|Shares Out. (in M):||94||P/E||7x||6x|
|Market Cap (in $M):||6,320||P/FCF|
|Net Debt (in $M):||2,623||EBIT||0||0|
After a recent pullback, we believe shares in Adient represent an extraordinarily compelling investment at current levels with the potential to more than double your money from the current price in the next few years.
Bruno677 had originally written up Adient (ADNT) last November after its spin-off from Johnson Controls. Now that the initial spin-related dynamics are behind us and the company has reported three quarterly earnings reports as a standalone company, we wanted to share a more detailed write-up regarding our thoughts on Adient and the progress the company has made thus far on its financial targets.
Brief Background on the Company and Last Fall’s Spin-off
We would encourage anyone interested in the company’s history under Johnson Controls and how the spin-off dynamics have led to a dramatic undervaluation of Adient’s shares to review Bruno677’s write-up and our remarks in the comments section of his write-up. The company is the world’s largest automotive seating manufacturer with an estimated global market share of ~33% (including China through joint ventures). Adient has 36% share in the Americas, 38% share in Europe, 44% in China and 13% in the rest of Asia. Other competitors include Lear, Faurecia, Toyota Boshoku, Magna, in-house operations and other smaller players. To put Adient’s market position in key markets differently, it is roughly 50% larger than its closest peer in the U.S., double the size of its closest peer in Europe and four times the size of the closest competitor in China.
Despite the dominant market shares discussed above and associated scale advantages, Adient’s operating margins have surprisingly lagged those of its closest competitor, Lear. The source of this margin gap stems largely from (1) higher overhead vs Lear and (2) underperformance of the company’s metal structures and mechanisms business, which accounts for roughly 18% of Adient’s sales but fails to generate any operating profits today. We believe the margin opportunity afforded by the restructuring of these two areas represents a tremendous potential for cost reduction and earnings growth over the next several years.
Phase One: SG&A Reductions to Drive Earnings Improvements in FY 2017 and 2018
At the time of the spin-off, Adient’s SG&A as a percent of sales was roughly 200bps higher than Lear’s even though Adient’s larger scale should arguably result in better operating leverage. As one former competitor stated in our research, “From an SG&A standpoint, I always believed [Adient] was a lot fatter than we were… I went to customers and they showed the [Adient] org chart vs ours on similar programs and we’d have half as many people on the program.”
We think much of the cost difference can be reduced through basic restructuring initiatives that will be completed in the near-term (within two years of the separation). Importantly, we believe the company is already executing on these cost savings faster than even the most optimistic expectations, giving us confidence in the management team’s ability to continue to deliver on their profit improvement goals. For example, in the fiscal year ended September 30, 2016, Adient reported adjusted SG&A of $817 million. In fiscal Q1, Adient reported $176 million in adjusted SG&A ($704 million annualized), which represents a 14% reduction from the prior fiscal year. In the recently reported fiscal Q2, Adient’s adjusted SG&A was down to $153 million ($612 million annualized), representing a further 13% reduction sequentially and a cumulative 25% reduction from FY 2016. In the fiscal year to date, Adient’s adjusted SG&A as a percentage of sales has been 4.0% vs last year’s 4.9% and Lear’s 3.1% over the same period. In other words, we believe Adient is about halfway to Lear’s overhead levels in just two quarters as a standalone company, with significant earnings contribution from continued execution on this plan (and the potential for Adient to over-deliver on their targeted SG&A levels).
Phase Two: Metals Business Restructuring to Drive Earnings in FY 2019 and 2020
Adient’s other key margin improvement opportunity relates to its $3 billion metals business, which accounts for ~18% of Adient’s sales but currently generates no profits. We believe improvements in this business will provide the second phase of margin improvement starting in late FY 2018. While we acknowledge that there is some execution risk in the metals turnaround, our industry research and discussions with management about the business gives us confidence that they can achieve enough improvement in the metals business to deliver on their overall margin improvement plan.
Management is confident that improving the metals business is not reliant on customer wins or works council approvals to shut a plant, but is simply a timing exercise as they phase out their highest cost/less efficient production. They expect improvements to pick-up in late 2018 as they close a couple of big money losing plants in Western Europe. As an example of the restructuring opportunity highlighted in their 2016 pre-separation Analyst Day, Adient has a plant in Germany that is currently losing $40 million annually. The closure of this one plant should improve the margin of the metals business by 130bps and the overall company margin by 25bps.
We have spoken to numerous industry participants and there is broad agreement that the metals business should earn a double-digit margin over time, which would imply 200bps of margin improvement potential for the company overall. Management is targeting margin improvements from the metals restructuring of 100-200bps, indicating they believe they can get to at least mid-single digit margins over the next few years, which we view as a reasonable target.
China JV Value
Furthermore, we believe Adient’s Chinese joint ventures are being undervalued by the market and the analyst community. Many sellside analysts value these ventures at 8x net income, a considerably lower valuation than publicly-traded Chinese auto suppliers, which on average trade at ~13x earnings for H-shares listings and ~24x earnings for A-shares listings. Moreover, sell-side valuations do not account for the significant net cash balances sitting at the China JVs. Since the spin-off, management has provided more detail regarding the proportionate net cash at its China JVs and we believe there currently is over $700 million in proportionate net cash attributable to Adient at the JVs (representing ~$7.50 per share and ~11% of the current share price). Said differently, sellside analyst price targets based on 8x earnings value Adient’s dominant China franchises, which control almost half the market, at just 6x earnings net of cash. We think this is simply too low.
While we have assumed 4-5% growth in China over the next few years, we would highlight that management believes they have significant opportunities in China in the coming years. Adient believes that, due to its dominant share and scale advantages, it has much better product quality and higher margins than competitors in the market. Based on customer discussions surrounding upcoming product launches and a mix shift towards more expensive vehicles (where Adient has a higher share), management believes they have a real line of sight to increasing their market share in China over the coming years from today’s 44%. Internally, they have dubbed this the “Drive for 55 [% market share].”
Further, in 2015, Adient sold most of its interiors businesses to Yanfeng Automotive Interiors (YFAI), where Adient now owns 30% of the company. Management has indicated that YFAI is expecting meaningful margin improvement over the coming years, as they complete their own restructuring activities and due to strong growth in backlog that management claims is at higher margins than the business is currently earning.
While we are hesitant to assume significant upside to a Chinese auto supplier, we think there is a reasonable probability that Adient’s Chinese joint venture income could meaningfully outperform expectations in the coming years if they are able to deliver on some of the opportunities highlighted above.
While we expect that many reading this write-up will have an instant fear of Adient’s exposure to U.S. SAAR, we think those concerns are overstated as Adient’s exposure to U.S. SAAR likely represents ~25% of Adient’s total earnings, given its significant exposure to Europe and Asia. Further, we believe Adient’s meaningful self-help initiatives will help offset a significant amount of potential SAAR headwinds.
To explain what we mean by this, we believe North American sales will total ~$7.3 billion this year out of $16.2 billion in total consolidated sales (ex-China). Therefore, every one million unit decline in SAAR represents ~6% impact on North American sales (and ~2.5% for the consolidated business ex China given Adient’s significant Europe/Asia/Latin America business). Assuming 17.5% incremental cash gross margins (management has stated incrementals/decrementals are in the high teens), a one million unit decline in SAAR would be a revenue impact of ~$420 million, a profit impact of ~$75 million and ~35bps of overall margin headwind. With approximately 125bps remaining after FY 2017 on Adient’s margin improvement program, they could theoretically absorb a decline in SAAR of more than 3 million units and keep earnings flat, assuming zero growth from either the non-North America business or China equity income.
Electric Vehicles / Autonomous
Further, we expect that some investors may also wonder what happens to this business assuming the rapid adoption of electric vehicles and/or autonomous driving. In the case of Adient, the global leader in seating, we think if anything, they could be a beneficiary of these trends. As the market potentially shifts to autonomous vehicles, there is a logical argument that seating manufacturers could see higher content per vehicle (more flexibility, potential to swivel or fully recline may be demanded by consumers). But at a minimum, we think it is highly unlikely that a quality, comfortable seat would become less important in the future.
Aircraft Seating Opportunity
Adient is also working on entering the aircraft seating market. While it is still early days, the company has announced a collaboration with Boeing, has recently demonstrated a business class seat to customers and expects to have a production seat finished by September of this year at which time they expect to “go to market with a ready to sell product.” We think this could represent a $3 billion market opportunity with mid-teens margins potential. At a 20% share, we believe this could contribute $0.80 per share of earnings that would command a mid-teens multiple (due to higher margins than auto seats), which could add $12 per share of value or nearly 20% of the current price.
Other Developments Since the Spin
With its recent earnings announcement, management raised its expectations for EBIT by over 6% from its original guidance, despite a weaker revenue outlook (down by 4% due to FX and weaker passenger vehicle production outlook). In addition, management’s free cash flow guidance for the year was increased by 60% and the Board approved a $250 million share buyback (~4% of the current market cap).
Assuming a 16.5 million SAAR (down meaningfully from the peak), ~1% annual production growth ex-US and mid-single digit growth in China with EBIT margins of 6.9% (excluding equity income), we believe Adient can generate ~$14.75 in FY 2020 EPS (which begins in October 2019). To put that margin assumption in perspective, Lear’s seating business (with fully allocated corporate), generated a 7.1% operating margin over the past 12 months.
Assuming Adient trades at approximately 10x forward earnings, the stock would be worth $150 including dividends, a gain of 125% from the current share price in 2.5 years, an IRR of ~40%.
As a separate note on valuation vs. Lear, some might argue that Lear’s higher margin electrical business (which accounts for 35% of LTM adjusted EBIT) might indicate Lear should trade at a premium to Adient. However, we would highlight that Adient’s high growth China business represents a similarly-sized earnings contributor (~40% of total earnings) and would itself almost assuredly trade at a higher multiple as a standalone public company in either Hong Kong or the A-shares market. In addition, we believe Adient’s dominant global position in auto seats actually warrants a premium valuation to that portion of Lear’s business.
|Entry||05/31/2017 01:01 PM|
Thanks for the idea hawkeye901 - the one fundamental question I have is why does this opportunity exist? why is the stock mispriced? has the market basically overlooked the magnitude and feasibility of the margin improvement opportunity? if so, why?
|Subject||Re: Why mispriced?|
|Entry||05/31/2017 02:02 PM|
Regarding the opportunity and why it exists, we think Adient has faced: 1) a former JCI management that constantly talked down the auto business, 2) a spin-off that occurred shortly after the JCI/Tyco merger, leaving Adient's stock in the hands of shareholders who had little interest in, or in the case of former Tyco shareholders, little knowledge of, the comparatively small and noncore automotive supplier, 3) large ETF/index fund holders forced to sell their shares following the spin-off, and 4) a new company that is unknown to the investment community. In our experience, these spin-related dynamics can take a long time to dissipate and for the stock to fully close its valuation gap vs peers.
In addition, we think concerns over U.S. SAAR have held the stock back but as stated in the write-up, we think the true exposure is less than probably many investors appreciate. Last, we think the unconsolidated China JVs have created some confusion in valuation. First, few people appreciate the net cash at those entities and management has just begun providing more details in the past few months. And as a further example, Goldman's price target is based 50% on a 4x consolidated EBITDA valuation. However, the after-tax JV net income is part of Adient’s EBITDA, so Goldman effectively values these entities at 4x fully-taxed earnings (or roughly 2x net of cash).
Based on the above, we believe significant confusion remains surrounding the company and the opportunity. However, given the low starting valuation of just 7x earnings, we think the passage of time and the company continuing to deliver on its targets will cause the share price to take care of itself.
|Subject||Re: Re: Why mispriced?|
|Entry||05/31/2017 02:38 PM|
Got it, thanks. So you think Adient suffers from the "baby bathwater" syndrome re the US SAAR overhang? I think the damage from the expected decline in US SAAR has been relatively contained to the OEMs...other tier 1 suppliers such as DLPH, VC and LEA haven't been hit. Also is it possible to get the financials for the China JVs? Curious how much free cash those JVs generate and what the capital structure looks like at the JV level.
|Subject||Re: Re: Re: Why mispriced?|
|Entry||05/31/2017 03:16 PM|
Just to be clear, we don’t think U.S. SAAR is the only overhang, but is just one of a number of possibilities we suggested in response to your question on why this opportunity exists. That being said, I would highlight that Adient’s stock fell 7.9% on May 2nd when April SAAR was released, so it does seem like some people are concerned about the issue.
For the China JVs, as part of the Form 10, Adient provided detailed 2013-2015 financials for the largest JV, YFAS (formerly called YFJC and representing close to half of total equity income). Since that time, for YFAS and the other JVs, Adient has provided quarterly summaries of key income statement and certain balance sheet items. Adient has also stated that the 12/31/16 YFAS financial statements will be filed on or before June 30th (within six months of the end of the JV’s fiscal year).
|Subject||Re: Net income vs. Cash flow|
|Entry||06/06/2017 01:38 PM|
Given the noise from historical pro forma financials and the restructuring / separation costs the business had taken prior to becoming public, I think the best way to analyze Adient's current FCF is to start with their FY 2017 guidance and some of the one-off items that are in this year's results. First, Adient has guided to $400m of free cash flow this year, which includes $230m of cash restructuring expense ($280m original guide less $50m shifted to next year), $100m of “becoming Adient" expenses to get its infrastructure in place, $75m of elevated capex related to stand up costs, and $20-30m in lower JV dividends from YFAI (not reflective of full year run-rate). Adjusting for these items, Adient's FY 2017 normalized free cash flow generation capacity would be ~$830mm, just over 90% of their net income guidance.
Going forward, there are a couple of items that will affect the bridge from adjusted net income to free cash flow: (1) We expect capex in the near-term to remain above D&A, (2) we budget for $100 million in ongoing annual restructuring costs and (3) the China JV distributions will be below net income.
|Subject||Re: Recession Scenario|
|Entry||06/06/2017 01:40 PM|
As a starting point, in my opinion, the 20% drop in SAAR that you highlighted does represent a substantial decline in SAAR. To put it in historical perspective, a 20% decline from last year's 17.5mm SAAR would be just under 14mm. While SAAR was below 14mm from 2008-2011, the last time it was below 14mm prior to that period was the early 1990s (and the US population is 27% higher today than it was back then). So we do think what you’ve suggested is more than just a garden variety recession case.
However, even in the 20% SAAR decline, we think the EBITDA decline is more manageable than what you're suggesting (unless accompanied by similar auto sales declines in Europe and China). We have discussed decrementals with the CFO numerous times and he has been consistent that he believes decrementals are in the mid- to high-teens. Based on this guidance, we tried to address what we believe is Adient's sensitivity to SAAR relative to their remaining SG&A and metals margin improvement opportunity. Based on the company's remaining margin opportunities, we think they can roughly handle a 3 million unit decline in SAAR with EBITDA/earnings remaining flattish.
|Subject||Re: Re: Recession Scenario|
|Entry||06/12/2017 09:31 AM|
Can you talk at all about what pushed Lear into bankruptcy in 2009, recognizing that there was a historic drop in units at that time? But was Lear too highly leveraged, or can this business just not withstand a severe global recession? How does ADNT's leverage compare to Lear's at that time?
Also, what is the pricing position of suppliers vis a vis OEMs at this point? Is this a two player business where Lear and Adient can hold price, or are there tons of smaller producers who the OEMs can use as backups and continue to squeeze margin?
|Subject||Re: Re: Re: Recession Scenario|
|Entry||06/12/2017 05:18 PM|
We think Lear's four-month trip through bankruptcy in 2009 is a bit of an extreme comparison. GM and Ford accounted for 50% of Lear's 2007 sales, at least 50 auto suppliers went bankrupt in 2009, and the auto supply chain was operating at approximately mid-40% capacity utilization. In addition, Lear did head into the financial crisis levered at just around 2x (end of 2007) with a fairly significant unfunded pension/OPEB liability. Given that backdrop, by the end of 2008, Lear had breached its debt covenants and filed for bankruptcy in July 2009. But to your question on whether the business can’t survive a severe recession, we think this was really a function of the severe decline in volumes than anything uniquely concerning about the auto seating business. From 2007 to 2009, Lear’s seating sales fell by 36% and adjusted EBITDA fell by 53% for decrementals of ~12% over the period.
Regarding Adient’s leverage, it currently stands at 1.64x and they expect to be ~1.5x by the end of their fiscal year (September 2017). We think management's rapid execution on its cost opportunity will help bring the headline leverage ratio down much more rapidly than people are expecting (in fact, even the current ~1.6x leverage level is overstated on a run-rate basis when you consider the progress management has made on cost reductions in the past few quarters). Longer term, Adient's target is to run at ~1x leverage, which they should reach next year. Moreover, Adient’s headline net leverage figure does not represent true economic leverage as it excludes the significant cash held at the JVs and does not account for the JVs’ full profitability (since consolidated EBITDA includes after-tax equity income rather than proportionate EBITDA). Adjusting for these JV-related items, net leverage would fall to 1.1x. Further, Adient's customer concentration is much lower than Lear’s, which we think helps mitigate risks. Ford and GM together accounted for 50% of Lear's 2007 sales (and remain 42% today), while Adient's largest customer accounts for just 12% of consolidated sales (and its top 2 customers combined are just 23% of sales). Importantly, if you consider Adient's significant non-consolidated China business, the customer concentration is even lower than it appears (as JV income accounts for 25% of EBITDA).
Regarding your question re seating manufacturers vs the OEMs, we are not going to argue that Adient is the highest quality business or that it operates in some cozy duopoly. However, we do think industry pricing dynamics appear stable based on our research and LEA/ADNT financial reports. Further, in the past, OEMs did shift from buying a full seat from one manufacturer to disaggregating the purchase of seating components in order to increase pricing transparency and pressure suppliers. Consequently, we believe the OEMs have already pulled that lever and it is reflected in the financials of both Adient and Lear. While there are smaller players, with the top 3 suppliers accounting for 75% share in the Americas, 72% in Europe and 54% in China, we do think it’s a fairly stable and consolidated market.
|Subject||Re: Re: Re: Re: Re: Re: Recession Scenario|
|Entry||06/13/2017 12:40 PM|
The company’s China JV margins benefit from 2 key differences vs other regions globally: (1) a highly profitable metals business and (2) lower SG&A. Adjusting for the SG&A and metals differences, the China business does not earn excessive margins vs seating businesses in other regions. We would also highlight that the company has a very strong market position and is four times larger than the next largest competitor in China.
Regarding the China metals business, management has stated that it earns margins approaching 20%, compared to the consolidated metals business, which is currently breakeven to slightly negative profitability. Adient’s China metals business benefits from a high portion of local content, whereas competitors import much of this content and therefore must contend with import duties.
On the SG&A point, the China JVs have lower SG&A due to more efficient operations and a certain amount of overhead that is borne by the consolidated Adient business. On this last point, we think looking at the ~10% operating margins on the China JVs somewhat overstates the level of profitability as there is a sizable China support function that sits at Adient corporate.
In addition to the points above, we think Adient’s China JVs have some nuances vs traditional suppliers due to the fact that the OEMs share in the JV economics. While your point on potential margin compressing offsetting some of the consolidated business improvements is a potential concern, we have tried to take a relatively conservative view on the JV earnings (with growth of 4-5% per year) to reflect these risks, even though (1) recent performance has been much stronger and (2) the YFAI JV has significant company-specific tailwinds over the next couple of years.
|Subject||Re: Re: Re: Re: Re: Recession Scenario|
|Entry||06/13/2017 12:43 PM|
We certainly acknowledge that SAAR can drop 20% from here in a recession. There do not appear to be many other areas of the market that are indicating a recession is likely on the horizon although of course we need to consider the possibility for any stock. As we indicated, we believe the company can still hold earnings flat (assuming stability in other regions) due to the substantial margin opportunities and the geographic diversification of its revenue base. In this case, ADNT would be trading at 7x EPS on depressed earnings at current levels, which we think would make it a very attractive investment.
|Subject||Adient FQ3 17|
|Entry||07/31/2017 08:43 AM|
Adient reported FQ3 results last week that were on track with our expectations and management reiterated its recently increased FY 2017 guidance (with just one quarter remaining). At the current share price of $65.60, the stock is trading at 7x current earnings. Given we are just one quarter from the end of ADNT’s fiscal year (September 30), we think investors and the analyst community will shortly begin to focus on Adient’s FY 2018 earnings. With consensus currently at $10.13 in FY 2018 EPS, we think the stock is very cheap at 6.5x next year’s earnings.
However, we think two discrete items alone can drive earnings well above consensus in FY 2018. First, the Company’s continued progress on its SG&A initiatives (and the full year impact of FY 2017 actions) should drive ~$80mm of pre-tax profit improvement next year ($0.70 per share). Second, the Company’s tax rate of ~22% on the core business this year is higher than normal (normal is 16-17% on core business ex JV income). Management expects the tax rate to revert to normal next year, which should drive ~$40mm of incremental net income in FY 2018, or ~$0.45 per share in EPS. When combined with modest growth in the China JVs and slightly lower interest expense, we think ADNT can generate over $11 in EPS next year, well above consensus and putting the stock currently at just 6x earnings.
In FY 2019 and 2020, we believe the Company has even greater earnings upside from the restructuring of the metals business (will begin to benefit margins mainly in FY 2019) and the return to growth of the backlog in both FY 2019 and 2020 (after capital constraints under JCI). Taking these items together, as stated in our initial write-up, we think Adient can generate ~$14.75 in FY 2020 adjusted EPS, putting the current stock price at just 4.4x earnings. At 10x earnings, the stock would be worth ~$150 per share including dividends in just over 2 years from today.
|Subject||Re: Adient FQ3 17|
|Entry||07/31/2017 11:27 PM|
Hawkeye – thanks for the ideas and commentary.
I like the idea too and generally agree with you. But I’m curious to get your thoughts on a few questions regarding the quarter / conference call.
1) 4Q17 implied guidance
Implied guidance for 4Q17 (assuming for FY17 low end of sales, the mid-point of EBIT and $400mm of equity) is $3,883mm, $290mm and $97mm respectively.
For 4Q16, those figures were $3,944mm, $290mm, and $102mm. If we take management at their word, none of the figures are inspiring aside from the continued margin gains.
Do you have any concerns with the figures (and if so, what they may portend for FY18 and beyond) or do you believe management is simply being conservative in not further adjusting guidance after 3Q17?
2) Commercial settlements
Were you satisfied with the answer management provided? What is your estimate for how much EBIT benefit commercial settlements delivered for 3Q17?
3) FX benefit
Similar question as above - were you satisfied with the answer management provided? The benefit seems to be not immaterial and yet management seemed to play it down – why?
4) Competitive issues
Another similar question – were you satisfied with the answer management provided? Do you think there is risk in smaller firms winning large bids and do you think there’s been any material change in the tenor of negotiations with the OEMs?
|Subject||Re: Re: Adient FQ3 17|
|Entry||08/01/2017 03:38 PM|
1. 4Q17 Implied Guidance: Last quarter, despite weaker sales, management raised its old EBIT guidance by $75mm (at the midpoint). We think given the concerns around the auto cycle, management is simply continuing to be conservative and the implied Q4 guidance reflects that. In fact, the CFO stated in response to this question "we'll obviously look to beat it [the guidance]." Further, since last FQ4 North American light vehicle production reflected the more elevated SAAR levels, we think the implied guidance still demonstrates strong earnings performance in a more muted production/SAAR environment.
2. Commercial settlements: While these commercial settlements occur regularly as management stated on the call, it's hard to know exactly the timing of the associated costs that were incurred and therefore exact EBIT impact. Management stated that it's more likely associated with current production though there can be some delay in recovery (when you consider the recoveries amounted to just over 1% of quarter’s sales, it seems very plausible these were mostly intra-quarter customer change orders etc). So our base case is that the EBIT impact this quarter was not exceptional given both management commentary and the fact that gross margins this quarter were fairly consistent with history (both FQ3’16 and FY’17 YTD).
3. FX benefit: We thought management discussion about the FX impact was fairly logical. While the recent EUR strength will help vs their prior assumptions (they were using ~1.10), the EUR has averaged 1.15 quarter to date and they're probably not willing to extrapolate too much of the recent move out of conservatism. Management stated that it will be "a few million [of benefit]" during the Q&A which is consistent with what we would expect in terms of a FQ4 EBIT impact given the size of their European operations. If the EUR holds at current levels, the impact on FY18 should be more substantial, but management hasn't provided any guidance around that yet.
4. Competitive issues: We don’t get any sense there's been a material change in the competitive environment. On its call, Lear said that OEM pricing pressure "is not incremental, it's consistent" and that regarding long-term margins, they'd "expect the margins to stay fairly consistent." And Adient stated that OEMs are always aggressive and they wouldn't note anything abnormal. And they further stated that they're committed to the margin expansion that they've talked about and "taking on a bunch of business that's going to be below that when it launches is a fool's game for us so that's not what it's about." We felt that management sounded pretty upbeat on the prospects for the 2019-2020 bookings.
|Subject||Nice run so far|
|Entry||12/19/2017 03:24 PM|
Thanks for the idea hawkeye901, the stock has had a nice run since the spin-off and your write-up. How much of the thesis has played out and what are your thoughts (to the extent they have evolved) on the story going forward? I guess to what extent is the stock still mispriced?
|Entry||01/22/2018 07:59 AM|
what are your updated thoughts post the recent news and stock decline? thanks
|Entry||01/23/2018 12:49 PM|
While the recent issues around Adient’s metals business are clearly disappointing and will negatively impact the company’s near-term financial results, we also do not believe it is reasonable to capitalize losses into perpetuity. With the company’s strong SG&A reduction since the spin-off and the solid performance of the China business, we believe ADNT is generating close to $11 of EPS this fiscal year excluding the metals losses, leaving the stock trading below 7x “core” earnings.
Further, we think Adient can generate over $13 in EPS during FY 2021 even if the metals business generates $0 of operating profit. And assuming metals can get to just a 3% margin (vs their targets of 5-10%), we believe they will do ~$14.50 in EPS in FY 2021. In either case we think the upside is significant from today’s share price of ~$73 per share. At 10x earnings under the $0 of metals profit case, the stock would be worth ~$136 including dividends for almost 90% upside and a 25% IRR over 2.75 years. And in the 3% metals margin case, the stock would be worth $148 including dividends for 100% upside and a 30% IRR over the next 2.75 years.
On the bright side, they also announced a seating JV with Boeing which we think is very positive given the potential for Boeing to help drive business to the new Adient JV. If the JV can get to 15-20% market share of business class seats over time (at a mid-teens margin), it could add ~$4-8 per share in additional value to Adient at 15-20x earnings.
|Subject||Re: Why ADNT and not LEA?|
|Entry||03/14/2018 01:11 PM|
We have nothing against LEA – it’s a well-run company and a relatively inexpensive stock. That said, we think ADNT is extremely dislocated and trading at a significant valuation discount given the near-term earnings impact of their metals issues and the spending on the Boeing seating JV.
First, ADNT’s updated guidance is for ~$7.75 of EPS (at the midpoint), leaving the stock at sub-8x earnings. But this earnings number includes ~$0.30 impact from the seating JV, which is a promising opportunity to partner with Boeing in an attractive market that should generate real value to ADNT shareholders over time. And most impactful is the metals losses, which accounts for a more than $2.00 negative impact on EPS this year. If you simply give them zero value for the aerospace JV and assume metals can get to breakeven over time, the “core” EPS of the business is over $10 this year, leaving the stock at sub 6x earnings.
However, to frame your question re Lear, we would highlight that if you take their EVs (including after-tax pension liabilities and non-controlling interest at 10x earnings), you have an EV for LEA of $14.4bn and $9.7bn for ADNT. However, the significance of ADNT’s Chinese JVs distorts any easy comparison in our view, so let’s deduct their JVs at 12x earnings, which would leave you with “Core” EVs for LEA and ADNT of $13.7bn and $4.9bn, respectively. Those core/consolidated operations will generate $21.5bn in sales for LEA this year and $17.1bn for ADNT (I am ignoring the slightly different fiscal years for simplicity). So while LEA has the electrical business that is higher margin (and accounts for ~22% of sales), the consolidated business of LEA is trading at 0.64x sales while ADNT is trading at 0.29x sales a 55% discount to LEA. You would have to assume that ADNT’s metals business is zero margin into perpetuity and that ADNT’s core seating business does a 4.5% margin into perpetuity (vs LEA’s 7% margin) for the businesses to be trading at similar EBIT multiples. Said differently, the core businesses are trading at similar EBIT multiples on 2018 numbers, where ADNT’s margins are less than half what LEA will generate.
|Subject||Re: Re: Re: Re: Why ADNT and not LEA?|
|Entry||03/15/2018 03:42 AM|
I would be very interested to hear how they think about capital allocation. To Hawkeye's point, the stock looks very cheap and I believe they have an authorized buyback programme in place. Is this a time to use it? If not, why? They are paying a dividend..
|Subject||Re: Re: Why ADNT and not LEA?|
|Entry||03/15/2018 11:22 AM|
Hawkeye, does it worry you that cash earnings at ADNT is nowhere near reported earnings? The FCF conversion at ADNT vs LEA seems to be night and day. LEA has a 45% higher EV, but is expected to generate over 4x the FCF of ADNT next year. If we look at it on a cash earnings basis, LEA looks considerably cheaper. Are we missing something?
|Subject||Re: Re: Re: Why ADNT and not LEA?|
|Entry||03/15/2018 05:59 PM|
Regarding the margin opportunity, all we were outlining in the prior post was that we don’t need to have significant levels of profitability in the metals business to get to a very cheap stock. Our $10+ EPS is based on current margins in the core seating business and simply getting back to 0% margin in metals (where it was at the time of the spin). Even if metals stays at 0% margin, we think you can get to ~$11.50 of EPS by 2020 with core business growth coming on and some continued growth out of China.
Regarding JCI’s views on the business, its old CEO Molinaroli clearly didn’t like the auto business but I’m not sure that matters. If JCI liked its core industrial business better and felt that owning an auto supplier was holding back its valuation, it seems logical to split them up (as they did), but I’m not sure this necessarily means ADNT is a worse business than any other similar auto supplier.
|Subject||Re: Re: Re: Why ADNT and not LEA?|
|Entry||03/15/2018 06:00 PM|
Teton0321 (and Beethoven),
We understand your concerns on cash flow, but we do think there is some nuance here that should be taken into account in 2017-2018. First, as they outlined at the time of the spin, restructuring actions and setting up the standalone company are resulting in heightened costs this year of $235mm (some shifted from last year to this year), but this should reduce significantly going forward. Also, 2018 has a big drag from the losses in the metals business (before the metals problems, their 2018 FCF guidance was $525mm). The most important structural difference though is the ~65% payout ratio from the China JVs. However, these JVs are generating real cash for the benefit of ADNT shareholders – it’s just not all coming up to ADNT at this time (the JV’s currently have $1.2bn in cash on a 100% basis, or over $7 per ADNT share on a proportionate basis). Given these dynamics (and assuming some increase in the China JV payout ratio), we think ADNT’s FCF conversion will be ~80% of net income in a couple of years.
|Subject||Re: Re: Re: Re: Why ADNT and not LEA?|
|Entry||03/16/2018 08:56 AM|
Thank you Hawkeye901. This is very helpful as we did very quick initial work.
|Subject||Re: Re: Re: Re: Why ADNT and not LEA?|
|Entry||03/19/2018 10:36 AM|
Did you get any incremental insights after your meeting you can share?
|Subject||Re: Re: Re: Re: Re: Re: Re: Re: Why ADNT and not LEA?|
|Entry||03/20/2018 03:27 PM|
We don’t fully agree with some of your earlier statements regarding ADNT vs LEA. While there are clearly mix differences in the businesses and we agree that LEA is a solid, well-run business, we think it’s important to set the record straight on the relative business mix of the companies…
First, LEA does have a metals/structures/mechanisms business. They talk about it regularly and while it's clearly been much better managed than Adient's, it still accounts for ~12% of their sales (based on disclosures made in a January 2017 presentation) vs ~18% at ADNT.
Second, LEA's JIT mix is ~66% of its seating business, which management has stated numerous times (and also can be independently calculated from the same presentation referenced above). By contrast, we believe ADNT's JIT mix is about 50%.
Other seating components (including trim, foam etc) account for the rest of the businesses and total ~22% at LEA vs 32% at ADNT.
We struggle to understand how these business mixes can lead you to the conclusion that LEA has carved out something dramatically different than ADNT.
To put it differently, while we agree metals is capital intensive, let's look at LEA vs ADNT on D&A and capex. In 2017, LEA's D&A was 2.1% of sales vs 2.0% at ADNT. Over the past 3 years, ADNT’s capex has averaged 2.8% of sales, in-line with LEA at 2.8% of total revenues.
On working capital, ADNT's business actually appears to be more efficient than LEA. DSOs are 48 at ADNT vs 53 at LEA, inventory turns are 21 at ADNT vs 16 at LEA, and days payable are 70 for ADNT vs 58 for LEA. Every single working capital metric is superior at ADNT (and has consistently been over the past few years). Given this dynamic, we think the near-term restructuring and metals challenges, combined with the lack of a full payout from the China JVs, are the key drivers of the current poor cash conversion.
|Subject||Re: Re: Re: Re: Re: Re: Re: Re: Re: Why ADNT and not LEA?|
|Entry||03/20/2018 04:53 PM|
Great post hawkeye. It is a dramatic overstatment to say that LEA's seating business is "in a different league" than ADNT's.
|Entry||05/30/2018 11:42 AM|
As we discussed in our earlier comments, the SS&M business has been very disappointing and is clearly going to take time to turn around. The market seems to be capitalizing this loss into perpetuity. While the market has punished the stock for management backing off of its 2020 margin target, this should have been clear several months ago (in our opinion) when they highlighted this business is off track, and at this point, merely reducing those losses in the coming quarters could drive significant upside in the stock.
We take some comfort from the fact that losses in FQ2 improved sequentially and that their guidance for the rest of the year implies further sequential improvement. While we wouldn’t argue for assigning much value to the metals business at this point, we don’t think it is reasonable to conclude that this business should be significantly loss making into perpetuity, particularly given that Adient makes good margins in metals in China and the company’s strong market share position. If you value the China JVs at 11x current earnings (below peers and at just over 9x net of the estimated JV cash balances), consolidated Adient is trading at just over 5x EBIT excluding the metals business (assuming zero value and backing out the current losses). If the metals business ever produces a positive margin, the company could generate well over $12 of EPS in 2-3 years. In the meantime, the stock should generate $7+ of earnings even including the metals losses. At the current price of $53 per share, we think the upside is substantial.
Said differently, the current market cap is below $5 billion (with moderate net debt, considering cash at the China JVs), which seems far too low for a company that produces about one out of every three automotive seats in the world… a business that is durable and not at risk of any disintermediation or obsolescence. It’s pretty remarkable when you consider how little you get for $5bn in this market (we won’t list specific names but we can readily think of dozens trading at similar or greater market caps that will likely generate a fraction of the cash flow that Adient is likely to produce in the coming decades).
Regarding China, like Chatham, we are not aware of anything concerning but would be curious if there was anything concrete that is particularly worrisome to you. However, we would highlight that Adient has been in China since the late 1990s. These JVs have grown tremendously and worked to the advantage of both parties. With the capabilities and large market share Adient has built-up across these JVs, we view the risk you highlight as low.
|Subject||Any thoughts on the quarter?|
|Entry||07/26/2018 12:37 PM|
|Subject||Re: Any thoughts on the quarter?|
|Entry||07/26/2018 01:24 PM|
My take - I was encouraged by the sequential improvement in SS&M, and somewhat disappointed with the margin deterioration in the Seating segment. It appears the company does not have enough resources to put out all the fires at once and so we've seen inefficiencies crop up in other areas as they've moved to fix SS&M.
That said, the company should be able to get things back on track over time and there is tremendous earnings power when they do. My hunch is that fundmentals have bottomed and so has the stock.