Description

Company Overview

Cooper Standard Holdings (CPS) is a leading global supplier of Sealing Systems, Fuel & Brake Delivery Systems, Fluid Transfer Systems and Anti-Vibration Systems manufactured primarily for the global automotive original equipment manufacturers (OEM) and replacement markets.  Approximately 82% of their sales are to global OEMs, with the remaining 18% to Tier I and II automotive suppliers.  With its recent divestiture of non-core product lines (thermal, emissions and coatings and trim), CPS has been focusing on gaining and maintaining its leadership role in its four key business segments.  According to the company, CPS is the global market leader in Sealings Systems, maintains the number two global market share in Fuel & Brake Delivery Systems, is the third largest global player in Fluid Transfer Systems, and is the North American leader in Anti-Vibration Systems.  The company’s products are used primarily for lightweight vehicles (automobiles and trucks) and are designed, manufactured and distributed to global OEMs.  Since emerging from bankruptcy (Chapter 11) in May of 2010, Cooper Standard Holdings, through acquisitions, partnerships/joint ventures, and organic growth, has been able to establish a global footprint through manufacturing scale, reduced structural costs, and diversifying their customer base.

In October of 2012, Jeffrey Edwards became the new CEO of Cooper Standard Holdings, adding the title of Chairman in May of 2013.  Edwards has refocused the company to initiate and maintain profitable growth strategies with the goal to be amongst the thirty largest global automotive suppliers in terms of sales, but one of the top 2 when measured by return on invested capital (ROIC).  To achieve this goal, the company has implemented the Cooper Standard Operating System (CSOS) to ensure global consistency in engineering, design, manufacturing and distribution.  By standardizing their operations within its 98 facilities (79 manufacturing and 19 design) located in 20 countries, and by centralizing both its bidding process and cost structure, CPS expects to achieve greater efficiencies, reduce expenses and expand its ability to service the growing global demand of its OEMs and their platforms.

Industry

The automotive supply industry is highly fragmented.  It is characterized by high barriers to entry, significant start-up costs, and long-standing customer relationships. The key criteria by which an OEM judges an automotive supplier include:  Quality, price, performance, design and engineering capabilities, innovation, timely delivery, financial stability, and global footprint.  

Supplying automotive OEMs can become a very sticky business.  Once a product of an automotive supplier is included in an OEM’s platform, the revenue becomes very predictable and sustainable for the life of the contract.  The duration of most contracts is five years, and as long as the incumbent supplier was able to fulfill the contract without complication, it stands a very good chance to win the renewed contract or be invited to bid on the redesign or replacement platform.  The downside to being an automotive product supplier is that the company’s revenues and profitability are highly correlated to the cyclicality and seasonality of automotive production and sales.

Given the recent trend by OEMs to reduce their production costs, many are sourcing multiple and global platform products from a single automotive supplier.  Having a global design, manufacturing and delivery footprint is not only a competitive advantage for an automotive supplier, but essential to winning and fulfill global contracts.  The lack of a global footprint is causing the automotive supply industry to bifurcate and consolidate.

Thesis

Cooper Standard Holdings profitability is highly correlated to the global automotive, light vehicle OEM market.  Research and analysis firms, like IHS Automotive, are expecting a tepid 2.5-3% CAGR for both North America and Europe automotive sales over the next five years, with the only true growth coming primarily from China and Asia Pacific. North America and Europe represent approximately 85% of CPS’ revenue.  However, even with the muted outlook or even a possible downturn in the auto market, CPS still represents a significant investment opportunity for the patient investor given its potential future growth driven by both revenue and margins expansion.

Growth Catalyst

There are three main catalysts that will drive CPS’ future growth:  1) New/renewed contract wins combined with increased number of global platform products and premium products per vehicle;  2) Expanding the company’s global footprint and revenues to reflect higher growth regions, especially China and Asia Pacific; and 3) Global adoption of Cooper Standard Operating System (CSOS), including centralizing the company's worldwide bidding process and cost structures, while restructuring European operations to reflect global OEM and regional changes.

New Contract Wins

When Cooper Standard Holdings emerged from bankruptcy in May 2010, the company was more focused on contract wins and facility utilization than it was on profitability, resulting in lower revenue and compressed margins.  Most platform contracts last about five years and have been coming up for renewal or request for quote (RFQ) for a redesigned platform model.  With a more robust balance sheet, CPS not only has the ability to focus on ROIC and profitability, but has become a stronger and more dependable partner to the automotive OEMs it supplies.  This has led to recent renewal and new contract wins with higher revenue and gross margin.  

Additionally, with its new focus on only four revenue segments, Cooper Standard Holdings has made inroads into supplying multiple and premium products to global OEM and their platforms.  IHS Automotive expects that over the next 5 years, more OEMs will gravitate toward global platforms, reducing the number of suppliers, while simplifying and minimizing production costs.  Having the ability to design, manufacture and supply global OEMs and their platforms is a competitive advantage that CPS has over its regional competitors.  With its recent acquisitions and joint ventures, CPS has also added a number of premium products to their catalog that are more durable and significantly lighter than the legacy products they are replacing.  These premium products carry higher ASP and margins as they help OEMs meet future CAFE standards, by reducing the weight of their automobiles which, in turn, increases the number of miles an automobile can travel on a gallon of gas.

Regional Expansion

Globally, North American and European OEM production accounts for approximately 43% of total light vehicle production with Asia Pacific making up 42%.  Over the next five years, Asia-Pacific (mostly China) is expected to represent nearly 50% of global production with North America and Europe falling to slightly above 40%. Currently, North America (53% of revenues) and Europe (32% of revenues) accounts for 85% of Cooper Standard Holdings’ global revenues, with Asia Pacific representing around 12%.  In order for CPS to be a true global OEM supplier, it needs to expand its regional revenue streams to reflect the current and future global production levels.  Over the last two years, management has been addressing its lack of exposure to the Asian Pacific region through acquisitions and joint ventures in China, India, and Thailand.

In the future, EBITDA margins will also reflect Cooper Standard Holdings growing Asian Pacific exposure.  Currently, North America represents 80% of total EBITDA.  Product mix, facility utilization, and cost structure are the key variables that have lead to North American EBITDA margins to be just shy of 16%.  Both Europe and Asia Pacific EBITDA margins are currently around 8% but are expected to improve.  With the planned restructuring in Europe to move some facilities from Western Europe into Eastern Europe, and to be closer to OEM production, labor and production costs will fall dramatically.  The European restructuring will also benefit in supplying Asia Pacific OEMs. Expectations are for North America EBITDA margins to be around 16-17%, with Europe and Asia Pacific expanding to 11% and 10%, respectively, by 2020.  Overall, EBITDA margins will improve from 11% to 13.5% over the next five years.

Cost Saving

At the same time that Cooper Standard Holdings is focusing on increasing revenues and margins, corporate profitability is also being addressed through cost savings.  Over the last two years, CPS has centralized both its bidding process and cost structure.  This has helped streamline operations by integrating global design and manufacturing facilities to work seamlessly with one another.  However, the true impact on profitability will be felt once the Global adoption of Cooper Standard Operating System (CSOS) is achieved.  CSOS is a top down, best practices, operating system to ensure that the design, manufacturing, delivery, and customer service is unified and of the highest quality across all global facilities.  With a special focus on lean manufacturing, optimizing global performance, innovation processes, and common communication throughout all facilities, CPS expects that the capital expenditures that they have made, will result in approximate savings of $30 million per year.  When combined with future savings anticipated from relocating Western European facilities into Eastern Europe, CPS could save close to $90 million per year.

Valuation

Cooper Standard Holdings currently trades at 4.8x EV/EBITDA.  Given the past range of this metric along with the outlook for North American and European automotive production, one could easily make the case that the stock is fairly priced.  However, with the number of future catalysts, both positive and negative, CPS' valuation can be broken down into three outcomes:  Base Case, Bear Case, and Bull Case.

Base Case

The base case is a conservative outlook for the company with the key assumptions being that North American revenue will grow around 6%, faster than the 3% projected for the automotive industry.  Europe’s growth will be flat until 2018, and then grow at 3%; Asia will grow around 15%, and EBITDA margins will expand from 11.5% to 13.5% by 2020.  There is no change to current debt or cash levels and the EV/EBITDA multiple will increase to 5.5x.  This puts the CPS’ share price at $100/share by 2017, and $150/share by 2020 or a 12% CAGR from today.

Bear Case

The bear case assumes North America’s revenues will decline by 5% in 2017, decline 3% in 2018, before returning to 3.5% growth in 2019 and 2020.  Europe remains flat in 2017 and grows at 3% from 2018-2020, and Asia grows around 15%.  EBITDA margins will fall to 10.75% in 2017, recover to 11.75% in 2018, and grow to 13% by 2020.  There is no change to current debt or cash levels and the EV/EBITDA multiple will decline to 4.5x in 2017, before recovering to 5.5x by 2020.  CPS’ share price falls to $65/share by 2017 and recovers to $130/share by 2020 or a 9% CAGR from today.

Bull Case

The bull case is an optimistic outlook for the automotive industry and CPS’ opportunities to exploit it global footprint.  It assumes that North America’s revenues will grow 7% in 2017, up to 10% by 2020, with new contract wins and product mix.  The restructuring of Europe occurs with revenues flat for 2017 but growing to 7% by 2020, and Asia’s growth is steady around 20%.  EBITDA margins expand from 11.5% to 14%, with a positive impact from North America’s contract wins and product mix, Europe’s restructuring, contract wins, improved utilization in Asia, and successful implementation of CSOS.  There is no change to current debt or cash levels and the EV/EBITDA multiple will increase from 5.5x to 6.5x by 2020, reflecting CPS’ significant growth and in line with peer multiples.  CPS’ share price rises to $120/share by 2017 and continues to grow to $210/share by 2020, or a 20% CAGR from today.

Risks

There are a number of risks facing Cooper Standard Holdings and the automotive supply industry:

• Even with the fact that the average age of US automobile/truck on the road today is over 11 years old, a downturn in the North American market is possible, especially if interest rates and/or gasoline prices were to move higher.

• Given the ongoing consolidation in the automotive supply industry, CPS could destroy shareholder value by overpaying for an acquisition.  However, this is unlikely given management’s continued focus on ROIC.

• CPS is unable to make significant inroads into Asia Pacific and remains highly dependent and correlated to North America and Europe

• The European restructuring continues to be delayed and the cost savings are not reflected in higher EBITDA margins.

Summary

The automotive supply industry is highly fragmented, however there are only a few companies that compete with CPS that can supply global automotive OEMs and their growing global platforms.  Since emerging from bankruptcy in 2010, and receiving new management in 2012, Cooper Standard Holdings has fortified its balance sheet, streamlined its global operations and footprint, making it a much stronger partner to the OEMs it supplies.  The ongoing consolidating regional segment of the industry should provide CPS with the opportunity to acquire “tuck-in” acquisitions that will either provide a premium product to add to its catalog, or inroads into supplying Asian Pacific OEMs like Toyota.

Cooper Standard Holdings is well positioned to grow both it revenues and EBITDA margins faster than the car manufacturing industry as a whole.  It will accomplish this through expansion of the quantity of products it sells to OEMs through new bid wins, the revenue mix, the quality of new products it is bringing to market, and the continued growth in OEM global platforms.  These opportunities, as well as the ongoing CSOS cost cutting program, will lead to higher EBITDA and earnings.

Even with all the uncertainty, the expected tepid future growth in North America and European automobile industry, as well as the potential for a North American production downturn, Cooper Standard Holding is a well managed global supplier in a niche segment of the automotive industry and a good investment for the patient investor.  Starting a position at current levels with the objective to grow it if the share price fell below $70/share, is a good investing strategy.

Catalyst

1) New/renewed contract wins combined with increased number of global platform products and premium products per vehicle;  

2) Expanding the company’s global footprint and revenues to reflect higher growth regions, especially China and Asia Pacific; and

3) Global adoption of Cooper Standard Operating System (CSOS), including centralizing the company's worldwide bidding process and cost structures, while restructuring European operations to reflect global OEM and regional changes.