Aftermarket Technology ATAC
December 30, 2002 - 9:34pm EST by
hack731
2002 2003
Price: 14.25 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 349 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

ATAC is showing signs of solid execution across each of its three business segments. Along with a low valuation (7.4x C02 EPS, 7.1x a likely conservative C03 EPS) and with a significant share repurchase program announced in October now underway, the stock looks interesting.

ATAC is a leading provider of remanufactured transmissions for the automotive aftermarket and logistics programs. Though U.S. auto sales have been fairly weak in recent years (with expected sales of 16.3 million units in 2003, down from a peak of 17.3 million units in 2000, per Wachovia Securities), ATAC has grown revenues and earnings by a compounded rate of 6.2% and 30.4% from 2000-2002E, respectively. The company is growing revenues and earnings for three primary reasons: 1) the company serves the aftermarket, where it benefits from the consistent growth in the installed base of cars and the trend towards longer OEM warranty programs (rather than from the trend in new car sales); 2) the company is experiencing an improvement in fundamentals in each of its three divisions, which should continue through 2003; and, 3) the company has successfully implemented several cost improvement initiatives.

The company’s three divisions are Remanufactured transmissions, Engines, and Logistics.

In the remanufactured transmissions segment (70% of sales), the company sells remanufactured transmissions for use as replacement parts by domestic dealers during the warranty and post-warranty periods following the sale of a vehicle. This segment primarily serves Ford (56% of segment revenues in 3Q02) and DaimlerChrysler (23% of segment revenues in 3Q02) through long-term contracts. Recently, the company has secured several important design wins with GM, Kia and Honda. These design wins should enable the company to grow its remanufacturing transmission business by 6-7+% next year (per guidance issued on conference call on December 20th), a healthy improvement y/y. The Honda design win, in particular, is important because it broadens the company’s footprint to include Asian OEMs.

In the engines segment, the company remanufactures and distributes domestic and foreign engines. The engines segment has lost $2.2 million on $13 million in revenues for the last 9 months ending Sept. 30, 2002 versus a profit of $1.5 million and $18.4 million in revenues for the prior year period. In June, the company launched a new program with AAMCO. The company expects about $1.5 million in revenue from this program in 2002. With the program, the company expects the engine segment in 2003 to deliver $30 million in revenue and be EPS break-even, which would be a significant improvement over 2002. The AAMCO program also gives the company an efficient means of penetrating the $1 billion independent aftermarket for remanufactured transmissions (before, the company’s overall market opportunity was about $400 million).

In the logistics segment, the company provides warehouse and distribution services (including the related IT systems) for AT&T Wireless, a materials management program for GM, and another program for Delphi and Visteon. AT&T Wireless contributed 71% of segment revenues in 3Q02 and represents an estimated annual EPS of $0.50 (about 25% of earnings). On December 20, the company finally extended its logistics contract with AT&T Wireless (which was set to expire on December 31st). The uncertainly of signing a new contract had depressed the stock over the last six months but was largely expected given the high switching costs given the IT systems that ATAC has put in place. ATAC decided against a multi-year contact, choosing a one-year contract because it wanted to avoid an exclusive agreement with AT&T Wireless. Though the new agreement has some price concessions, the program with AT&T Wireless is healthy with revenues up 12% y/y in the prior quarter. Importantly, with a non-exclusive agreement with AT&T Wireless, ATAC is now pursuing logistics business with Verizon, Cingular, Nextel, Toshiba, Nokia and Hewlett-Packard. A contract with any of these vendors would be a significant near-term catalyst for the stock in 2003.

In addition to ATAC showing signs of solid execution in each of its three segments, the company has successfully implemented several cost improvement initiatives (e.g. lean manufacturing). For the last 9 months, gross margins are at 34.6% (up from 34.1% for the prior year) and operating margins are 19.4% (up from 16.1% the prior year). ROE now stands at 24%.

VALUATION

In the recent conference call, management provided EPS guidance of $1.90 for 2003. The guidance does not include the positive effect of the current share repurchase program, which could add $0.11 in annual EPS if management repurchased all 1.4 million shares authorized. I’m putting 2003 EPS at $2.00.

O/S 24.5 million
Market cap $349
Cash $58 million
Debt $159 million
Net debt $101 million
EV $450 million

EPS (2002) $1.92
EPS (2003) $2.00

The guidance is likely conservative, as management wants to continue to build a track record of meeting estimates. Over the last six quarters, ATAC has topped estimates by an average of 7.5% a quarter. Upside to the $2.00 could come from less mild weather (cold winters tend to increase demand for Chrysler transmissions and hot summers tend to increase demand for Ford transmissions), new logistics deals and/ or better-than-expected growth from its new design wins.

So, at $14.25, the stock is trading at 7.4x C02 EPS and 7.1x a likely conservative C03 EPS. By contrast, the company’s peers (DPH, AXL, BWA, DCN, JCI), several of which are experiencing deteriorating fundamentals, trade at an average of 9.2x C02 EPS and 8.2x C03 EPS. A conservative 9x multiple of ATAC’s 2002 EPS of $2.00 would yield an $18 stock in the near-term. Any potential growth in auto sector in 2003/ 2004 would likely cause multiples to expand in this industry.

The investment case becomes more compelling when one looks at how the company is being smart with its cash. Besides repurchasing a significant amount of shares, the company is using its free cash flows to markedly reducing its debt. Its target level for net debt at the end of 2003 is $75 million, down from $101 million at present. So, the company is effectively trading at an EV/FCF of 6.6 when one looks at the year-end 2003 capital structure. With its current run-rate of free cash flow, the company could pay off its debt and complete the 1.4 million share buyback within two years.

Target at end of 2003:
O/S 24 million
Market cap $342 (implied)
Cash $75 million
Debt $150 million
Net debt $75 million
EV $417 (implied)

FCF (2002) $63.5 million
EV (2002)/FCF 7.1x
EV (2003)/FCF 6.6x

The company is also considering making one or two small acquisitions with its cash. Importantly, management is careful to note that any acquisition must be accretive to shareholders and it must have minor operational issues (i.e. be small).

RISKS

Auto sales, which have been soft in 2001 and 2002, could be soft again in 2003. However, ATAC’s growth is not directly tied to new auto sales. Instead, the company is growing revenues through the growth in the installed base of cars, the trend towards longer OEM warranty programs, and its penetration of new and existing accounts.

The company has high exposure to Ford (42% of revenues in 3Q02), DaimlerChrysler (16.9% of revenues in 3Q02) and AT&T Wireless Services (18.8% of revenues in 3Q02). However, their contracts with companies like Ford and DaimlerChrysler are long-term in nature, which is actually a competitive advantage. Though its contract with AT&T Wireless must be renewed each year, the high switching costs make this scenario an unlikely one. ATAC’s high operating margins (around 20%) and ROE (around 24%) are evidence of its entrenched competitive position and its high-value add.

Catalyst

The company recently announced a significant share repurchase program. With its current run-rate of free cash flow, the company could pay off its debt and complete the 1.4 million share buyback within two years.

Any potential growth in auto sector in 2003/ 2004 would likely cause multiples to expand in this industry.

Upside to 2003 EPS of $2.00 could come from less mild weather, new logistics deals and/ or better-than-expected growth from its new design wins.
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