Methode Electronics, Inc. (MEI) Earnings Call Transcript

Thanks, everyone, for joining. My name is Rajat Gupta. I'm a member of the Automotive Equity Research team at JPMorgan. Very pleased to have with us the team from Methode Electronics; Don Duda, CEO; Ron Tsoumas, CFO; and Rob Cherry, Vice President, Investor Relations. Don has a slide deck and a few prepared remarks. And after that, we'll go into Q&A.

Good afternoon, and thank you for joining us today. And I'd like to thank the JPMorgan team for inviting us to the 2022 automotive conference. I will remind you that my statements today are subject to safe harbor protection. For a complete summary of our disclosures, please see Methode's filings with the Securities and Exchange Commission, such as our 10-K and 10-Q reports. Methode is a leading global supplier of custom-engineered solutions for user interface, LED lighting, power distribution an sensor applications in the transportation, industrial, equipment, cloud computing and medical device and markets. Our fiscal 2022 sales were $1.16 billion, which was a record for Methode. Approximately half of our business is in North America, with the other half in Europe and Asia, which are both growing regions for us. We operate our business via our automotive, industrial interface and medical segments. From a solutions perspective, we view the business through our main applications of user interface, LED lighting, power and sensors, and we are widely recognized as a global Tier 1 technology supplier to OEMs. Methode is proud to be committed to ESG. Our robust governance framework, commitment to safe operations and emphasis on clean technologies such as electric vehicles has resulted in favorable ratings from both Sustainalytics and MSCI. ESG is a long journey and Methode is proud to be on it. Methode's journey as a company has lasted over 75 years. We have participated in the support of technology developments from television to the space program to advanced aerospace projects and now to electric vehicles. Along the way, we have navigated this technology evolution survived and prospered. Last year, as I said, we achieved record sales and was named by Forbes as one of America's best small companies, and we have every intention to for us through the next 75 years. Since fiscal 2019, our sales have grown at an annual compounded rate of over 5%. On our last earnings call, we also guided for sales growth this fiscal year and provided a 3-year annual growth rate of 6%. We achieved our recent growth despite the significant headwinds of the pandemic and the various supply chain challenges over the past 3 fiscal years. This is directly related to a strong order pipeline over the past several years as well as significant exposure to the growing EV market. However, we were not able to completely avoid the cost impacts from the pandemic and supply chain challenges as well as from inflation. As such, we did experience some regression in EPS. However, for our latest guidance, we are expecting an inflection in earnings and have guided for EPS to grow over 7% this fiscal year. We have invested in the global footprint with our headquarters in Chicago, Illinois and vertically integrated manufacturing locations in North America, Europe, the Middle East and Asia. This cost-effective footprint is strategically located in proximity to key customers. On the next 2 slides, I will briefly describe the technology solutions that drive Methode's business. User interface products include switches, consoles and industrial remote controls that are leveraging growth drivers such as EV and worker safety. Lighting products include forward and rear lighting, ambient lighting and warning lighting that are benefiting from the demand for energy-efficient LED lighting systems as well as the increased focus on driver and vehicle safety. Power distribution products include busbars, high current connectors and battery disconnect units that are benefiting from the significant growth in EVs and cloud computing. The combination of our automotive pedigree and power distribution know-how has been a key differentiator and a competitive advantage driving our growth in EVs. Sensor products include position, torque and load sensors that are leveraging growth drivers such as e-bikes and vehicle safety. These products leverage our proprietary magnetoelastic and eddy-current sensing technologies. Digital data products include copper-based transceivers that are leveraging growth drivers such as cloud computing and e-commerce, which require additional digital bandwidth. Medical consists of our Dabir system for pressure injury prevention. These solutions are leveraged across multiple end markets from automotive and commercial vehicle to data centers and industrial equipment. Our ability to expand these solutions to multiple markets has resulted in an enviable and diversified customer base of brand-name global companies. We believe that Methode is an attractive investment given its exposure to key macroeconomic trends such as electrification. Also, our ability to leverage and scale our product portfolio, our world-class lean manufacturing, combined with the strategic footprint and Methode's strong cash flow and low net debt. We firmly believe in our time-tested strategy to deliver integrated value-added cost-competitive solutions for OEM customers in end markets with products and technological commonality, producing high-growth margins, cash conversion ultimately creating stakeholder value. Methode Wind's business with close engagement with OEMs, our integrated design and production approach, our lean operations in our customers' regions and vertically integrated manufacturing with world-class quality. We grow by capitalizing on EV and other market growth trends, leveraging our technologies across the customer base, utilizing our product portfolio to drive an increased vehicle content and pursuing acquisitions that build on our successful business model and skill set. This formula has given us the confidence to guide to a 3-year annual growth rate target of 6%, as I had previously mentioned. With the shift from internal combustion engine vehicles to electric vehicles, Methode has a clear opportunity to grow our content, building on our traditional scope of content of user interface, lighting and sensor solutions, we have the opportunity to significantly increase content per vehicle via power distribution solutions. Our scope and EV can be more than double the content we currently have on internal combustion engines. For fiscal 2022, we reported that EV applications were 17% of our total sales. Our healthy pipeline of EV programs gives us the visibility to project that this percentage will be at least 20% in our current fiscal year. Methode's combination of solutions is a winning formula in EV and positions us well for continued growth in this very exciting market. I'd like to further elaborate on our footprint in EVs. The architecture of an EV is generally divided into 2 parts, the top hat and the skateboard. The top hat is essentially the body of the vehicle and varies from model to model. The skateboard is the chassis or framework of the vehicle. As many of you know, this type of vehicle architecture is a game changer with EVs as it can be standardized and leverage across multiple models. On the top hat, Methode offers its traditional solutions of user interface, LED lighting and sensors, along with by-wire controls are shifting, steering and braking. Here, we show a skateboard. This is where Methode leverage its unique combination of auto grade manufacturing, our auto pedigree and our power distribution expertise to supply various busbars, connectors and battery disconnect units, the EV OEMs. We are also gaining traction with sensor solutions for position, torque and battery monitoring systems. Power distribution is where our largest content growth opportunity lies. Historically, our participation with power products on internal combustion vehicles was minimal. In EV, it is quickly growing and approaching half of our product sales into EV applications. Consequently, Methode is a clear opportunity to incrementally grow our content per vehicle with the industry's transition to EVs. As I mentioned earlier, our content in EV can be more than double our content on an internal combustion vehicle. EV is a definite organic growth tailwind for Methode. In addition to driving growth, our EV as well as our commercial vehicle businesses have helped further our customer diversification. While General Motors has been and is expected to continue to be a good customer that fueled Methode's historical growth in recent years, we have strategically and systematically broadened our customer base. Our non-GM business grew to -- grew to 77% of our fiscal 2022 sales, up from 50% several years ago. Consequently, we have become less exposed to the roll-off of any specific customer program. Our capital allocation history clearly demonstrate that we are focused on investing to grow the business through R&D, capital investments and acquisitions, all of which accounted for almost 60% of our capital spending over the last 4 years. This is balanced with our methodical approach to debt reduction and returning capital to shareholders. In particular, we have a $200 million share buyback program, which at the end of last fiscal year, we had $129 million in capacity. Our strategy is to deploy resources in the most effective manner and use our capital investments to drive growth, improve operating efficiencies and create value for our shareholders. Our relentless focus on generating cash will continue to support this strategy. Since taking on debt to finance a Grakon acquisition, we have diligently and systematically delevered the balance sheet. Our net debt-to-EBITDA ratio now stands at near 0, and we clearly have dry powder for future M&A. When it comes to M&A, our framework is relatively straightforward. We look for companies that align with our strategy and can leverage our technologies, our path to market and our manufacturing capabilities. This disciplined approach has served us well, and we will continue to employ it. In summary, we believe the Methode is a very attractive investment given its exposure to key macroeconomic market trends such as electrification, its ability to leverage and scale its diversified product portfolio with world-class lean manufacturing and a strong cash flow and low net debt. With that, I thank you for your interest in Methode and listening, and I think we can move to questions.

Great. Thanks, Don, for that presentation and overview. Maybe just to start, if you could give us a sense of how have you been able to grow sales so meaningfully over the last 5 years in light of the GM strike, the pandemic and all of the supply chain challenges. Could you just help elaborate on like the differentiation and the execution?

Sure. We -- several years ago, made investments in our EV products, our EV manufacturing or sensor products. And that helped fuel our pipeline of orders. Now we had a very good help from the EV market taking off. I think we shipped our first busbar probably in 2006. So I think I could say we were probably an early mover in the EV. And then -- and we're seeing the benefit of that in the last several years.

Got it. Got it. Makes sense. And just following up on that, you have this 3-year organic CAGR of 6% -- given like just the supply chain disruption, just the uncertainty around production, what gives you confidence to give out a target like that at this point in time, if production does come in weaker than expected, are there any offsets on the content side or anything else that we should keep...

We're still booking business for that year. But in auto and EV and heavy truck, you do get long-term contracts and those we announced each quarter. No, that's subject to the customers' business. And obviously, if there was a deep recession in that third year, we'd have to account for that. But the fact that we have had strong bookings, there are written contracts that are executed gives us a high confidence in that. And we're not done booking yet.

Got it. Got it. And just following up on that EV question, it's approaching 20 -- your EV exposure is approaching 20% of volumes. How are you growing sales content? I mean, how do you plan to grow sales content even further with EVs? What are the incremental opportunities that you see maybe on the R&D side or just the investments that are going on in the business. to continue to grow that content.

We continue -- first of all, we grow our content in EV. It starts out with power products. And we've been making busbars since long before Ron and I joined the company. So we have a strong basis in that. And from that deleverage into user interface and lighting and the other products that we offer. But if you look at the skateboard and we do 10-year product plans, so we'll continue to add to our product offering. And as EVs continue to grow, we will grow along with it. Ron did I...

Regarding the EV proliferation all over the globe, we we're investing a lot of capital to increase our capabilities and capacity at -- in all of the -- our geographic resins that they serve as a lot of our customers prefer suppliers, especially now with supply chain to be closer to the customer. So the combination of all those things gives us confidence that we're making the right investments to reap as much growth as we can on a go-forward basis.

And we have a strong belief that you manufacture where you sell. Now I can't say that's 100% because we do have -- when we bought Grakon, they were solely in China. But in general, our intent is to minimize at least logistic issues by manufacturing, [ discloses it ] can to the customers. without getting a proliferation of facilities, obviously.

And the products where you see the biggest growth opportunities on EV platforms going forward? Is it mainly on like the power side, like any other -- which one is going to be like the biggest contributor in terms of that going forward?

In terms of total product or just EV product.

EV product.

EV power. No question about that, that we've been -- again, we're making battery busbars. And I quite like the transmission on ICE vehicles. If you're on the skateboard, that's a long program. That can be -- we've got a transmission program that's probably 10 or 11 years, we'll see the same in the EV skateboard and that's a target for our R&D.

What I would add to that is the power is such a big advantage for us. And as Don mentioned, we do lead frame assemblies and that on ICE vehicles. The potential that we have in the power side of vehicle electrification dwarfs whatever potential cannibalization there might be on the ICE side for the transmission side.

Yes. Got it. That makes sense. I do want to like touch upon like some of like the semiconductor shortages and just production disruptions, how you're managing through that? I mean how has that affected your competent sourcing strategy and pricing? And then just how are negotiations with your customers about reimbursement may be progressing?

That's a long answer question in and answer. -- like any Tier 1. I mean we've had to navigate not just our supply issues, but our customers as well. If they can't build vehicles, they're not going to buy product from us. So we've helped with our customers' issues as well, but it has affected us. It's affected our EPS, as I said in my prepared remarks. Can we pass on those costs to the customers? Yes, and we do that diligently, but there's always a lag. And you'll see in any -- I think the last several quarters, Ron, we talked about we've been paid for either of these spot buys or the logistic issues. And like any supply, we've had to raise prices, and that also lags some time. in this inflation cycle, you might raise a price once in a while to an automaker, but we've had to do it and our peers have 2, 3x. And again, so there's always a lag. So we've seen the pressure from that. Logistically, as we continue with our build where we sell strategy, some of the logistic issues will go away. We've seen some improvement in logistics. But I'm not going to say that we're anywhere near out of the woods there. So we will continue to have discussions with our customers on pricing.

Got it. And maybe because just of your proximity to the semiconductor situation, what are you seeing out there? What are you hearing in terms of availability, in terms of like the pickup -- on the semiconductor side, No.

Well, let me speak to our fourth quarter. We still saw our revenues impacted by that. I'd like to say that we've reached a bottom and maybe we're starting to come off of that. But every time I say that, we see another shortage. So it looks better, but I -- we're still seeing the pressure -- and our customers are seeing pressure, too.

Got it. Maybe moving to just the manufacturing side of things. Can you elaborate on your targeted manufacturing footprint and just your strategy around it?

Sure. Again, I talk about build where you sell the product. We have -- in North America, we have our manufacturing campus in Monterrey, Mexico. In Europe, we have a manufacturing facility fairly automated in -- on the island of Malta, and that's augmented by our low-cost production facility in Egypt. And then in China or in Shanghai and Dongguan and we'll probably do some consolidation at some point there. But we try to have 3 locations. Now we will have more engineering locations and so on because we want to engineer a near our customers, but the -- or near the customers' engineering centers. But that's been our strategy, and we've pretty much stuck to that over the years. And we employ -- I think this is very important. We employ the same manufacturing system in the same quality system. The language may change on the storyboard, but the system is the same. So a customer that wants that maybe starts purchasing from us in the United States and then wants an overseas supply, they have audit facility, but they'll see the same thing that they see in the United States. And I think that's been part of our success. And if your cost of quality is low, you throw them more to the bottom line.