digit adjusted EBIT margin at or slightly above 7%, a significant improvement in adjusted EBIT margin through 2020, what was at 6.2%. These earnings will support the strong adjusted free cash flow generation seen historically. Lastly, our electrification strategy that is focused on providing lightweight and energy-efficient solutions for both refrigerant and coolant systems in electrified vehicles and the modularization of these solutions where TI Fluid Systems is perfectly placed is progressing very well with Q3 business awards, lifetime revenues exceeding EUR 230 million. The strong booking performance more than indicates the company's ability to address the changing market. With that, I will now hand the call over to Ron to highlight a few items of our Q3 2021 trading update and the outset. So Ron, please over to you.

[Ronald T. Hundzinski, CFO & Executive Director]

Thank you, Hans, and good day, everyone. As Hans mentioned, the trading conditions continue to be volatile. In spite of this, the group generated a strong level of revenue of EUR 2.180 billion in the 9 months through the end of September 2021. We continue to benefit from solid launches and fluid handling for electric vehicles. The third quarter was impacted by the volatile global vehicle production environment arising from the microchip shortage and saw global light vehicle production levels down 19.7% compared to the same period last year. Q3 last year did benefit from a production bounce back due to the COVID-19-related factory closures in Q2 of 2020. In turn, while our revenue decreased by 14.7% year-over-year at constant currency, this represented a robust outperformance of 500 basis points, as Hans mentioned. By segment, on a constant currency basis, FCS Q3 year-over-year revenue declined by 12.3%, while FTDS Q3 revenue declined by 17.7%. The impact of supply chain disruptions were seen in all major markets and revenue in the quarter declined across all regions. On a constant currency basis, European African region revenue decreased by 12.5% year-over-year, North America by 20.4% and Asia Pacific by 13.1%. Moving on to the year-to-date performance. Global light vehicle production increased by 9.5% in the 9 months through September 30, 2021, and our revenue increased by 13.7% year-over-year at a constant currency. This reflects an outperformance of 420 basis points for the 9 months of 2021. Reviewing segment revenue. FCS revenue increased by 12.8% year-over-year on a constant currency basis to EUR 1.2 billion, outperforming global light vehicle production by 330 basis points. This outperformance was primarily driven by the BEV business launches in Europe offsetting the impact of power train deemphasis in North America. FTDS revenue increased by 14.7% year-over-year on a constant currency basis to EUR 1 billion. This revenue increase outperformed the market by 520 basis points. FTDS continues to benefit from successful business launches in Europe and North America as well as a favorable mix. Looking at the regions. Europe and Africa revenue increased by 18.6% year-over-year at constant currency while European and African light vehicle production volumes increased by 6.9%, resulting in a double-digit outperformance of 1,170 points. Europe and Africa revenue was driven primarily by HEV and BEV business launches in both segments. In Asia Pacific, our revenue increased by 10.9% year-over-year on a constant currency basis and outperformed Asia Pacific light vehicle production by 30 basis points. This marginal outperformance was impacted by the aforementioned supply chain disruptions and program ramp downs in China. In North America, our revenue increased by 8.4% year-over-year on a constant currency basis and outperformed North America vehicle production by 160 basis points. This outperformance was driven by business launches and mix in FTDS. Now to the outlook. The group's performance continues to be strong and was impacted by a combination of lower production volumes and high volatility of customer releases in Q3 of 2021. It is expected that these challenges will continue for the rest of the year and into 2022. The group has undertaken a range of actions to offset these challenges. And along with the success of the group's restructuring process started in 2020, we remain confident in targeting full year 2021 revenue to outperform global light vehicle production volumes, excluding the impact of currency movements. We expect our adjusted EBIT margin to be at a high single digit at or slightly above 7% and a strong adjusted free cash flow generation rate at historic levels. Now with that, I would like to hand the call back to Hans.

[Hans Dieltjens, CEO, President & Executive Director]

Well, thank you, Ron. So with that, I would like to open the phone lines for any of your questions. So please, if you have any questions, please do come forward.

[Operator]

[Operator Instructions] We will now take our first question from Dom Convey from Numis.

[Dominic Convey, Research Analyst]

Just 2 questions, if I may. Firstly, with regard to the EUR 232 million of incremental lifetime revenue in EV business wins in the quarter. Could you just give us perhaps a little bit more color whether specifically any key OEMs or specific platform wins there? And also, I guess, how we should think about this number in the context of the natural replenishment rate for the group with regard to auto platforms? And secondly, in terms of next year, clearly, I think is the key now. And I'm just keen to really understand what faith you're putting on the current IHS forecast for next year of 82 million units. And in that context, are you planning more structural cost adjustments for next year?

[Hans Dieltjens, CEO, President & Executive Director]

Yes. Thank you, Dom, for that question. So the -- for next year, IHS volumes, while we have, let me say, slightly lower views than IHS on that. We see a -- obviously if we look at -- if we look forward to what is out there, if we look forward to what we see, we see a maybe around 80 million or slightly under 80 million volume for next year. Then on the booking target. This is the first time we really expressed a lifetime booking for our electrification business. So I do think that the EUR 230 million in the quarter is a very strong booking target. Remember that our bookings in the electrification business are generally above 40% of our total bookings for our business. Last year, actually, we achieved a 47% of booking what indicates how strong this thermal booking is. It is resulting, obviously, from the product portfolio that we're offering in the market and the tight and historically strong relationships that we have built with many OEMs. Towards the OEM, so your question on where does these bookings lie? It's a good grasp of OEMs that we cannot disclose now as all of these vehicles are allowance, but we will do so as we go forward and announce obviously, these bookings. But I can share with you, this is a good diverse grasp of the OEM base and customer base out there what shows the correctness of our strategy and the importance of our product lines to our customers.

[Dominic Convey, Research Analyst]

I guess just 1 follow-up there with respect to the outlook for next year, whether you're planning any more structural cost adjustments we should factor in numbers for next year?

[Hans Dieltjens, CEO, President & Executive Director]

Well, we have -- yes, go ahead, Ron.

[Ronald T. Hundzinski, CFO & Executive Director]

Yes. So Dom, we started the 2020 program. And that's still underway. We're putting the finishing touches on it. And the majority of those benefits will be seen in 2022. The company continuously reviews restructuring programs. We continue to move production to best cost economies. That's just the way the supply chain industry works. So yes, we are investigating what the impact of, as Hans mentioned, a lower production environment in 2022 that was not really anticipated until probably mid-summer this year. We were expecting more of a 90 million unit, as you know, prior to that. So the company will have to continuously take a look at restructuring programs going forward. Now that 2022 seems to be around this, say, 80 million units, all with the intention to become more profitable also to get more competitive for our customers, that would be the reasons we're doing this.

[Operator]

We will now take our next question from Jarek Pominkiewicz from Jefferies.

[Jaroslaw Marek Pominkiewicz, Equity Analyst]

I have 2. First 1 is a quick one. Just wanted to confirm that I heard it properly that you were expecting global light vehicle production volumes at or slightly below 80 million for next year. And the second question is around your outperformance of global production volumes. In Q1, it was 20 basis points, 350 for H1, raising to 420 for the first 9 months of the year. It feels like the headwind from the phasing of the ramp downs in North America is starting to come out of the figures. So what shall we be thinking of in terms of our performance going forward. Is it reasonable to expect that we'll move beyond the kind of 200 to 300 basis points level that you're guiding to at the beginning of the year to maybe closer to 400 to 500.

[Ronald T. Hundzinski, CFO & Executive Director]

Hans, if you don't mind, can I answer 1 thing before you go into the future a little bit. Jarek, 1 thing I'd like to -- I want to mention is that 500 basis points of outperformance in the quarter does not exclude the headwinds from our powertrain business. The headwinds from our powertrain business continue and we expect it to continue 1 more year. So the outperformance, if you exclude that in North America was much, much higher. I'm trying to get you the number here. But those headwinds did exist in the quarter. So if you exclude that, which I know we've talked about it in the past, you can say that our performance was outstanding basically, right? Because of -- yes. So I just want to make sure it's clear to you that those headwinds have not dissipated for us, quite frankly, in the quarter. And that probably...

[Jaroslaw Marek Pominkiewicz, Equity Analyst]

So the headwinds that are still continuing. Okay. So that's very impressive.

[Ronald T. Hundzinski, CFO & Executive Director]

Yes. Yes. So just for example, in the quarter, our North America performance would have been nearly 11%, excluding the powertrain. And our quarter 3, total company that was 500 basis points would have been 11%. So I mean I didn't say that in my script, but just to give you an idea of the magnitude of that headwind and we do still expect that 1 more year. With that, Hans, I'll turn it over to you about future outperformance, okay?

[Hans Dieltjens, CEO, President & Executive Director]

Okay. All right. Thank you, Ron. So the light production volume was your first question at or slightly below 80 million. That is indeed what our view is currently. But as you know, these volumes are very volatile, the situation remains still very uncertain out there. So there is only 1 certainty here is that whatever predictions we make, it's going to be wrong, right? And that's what we've seen historically. There's no crystal ball here, but we can only take the elements that we have in front of us. And I think you also saw that during this year, IHS also significantly reduced their volume forecast in September in 1 month. So there is this ongoing uncertainty around this, but that's what we can share for now. So if you look at the outperformance and the -- what you call the growth of the outperformance, if you go to the different quarters or if you go through the year and will that continue going forward? Well, obviously, this outperformance as stated, it was mainly driven by Europe and partially North America and was to a great extent also driven by our electrification business, what -- to a great extent did not suffer the same drop than we saw in the ICE-related businesses. And additional to that, the launches that we have done in both regions are now also coming to full effect. So that's together with quarterly outperformance can be somewhat also suffers a little bit from the same volatility of the cyclic behavior of launches and ramp downs of different programs. So I think you shouldn't try to read too much in the quarterly numbers, but the overall half year or better yearly numbers, I think that's a better reference to take a look upon. But it is our expectation to deliver similar outperformances than we had done historically in the range of 200 to 300 basis points will be -- should be an achievable outperformance for our company.

[Operator]

We will now take our next question from Harry Philips from Peel Hunt.

[Harry Philips, Analyst]

Just a couple of questions, please. First of all, just in terms of cash flow, Ron. How are you looking at working capital and CapEx? Are you sort of keeping -- are you sort of making sure you keep hold of inventory, your own inventory just to make sure that you can testify demand and what have you? And are you sort of tinkering at the edge around CapEx and delay in projects, if you can, by a few months and things like that? And then secondly, and maybe trickier 1 to answer just more in definition. Is it possible to -- obviously, you've got the volume slowdown, and we can all see that and sort of take note of that impact. But secondly, what -- you talked about the volatility of schedules is a thing that your peers have called -- talked to lot but as well in terms of call-offs and very short-term notice. How much of the margin pressure is down to that volatility rather than just simply the volume drop. Is there any way of measuring that?

[Ronald T. Hundzinski, CFO & Executive Director]

So yes, let me answer your questions, Harry, from the order that you asked them. The first 1 on CapEx. So when you look at the year. We came into the year expecting a pretty robust market of, say, around 83 million units that have been materialized. But I would say that the management team, we've done a great job in identifying very quickly in Q2 that, that was not going to happen. And Hans quickly made the call inside the organization, quite frankly, as you know, after the first half results that we were planning around 78 million to 77 million units and granted now it's around the 74 million to 75 million. But Hans quickly said to the organization that we're going to plan differently. As a result, we started monitoring our expenditures. And then obviously, CapEx I would say, would be probably in line with that 3% of sales, which means we had plans to spend more in a nominal mode because their sales are going to be higher. But as we started to see sales dip, CapEx started coming back, and we're going to hold that range of 3% of sales. So that's the first thing. Now working capital is a little bit more of a challenge. As we geared it up in the first quarter and struggled in the second with production, I will be honest that for us and for rest of our peers, working capital management in the inventory area has been a challenge to get out of the system. And I'll have Hans maybe talk more about the disruptions, what the customers are doing, and I'll give you some clarity around that as far as the impact possibly. But it has been a struggle. The customers continue to give us releases that are extremely high in the beginning of the month and our operations are very protective of always making sure customers get product, and we've been difficult to turn this picket off. It's been -- because the customers tell you 1 thing and do another, it's going to struggle. As you know, we always measure working capital changes as a percent of sales. So for the full year, we're going to be flat, we'll call it, basically, maybe it's slightly up, but we'll call it flat for -- just for to make the math easy for us. And a year like that, we would expect working capital to be basically unchanged. Unfortunately, I'm not going to give you a value here, but we are going to have headwinds and show working capital increases for the year-over-year performance, which will be a drag on free cash flow. Now we've taken other measures on cash to offset those, like I mentioned, CapEx. And our goal, and I think we'll hit these goals is to make sure that the conversion, however, you measure it off sales off of EBITDA off of EBIT will be the historical norm, say, of 2019, 2020 was unusual. So we're ensuring that the ratios remain the same, but I will tell you, it's been a difficult struggle for us. Now as far as impact on margins, the customers shut down -- going to have Hans speak to this for a second, and I'll give you some numbers. I think the inflationary environment is more of a headwind for us and also the management of labor. I would say that it's -- right now, we're looking at possibly a 20 to 30 basis headwind on margins probably year-over-year for the timing of recoveries from our customers on materials because it takes time -- their index sometimes and we have to negotiate. And that would include labor inefficiencies in the back half of the year in that 20, 30 basis point of impact. With that, maybe Hans can talk a little bit more about what the customers' disruptions are doing to our operations. Hans?

[Hans Dieltjens, CEO, President & Executive Director]

Yes. The volatility of schedules is something that we have seen for a longer period now, where, as you know, we call off and this can be at the end of the month, even up to 1 week different or kind of be up to 25% different of what they had in their order system of what we see finally in our supply reality to the different customers. So we clearly have not seen a lot of improvement on this. Currently, it has to do with the volatility OEMs are experienced in the supply of their components among other chips. Obviously, that is difficult for us to predict on how many they will get or will not get. So it's an ongoing issue. So we have taken several actions in order to try to overcome this is to have a schedule at our company that is somewhat different than the OEM schedule preempting some of these moves that generally are ongoing within the period and providing information to our customer base upfront of that so that they're aware of what we are planning for can be slightly different than what the OEM would be planning for. That together and combined with recovery actions that we have strongly initiated with our customer base to assure ourselves that these costs do not stay to the full extent with our company as we do strongly believe this is an element our customers should be able to manage better and to control better and not having a level of cost that being stuck in the whole supply chain. So the impact of the margin pressure of this is -- it's important, but it is, as Ron correctly said, we do see higher levels of impacts coming from the inflationary increases. What is the large raw material costs, but also labor, transport and energy costs that show this inflationary increases and the necessary recoveries related to that as 1 package with our customer base.

[Harry Philips, Analyst]

Fantastic. And then maybe just looking at in a slightly different way. As and when volumes pick back up, which hopefully will be second quarter possibly, certainly, hopefully, third quarter. Is there -- do you need to commit much resource to sort of ramping back up production? Or should your initial drop-through come through sort of nicely in your favor, notwithstanding your comments around sort of raw material inflation and what have you. But is that a logical assumption?

[Hans Dieltjens, CEO, President & Executive Director]

Yes. Well, I don't think that ramping volumes back up is going to cost us a great difficulty or great stress. It depends a little bit on the labor situation in the different areas in the world as you -- as we experience among the rest of the industry, some shortages of availability of labor. But outside of that, I do not see any real issue in ramping up production. For our company, I do believe that there could be a little bit more disturbance in the supply chain or the downward supply chain, down chain. And as we saw and as we experienced now that even with this lower volumes, you can see this ongoing volatility in the supply chains and the availability of materials and components. So I think that's probably much more of the issue than the internal TI manufacturing ramp-up.

[Ronald T. Hundzinski, CFO & Executive Director]

Yes, Harry, I'll just follow up. I know you're getting at the gearing factor. Our goal would be to get a gearing factor into the 30% range, right, which would rapidly expand margins. That would be a goal, like I said, just pointing that out. But we know 1 thing is that volume is a friend to us. And when we get volume rising tailwinds we can generate a lot of profitability out of it.

[Operator]

We will now take our next question from Akshat Kacker from JPMorgan.

[Akshat Kacker, Analyst]

Akshat from JPMorgan. Two from my side, please. The first 1 is on cost inflation again. And as you just mentioned, we are seeing inflation on a number of components, raw material, freight, labor as well as energy costs. Is it possible to quantify the impact in the second half of 2021? And what are you thinking as of today for the next year? And how much of this can actually be passed on to the OEM? That's the first one. The second question is on thermal management systems. I've seen some of your competitors and peers talk about air-cooled thermal management systems. Obviously, today, we are in early stages of BEV architecture development and lay out from different OEMs, who are still experimenting with this technology. But just I'm interested in understanding how does your product offering change if it's an air-cooled versus a liquid-cooled thermal management system for the battery and power electronics?

[Ronald T. Hundzinski, CFO & Executive Director]

Hans, I'll answer the first part and he can handle the strategic on the thermal side. So the headwinds, Akshat, for the second half of the year. So a couple of things to keep in mind here. We do have recovery actions. Some of them are contractual and some of it are negotiations. The company's goal is always to return 100% of the increase from inflations are passed to the customer. Keep in mind that TI historically net pricing has always been between say, 0% to 1% price downs, which, quite frankly, is outstanding for an automotive supplier. I can speak from experience that many suppliers are in the 2%, 2.5% range. So the company has a long history of strong commercial activities, first of all. Now there's timing involved. So when you have a rising inflationary environment, the contractual agreements take time because they're set on a sometimes 3 months, 6 months, maybe longer depending on the commodity. So as we saw rising inputs, we go to the customers and start getting recoveries. But that said, because of the timing, we won't get all of our recoveries in 2021 and delve into 2022. To give you a flavor of the possible headwinds we're seeing. I've said before, I think earlier with Harry here is that we're anticipating possibly a 20 to 30 basis point headwind currently. Obviously, when the year ends, we'll all have a better number for you of what we're experiencing in the business to our margins. Now like I said, some of that may come back next year, and we give guidance in 2022, I'll probably clean that up for you, let you know what the headwinds were and then possibly what we can get back in the 2022 numbers once we close the books and understand exactly where our negotiations with for our customers. So hopefully, that helps you a little bit. With that, Hans, I'll turn over the strategic question to you on the thermal business.

[Hans Dieltjens, CEO, President & Executive Director]

Yes. Thank you, Ron. The thermal management systems, your question was air-cooled versus liquid and how that will impact our business. You have to see that air-cooled thermal systems are not anymore in scope at about all OEMs. Air-cooled systems have been used historically, for instance, is on leave or some others have had air-cooled systems. But the temperature management side of that is not sufficient to have the batteries operating at a certain temperature. Batteries only operate at a very limited temperature span to the maximum of their efficiency and technically seen the best way to do that are about the only way to do that is by liquid cooling. That's why we see all the new programs, all the new awards that we have achieved are all liquid cooling and liquid -- and so you have -- just to remember, you have 2 systems in the car, you have the refrigeration system and you have the cooling system. The refrigeration system provides the cool or the heat for heating or cooling the batteries and the coolant system basically takes that cool or heat and moves that to the different areas into the car where it's then cooling or heating a certain component, either be batteries or some power electronics or even the motors or other components into the car. So overall, we see this as an increasing potential, an increasing business opportunity, especially for our assets, we handle liquids in vehicles. And we do not see at all this going back to air cooling as it is physically difficult, if not impossible, to bring that sort of accuracy in the heating and cooling requirements added points in the car that it's needed to be. Actually, what we see is somewhat the opposite where we can see the tightness of the control of the temperatures is increasing, and it's not decreasing for that matter. So the only additional thing I would say to it is that a trend we see coming, and we see more is what we call modularization of the concepts where historically, the designs were traditionally lines and connectors, connecting the different parts where we now see an upcoming trend of having more modules that integrate different functions into 1 component, into 1 assembly of -- so that we have better efficiency, lighter weight and a better economical situation on that sort of components. So -- but that doesn't change anything between air or liquid cooling.

[Akshat Kacker, Analyst]

That is amazing color. I had the same understanding. I was just slightly surprised because on this quarterly call, Gentherm came out with a new air cool product, and they were winning new orders. That is why I just wanted to check in, but that is amazing color.

[Operator]

[Operator Instructions] We will now take our next question from Dom Convey from Numis.

[Dominic Convey, Research Analyst]

Sorry, just a quick follow-up, if I may. Just with regards to that EUR 232 million of incremental lifetime revenue. Can you put that into context as what you're seeing with regard to content per vehicle. And specifically, how that compares with the EUR 135 average and I think EUR 480 max was the figures that you gave at the Capital Markets Day earlier this year.

[Hans Dieltjens, CEO, President & Executive Director]

Yes, Dom. What we see in content per vehicle is we do see some variation into our content per vehicle as obviously we do not have always all content on the same vehicle, so it is dependent on the amount of vehicles adjust content down. So I would look at it like that. I would look at the quarterly number and to see what that does for us and for you on a yearly base and then reflect that our business going forward. But overall, CPVs are lumpy and they are strongly defined by the type of award. Is it a refrigerant award in a heat pump system or is it a coolant system and to what level are in this coolant or heat pump system or refrigerant system are components integrated. So it pretty varies overall. But I would say, yes, we continue to see CPVs to a similar level than we saw historically.

[Operator]

There are no further questions in the queue at this time. I will turn the call back to your host.

[Hans Dieltjens, CEO, President & Executive Director]

Yes. Thank you. So if there are no further questions, and in closing, thank you for participating today, and we look forward to further update you on our progress in late January or in 2022 with our full trading update. So thank you, and please remain safe. With that, operator, please disconnect the call. Thank you.

[Operator]

Ladies and gentlemen, that will conclude today's conference. You may now all disconnect.