Linamar Corporation

Good afternoon, ladies and gentlemen, and welcome to the Linamar Q3 2023 earnings call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded on Wednesday, November 8, 2023. I would now like to turn the conference over to Linda Hassan-Fratz. Executive Chair and CEO. Please go ahead.

Thanks very much. Good afternoon, everyone, and welcome to our third quarter conference call. Joining me this afternoon are members of our senior teams, Jim Gerald, Dale Schneider, Elliot Berger, and Kevin Hallahan, and some members of our corporate IR marketing, finance, and legal teams. Before I begin, I'll draw your attention to the disclaimer currently being broadcast. I'll start off with a review of sales, earnings, and content. Sales for the quarter were $2.43 billion, up 16% to last year on solid launches, market share growth, our recent battery enclosure acquisition, and better pricing. Normalized net earnings for the quarter were $136.3 million, and normalized EPS was $2.21. EPS is also up 16% over last year on stronger sales performance, offset by FX headwinds and higher costs. Our industrial segment had another strong quarter with sales and OE significantly up, but SkyJack in particular, primarily thanks to market share growth in targeted products. MacDon and Salford also saw both sales and earnings growth. Higher sales helped offset higher costs that we're seeing in these businesses. The mobility business had a strong quarter on the top line thanks to strong launch performance The acquisition done in the segment and some market growth. FX rates were unfavorable in comparison to Q3 of last year for mobility, hitting earnings hard this quarter. Higher costs also continue to drag on results, although customer pricing relief is helping to offset at least part of those costs. We felt a negative FX impact in comparison to Q2 of this year as well this quarter, without which we would have seen some OE growth compared to Q2 as we had forecast. We expect to see improvements sequentially in Q4 for this segment, with a full quarter instead of two months for the battery enclosure business and two months for our recently announced MOVEX acquisitions. This quarter represents another solid quarter of earnings growth and margin growth in what is a very tough environment, which we are very proud of. Our business is diversified and allows us to drive consistent, sustainable growth on an ongoing basis, as you can see by this chart, which is exactly what we are delivering. We saw another quarter of solid market share growth in our mobility business with global content for vehicle up over last year. Both Europe and North America saw content for vehicle growth on launching business to new record levels. Commercial and industrial sales were up 25% with strong growth of Skyjack and both agricultural businesses also growing. Market share growth has been a big driver this quarter for all of our industrial businesses. CapEx continues to run at a more normal level than seen in recent years to support global launches and growth. CapEx has a percent of sales of 8.2%, so in line with the level of spending of 6% to 8% that will support targeted double-digit growth. CapEx will be up significantly this year over last year and at the high end of our normal range. Next year, CapEx will stay in our normal range of 6% to 8%, but will decrease in absolute terms from 2000 and 2023 levels, promoting stronger free cash flows. Free cash flow was negative for the first quarter in a while, down $124 million, with a big draw on working capital alongside another quarter of stronger capex. We do expect to see positive free cash flow in the fourth quarter to end the year on the positive side overall. We continue to have ample cash available for growth, with $1.4 billion of liquidity available to us. Our net debt position is solid at just 0.79 times EBITDA. I believe our strong balance sheet is an important factor in the timeframe of some economic uncertainty. I'll turn now to market outlook. Market demand is continuing to look positive for 2023, with growth in most regions and businesses expected this year. Next year is seeing a mix depending on the market, although notably North American light vehicles still forecasting growth, as is the access market. Turning to the specific markets, industry experts are predicting growing light vehicle volumes globally this year to 15.2, 17.7, and 50.4 million vehicles in North America, Europe, and Asia, respectively. This represents 6%, 12%, and 7% growth, respectively. 2024, we'll see further growth in North America of 5% to 10%, but flat volumes in Europe and Asia. Industry experts are predicting on-highway medium-heavy truck volumes to grow in Europe and North America this year with double-digit growth in Asia after a couple of tough years. Next year, we will see continued growth in Asia, but declines in Europe and North America. Industry experts predict double-digit growth in the access market globally this year with with North America and Europe expecting high single-digit and Asia low-digit growth. Next year, we'll see further growth of another 5% to 10% globally and in each region. Lastly, the egg industry is predicting growth in the combine draper market this year in North America, but reasonably flat in other parts of the world. The wind drower market will also see single-digit growth globally this year, driving mainly out of Europe and Australia. There's a positive outlook for market growth in both tillage and crop nutrition equipment for this year as well. We'll have a better picture of the agricultural market for next year in the next month or so, but early indicators are for the market to be fairly flat globally next year, depending on the outcome of this year's harvest and general economic outlook, so not dissimilar to this year. Looking at the access market in more detail, we saw solid growth in North America in the third quarter, with Asia and Europe dialing back. All three regions are expecting solid market growth this year and more moderate growth in 2024, as already noted. Rental company demand remains positive as companies continue to look to counter fleet aging that was experienced during COVID. Equipment utilization in North America is well ahead of 2022 year-to-date levels in line with or at times exceeding peak 2019 levels. Utilization levels in Europe are also above 2022 levels and well ahead of 2019 peaks. Our backlog at SkyJag is solid and with some relief on the supply chain side, we're increasingly enabled to deliver on such as we saw demonstrated so strongly in the third quarter. With market and market share growth, we feel confident we can again grow SkyJax in double digits this year and next. We're, of course, keeping a close eye on potentially shifting market conditions in the event of any economic slowdown. In the agricultural business, Q3 combine retails in North America were down a little, but high horse power tractors up 6% to overall fairly flat. Both markets are up for the year. As noted, we expect to see market growth primarily in North America for our ag markets this year. Inventory of ag equipment retailers has normalized to some degree, but is still low in historical terms, which will continue to drive demand. The order book and demand are still strong for MACDON. Our current forecast is for double-digit sales growth this year again for MACDON with continued growth in 2024 as we continue to grow our market share. Salford is seeing a strong order book as well and is also predicting double-digit sales growth in 2023 and continued growth in 2024. Looking at the mobility side, you can see vehicle inventory levels in North America are sitting at about 40 days, still well below historic levels. In looking at production levels compared to what was forecast at our last conference call, you can see a stronger Q3, all driving out of Asia, which ended at 22.3 million vehicles, up 4% from last year, which was 21.5 million. Q4 is forecast to be 22.7 million units, again, up 4% from last year, and in line with what we forecast back in August. The full year, as noted, is predicting overall growth now at 7.7% over a prior year. Looking at launches for the mobility business, you'll be pleased to know we had another strong quarter in new business winds, and once again, a very strong quarter for winds in the electrified and propulsion agnostic space, which is dramatically shifting the landscape of our mobility business. We had a solid first three quarters of the year in terms of business winds for both battery electric and hybrid electric vehicles, as well as propulsion agnostic areas of the vehicle. Year-to-date wins are now 74% for a combination of electrified vehicle and propulsion agnostic work, which is outstanding. Nearly 60% of our books light vehicle sales as soon as 2027 are now for a combination of electrified vehicles or propulsion agnostic products. And this figure is growing every quarter. Our strategy is to continue to grow this percentage to minimize the concentration of our business at risk as ICE vehicles ramp down over the next decade. We are seeing ramping volumes on launching programs which are predicted to reach 20 to 30% of mature levels this year, generating incremental sales of 700 to 800 million. We will see further growth of another incremental 800 to 900 million next year. These programs will peak at nearly 3.7 billion in sales. Nearly $900 million of programs moved from launch to production in the last quarter, partially offset by business wins in the quarter. Launching business in conjunction with acquisitions and growing markets will result in double digit sales growth for the mobility segment this year and next year. Let's turn to a summary of that top line outlook and also look at the bottom line margins and next quarter in a little more detail. With strong markets and market share growth, we are expecting to see double-digit growth on the top line in 2023 and 2024 for Linnemer overall. This drives from double-digit top-line growth in both our industrial and mobility businesses. Net margins will expand this year on growing sales. We expect significant growth in margins in the industrial segment, where margins have expanded back into their normal range. Mobility margins will contract through the year, noting stronger margins are expected in the back half of the year than the first half. This will mean significant double-digit growth in industrial segment OE offset by a lower OE performance in the mobility segment, combining to nevertheless drive significant double-digit growth in EPS in 2023. In 2024, we expect continued expansion in overall margins driving out of expansion in margins in the mobility segment and continued strong margin performance in the industrial segment. This will mean double-digit growth in earnings in both segments and another year of double-digit EPS growth in 2024. We will also see continued positive free cash flow this year and strongly positive free cash flow next year, leaving us in an excellent position from which to drive further growth. Looking specifically at Q4, you should expect double-digit OE growth from prior year, but seasonally down, of course, from Q3 of this year. The mobility segment will see earnings up sequentially over Q3 of this year, despite normal seasonal slowdowns, thanks to a full quarter for our new battery enclosure plans, as well as two months of our MOBEX acquisition, and continued expected improvements in terms of cost and recoveries. expect modest growth over Q4 of last year. I will note this outlook excludes any knock-on impact not yet known to the fourth quarter from the recently resolved UAW strikes at Ford, GM, and Stellantis. Although we did feel some impact from the strike in October, which I have considered in our outlook, it is not clear if call-outs might be increased or potentially cut. in November and December as a result of inventory levels post-strike. If banks were built pre-strike, schedules could be cut. If not, schedules may be increased to catch up and refill the pipeline. What we know now is in our outlook, which again is for growth both sequentially and over prior years. The industrial segment will see OE down sequentially in comparison to Q3, of course, due to normal seasonality of all businesses. but up in double digits compared to last year. Moving on to an operational update, we were very excited to announce during the quarter a second acquisition for our mobility business for 2023 for another propulsion agnostic business, Movex. Movex is a vertically integrated casting, machining, and assembly business. MobX has a patented vacuum riserless casting, or VRC, and pressure riserless casting, PRC, technology that is very well suited to large hollow body parts such as knuckles or control arms and other structures. It can cast lightweight parts with superior strength. As an example, the MobX process is able to cast the large knuckles required on pickup trucks and SUVs. We already cast in machine knuckles, but our current process is more suited to smaller vehicles, mostly passenger cars. The Mobex capabilities are a great complement to our existing knuckle casting capabilities to allow us to offer a full spectrum of products to our customers. Mobex's casting capabilities also complement our existing light metal casting technology, which now ranges from static and tilted gravity to three types of low-pressure casting to high-pressure die casting as well. Having this flexibility is critical to be able to offer our customers full range capability in casting to produce the specific technical, mechanical, and performance requirements that they might have for their castings. The business generates approximately $450 million Canadian dollars in sales annually. The purchase price is $64 million US dollars. We expect operating earnings levels to be a little under our normal target range of 7% to 10% of sales for our mobility business, but we anticipate to see them reach that level within 12 months. The financial results will be consolidated into our existing mobility segment results. We welcome the Mobex team to the Linnemar family. The business will join our new gigacasting facility announced earlier this year, as well as our existing Mills River high-pressure die-cast facility and our new battery enclosure business as a key anchor in our fully electrified vehicle and propulsion agnostic group, the Linnemar Structures Group. With this latest addition, the Structures Group has already become a global powerhouse at about $1.5 billion in sales with additional opportunities under pursuit. Moving on to new business wins on the mobility side, I'll highlight a few of our more interesting wins this quarter. First, I'd like to highlight nearly $40 million worth of wins in various differential assemblies. that will be used in battery electric vehicles for a couple of different customers. Production of these components will start next year in facilities in France and in China. Secondly, we saw several wins for structural components that will launch in the US, in Germany, the UK and France. Structural components are a huge growth area for us at Lindemeyer and have the benefit of being propulsion agnostic. Building a strong business in this area is an important strategy to stay flexible in a changing market environment. Third, we won a few important programs for hybrid electric vehicle components and assemblies. Again, it is for a variety of locations and customers throughout Europe and Asia. And finally, we have already secured an additional business win. for one of our brand new plants acquired last quarter from Dora Shiloh for a structural component for an electric vehicle to be produced in the U.S. The program starts production next year and will ramp to a volume of $240,000 per year at peak. Turning to an innovation update, I'd like to highlight Skyjack's latest telematics update known as Elevate Live 2.0. Building on the initial elevated telematics package, Live 2.0 provides SkyJax rental customers with even greater machine usage and fleet status insights, now including recent overload and safety warnings, battery health, machine control, condition, fuel condition, and engine diagnostic details. Intelligence that enables fleet operators to run their business more efficiently. Another example of our customer-focused technologies that SkyJax provides owners with better return on investment. Next, MacDon has just released its latest self-propelled wind grower, the M2 model. MacDon's market leadership and swapping goes back decades. The M2 builds on that reputation with a new engine that provides more horsepower. It features intuitive new touchscreen operator controls. while maintaining all the other familiar features of MacDon's self-proclaimed wind grower products. The new M2 proves that even MacDon's longest-running product line is still among the most advanced and innovative in the market. And lastly, Sulfur has introduced the 56M series cover crop seeder application for usage on its line of narrow tillage implements like the Halo VRT. The market is seeing increased demand for cover crops, an agricultural practice that helps protect the environment by reducing the risk of soil erosion. Salford's expertise in precise air delivery systems enabled them to design a system very well suited for limited space installations while still delivering accurately to achieve maximum agronomic and environmental benefits. Finally, we continue to execute on our global digitization journey with more and more connected machines, data connections, and robots being commissioned in our plants every day. With that, I'm going to turn it over to our CFO, Dale Schneider, to lead us through a more in-depth financial review. Over to you, Dale.

Thank you, Linda, and good afternoon, everyone. As Linda noted, Q3 was an exceptional quarter as we achieved double-digit sales and double-digit earnings growth despite the challenges of the strikes of the OEMs. the continuation of supply chain cost issues that have further impacted our earnings in the quarter. Q3 was also another positive quarter for cash generation, with strong liquidity hitting $1.4 billion. For the quarter, sales increased 16% to $2.4 billion. Earnings were normalized for FX gains or losses related to the revaluation of the balance sheet and potentially other items that have recurred. In the quarter, earnings were normalized for FX gains related to the revaluations balance sheet, which impacted EPS by 17 cents per share. Normalized operating earnings for the quarter were $200 million. This compares to 168.4 million in Q3 22, an increase of 32 million or 19%. Normalized net earnings increased by 15.3 million. or 12.6% in the quarter to $136.3 million. Further, fully diluted normalized EPS increased by 30 cents or 15.7% to $2.21. Concluding the earnings for the quarter was foreign exchange gain of $14 million, which resulted from a $13.9 million gain from the revaluation of operating balances and a $100,000 gain from the revaluation of financing expenses balances. As I mentioned, the net FX gain impacted the quarter by 17 cents in EPS. From a business segment perspective, the Q3 FX gain of $13.9 million related to the revaluation of the operating balances was a result of an $8.5 million gain in industrial and a $5.4 million gain in mobility. Further looking at the segments, industrial sales increased by 26.8% or $143.2 million to reach $676.6 million in Q3. The sales increase for the quarter was due to the higher access equipment sales driven by global market share growth. The positive impact from FX rates since last quarter and higher agricultural sales driven also by global market share growth. Normalized industrial operating earnings in Q3 increased 47.6 million or 64.1% over last year to reach 121.9 million. The primary drivers impacting industrial earnings were the increased contribution from the higher access equipment sales, the increased contribution from the strong agricultural equipment volumes and the positive impact from FX rates since last year, which these are partially offset by increased S&A costs that are supporting the growth. Turning to mobility, sales increased 192.9 million or 12.3% over Q3 last year to 1.8 billion. The sales increase in the third quarter was driven by the positive impact from changes in FX rates the increased volumes on launching programs, the increasing volumes on certain mature programs, the acquisition of the battery enclosure business, and cost recoveries achieved in the quarter from our customers, which partially offset increased supply chain costs. These are partially offset further by lower volumes on certain programs that are winding down to end of life. Q3 normalized operating earnings for mobility were down over last year at $78.5 million. In the quarter, mobility earnings were impacted by the increased contribution on the higher launch and mature program volumes, the sales related to the acquisition of the battery enclosure businesses, but these were offset by lower volumes on ending programs, an unfavorable impact from exchange rates at the operating level, the increased SG&A costs that are supporting the growth, and also the net increased cost of supply chain issues, net of the customer recoveries. I would note that the strikes of the OEMs that started in Q3 2023 had no material impact to Lenmar's results in the quarter. Returning to the overall Lenmar results, the company's gross margin was $340.3 million, an increase of $62.4 million compared to last year due to the same situation factors that drove the segment results. Cost of goods sold amortization expense for the third quarter increased to $121.3 million compared to Q3 2022. This was mainly due to the launching programs in addition to the acquisition of the battery enclosure business. COGS amortization as a percent of sales, though, did decrease to 5%. Selling general administration costs increased in the quarter to $139.4 million from $108.7 from last year. The increase is primarily the result of the increased management and sales costs supporting the growth, the increased SG&A costs from the acquisition of the battery enclosure businesses, and finally the increased travel costs that are also supporting the growth. Finance expenses increased $8.9 million since last year. mainly due to the additional interest expense due to the Bank of Canada and the U.S. federal rate increases since last year, increased debt due to the acquisitions completed last year in 22, and the share buyback program from last year. Additionally, we also had the new private placement notes that were issued in June 2023, which was used to fund the battery enclosure business acquisitions. These were partially offset by increased interest earned That was driven by the interest rate from last year as well. The consolidated effective interest rate for Q3 2023 was 4.6%. Effective tax rate for the third quarter increased to 25.3% compared to last year, mainly due to the increase in non-deductible expenses compared to last year. We are expecting the 2023 full year tax rate excluding the withholding tax issues in Q1 and Q2 to be in the range of 24 to 26% and higher than the 2022 full-year tax rate. The minimum cash position was $694.6 million on September 30th, a decrease of $165 million compared to December 2022, mainly to fund the CapEx and the acquisitions in the quarter, net of any cash generated from operations and the net proceeds from long-term debt. The third quarter generated $74.6 million in cash from operating activities, which was used to support those capex and debt repayments. As a result, net debt to EBITDA increased to 0.79 times in the quarter from a year ago, mainly due to the acquisition of the battery enclosure plants in the corridor Based on our current estimates, we are expecting 2023 to maintain our strong balance sheet and leverage is expected to remain low. The amount of available credit on our credit facilities was $675 million at the end of the quarter. Our available liquidity at the quarter remains strong at $1.4 billion. As a result, we currently believe we have sufficient liquidity to satisfy our financial obligations throughout 2023. To recap, sales and earnings for the corner was a story of improving markets and increasing market shares in both segments, which drove double-digit sales growth and EPS growth. Supply shortages have been hampering the OEM productions, have continued to improve, adding additional sales to mobility. The supply chain-related cost issues continue to impact both segments, but Linamar has continued our discussions with our customers for sales price increases and cost recoveries. These negotiations remain ongoing for certain customers. Despite these challenges in the quarter, we still maintain our liquidity levels at $1.4 billion. That concludes my commentary, and I would like to open up to questions.