Martinrea International Inc

TSX:MRE

Earnings Call Transcript 2022-Q4

[Robert Wildeboer, Executive Chairman]

Good evening, everyone. Thank you for joining us today. We always look forward to talking with our shareholders, and we hope to inform you well and answer questions. We also note that we have many other stakeholders, including many employees on the call, and our remarks are addressed to them as well as we disseminate our results and commentary through our network.

With me are Pat D'Eramo, Martinrea's CEO and President; and our CFO, Fred Di Tosto. Today, we will be discussing Martinrea's results for the year and quarter ended December 31, 2022. I refer you to our usual disclaimer in our press release and filed documents. I will speak, Pat will speak then, Fred, and then we will do some Q&A.

Welcome to 2023, a year of promise and anticipation, building on a very solid 2022, it turns out. I want to start with a word about our people and our culture. We believe our people are the most valuable assets of our company. It's been 3 years or so since the World Health Organization declared a pandemic. And we, as a company and as an industry, faced a series of monumental challenges that, in many respects, were new, unprecedented for us. Our people faced the challenge with courage and tenacity, and we have never been more proud to work with such a great group from the receptionist to the shippers in our plants to our executive team and our support functions. What many felt for the worst of times, may have turned out for us to be the best of times although it certainly was not always a fun time.

We talk about our culture a lot at Martin Brand, as all our stakeholders have come to know. Our vision is making lives better by being the best supplier we can be in the products we make and the services we provide. Our mission is basically to take care of our people, our customers, our communities and our stakeholders, lenders and shareholders. Our 10 guiding principles represent the way we approach our business. Our sustainability and success, we believe, comes down to culture. As leaders, we are the Chief Culture officers of the company. Living our vision is at the core of the future. Our culture, especially as we have cultivated it more and more over the past few years is a sustainable competitive advantage.

To us, the golden rule means treating people the way you want to be treated. It covers so much. It covers dignity and respect. It covers teamwork and coverage integrity and truth covers diversity and inclusion. It covers ESG, it covers good leadership. It makes us a great company. We don't want to say we're a great company because we have diversity. We want to say we're a diverse company because we are great. Think about it. There's a meaningful distinction. Their people have to trust you to lead them this way, to trust that you care for them. Leadership is stewardship and think about this progress travels at the speed of trust. Some people may be skeptical. They may ask, but what are your people say? Let's talk about that.

Every year, we do detailed employee surveys administered by third-party experts who performed similar functions for many companies, including some of our competitors and customers. We are told we have not just industry-leading stats, but we are one of the best-performing companies anywhere. Our employee surveys are voluntary but we had almost 15,000 surveys submitted. That's a pretty good sample. We have 58 locations now in 9 countries on 5 continents and different product groups. That's also a good sample. We scored very well in the general categories, the way we work, covering health and safety, work environment, teamwork and collaboration, supporting our people, addressing communication, fair treatment, diversity and inclusion, value and recognition, covering compensation and incentives, career advancements, appreciation and shaping the future, addressing personal goals, performance feedback, growth and development.

While the scores are not perfect and we can always improve and we'll strive to do so, here are some answers to some critical questions. I fully understand my job role and responsibilities; 95% agree. Our location works to improve health and safety; 89% agree. I feel a sense of personal accomplishment at the end of the workday; 82% agreed. How many plants can beat this? This is a huge number. I respect my General Manager; 95% agree. Martinrea prioritizes encourages diversity; 89% agree. My direct supervisor treats me with Digit in respect; 88% agree. Not perfect, but outstanding results overall. In order to get this feedback from your people, you have to walk the talk. You have to care for your people Analysts and investors look at numbers. I believe these numbers and our safety numbers are even more important than a quarterly margin or EBITDA number. It would be great to see these referenced in some analyst reports. I believe our shareholders care about them, too. We believe that a happy, motivated and powered, purpose-oriented workforce is the foundation of company success in the short, medium and long term. A strong thank you to our people -- let's turn to the other highlights of 2022.

Last year at this time, we indicated that we believe 2022 would be a good year, and our results would improve throughout the year as supply chain conditions became more normal. As industry volumes would recover somewhat and production schedules became more stable and as we deal with cost inflation through negotiations with customers and suppliers. We knew we would have many challenges with the war in Ukraine, energy shortages on and on. But we did say that the first half of the year would show profitability and that the second half of the year would be better than the first in general, that's how the year 2022 played out for us. Here are some of the key highlights of 2022. The full range are found in our annual information form and our year-end releases. Our industry-leading safety metrics continue to improve again, we take safety seriously. Our total recordable injury frequency, or TRIF, was 1.21, an improvement of 12% over last year, but more impressively, an 86% improvement over 2014 when we made safety our priority.

Note that a TRIF of 1.21 is less than half the industry standard of 3.1 on -- as many of you know, over the past 2 decades, we have bought a number of troubled plants where safety culture often had to be emphasized as part of the plant culture. We are very proud of this improvement. A safe plant is generally a good and profitable plant also. We recorded record revenues of $4.75 billion, an increase of over 25% from 2021. We saw increased revenues from some of our key programs, but we also have launched many new products in 2021 and 2022 that are driving some of the revenue growth, all during the pandemic.

We generated a record level of EBITDA during the year. Each of the third and fourth quarter showed record quarterly EBITDA. This operating cash flow also translated into free cash flow in the second half of the year of approximately $80 million. Our 2022 fully diluted net earnings per share of $1.76 adjusted or $1.65 unadjusted was significantly higher than the $0.41 adjusted and $0.45 unadjusted in 2021. Our balance sheet improved throughout the year, ending the year with a net debt-to-EBITDA ratio, excluding IFRS 16, of under 2:1, the best it has been since before the pandemic. We maintained our dividends to our shareholders in 2022. During the pandemic, we have not reduced dividend payments. Quality is important to us and our customers. Many of our products are safety parts, and we won a number of quality awards in many of our plants.

We continue to invest heavily in the business, given the significant amount of new business we have won. We note that in the past 3 years, we have spent close to $1 billion on CapEx, the highest for a 3-year period in our history. But the majority of the spend was the launch work we had won. We did not slow down our investment activity during the pandemic, and that is the primary reason we are coming out of it with significantly higher revenues. Not many automotive parts suppliers have a similar experience. Do not believe in perfect launches, we believe in better ones each time. We had many good ones. Not only have we grown our business, we have significant content on the vehicles our customers are making, electric, hybrid or ICE. Our portfolio is matching what the industry is making.

Our lightweighting technologies are precisely where our industry needs. We continue to both utilize and invest in leading-edge technologies in our regular operations and through Martinrea Innovation Development or Mine. We have investments in graphene and graphing enhanced batteries through our NanoXplore relationship, a loaner battery technology through AlumiPower and several other new technologies such as Afenco using supercapacitor technology. Our innovation efforts were recognized in 2022 with Martinrea being awarded a PACE Award for our GrapineGuard enhanced Brakelines. This is generally regarded as the most prestigious technology award in the automotive industry, a big congratulations to our team. We continue to drive sustainability initiatives at Martin [ph] and we encourage you to read our 2022 sustainability report.

A few highlights. On carbon reductions, carbon intensity as carbon emissions relative to sales has reduced by 19% since our 2019 baseline. -- energy reductions, energy intensity, which is energy consumption relative to sales has reduced by 16% since our 2019 baseline. Renewable energy, approximately 42% of our electricity consumed comes from renewable sources today. Our CDP score, we increased our score to be for management of climate issues up from a C in 2021. Long-term targets. In 2022, we set a target to reduce our carbon emissions by 35% by 2035 without the use of carbon credits. In diversity, our CEO-led diversity committee formed additional subcommittees to focus on mental health, mines matter, women at Martinrea, young professionals are YoPRO and women in manufacturing.

As we look to 2023 and beyond, we do so with renewed confidence. We have been through a tough 3-year period. We believe we will see better industry sales and production growth, especially in North America, where most of our operations are located. There is pent-up demand, vehicle inventories remain low. While interest rates have risen and may remain elevated this year and maybe beyond, automotive financing is available often at competitive rates. And consumers, especially in the United States, have generally strong household balance sheets and good jobs. Our 2023 outlook shows growth in revenues, adjusted operating income margin and free cash flow, a very solid outlook.

And as noted, we believe sustainable companies with a great culture will be around for a long time. Our future is great. We look forward to sharing it with you.

And now, here's Pat.

[Pat D'Eramo, President & Chief Executive Officer]

Thanks, Rob. Good evening, everyone.

As noted in our press release, we generated an adjusted net earnings per share of $0.58 and an adjusted operating income of $71 million in Q4, up significantly from a loss of $3 million in Q4 of last year. Production sales came in at just under $1.2 billion, up 38% year-over-year, and Q4 adjusted EBITDA was $149 million, which is a new quarterly record for the company. Adjusted operating income margin came in at 5.5%, which is slightly lower than the 5.8% we generated in Q3 due to a quarter-over-quarter increase in tooling sales, which typically earn lower margins for the company and some previously recognized favorable commercial settlements that were reclassified into sales in Q4, a cost offset accounting treatment with no corresponding volume or bottom line impact to the quarter. Adjusting for these impacts, fourth quarter production sales and overall operating income margin were similar to Q3. Another strong quarter, especially when you consider the ongoing volatility in the environment.

During the quarter, we continued offsetting inflationary costs commercially and continue to improve our operations despite continued supply chain disruptions impacting a level of stability of customer production schedules, albeit at a lower level. I'm happy with the work the team is doing on all these fronts. It's been a challenging time to be in the automotive parts business in many respects and still is. Our team has faced these challenges head on, negotiating fair agreements with our customers and suppliers. The business continued to drive operational improvements across the organization. I can't thank our people enough for their hard work and Tanate during this time.

As I mentioned on our last call, commercial negotiations will continue, but we do see them normalizing as the year progresses, assuming a continued easing and inflationary pressures. On that front, a warmer-than-expected winter and improved supply conditions in Europe have resulted in a drop in natural gas prices in the region. And the worst case scenarios that were contemplated as a result of the energy shortage, including production shutdowns have not come to pass. This is good news. Notwithstanding inflationary headwinds persist in other areas and labor conditions continue to be tight, particularly in the United States. And while production environment is gradually improving, we continue to be impacted by supply-related production disruptions with several of our customers, as I already noted.

Looking forward, we continue to expect 2023 to be a good year with better production volumes, margins and free cash flow compared to 2022. And what we expect will be the beginning of a strong cycle with most of our plants running at capacity. We updated our 2023 outlook on our Q3 call back in November. As a reminder, this outlook calls for a total sales between $4.8 billion and $5 billion, adjusted operating income margin to be between 6% and 7% and free cash flow to be between $150 million to $200 million. We're maintaining this guidance and continue to see it as reasonable and achievable. Of course, volumes are difficult to predict and mix is always a factor.

Looking at our global operations in North America, our adjusted operating income margin contracted somewhat quarter-over-quarter in Q4 compared to Q3. The quarter-over-quarter increase in tooling sales and reclassification of commercial settlements mentioned earlier, took place primarily in North America. This had the impact of increasing sales without any flow-through to earnings. In addition, our mix in North America was less favorable, and we had a lower level of commercial settlements during the quarter. On a full year basis, our North American operating income margin for 2022 came in at 5.7%, up nicely year-over-year from 2.4% in 2021. We expect further year-over-year margin gains in 2023, absent quarterly fluctuations we see from time to time as our outlook calls for.

Further, margin gains are expected to come from planned volume and mix normalization of input costs, continued lower launch costs and continued operational improvements. What I now call our pandemic launch activity was among the busiest launch cycles we've ever had. I'm happy to report the products have stabilized, and we are in a great position to enhance our margins as our customers ramp up.

Turning to Europe; we saw a notable sequential improvement in adjusted operating income during the fourth quarter, mainly driven from our favorable commercial settlements. As I mentioned earlier, we devoted a lot of time to recover our fair portion of the elevated energy costs that have been weighing on our European business. We concluded several agreements on favorable terms, which have had a positive impact on our margins in this segment in Q4. Our operating income margin in Europe for the full year 2022 came in at 1.7%, up from a loss in 2021. We made some good progress in this region as well. In our Rest of World operations representing 3% to 4% of our business.

Adjusted operating income declined slightly quarter-over-quarter given a weaker sales mix. These ultimate segment tend to vary more than others because it's relatively small in size. But overall, we're happy with the performance in Q4. I'm pleased to announce that we've been awarded approximately $90 million of new business over the past number of months. This consists of $60 million in our lightweight structures commercial group, including additional EV content on GM's new EV pickup truck, Lucidar and the Jeep Gladiator hybrid electric as well as additional business with Audi, JLR and Toyota. $15 million in our Propulsion Systems group with Salentus, Scania and Nissan and $15 million in additional content on Malucider and our flexible manufacturing group.

As you can see, we continue to win meaningful work on our EV platforms with key customers. It's also worth pointing out that over the last 4 quarters, we've also secured roughly $250 million in replacement business, including the next-generation GM Equinox crossover. Of note, we are now constructing a new metallics facility in Mexico that will accommodate work on GM's new Fed 3 electric vehicle program. This on the heels of expanding our FMG plant and a new fluids plant in that country. We have a lot of great activity happening in North America, particularly in Mexico.

Let's turn the page and discuss a great new investment. Monday, we announced the acquisition of the assets of Montreal-based Defend co development, which was actually completed last year. Finco designs, manufactures and markets innovative technologies for the electrification and connectivity of heavy-duty vocational trucks. The Apenco hybrid electric solution augments the vehicles powertrain and electrifies onboard equipment utilizing a unique ultracapacitor-based technology, which reduces greenhouse gas emissions by 30% to 40%, while also reducing engine usage hours, fuel consumption, noise pollution and related maintenance costs.

The Finco is a global CleanTech 100 company and a global technology leader in the innovative use of ultracapacitors. We're very pleased with this acquisition and look forward to building on Avengo's leading-edge technology with the company's existing customers as well as new customers. We welcome the Avengo team to our Martinrea family. Again, many thanks to the Martinrea team for their great work leading to another solid quarter.

With that, I'll pass it to Fred.

[Fred Di Tosto, Chief Financial Officer]

Thanks, Pat, and good evening, everyone. As Pat indicated, our fourth quarter financial results were essentially consistent with the third quarter.

Notably, Q4 adjusted EBITDA set a new quarterly record for the company. As we said, the back half of 2022 will be better than the front half, and that is essentially how the year unfolded for us. Notwithstanding our company in the auto parts industry in general, continue to deal with headwinds on multiple fronts, as many of you are well aware of. These include ongoing supply-related production disruptions, inflationary cost headwinds and tight labor market conditions. Despite these challenges, we have made great progress in recent quarters towards getting our margins back to levels that we are accustomed to. The strong performance continued in the fourth quarter. We expect our results to improve further as supply chain disruptions abate, production volumes continue to recover, and our launch activity continues to normalize.

As Pat noted, we have maintained our outlook, which calls for higher production volumes, sales, margins and most importantly, free cash flow in 2023. Taking a closer look at our performance quarter-over-quarter. Production sales were 4% higher, largely due to the reclassification of previously recognized commercial settlements into sales, as Pat mentioned, and general timing of commercial settlements. Excluding these items, production sales were essentially flat quarter-over-quarter. Generally, the production environment was similar to last quarter but is expected to gradually improve as the year unfolds.

Adjusted operating income margin came in at 5.5%, a bit below the 5.8% we generated last quarter due as patent order to a quarter-over-quarter increase in tooling sales and the reclassification and timing of commercial settlements previously discussed. Overall, excluding these items, adjusted operating income margin was essentially flat quarter-over-quarter. Free cash flow came in at $15 million, another positive quarter, but below Q3 levels, reflecting the timing of capital expenditures. On a full year basis, free cash flow was $50 million, positive, a strong result considering the ongoing challenging environment. Free cash flow is expected to improve significantly this year as our 2023 outlook complies, reflecting a higher level of EBITDA and lower CapEx.

We -- looking at our performance on a year-over-year basis. Fourth quarter adjusted operating income of $71 million was up sharply from a loss of $3 million in Q4 of last year and adjusted EBITDA of $149 million more than doubled on production sales that were 38% higher. Recall that the back half of 2021 was when supply-related production disruptions were at their worst. Mark and all point in our financial performance before results began to improve materially in subsequent quarters. While a stronger year-over-year performance is nice to see, results are still below what we know we can achieve. We expect to go a long way towards bridging this gap in 2023 as our outlook implies.

Moving on to our balance sheet. Net debt was about $20 million lower quarter-over-quarter, closing out the year at $909 million. Our net debt-to-EBITDA ratio was 1.95x, in line with our expectations to be below 2x at year-end. This represents a comfortable level for us and is well below our covenant maximum of 3x. The leverage ratio should naturally improve in the coming quarters as we generate an increased amount of EBITDA and free cash flow, a portion of which we will use to pay down debt. We have strong relationships with our lenders, and we thank them for their continued support.

I'm now going to spend a bit of time on capital allocation and capital spending. I should note that we have had for some time an investor newsletter on our approach to capital allocation posted on our website. Neil Forrester, our Director of Investor Relations and Corporate Development, who has been both an auto analyst and an investor with Franklin Teplton, has set out our thinking very nicely for you. In any business, how the company allocates its capital is among the most important decision management has to make. Capital allocation is equally as important as operational decision-making and execution. We have to be effective at both to ensure our organization prospers even survive over the long run. Profitable businesses with strong operating track records can be derailed by a poor capital allocation strategy. Therefore, it is critical that we get this part of the corporate strategy right.

In Maria, we spent a lot of time thinking about capital allocation. Our overarching priority is quite simple to generate long-term positive returns for our shareholders. Generating returns as part of our mission. In that sense, we are no different than an investment manager running a mutual fund pension plan or endowment fund or an individual investor managing his our own portfolio. We are committed to the long-term sustainability of our company, in line with our vision, mission and principles. We're all owners, increasing our holdings of shares and equity-based investments over each of the past 7 years with minimum shareholding requirements and a robust equity share ownership program. In the last 3 years, we have met the challenge of the pandemic, chip shortages and inflation and so on, head on. And today, we are a strong company as we've ever been because are owners and behave like owners.

Taking a closer look, our capital allocation framework is as shown on this slide. While maintaining a strong balance sheet, we seek to invest in growth and maintenance opportunities that have the potential to generate strong returns for our shareholders. This can take the form of organic capital investments and research and development initiatives as well as acquisitions and make strategic and financial sense. These priorities are driven by a disciplined internal rate of return and return on investment capital framework. That is, we choose the options that have the highest expected returns over the long term.

In late 2014, Pat joined us as President and CEO, and we embarked on our lean transformation journey, a period to be referred to as Martinrea 2.0. For the next 5 years, adjusted operating income margin nearly doubled to 7.5% in 2019, over 8%, excluding the impact of the 2019 GM strike, you may recall, putting us among the top in our peer group. We achieved this through a combination of plant-level operating improvements in our lean manufacturing practices and a more disciplined go-to-market approach there into a strict hurdle rate in quoting new business, which has generated ROIC at are among the best in our peer group. We have had margin challenge over the past 3 years, but as noted, margins are improving and are expected to continue to do so in 2023.

So let's talk about free cash flow playing the long game. Free cash flow is an important metric in assessing the merits of any investment is a key element for many investors, from any of you, and ultimately, a key driver of valuation. The value of an investment is equal to the President Vale's future cash flows discounted at the appropriate cost of capital. Importantly, the cash generated potential of business must be looked at through a long-term lens. The company may have options to invest capital in high-return organic growth opportunities that will provide a steady stream of free cash flow in future years. However, those investments reduced free cash flow initially. Working capital falls can also be unpredictable over short-term periods, skewing the true cash flow picture. And allocating capital is incumbent on us to play a long game and not be distracted by near-term ebbs and flows.

Minor 2.0 journey, especially in the last 3 years, has also included substantial capital investment, mostly on program launches reflecting all the work we have won. This year, we are expecting CapEx to decrease from 2022 levels, helping to lead to an expected strong free cash flow profile in 2023. What about acquisitions? Our acquisition strategy has been and is disciplined and has served us well over time. Historically, our acquisition and strategic investment strategies revolved around acquiring businesses that broaden our product offering, technology, fit print or our customer base. They helped us grow rapidly from a start-up to a company with over $4.5 billion in revenues, a true growth story. Primarily, these were distressed assets required investment and resource turnaround.

We were able to acquire these companies cheaply in the structure of the operations, thereby putting them on a more sustainable path. We have proven our effectiveness of turning around struggling businesses. We are prudent and disciplined buyers, and this is a big part of how we built our organization. Our acquisition strategy has evolved over the years, the valuation remains a key component. Great companies can end up being bad acquisitions if you pay too much. So we are selective and prudent in our approach. Basically, we look for companies that can help us achieve some combination of advancing our lightweight strategy, enhancing our product and technical capabilities and diversifying our customer base, and we look to acquire these companies that are reasonable to attract the valuations.

While I won't go into further here, our investments in Metalsa assets and the Nano Explore proving to be great investments to maintain and grow our business. Strong balance sheet is also paramount as it gives us the confidence and ability to withstand downturns if and when they arise, like during both the -- great Recession of 2008, 2009 and the recent COV-19 shutdowns. Our customers also prefer to deal with suppliers who are financially sound that they know will be around to serve them in the long run. So a strong balance sheet is fundamental to maintaining and growing our business. We believe our targeted net debt to adjusted EBITDA ratio of approximately 1.5x is appropriate for [Technical Difficulty].