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Edited Transcript of MRE.TO earnings conference call or presentation 12-Nov-19 10:30pm GMT

Q3 2019 Martinrea International Inc Earnings Call

Vaughan Dec 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Martinrea International Inc earnings conference call or presentation Tuesday, November 12, 2019 at 10:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Frank Patrick D'Eramo

Martinrea International Inc. - President, CEO & Director

* Fred Di Tosto

Martinrea International Inc. - CFO

* Robert P. Wildeboer

Martinrea International Inc. - Executive Chairman of the Board

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Conference Call Participants

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* Kevin Chiang

CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst

* Peter Sklar

BMO Capital Markets Equity Research - Analyst

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen. Welcome to the Martinrea International Third Quarter Results for 2019 Conference Call. (Operator Instructions)

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Robert P. Wildeboer, Martinrea International Inc. - Executive Chairman of the Board [2]

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Good afternoon, 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 financial results and commentary through our network.

With me this afternoon are Pat D'Eramo, Martinrea's CEO and President; and our CFO, Fred Di Tosto. We've just finished our Board meeting and Annual Budget Meeting. Pat is on the Board of the OESA, and they have their annual meeting and conference starting tomorrow morning. As a result, we are talking to you late in the day today. We'll be discussing Martinrea's results for the quarter ended September 30, 2019. Pat, Fred and then I will make some brief comments, and then we'll open the call for questions and we'll endeavor to answer them.

Our press release with key financial information discussed on a fairly detailed basis has been released. Our MD&A and full financials have been filed on SEDAR and should be available. These reports provide a detailed overview of our company, our operations and strategy and our industry and the risks we face.

We're very open to discussing in our remarks, and we hope in the Q&A, some highlights of the quarter, the state of the industry today, how we are addressing the challenges and progress in our operations. As always, we want you to see how we see the world.

As for our usual disclaimer, I refer you to the disclaimers in our press release and filed documents. Our public record, which includes an AIF Form and the MD&A of operating results is available on SEDAR, and you may look at the full disclosure record of the company there.

And now here's Pat.

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Frank Patrick D'Eramo, Martinrea International Inc. - President, CEO & Director [3]

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Thanks, Rob. Good afternoon all. As noted in our press release, our good story continues with Q3 adjusted net earnings per share coming in at $0.53, in the range we discussed in our Q2 call of $0.53 to $0.57.

Q3 2019 performance represents our best third quarter to date. Our adjusted operating income margin came in at 7.1% for the third quarter, up from 6.9% in Q3 of last year, on production sales of $847 million as compared to our guidance of $820 million to $860 million. We were able to produce these results despite the impact of the September portion of the GM strike. The impact of the GM strike was offset with a lot of good effort in Q3.

In Q4, the strike went longer than anticipated. Our full month without sales from one of our largest customers could not be offset. This is being compounded by softening sales in Europe and China as well as a little bit in North America. Due to the strike and softer market, we've reduced our Q4 expectations. Our current forecast for EPS in Q4 is between $0.35 and $0.45. The wider range is due the unknown makeup volume effects by GM.

It's clear they are pushing to make up what's possible the remainder of the year, but the line of sight is not 100%. It will not be possible for GM to make up the volume lost during the strike by the end of the year. What's not made up in '19, we believe, will be made up in Q1 and Q2 of 2020.

Our sales rate for Q4 is $750 million to $810 million. Again, the primary variable being in the GM volume recovery. We view Q4 as a temporary situation and expect GM to recover the majority of the lost volume somewhere between now and possibly into Q2 of next year. Other than the GM strike, 2019 has been a great year overall, with operations continuing to improve and launches on the whole going well.

Our outlook shows sales slowing in Europe. This is particularly noticeable with JLR, one of our larger European customers. The situation is possibly compounded by Brexit. In addition, we are also seeing some lower volumes in Q4 from Daimler.

Along with softening sales, primarily outside of North America, we are experiencing several new program delays from our customers. This is across multiple customers and, for us, large programs. These delays will affect our targeted sales and margin improvements in 2020.

You will recall our 2019 and 2020 margin targets have 2 key components: sales of new higher margin products and continued operational improvements. For 2020, this includes sales of $4 million or more and continued operational improvements, led by our lean activities in our operations as well as great launches.

Our new programs come in with the benefit of meeting or exceeding our established hurdle rates, making new work more profitable. I'm happy to report our lean activity and launches continue to go well. I'm particularly pleased with the operational improvements. I could argue that some of our plans are now benchmark in the industry. That portion of our plan remains on schedule and within our control.

Related to our customers, we are seeing many new program delays and slower ramp-ups than originally planned. Most of the delays are 6 to 9 months, moving out over $200 million of projected production sales originally planned for 2020 into 2021. The delayed programs include a Jeep Grand Cherokee, Nissan Rogue, Pathfinder and Ford's new product in the Hermosillo assembly plant meant to replace the Ford Fusion, all of which are large and impactful programs for us.

These programs represent an excess of $400 million of full annualized sales at peak volumes. A dollar of new model sales when launched has more margin than most current production. The retiming of our customer new model introduction will push our 2020 $4 billion sales target into 2021. Along with that, our target of 9% operating income will move into 2021 as well.

Despite the expected flat sales and delayed launches of new programs, we expect our margins to improve year-over-year, exceeding our original 8% target for 2020, assuming customer programs remain on schedule.

It's been a challenging few months between the GM strike and some softening volumes. I'm very proud of the team's response to the volume shortfalls, reducing costs, flexing labor where possible and making improvements from the operation at even a faster pace, finding cost savings throughout the enterprise to bring in a record Q3.

We have a great team willing and able to do whatever is necessary to keep the go-forward momentum at Martinrea, and it's great to be a part of it. Thanks, again, for all your hard work.

With that, I'm going to hand it over to Fred.

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Fred Di Tosto, Martinrea International Inc. - CFO [4]

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Thank you, Pat. As Pat has already noted, the third quarter was another strong quarter for us, a record third quarter from a sales and earnings perspective. Q3 production sales and adjusted net earnings per share both came in within the range of our previously announced guidance, and this despite the disruption on the GM strike for 2 weeks during the month of September.

As Pat has already noted, the team did a great job of reacting to the headwind resulting from the strike and on delivering Q3 earnings in line with expectations, aided by strong results in our Rest of World segment. However, as Pat already noted, the impact of the strike to Q4 was far greater and cannot be offset, compounded by some other volume headwinds.

It's not easy when your largest customer had a significant work stoppage for an extended period of time. As a result of the strike, we lost about $20 million in production sales in September and approximately $70 million in October. So overall, the impact was significant.

We are obviously happy that the strike is now over. It was a temporary blip, and we expect most of the lost volume to be made up over time, just not in the fourth quarter as you can tell by our Q4 guidance. It's time to move on and put the matter behind us.

Outside of the strike, 2019 has been and will be a good year for Martinrea. Overall, I'm very pleased with the Q3 year-to-date financial performance. We delivered solid adjusted margin and earnings, very much in line with expectations despite our global environment and generally outperforming our peer group from a margin perspective.

Our Q3 year-to-date adjusted operating income margin was 8%, and this despite the September impact from the GM strike and abnormally high tooling sales, which tend to be at low or no margins. We were very much trending to be north of 8% for the year before the strike kicked in, in line with our 2019 target. And this despite an overall softness in volume, predominately outside North America.

As such, we are very happy with the overall progress we're making as an organization and our ability to deliver. We keep getting stronger every year and 2019 is no exception. I, too, would like to thank the Martinrea team for their hard work and dedication. As I've said so many times before, we are making a difference.

Another important positive this year has been our free cash flow profile. They've been very consistent with our messaging on this topic. We have said for quite some time that you'll start seeing our free cash flow profile turn positive in 2019, and I'm happy to report that our year-to-date performance reflects that. We were free cash flow positive in Q2 and again in Q3.

We generated free cash flow, as defined in our MD&A, of $39 million in Q3 and $75 million year-to-date, with the cash generally used to buy back shares, make some incremental investments in NanoXplore and pay down debt. So overall, a good result and in line with what we've been saying. We expect this positive trend to continue heading into 2020, as promised, and in line with our new Board-approved annual business plans.

Lastly, I just want to touch upon our balance sheet for a moment, which continues to be strong. Our net debt decreased during the quarter, with net debt to trailing 12 months adjusted EBITDA, excluding impact of IFRS 16, ending the quarter at 1.45x, very much in line with our targeted range. We have a strong balance sheet within this industry and are committed to keeping it that way.

Our strong balance sheet, in addition to providing us the flexibility to invest for growth and capitalize on opportunities, helps us with our customers. Our customers, frankly, like companies with financial strength because they know we are there for the long term.

It also creates opportunities when customers have supplier problems they need solved. We can and are there to help them, like we have done so many times before. As such, we will continue to maintain a strong balance sheet as we execute on our capital allocation strategy. Thank you.

With that, I now turn you back over to Rob.

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Robert P. Wildeboer, Martinrea International Inc. - Executive Chairman of the Board [5]

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Thanks, Fred. Some very brief comments on our industry. The industry has been seeing some challenges, but we believe we are seeing some positive signs now. Trade issues for North America and for China and Brexit are showing positive signs of getting resolved. The USMCA may get signed this year, we'll see. Labor issues are also getting resolved as the GM strike is over and there is a deal coming for the other OEMs also. Both have been issues facing the industry.

The underlying economy in North America and elsewhere is showing resiliency and some positive signs such as lower interest rates. Also, I think we may be seeing some positive sentiment in the public markets. People are still going to buy vehicles, and a lot of those vehicles will have our product on them. Volumes, while off, are still pretty good. We should be able to make money in this environment. Good money.

With our strong financial performance and cash flow, we will continue to invest in the business, maintain a strong balance sheet, make solid strategic investments and acquisitions where appropriate, and invest in ourselves by repurchasing shares where it makes sense.

In the third quarter, we did renew our normal course issuer bid and bought over 1 million shares. We also increased our investment in NanoXplore. We believe our company is performing very well on an absolute and relative basis, and the challenges and opportunity in the industry provide opportunities for us.

In a flat overall market, this company and our team are doing a fantastic job, evidenced both by our absolute results and our improvements in key metrics relative to our peers. We continue to write a great story. Our team is delivering well. I would like to thank our people for their efforts and our customers for their support.

Now it's time for questions. We see we have shareholders, analysts and competitors on the phone, so we may have to be a little careful with our answers, but we will answer what we can. Thank you all for calling.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have a question from Peter Sklar from BMO Capital Markets.

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Peter Sklar, BMO Capital Markets Equity Research - Analyst [2]

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I had some questions about your geographic segmented reporting. So if you look at your European operating profit, I believe that essentially doubled year-over-year. And so I'm just wondering on an adjusted basis. So I'm just wondering if you could talk about what's going on in Europe.

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Fred Di Tosto, Martinrea International Inc. - CFO [3]

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Yes. Europe, it increased substantially year-over-year. But in Q3 last year, the quarter was impacted by some higher-than-normal launch costs, there's also mix issues. And we also had significant lower JLR volumes during that quarter, so it was abnormally low. So that kind of explains the baseline. And then the increase to 8.8% for the quarter, essentially was driven by improvements, the lower launch costs and some positive mix. And we've been at the 8% range in the past. The thing is that the European segment is not that big in the grand scheme of things for us. So when there's movements there, they become more visible. And that's why you kind of saw the -- a bit of a flux in the quarter. It was positive, but nonetheless, it was movement.

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Robert P. Wildeboer, Martinrea International Inc. - Executive Chairman of the Board [4]

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There was a flux.

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Peter Sklar, BMO Capital Markets Equity Research - Analyst [5]

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Okay. And then similarly for your Rest of World segment on an adjusted basis, I believe it was $6.7 million of operating profit. I don't believe it's ever come anywhere close to that level of operating profits. So I'm just wondering what's the story there.

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Fred Di Tosto, Martinrea International Inc. - CFO [6]

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Yes. And it's -- a similar story there, it's even smaller. So when there's movement, it's very noticeable. And I don't want to get into specific margin discussions by program or customer there, but we had a very positive mix during the quarter that helped the margins in that segment. In addition to that, as you know, we also performed some restructuring in Brazil as well as in our China fluids facility earlier this year, and we're starting to see some benefits coming from that.

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Peter Sklar, BMO Capital Markets Equity Research - Analyst [7]

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Okay. And then lastly, I just wanted to ask, in terms of the operating profit of your North American segment, like we know the impact of the GM strike. But taking that into account, were you satisfied with the level of profitability in that segment? Or were there any issues during the quarter?

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Fred Di Tosto, Martinrea International Inc. - CFO [8]

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I would say, generally speaking, we're satisfied. As we note in our opening remarks, the team did a good job reacting to the strike headwinds. The other variable that played into our margin percentage in North America is the higher-than-expected tooling sales, so we've been talking about that in the last couple of quarters. So some of that came in, in Q3 and we expect more to come in Q4. So for the year, our tooling sales are going to be abnormally high, let's call it, in and around $400 million, and that's anywhere from $100 million to $200 million higher than our normal levels. So that's impacting the percentage. But overall, I think North America reacted as best as they could in terms of -- as it relates to the segment and the headwinds resulting from the GM strike.

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Operator [9]

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The next question is from Kevin Chiang from CIBC.

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Kevin Chiang, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst [10]

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And I apologize if you mentioned this in your prepared remarks earlier, I did get on late. Just as you look on to 2020, you have some targets in terms of sales and margins. Just wondering how you think about that as we enter into next year, especially as you think of that -- some of that lost GM work potentially being a tailwind next year, it sounds like, as you make up for some of that lost production?

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Frank Patrick D'Eramo, Martinrea International Inc. - President, CEO & Director [11]

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Yes. We'll see some of that made up, like we said, this year. We know they're going to push as much as they can into the fourth quarter. But certainly, they're not going to be able to make the impact that they lost. So we expect to see that in the first quarter and into the second quarter, most likely.

The inventories aren't terrible, by any means, for those vehicles. So I think they'll be smart about it and try to do it wisely from a cost point of view. But certainly, we expect to see -- I don't know if it's going to be a significant increase or they'll level it through to the 2 quarters. But I certainly think, especially on the trucks, that they're going to do whatever they can to make those up.

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Kevin Chiang, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst [12]

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Okay. And I guess like the $4 billion in top line and roughly 9% -- over 9% EBIT margin, those are still -- based on what you see with GM and your overall macro view, those are still achievable targets in 2020?

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Frank Patrick D'Eramo, Martinrea International Inc. - President, CEO & Director [13]

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No, I think the bigger problem in 2020 is we've had some substantial delays from some key programs. And as I stated in the -- the new products, they meet our new hurdle rates and so they're more profitable overall. And we've had delays of what's going to be, on an annualized basis, over $400 million a year. So that's going to potentially, at least unless we see some other tailwinds, push the $4 billion into 2021, which would carry the 9% into 2021. 8% we originally had targeted for 2020, we'll continue to, I think, exceed that. But the 9% will be very volume-dependent. And these launches have already been announced as delayed, so I don't see that changing by any means. And these are big programs for us as well.

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Kevin Chiang, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst [14]

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That's helpful color. And then just on Europe, when you look into next year with the new CO2 regulations, just -- do you have a sense of how that -- and I know Europe's not a huge part of your business, but how you see that playing out? And do you feel the OEMs are prepared there? Or are you expecting a heightened level of volatility as you look at the next 12 months in that continent?

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Frank Patrick D'Eramo, Martinrea International Inc. - President, CEO & Director [15]

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In North America, I don't see an impact. We see a lot of RFQs on electric vehicles, and we're bidding on a number of those. But those aren't something that you're going to see any massive change in the next few years. I think you'll see Europe as being more reactive to those things, certainly as we know China is as well. But I'd say for 2020, I don't see anything significant.

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Kevin Chiang, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst [16]

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Okay. And just last one from me, your investments in NanoXplore, can remind me, are you working on anything with them? Or is this just an equity investment in a company that's advancing, working in graphene? Or are you preparing to do anything with them? Any color there would be helpful.

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Frank Patrick D'Eramo, Martinrea International Inc. - President, CEO & Director [17]

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So we're big believer in the material, so we're definitely an investor. But we are also working on a number of products. My expectation is we'll see potentially one of those products available for sale in 2020, if all goes based on our testing so far, which implies we'll be ready.

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Robert P. Wildeboer, Martinrea International Inc. - Executive Chairman of the Board [18]

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And from the investor side, we're encouraged by the prospects. As we noted, we increased our ownership level in the company to 25%. But separate and apart from that, we have developed agreements and we're working with them on a number of products.

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Operator [19]

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(Operator Instructions) This concludes today's question-and-answer session. I would like to turn the meeting back over to Mr. Wildeboer.

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Robert P. Wildeboer, Martinrea International Inc. - Executive Chairman of the Board [20]

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Well, thank you very much. Appreciate the people that came on the call for the evening. Once again, as I said, we normally do the call in the morning but we have some industry commitments. If any of you have questions to any of us, the phone number is on the press release, so feel free to call Pat, Fred, or me. Have a great evening.

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Operator [21]

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Thank you. The conference has now ended. Please disconnect your lines at this time, and thank you for your participation.