Magna International Inc. (MGA) Q3 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Third Quarter 2013 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, November 6, 2013. I would now like to turn the conference over to Don Walker, Chief Executive Officer. Please go ahead.

Thank you. Good morning, and welcome to our third quarter 2013 conference call. Joining me today is Vince Galifi, Chief Financial Officer; and Louis Tonelli, Vice President, Investor Relations. Yesterday, our Board of Directors met and approved our financial results for the third quarter ended September 30, 2013 and we issued a press release this morning for the quarter. You'll find the press release, today's conference call webcast, our updated quarterly financial review and the slide presentation to go along with the call all in the Investor Relations section of our website at www.magna.com. Before we get started, just as a reminder, the discussion today may contain forward-looking information or forward-looking statements within the meaning of applicable securities legislation. Such statements involve certain risks, assumptions and uncertainties, which may cause the company's actual or future results and performance to be materially different from those expressed or implied in these statements. Please refer to today's press release for a complete description of our Safe Harbor disclaimer. Overall, we're happy with the performance in the third quarter. In North America, we once again had strong operating performance with an adjusted EBIT percent, excluding E-Car amortization, of 9.2% for the third quarter. In Europe, our progress continues, with solid reported adjusted EBIT of $72 million in Q3 compared to $13 million in Q3 of 2012. This marked the seventh consecutive quarter of increased year-over-year adjusted EBIT. We recorded restructuring charges this past quarter as we continue to take actions to improve European profitability. We continue to expect improved earnings for full year 2013 compared to 2012 in our Europe segment. In our Rest of World segment, we reported a small profit for the quarter and expect to be profitable for the year. Year-to-date, Asia has performed better than our expectations and South America,…

Thanks, Don, and good morning. I will review our financial results for the third quarter ended September 30, 2013. Please note, all figures discussed today are in U.S. dollars. A slide package accompanying our call this morning includes a reconciliation of certain key financial statement lines between reported results, and results excluding other income and expense items. In the third quarter of 2013, we recorded restructuring charges entirely related to our European exteriors and interiors business. These reduced operating income by $48 million, net income by $33 million and diluted EPS by $0.14. In the third quarter of 2012, we recorded a remeasurement gain on our 73% interest in E-Car arising from the acquisition of the remaining interest in E-Car. This increased operating income by $153 million, net income by $125 million and diluted earnings per share by $0.53. The following quarterly earnings discussion excludes the impact of these charges. In the third quarter, our consolidated sales increased 13% relative to the third quarter of 2012 to $8.3 billion. North American production sales increased 11% in the third quarter to $4 billion, reflecting in part a 4% increase in vehicle production to 3.8 million units. In addition, the increase is a result of the launch of new programs, acquisitions completed during or subsequent to the third quarter of 2012, including STT Technologies, and an increase in content on certain programs. These factors were partially offset by the weakening of the Canadian dollar against the U.S. dollar, programs that ended production during or subsequent to the third quarter of 2012 and net customer price concessions. Relative to our previous outlook, we also had better-than-anticipated mix of ongoing programs, which drove average content up in the third quarter of 2013. European production sales increased 18% from the comparable quarter, while European vehicle…

Thanks, Vince. Good morning, everyone. I will review our updated 2013 full year outlook. I'll only provide a summary of our outlook, since we covered the details of our revised outlook in our press release. With respect to our vehicle production expectations, we continue to expect 2013 North American light vehicle production to be approximately 16.1 million units, unchanged from our August outlook. We expect 2013 total European light vehicle production to be approximately 18.8 million units compared to 18.6 million in our August outlook. This increase to our European forecasted light vehicle production substantially reflects the higher-than-anticipated third quarter production. As Vince noted earlier, in North America for this third quarter, production mix on existing platforms outperformed our expectations, driving a high implied average content per vehicle. We expect the fourth quarter implied average content and product mix to be closer to the level seen in the first half of the year. The increased European production assumption is expected to lead to increased full year European production sales relative to our August outlook. Higher-than-anticipated Q3 assembly sales and a stronger Euro have resulted in an increase full year assembly sales outlook. And weaker currencies in South America relative to the U.S. dollar have resulted in reduced Rest of World production sales outlook. As a result, we expect total sales to be in the range of $33.9 billion to $34.8 billion compared to the range of $33.3 billion to $34.7 billion from our August outlook. At the low end of the range, this would represent record sales for Magna. Implied in our total sales for Q4 -- sorry, is Q4 tooling, engineering and other sales in the range of $800 million to $900 million, which is higher than our year-to-date run rate and higher than our previous expectations. We expect…

[Operator Instructions] And our first question comes from the line of Peter Sklar with Nesbitt Burns.

A question on the guidance. Although you took up your operating margin guidance, based on the year-to-date performance, your Q4 operating profit looks a little bit weaker than expectation. Is there any negative developments in the fourth quarter that could have a negative or could be a headwind for your anticipated results for the quarter?

Peter, good morning. It's Vince. Louis tried to address that during his formal remarks. I think the way to analyze it is if you look at North America and Europe and production volumes implied in our guidance, you'll get sort of North American production volumes, the implied number for Q4 is about 4 million units, which is a little higher than where we are in Q3. And in Europe, the implied sort of volumes for Q4 are almost identical to Q3. But a couple of things to note. One, we had, I'd say, pretty good mix in Q3, and we had some good implied content per vehicle and we see our content per vehicle moving more to the normal type range that it has been sort of in the first and second half -- first and second quarter of the year. The second thing to note is that when you look at implied complete vehicle assembly sales or implied tooling and engineering sales in Q4, they're higher than where we were in Q3. In fact, at the midpoint of our ranges, the vehicle assembly sales, tooling and engineering and other sales are higher than any other quarter we had in the year. So when you sort of put that all into perspective and say, "Well, we've got North America, some stronger volumes, content lower than Q3, overall Europe, even though production is about the same, implied production sales are higher, part of that is due to exchange. So again, European margins are less than consolidated margins, that's kind of a negative on our consolidated margin standpoint. And when you look at tooling and engineering sales, we will remain little or no margin and higher complete vehicle assembly sales and put that all into the mix, that's going to imply a lower operating margin in Q4. So that explains sort of the change, but we don't forsee it at this point, Peter, any negative surprises in the quarter.

Okay. And when you talk about the -- your mix reverting to the -- what was typical, what we saw in the first half of the year, are you talking about North America and Europe or just North America?

No. North American program mix is what we're talking about, which is going to be implied in the content per vehicle.

Right, okay. And I have just one other question on a different matter. So you've deployed a lot of capital on the Rest of World over the last few years. Can you review where you are in the ramps of that capital in terms of the plants that you've greenfield, particularly in China and Russia or any other jurisdictions that you feel are significant? I'm just trying to get a feel of where we are on the ramp curve.

Yes, just try to think, I can't remember the numbers exactly, Peter, it's not here. We still have a number of plants coming onstream, especially one very big powertrain plant in China. So it's just turning to ramp-up now. So we are still having some start-up costs in China, but if we exclude those, our operations in China are performing just about where we expect them. So good results. We have a number of issues in South America, some of them are product launches. But most of the issues we have down in South America are related to commercial recovery, inflationary issues in Argentina, also in Brazil. So a lot of them are commercial discussions we're having.

Peter, if you look at kind of the 3 regions that we operate, sort of North America, Europe and Rest of the World, when you think of kind of new facility costs in '13, expect this trend is going to continue in '14 as well. In both North America and Europe, on a year-over-year basis, usually costs are less in '13 versus 2012. So that's some tailwind to operating margins, so all these fully start to ramp-up and produce some sales, we're seeing some benefits in '13 and that should continue in '14. But one place that on a year-over-year basis is negative is still the Rest of the World segment. It's primarily China and India where we're seeing some substantial growth. I need to see the business plans that we're putting together to just see exactly when that turns around. I'm not at this point, sure whether China and India continue to be a drag in '14 based on new programs, new launches or whether we get to see some benefits but we will update that in January at the Detroit auto show for you.

Our next question comes from line of John Murphy with Bank of America Merrill Lynch.

Just a first question on North America, when we look at the growth that you had in the quarter up 11% versus production of 4%, that was pretty impressive and your citing mix as a big positive in the quarter. As we look at this, I mean GM is still ramping up on its large pickups. It's got it's HD's launching early next year, you got the Ford F-150 in the second half of next year, it seems like there's a pretty good runway of positive mix for you in North America, at least through the end of 2014. I'm just curious why you are really pointing out that mix in North America might revert to something less favorable than what we saw in the quarter because it looks like it'll be a lot more favorable than what we saw in the first half of '13 going forward?

Well, John, the comment really refers to Q4, not into 2014. And while we did have part of those mix in some programs and the key to FX was kind of below the overall decline that the Q2 to Q3, and we do expect that to get a little bit better. But there's some positives and negatives and things opposite direction, things like the Grand Cherokee and Landeau [ph] platform are very strong in the quarter. So it's more referring to Q4. We really haven't given any indication. In fact, we don't really have a role, if you will, what 2014 looks like. So I think we get to January, we will have a lot better view of content growth and what we're expecting for 2014 versus 2013. My comment is really related to what we expect in Q4 versus Q3.

Okay, that's helpful clarification. And then as we look at CapEx going from $1.4 billion to $1.3 billion, I mean, should we be reading anything into that? Or is that just good efficiency and thrifting? Or was there anything that was delayed in any customers because of the.. resulting in that?

What it is, is that obviously, we have a bottoms up approach to looking at capital and as you get closer to the end of the year and you look at how much capital has been approved, we're just not going to spend it all. It's not our view. So it's just being pushed in to 2014. It's timing. Remember, we're a pretty big company. A lot of businesses out there in every division estimates off by $200,000 or $300,000 or $400,000 or $500,000 that adds up to quite a bit of money on a consolidated level.

The other thing we've been doing as part of our world class manufacturing initiative which we've done a lot of effort on, we have been looking at very carefully at program capital to try and figure out how we can do things at more flexibility, spend less money that's not required. We've been doing cardboard factories and all that has a benefit of giving us probably better production facility at slightly lower capital. So it's a combination of things. There's nothing -- no concerns there.

Okay, it's encouraging. And then Vince, on the amortization of E-Car, that is done as of the first quarter of 2014. When does that rolloff?

No, it's done December 31, 2013, John.

So it's done as of 2014. We're not going to have it in our numbers, correct?

Yes, unfortunately, John, in Q1 '14, when we talk about Q1 '14 versus Q1 '13, we're going to have to readjust Q1 '13 to bring everything in line. But we won't have anymore charges in 2014 related to that amortization.

Okay, that's helpful. And then just lastly, on capital allocation, I mean, obviously, you're getting a little bit more aggressive on buying back shares, once again, it looks like the new authorization. I'm just curious are you seeing less opportunities on the M&A horizon and that's why you're looking at your shares? Or is it just because your shares are inexpensive and it seems like a good time to buy them and it's a good use of capital? Just trying to understand how you're balancing this out and why you're getting so much more aggressive? I mean, it's an encouraging thing I'm just trying to understand your thought process.

Been a long discussion again at the Board meeting yesterday about cash, we want to be from a net cash position. As we said in the past, our preference would be to spending -- spend the money on new programs, greenfield or adding to existing facilities because we know exactly what we're getting. We had a quota and we've always had pretty good results with that. Second priority would be to spend it on acquisitions. Our view and who knows, but our view is the economy seems to be going along pretty well in North America. It seemed to have hit bottom in Europe. We still are looking at a number of acquisitions but things aren't at a fire sale. We're looking at some technology. So we have -- we're going to look at a normal course issuer bid again of 12 million shares. The intent would be if we don't come up with acquisitions that we would fill it. If we do come up with some great opportunities for acquisitions and we might cut back as we're looking at where we want to end up from a cash balance standpoint. But if we don't have money -- if we don't find good acquisitions and I don't want to rush into an acquisition for the sake of doing an acquisition, then we'd be buying back shares. So there's, I wouldn't say a whole lot of things out there we're aggressively pursuing, but we are looking at a number of different opportunities out there. So it's hard to tell. We'll just have to track and see how things go.

John, just to add a little bit more color. We've talked about evolving our balance sheet over time. We completed the 12 million shares under the last bid. And you sort of sit back and you look at our business, and Don talked about kind of stable economic environment. We do generate quite a bit of cash from operations. We are investing a little bit through CapEx. So we have the ability to continue to buy stock. And how quickly we do that is going to depend on opportunities that come our way, whether it's capital or acquisitions. Our urge doesn't change in a macroeconomic environment. It's a good position to be in, so we'll move on the year buying back stock and adjusting that basing on opportunities we see.

Right. Just one follow-up on this. I mean, it's about, of course, using hand grenade, it's about $1 billion, depending on where the stock is. I mean should we think about that $1 billion being allocated out to either share buybacks or incremental growth investment or an acquisition? I mean, you're looking into those 3 buckets, but it is $1 billion roughly that you're seeing outside of what you're doing right now as far as operating the business that will be used for incremental value-creating events to shareholders. Is that a kind of a fair characterization and you're going to have to figure out exactly how that goes depending on market conditions, but it's $1 billion, is that correct?

Yes, I think that's a good way to look at it. I would have not classify it that way think. It's probably a good way to look at things. And if something changes dramatically in the economy, we may change our view. But assuming our view of the world and everybody else's view at the world bank is pretty similar, assuming that this is what happens and that's the way to look at it.

Our next question comes from the line of Rod Lache with Deutsche Bank.

It's actually Pat Nolan on for Rod. A lot of my questions have been answered. So I just wanted to follow up on just a couple of things. So just first, on the European mix impact, was that primarily just because a lot of the new programs come on with a really strong mix? Or is there some other -- something else going on as far as customer mix is in the quarter?

It wasn't European mix. It was the North American mix that I was referring to.

Okay. In that case, the European content per vehicle is up pretty nicely. Was that primarily currency? Or is that a mix impact as well?

I think content was pretty much in line with the second quarter.

Yes, I think when you look at it, Pat, year-over-year, there are number of things. We benefited from a number of program launches from a year ago. Acquisitions have also added to sales on a year-over-year basis. Remember, we completed the acquisition of ixetic in the fourth quarter of 2012. And another impact was foreign exchange on a year-over-year basis. But the biggest impact would have been new program launches and acquisitions.

And just a housekeeping, what was the FX impact in North America and Europe in the quarter?

Negative $60 million in North America and positive $98 million in Europe.

If I could just sneak one more and just the equity income seem to pick up a little bit sequentially in the third quarter. Was there anything extraordinary there? Is this kind of the run rate we should be thinking about going forward?

Sequentially.

It's up about $5 million sequentially.

Yes, nothing sort of comes out of mind as unusual. Just pretty normal operations, sequentially.

Our next question comes from line of Rich Kwas with Wells Fargo.

Just a couple of quick ones. Commodity costs, Vince, you talked about that being a benefit to gross margin. What was the magnitude of benefit this quarter?

It was really insignificant. When we try to look at kind of rolling sequentially operating income quarter-to-quarter, there were a number of, if I look at it sort of consolidated, a number of things that impacted us. So there was a little bit less warranty cost sequentially. We are hit by additional launch costs, particularly in Europe. New facility costs, primarily Rest of the World. And then the last thing I got in there is commodity costs, and that's the smallest impact of all the others that I just mentioned. It's really insignificant.

Okay. And then on the launch cost, you just mentioned launch cost, if I recall, for the full year, it's going to be flat or roughly flat. Is that still the case for '13?

Yes, it is.

Okay. And in South America, the year-over-year improvement or the improvement this year is not quite as good as what was expected. I assume you're still on a loss position there. What's kind of the update there as we think about moving forward into '14 and the expectations for improvement and the time line for that?

Rich, South America is in a loss position still in 2013. We are -- we have seen improvements, although loss in 2012. So you look at our Rest of World segment, we're positive and that's because we're generating income in China. We still have some new facility costs in India, so India is negative. But overall, China is bringing the segment up. And just in terms of progression, we're still dealing with some commercial issues and trying to recapture, recoup inflationary adjustments to our costs. So we're -- we have continued dialogue with our customers. So part, it's going to depend on how successful we are with our customers. We are making headway in terms of new facility costs and we're making headways in terms of operational inefficiencies. But I think the thing that's going to move us the quickest is going to be our success with customers on trying to recover inflationary adjustments to our costs.

I assume that's going to take some bit of time? I mean, not...

We've been having intense discussions for quite a while now. I haven't listened to what other suppliers have been saying in their conference calls. I suspect that everybody else is in the same situation. Our customers realize how difficult it is with our input costs going up and they don't want to do something to offset that than the long-term solution is we give the contracts back, we get out of the contracts. But I think you'll be hearing that from most people who are operating down there. So it's not like we're just starting discussions. These has been going on for 6 to 9 months extremely intensively. So I would hopefully get some sort of resolution here over the next quarter. I mean, you can never tell, but that's my expectation.

[Operator Instructions] Our next question comes from line of David Tyerman with Canaccord Genuity.

Just a question on the European margins and where we're going. So you seem to be running somewhere on low 2% range right now, EBIT at this point for 2013. And I think you're going to 4% to 5% you said over, I don't know, maybe 3 years or so. Is that still the expectation? And can you give us some idea of where you are in terms of is it getting more difficult, so this is going to be a more challenging process or there's a lot on the near-term horizon that will help you? And what are the drivers that would move you toward that level?

So David, maybe I'll start off and then hand it over to Don. We've talked about actually for quite some time that we're going to consistently focus on improving margins and it's going to take us some time to move margins up. And what we talked about and go back a year ago, we said it'd probably 4 years away. This year was kind of the 3 years away, so getting to about half of North American EBIT margins. I look at Q3 year-to-date margins in Europe, I look at adjusted EBIT, so I'm backing out restructuring costs. So last year, for the first 9 months, your margins was 1.5% for the 9 months. This year, we're at 2.5%. So over that 9-month period, we've been able to increase operating margins by 1%. And as I look forward into '14 and '15, our plans are, and we have plans in place to continue to improve that overall margin. Some of the restructuring we're doing in Europe, and it's painful cause it's costing us money today will help, in part, improve overall margins.

I would -- to answer your question where are we as to our plan, pretty well on, slightly ahead of where I would have predicted 2 years ago. But pretty well on track. And I still think we're on track going forward. And Vince just said that we've got a number of losing divisions we need to get back to breakeven. We've got some operational improvements. But overall, I'm pretty happy with where I see we have gotten to, and where I think we can over the next couple of years.

So just to clarify then, do you expect it to be kind of a linear process over the next 3 years or so?

Linear being year-over-year, you, obviously, have the fluctuations quarter-over-quarter.

Sure.

Yes, I would say, relatively linear. We can give an update. We're going to have our business plans coming through as we give an update where we think we would expect things to be in the new year.

Our next question comes from the line of Todd Coupland with CIBC World Markets.

I had 2 questions. Firstly, just to follow-up on the European margins. It looks like you're about halfway through your restructuring target for 2013. What are the things you need to do in Q4 on that?

Well, I guess there's a couple of things, Todd. One is what you do from an accounting perspective and what you do from an operational perspective. Some of the charges that we booked in Q3 relate to a facility that's not going to be fully shutdown until the first quarter of 2015. So we were able to record those costs on our income statement because we met the required sort of test. And again in Q4, we're expecting additional restructuring charges to the same facility, again, because what we expect to meet some of the accounting requirements. And as I look into 2014, based on some of the operational plans that we already have, we'll continue to have some additional restructuring costs in 2014. I think they're going to be lower than where we are in '13, probably significantly lower. But there's going to be continued costs. So accounting and operational are different. And I think it's going to take us 2 to 3 years from an operational standpoint to completely sit back and say, "We've done the heavy lifting, we're done that." But in our business, with so many operations globally, we're always going to looking at our manufacturing foootprint and fine-tuning, based on business opportunities and business needs.

Great, that's helpful. My second question, stepping back from the quarter, earlier in the year, you talked about trying to focus where Magna can be the leader and then maybe some of the businesses that don't make sense. Is that something we should anticipate an update on at the Analyst Day in New York?

I don't think we're going to have much new -- as we make decisions on product areas. We'll let everybody know, but it's a very sensitive issue. Obviously, impacts employees, has a big impact on customers. So we're not going to be giving much flavor until we make final decisions. We continue to spend a fair amount of time on our product strategy. We are finishing our business plans so we'll have good visibility into the cash flow and the profitability of each of the business units over the next 3 years, and we have that in about another month. And in some cases, we continue to make reasonable returns on business that, maybe long-term we either need to expand or do something or get out of that business area. But right now, we're seeing some pretty good results and we're not in need of any cash. So we're not in any panic to do things, but we're not going to get much update until we actually make final decisions.

Okay. So should our takeaway be, we'll see these adhoc decisions on where you're positioning and not expect a big rollout of a grand reworking plan?

That's right.

And there are no further questions at this time.

Okay. Appreciate everybody taking the time to dial-in. Overall, as I said, we're pleased with the quarter. We got a lot of great things going on with some of our internal initiatives, so I'm hoping to see many of you at our Magna Investor Day in New York on the 21st November. Thanks again for dialing in, enjoy the rest of your day.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation. And ask that you please disconnect lines. Have a good day, everyone.