American Axle & Manufacturing’s (AXL) Management Presents at 2017 RBC Capital Markets Global Industrials Conference (Transcript)

American Axle & Manufacturing Holdings (NYSE:AXL)

2017 RBC Capital Markets Global Industrials Conference

September 13, 201712:40 PM ET

Executives

Chris May – Vice President and CFO

Analysts

Joseph Spak – RBC Capital Markets LLC

Joseph Spak

American Axle, very pleased to have Chris May, CFO and Jason Parsons with us this morning here. Chris, I think you want to say sort of a couple of quick intro, words and then rollout, we’ll just start the conversation and head into Q&A.

Chris May

Sounds great. Thank you, Joe and good morning everyone. And again, thank you to RBC for hosting this event. This is always a great event each year, we look forward to here on the West Coast. Really an exciting time for American Axle coming off the backs on a year-to-date performance, very strong as it relates to EBITDA, free cash flow and sale generation, but importantly in that second quarter of 2017, as you know we close on our MPG acquisition in early April a very exciting time and of course even more exciting one of the main business objectives AAM has been searching for and requesting for through not only our organic growth, but was really delivering a de-concentration of our revenue with General Motors and for the first time, for the first time in our company’s history less than 50%. So, very exciting as it relates to the second quarter.

From a forward-looking perspective, focus on synergy delivery and I think we’re going to talk a lot of about that here today Joe, focus on our technology leadership as a company, we’ll talk about EAM which is our electrified space, of course EcoTrac, our QUANTUM, a bunch of other technology areas is and really one of the three pillars of the company. Technology leadership is or is up there was quality and operational excellence, again pillars of the company. Electrifications key, advance power transit key and again we’ll talking more about that I think as we go on over the next half hour.

And lastly, we’re focused on growth, we’ve got a nice healthy strong book backlog of $1.5 billion, active recording on a similar amount of which we’ve got a pretty successful win rate, again with our technology and our operational excellence playing into that success. So, we’ll work through that. So, an exciting and great time to be at AAM, exciting and great time to be here today. And I think it would be a perfect way to transition here.

Joseph Spak

Yeah. Absolutely, I think that’s sort a good overview of some of the topics that we can dive into a little bit here. Let’s start here more near term before we head into some of these sort bigger picture things. So, taking a step back right North American production was sort of forecasting to be down, think about 7% this quarter on a year-over-year basis which is quite frankly the largest decline we’ve seen since basically the downturn. Any sense as to sort of how that is shaping up. And then even more specifically with some of the unfortunate events of the storm, any preliminary indications from your customers as to sort of some of that replacement demand that might come through, there is estimates out there that range between that all the storms could be about a million units, clearly some go used or maybe most go used maybe not new. But, what are you’re seeing in terms of firming on the schedules?

Chris May

Yeah, certainly as it relates to the second half of the year, in terms of schedules the OEMs have predominantly now have laid out their schedules on a firm basis for the next four months if you will. So, we got good insight into that, not much different than we thought previously over the past month or two. There was anticipated in traditional downtime that you see in the July timeframe as it relates to most that we have at beginning of the month also at the end of the December. And as you know in particular as it relates to some of our core truck products, General Motors took some additional downtime in the third quarter with their conversion into the next gen trucks. Begin to get their factories ready so. But by and large in line with our expectations that we have been seeing now over the past quarter or so as we look forward. So, pretty much in line.

As it relates to potential impacts from the hurricanes whether it be in Texas or in the Southeast, obviously very unfortunate events, I think it’s a little early to tell in terms of the ultimate impact associated with that but if you look at some of the details, some of the past impacts obviously it would create some level of replenishment demand, potential, upward pricing pressure on these vehicle prices gets generally translates into positive developments for new car sales, if you look in particular into the Texas region a very high concentricity as it relates to pickup truck concentration in terms of sales, large GM and forward countries down there in terms of those products which as you know would bode very well for AAM as well as our key customers. So, again a little early to tell but some potential…

Joseph Spak

So specifically, with — a couple of concepts that came up there specifically with [indiscernible] taxes I think Florida is also pretty rich pickup state, and you mentioned for GM downtime and it sounds like your view is that the third quarter events for the fourth quarter should be in line with what you guys had — even storm aside what you’re seeing on the production schedules sort of in line with what…

A – Erin Gonzalez

Generally, in line with our recent expectations.

Joseph Spak

Now I guess the question is because of the changeover, should GM — do you think GM has the capability to sort of up the production schedule to sort of fulfil some of that demand?

Chris May

Yes, GM as well as the other OEMs certainly has a lot of levers in their toolkit to produce additional vehicles if they need to, they can run over time, they can add Saturdays, they can modify shipment production and they would meet demand as required. No concerns from that perspective.

Joseph Spak

From you as well.

Chris May

Absolutely.

Joseph Spak

And no disruptions to your supply chain from the storm or?

Chris May

No, not at this point.

Joseph Spak

So, moving onto sort of just the U.S. and I think one of the big topics and question to come up really with American Axle and I think a lot of it has to do sort of with leverage [indiscernible] is just the cycle. so now a couple of things I want to explore there, one maybe you can just sort of review, how you think about sort of downside protection if volume was down and with the specific focus on what’s different in the cost structure this time versus last time?

Chris May

Certainly obviously when we announced the transaction back in November, the transaction, the acquisition of the [GV] we consciously took on some additional leverage, some leverage risk associated with that, because we saw the short meeting and the long term benefits of that transaction on a lot of the business elements, but as we entered into that transaction we thought about in terms of what our downside protection was obviously due various planned scenarios but from a cash breakeven perspective we can run cash breakeven on a 25% to 30% down cycle from where we’re today, so with £70 million you can reduce that down — if you think about some of the main elements in the protection for that downside that we have, we’ve a highly variable cost structure and if you go back call it in the 2008, 2009 and 2010 timeframe we did a significant amount of work on the legacy AAM book of business in terms of bringing a very variable cost structure as it relates to our labour. So, we can rationalize that quickly, we can mobilize it quickly for up demand but we can also mobilize it quickly for down demand.

As it relates to purchase components which are a sizeable element of our cost structure today as we manufacture products approximately 60% of the input costs is associated with purchase components which are 100% variable, in simplistic term we can shut that off tomorrow, it’s not that simple when you are ultimately pretty darn close to that, so a couple that with a very variable cost structure as it relates to purchase components, a variable cost structure as it relates to labour, from a cost standpoint we’re confident we can manage it down.

If you think about some additional cash elements allow us breakeven, what we are obviously we spend a fair amount of CapEx, our business is capital intensive. We can obviously manage through some of the program launches which we continue to support for the customer, but we also have some levers and tools through our maintenance capital that we control. So that’s roughly anywhere from 1% to 2% of our sales as it relates to maintenance capital and in a time period of the industry circling down, we can lever that down relatively quickly and accommodate the market from a cash generation perspective. And of course, cash tax payments would reduce as well through that process. So, fair amount of leverage we can use to maintain that.

Joseph Spak

Has that sort of CapEx ratio I want to present you talked about compare pre-and post MPG, does it all very much?

Chris May

Not very much, I mean very similar so if you think about we meaning legacy AAM and forging business, machining business assembly, our new faculties now through the acquisition of MPG. Forging business, machining [indiscernible] so still a relatively capital intensive making the capital very similar.

Joseph Spak

Okay. And the other thing and I think this was another point you mentioned the second quarter had another interesting point that came out the second quarter was, people want to sort of — investors want to focus on sort of the SAAR, sort of the proxy for the industry, I think your specific business mix is a little bit different and I think what it illustrated that was I think you officially lowered the industry SAAR number, but the sales guys changed because of the strict programs you’re on. So, maybe talk a little bit more about how you sort of see industry mix progressing. And then also as it relates to the downturn scenario, you just talked about I mean you mentioned 25%, 30% down, I think that was an industry type.

A – Erin Gonzalez

Yeah. That would-be kind of flat overall.

Joseph Spak

Okay. So, this is just sort of mix of holes at current levels, okay. So then just a little bit about how you see sort of industry mix progressing here and sort of how the Axle portfolio plays in to that?

Chris May

I’m glad you mentioned that. We did associate very often with just US SAAR I mean AAM. And if you think about through our second quarter guidance that we came up with, we lowered our US SAAR projections yet maintain our revenue guidance for the full year. And if you really peel back you need to take a look at what’s driving AAM’s revenue. 50% of our revenue is associated with the full-sized truck and full-sized SUV programs, which continue to grow in SAAR share period over, period over, period over. And even through down cycles, that demand continues to remain healthy and very sticky if you will for lack of a better terms, for a variety of reasons and why people buy those vehicles.

The next element that continues to grow in our revenue portfolio is our exposure in the crossover vehicles and that’s about 15% of our revenue today. And that is a segment of the industry which is gaining share and you see that now when you take combine the full-size truck, full size SUV in the crossover vehicles 55% of our revenue but also its about 65% of SAAR mix and growing. We see that continuing to strengthen some yet as in our opinion left to continue to grow its view as SAAR.

So, we are not 100% tie in with the US SAAR, you have to look at our mix which is in the sweet spot or the strength of the SAAR segments today, we see that whole new strong. And then if you look at the rest of our book of business, 25%, 15% on a global market basis and then 10% on industrial commercial have nothing to do with US SAAR. So, we’re seeing strength in the commercial and industrial are seeing strength in our global platform, so we’re able to maintain this revenue.

Joseph Spak

Yeah. I’m actually quite glad about those over the next as where we wanted to go. So, you clearly with MPG you got a little bit more commercial vehicle also industrial and that’s sort of been trending a little bit, are you seeing some sort of inflection there and what’s the outlook as we move beyond 2017?

Chris May

Yeah. So, when we announced transaction in November these segments were generally on a decline, our view at the time was these were going — they’re of a cyclical nature and we’re going to cycle up at some point, it’s been probably a little stronger, a little faster than our original plan was in November so we’re certainly seeing strength in those markets and keep in mind, the bulk of our exposure there is in the North America commercial industrial segment, but we’re seeing a lot of strength there.

Joseph Spak

And I guess just sort of — maybe close a little bit below on ’17 and I want to get into some of the bigger picture stuff, but I think on your second quarter call you indicated, you felt pretty good sort of tracking to the high end of EBITDA margin guidance for the year which for reference is 17% to 18%, the pushback we received from that is the lack of absorption on some downtime from some of your key programs that you mentioned, any more detail or colour on some of the offsets from the cost side, I mean one of the things we’ve sort of tried to triangulate is that actually seems like some of the incremental margins on the new business wins has actually probably been pretty good and pretty strong so I was curious to know your thoughts on that and really what the puts and takes are to at least have that confidence in the forecast?

Chris May

Okay, just kind of levels at the table our guidance for the full year was 17% to 8% EBITDA margins half way through the year we’re just over 18% in the first and second quarter as a combined company. We’re obviously we’re pushing and striving to be at the higher end of the range as we mentioned and if you think about in terms of just normal production cadence, our backlog is a little more weighted to the second half of the year which we’ve talked about previously. And we had been experiencing — we talk about our margin profile of new business wins anywhere from 20% to 25%, we’ve been experiencing a little bit at the higher end of that range, which certainly plays into this consent, but at the same time some other positives that we have in the second half of the year would be our synergy implementation plan through the MPG acquisition is growing, it’s started in the second quarter, we started off to a great start there, but that will continue to grow from when we closed the deal in the beginning of April to really ultimately it’ll take two years, but that’s on a growth trajectory as well, so that would be some positives.

A little bit of offset associated with that we would see obviously as we get ready to convert over our facilities for the next gen trucks for whether it’d be General Motors or for FCA, we’ll incur some little extra project expenses associated with that, but big picture, those are probably the main in the short term puts and takes.

Joseph Spak

And commodities?

Chris May

From a commodity perspective, they have started to increase really in the first half, we’ve seen those levelled off a little bit here in the third quarter, you do have sometimes a little bit of a tail associated with timing when it moves around anywhere from one to three months I would expect probably a little bit in the third quarter associated with that on a minor basis but not a lot at this point of time. It sort of levelled up. But we’re subject to movement on that additional [push].

Joseph Spak

So, let’s sort of move back into the deal. The strategy was clearly, you mentioned one of diversification, but you can also argue of vertical integration. Is there something you see going forward as these sort of industry progresses, or that the customers are asking you that sort of compels you to sort of feel the need to get more vertically integrated?

Chris May

Great question. If you think about, I’ll rewind you back 20 years ago when the company was formed, AAM it was the driveline business when General Motors that came out, part of that also came was the forging businesses which was by design, which is a key vertical integration to the driveline business unit that we have today and that allows us — that philosophy has always remained within AAM on key critical components. We saw not only MPG, but we also the Mexico operations of your assembly acquire earlier this year which was vertical integration on our drive line for Axel tubes and others.

And we see very clear benefit from these types of transactions for a variety of reasons. One of which of course is some control and ability to manage your supply base on very critical components to our ultimate products. Two, would be the margin capture associated with it, why pay the supply base for something that’s core to us engineering, manufacturing, machining all that’s core to our company. And then thirdly, it’s a little more difficult to see from an outsider perspective, but when you’re able to control some of the design and development and manufacture of cost, some of your critical Tier 2, Tier 3 components that you ultimately will machine or assemble at a driveline capacity or in a power trend business unit, you’re able to design those products in partnership and conjunction towards more efficient to manufacture, more efficient to process, more efficient to assemble and you gain productivity through the entire value chain. Ultimately, we can then be more competitive when we’re out quoting customers.

So, we look very consciously, it’s some very critical components that we view for these are probably our [indiscernible] where we view that tube as well and the benefits associated with that. So, we think it’s an exciting piece of this transaction.

Joseph Spak

So, I guess somewhat related right in light of the GM decision to take some of the Axel business back in-house, one of the questions we get a lot is sort of in in-sourcing. Now, I won’t put words in your mouth there, I mean my own personal view is that it seems like in this instance GM made a while ago and I think if they were to have to make a decision maybe they would choose differently whether to in-source or not. And the reason I believe that is because I think there is — it’s all about allocation of capital and I think where they’ve got allocated capital to keep their businesses relevant in the future in terms of whether it’s electrification or autonomy other technological aspects they may need to invest. So, a little bit more there now.

And what I’m curious about I guess is as many auto makers begin to think about having to potentially allocate more capital towards those projects are you seeing or do you anticipate more outsourcing as opposed to the fear that others can follow the GM example and in-source or re-in-source?

Chris May

Yeah. That’s clearly our view from a short, medium and longer-term as an opportunity for our company. If you think about the products we supply play right into I think the area that you’ve just described. We certainly have the capabilities now with the acquisition of MPG, our global presence in terms of these core competencies whether they are forging and casting and power train play again right into some of that theme of the OEM. I would rather divert their capital on two things other than some of the more mechanical side of the business that play into our sweet spots. So, yes, we see this as an opportunity going forward. And a lot of OEMs still retain much of this in house and are probably going through the debate that you just described.

Joseph Spak

Okay. I guess just you mentioned sort of the synergy build, the MPG synergies building throughout the year that’s sort of the natural cadence and you’ve laid out overtime, I think by 2019, early 2019 that $100 million to $120 million. How is that — how would you say that’s progressing, have you as anything sort of caught you a little bit by surprise either to the positive or to the negative side. And I think if you take a step back the overall you are looking at sort of the scope and size of the deal didn’t seem like an overlay aggressive synergy target. Just wondering as you’ve now owned this for a little bit and recognizing it’s still early days, are there sort of potential sources of upside, where would they come from and how would they sort of flow in?

Chris May

Just a level set in terms of our total synergy expectation from the transaction was an objective of $100 million to $120 million. We would anticipate obviously closing in April of this year, we would anticipate a 70% run rate of achieving that by one full year of acquisition so call that the first quarter of 2018, and then the 100% run rate within two years, or call it first quarter of 2019.

If you break down sort of the three main driving elements of our synergies, we have about 45 million to 50 million in the overhead sort of category, so think of public company costs, duplicate overheads two finance departments, two IR departments etc., the second bucket 45 million to 50 million on the purchasing side, both the direct and the indirect side, so direct meaning components if you buy that directly apply to your product, indirect which could be things such as cooling and tooling things like that the operating factors, and the third element, is about 10 million to 20 million more on the manufacturing footprints in sourcing opportunities.

So, I would tell you big picture we’re on track to achieve the targets that we have laid out, we talked about that on our second quarter earnings call and we’ll continue to provide updates most likely on our earnings calls on a go forward basis.

But part of your question was also have you — do you see additional opportunities to continue to grow that? And what I would tell you if you think about those three elements that I just described, public company costs, overhead costs are generally very — they’re easier to get at, they’re quicker to get at, and then relatively easy to kind of define. We certainly see opportunities on the manufacturing footprint now that we have owned these factories now for call it four or five months, and the footprints, the capabilities of all the equipment in terms of product loading, in-sourcing opportunities, so we’re really now in the heavy evaluation mode, planning mode for that and really hopeful in terms of some opportunities there but those take some time to pour out.

One other element that we do not include in these synergy targets is of course the revenue synergy opportunities where now we are having dialogues with customers that traditionally we would not have had dialogue with before because they weren’t part of our product portfolio. You may have heard us talk about BMW or Hyundai that MPG brought, but conversely the customer such as JLR or Nissan on side, that now we have a little bit of profile, little different capabilities in some of the regions to help support additional revenue synergies there, again those take time, you plant seed and those time to play out but we’re pretty excited about some of those opportunities we are starting to see too. So, that’s how I would describe where we sit today, confident in our ability and on track from where we’re at.

Joseph Spak

Let’s shift gears a little bit here towards electrification which is certainly I think a theme that is accelerating, a lot of activity and press release activity out of Frankfurt this week, and I think there’s a sort of perception that American Axle sort of more legacy in that respect, your invention to EAM and you’re doing a lot of stuff there, big picture I guess sort of how do you think you need to sort of — maybe taking us back, while we describe what we have, but then also where you’re thinking the portfolio may need to go just sort of fully participate and keep the business?

Chris May

I think you used the word perception, and I think it’s a misperception in terms of American Axle. We have a significant product portfolio we can provide into the EAM space, we launch next year with full better electric vehicle that fits our front drive units and rare drive units associated with an upcoming platform which we’ll talk a lot more about next year in terms of who that is and that product.

But we supply that key technology and we can provide hybrid vehicles all electric vehicles, our e-Axle we also supply into the downsize IC engines, a little bit would play on the hybrid space. But our content can be anywhere from $500 to greater than $2,500 on an all battery electric vehicle depending on the configuration whether it’s two-wheel drive or four-wheel drive and the type of requirements they would supply on that to drive on system to that plus, there is also components that we make today that apply to all three platforms, whether it be a traditional IC hybrid or an electric type vehicle that we can play in a lot of different capacity. That could be up to another $400 of content per vehicle associated.

Joseph Spak

More than of what electric –?

Chris May

Different, breakout for example, different components related on the vehicle that we provide to our metal form business unit, our casting business unit a little bit on power train business. But they apply to all three, right so they are very relevant in all three. But clearly the main trust on the electrification plant is our e-Axle. And we continue to invest in that, our home loan is in Sweden today which we have developed and designed, very active dialogue with multiple OEMs in terms of future business opportunities, but also in current development opportunities with them today. We work very closely with them. So, it’s a very exciting time, very exciting product to the company.

Joseph Spak

Right. So, earlier I might have one sort of technical question here. I’m not the engineer either so it’s just going to be high level. But so, let’s try to sort of just compare and contrast what a traditional Axle today versus a new Axle. I understand there right in just lastly you have the casing and sort of the gearing, right. Any Axle you have is still a casing like I said in change in the advert, but then you have a motor and potentially a transmission. Is that at a high level?

Chris May

I think you are an engineer.

Joseph Spak

Okay. So, if that’s true, right like how do we think about the content perspective, but beyond that right, one of the questions I have is on the traditional side it seems like you’re doing all that and on the e-Axle side, I suppose you’re at least today you’re buying the motor and probably the transmission as well. So, how does the profitability of that look as well?

Chris May

Yeah. So, certainly as you described, call it the e-Axle you have the housing, you do every motor which we do not have make today. But then you refer to the transmission side, we do all, the transmission is very similar to our differential transmission. We do that work.

Joseph Spak

Okay.

A – Unidentified Company Representative

So that’s actually, what we would design, develop also vehicle integration. So, we do more than just the housing. Housing, machinery it’s a design, it’s the integration into the vehicle, from a control standpoint. So, we can do a lot more than just thousands. We provide a lot of content into that component. And we do not do the motor [indiscernible].

Joseph Spak

Right. So, from a content perspective and are they about equal, is an SME actually potentially higher content or?

Chris May

It’s a rough comparison and I see rough ending difficult comparing it to call it a traditional truck Axle because it’s on mobile on the truck Axle side they’re very large, they’re very heavy, they have a metal, lot of machines. So, it wouldn’t be the best comparison well this one is $1,600 and this one is $1,200. But, as I mentioned earlier, we can have up to greater than $2,500 content on an electric vehicle which is greater than average full-sized truck platforms in North America today which as you know we publicly talked about it is an overview.

Joseph Spak

What if you were to do an apples-to-apples like what if we were to talk about an e-Axle for a plus sized pick-up truck for instance?

Chris May

Yeah. Potentially, I mean depending on how it’s ultimately configured to test the wheels [indiscernible] could be somewhere.

Joseph Spak

And then from a margin perspective are you doing — even to the motors so you can argue that sort of maybe faster but then it sounds like you’re doing a little bit more on sort of the control and maybe even the power electronics for the side, so does that make up that sort of differential in terms of profitability or incremental margin?

Chris May

Yes, I would tell you on a margin perspective, I would think of contribution margin, you’ve heard us talk about 20% to 25% for this purpose, I would tell you I’d expect it to be consistent and in terms of the passthrough whether the OEM would have the motors are directed by Renault for example. We have similar components even on our axles today, breaks etc. are directed by passthroughs that we provide to the OEM, so you could make some argument that you have similar type to rectify concepts on both types of axles.

Joseph Spak

And then can you just remind us in the last backlog you gave what percent of that relates to sort of more of the EAM type technology and one of the other things which is necessary you need to come back to Axle, I think is sort of difficult to sort of gauge now is the share, because it’s sort of a market that doesn’t really exists yet, but clearly you are not the only one sort of playing here, you have some other competitors, some strong competitors. I mean what do you think is your fair share, what’s you sort of right to play here, what differentiates you to allow that?

Chris May

Yes, I think in terms of the differentiation for us, of course is we’ve been designing and developing this for quite some time. We’ve an awarded program in our backlog, we’ve not broken that out in terms of our total backlog but I will tell you it’s a program with reasonable volume associated with this.

In terms of other elements that are key to understand, it’s not only do we have this book program, but we’re also working very collaboratively with several other OEMs in the design and development of this so as you work closely with these OEMs, you start to build together this platform in the price that they require on their vehicles which will allow us to continue to remain relevant, give us additional cooling opportunities and ultimately be sourced into production for whatever vehicle they choose to build.

Joseph Spak

Hence, pretty scalable.

Chris May

That’s right.

Joseph Spak

With that I think we’re out of time. So, Chris, Jason, thanks for joining….

Chris May

Thanks really appreciate it, thank you everyone.

Question-and-Answer Session

End of Q&A

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