|Shares Out. (in M):||26||P/E||0||0|
|Market Cap (in $M):||370||P/FCF||0||0|
|Net Debt (in $M):||260||EBIT||52||70|
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Horizon Global Corporation (“Horizon”) is a manufacturer of towing and trailering components with leading market share in North America, Europe and Australia and is on a steady path to consolidate what remains a highly-fragmented industry. Along with acquisitions, the company is achieving consistent organic growth driven by strong demand for high-quality components to tow both recreational vehicles and industrial equipment. The management team is laser-focused on a cost cutting program forecast to expand operating margins nearly 500bps and double FCF over the next 2 to 3 years. However, after recently providing 2017 earnings guidance below analyst expectations – with the “miss” largely related to a recent acquisition with limited historical disclosure – shares are trading at $14.00, or 6.8x EV/2018 EBITDA and 5.8x EV/2019 EBITDA (or a 10.4% and 14.5% FCF yield, respectively), substantially below peers which exhibit lower earnings and cash flow growth. (Note: Horizon estimates are based on an internal model; figures track below management’s long-term guidance of 10% EBIT margin target by FY2019).
Horizon designs, manufactures and distributes their products to auto OEMs, aftermarkets and retail customers in three primary regions: Americas (largely US), Europe-Africa and Asia-Pacific. Management estimates they are the clear #1 player in both the US (with the #2 player Curt at approximately half their size) and in the Asia-Pacific market. While Horizon was previously the #4 player in Europe, after the recent acquisition of Westfalia/Terwa, they are also the market share leader in that geography, with operations spanning multiple countries. Given their multi-channel sales platform, Horizon’s revenues are less subject to the cyclical demand facing a typical teir-1 auto OEM supplier. Key end markets include commercial applications such as agriculture, construction, fleet, industrial, marine as well as recreational applications such as RV towing, power sports, equestrian and other specialty uses. Importantly, their strong primary brands (Draw-Tite, Reese, amongst others) and wide portfolio of technology/IP means they have the ability to protect pricing in what might at first appear to be a commoditized industry.
Key customer trends having a direct impact on Horizon’s business include:
· Consolidation in the Aftermarket and Retail channels means larger, more sophisticated distributors are taking share from smaller players and subsequently looking to rationalize their supply base by working with fewer vendors that have a greater breadth of products and product expertise. While Horizon experienced a temporary slowdown in ordering activity in early 2016 as a large customer consolidated warehouses, following this inventory levels are normalized and provide a base from which to take market share.
· Growth in the retail e-commerce channel is favouring players with a broad product portfolio, a robust online presence, and critical educational resources for installation. Horizon grew their e-commerce business 26% in 2016, expanding their market share in this critical channel. The potential cannibalization of sales from bricks-and-mortar to online is also margin accretive - even after accounting for direct-to-consumer promotional activity as Horizon is able to increase operating margins by effectively cutting out traditional distributors. Horizon has strong relationships with Amazon and e-trailer.com which protects their exposure to the large incumbents like Autozone and O’Reilly.
· OEMs are adopting global vehicle platforms to decrease product development costs and increase manufacturing efficiency and profitability; as a result they are selecting suppliers that have the capacity to manufacture and deliver cutting-edge products on a worldwide basis. OEMs are also increasing looking to outsource key design and engineering capabilities, turning to the domain expertise of well-resourced parts manufacturers. By offering a truly global platform and leveraging their robust in-house engineering team, Horizon is able to take share from smaller, regional incumbents. This is best exemplified in the >50 new OEM wins in the last year.
· There is a renewed focus on advanced technologies, integrating light-weight materials, computerized components and emphasizing safety. Horizon has an extensive R&D platform with numerous patents and an engineering team focused on both improving current products and designing new products to better address the market demand. Specifically, the acquisition of Westfalia included an extensive portfolio of advanced technologies that had growing popularity in Europe which legacy Horizon is excited to integrate into the North American product platform. These advanced products are typically higher ASP, higher margin than corporate average.
Key end-market trends having a secondary impact on Horizon’s business include:
· US recreational vehicle industry data indicated 2016 RV shipments were 430,961 total units, a 15.1% increase over 2015, and the highest annual total in 40 years. The year finished strong with December 2016 wholesale shipments to retailers of all RVs rising 17% year over year. While the RVIA industry association continues to be conservative, they recently upped their forecast from +1.5% growth in 2017 to +4.4% unit growth. Commentary from all the public RV manufacturers also indicate continued strong demand, with the market leader Thor Industries stating the following: “RV trade shows are seeing a record number of consumer attendees thus far in 2017. The Company continues to see younger consumers purchasing RVs, opting for affordably priced travel trailers and motor homes. The Company sees no signs of a slowdown and is further expanding capacity to meet demand.” All of these data points point to an increased number of both near-term and longer-term demand for Horizon’s core towing and trailering products as used-RV sales also stimulate aftermarket purchases.
· With nearly half of sales through the OE channel (with large customers including Ford and GM), the continuing trend of light truck sales outpacing overall sales by ~5-10% creates a growing market addressable market for Horizons core towing and trailering products. Most forecasts expect light truck sales to remain firmly positive over the next two years despite slowing/negative overall light vehicle sales.
· The large and emerging markets of Latin America and China are seeing increasing adoption of towing and trailering products. The rapidly growing middle class in each of these regions where Horizon operates represent massive potential new consumers for recreational uses as well as industrial uses to support the growing agricultural and construction markets. As global OEMs look to partner with established manufacturers that have local operations, Horizon is best positioned of any competitor to supply this increasing demand.
Horizon was spun out of TriMas (NASDAQ: TRS), a ~$1BN market cap industrial conglomerate, on July 1, 2015. As such, historical standalone financials are based on carve-outs and management estimates and to get a more accurate handle on the operating performance of the Horizon business units one must sift through old presentations and segmented data filed by Trimas. Doing so reveals a business that grew Revenue at a 4% CAGR and Segment Operating Profit at a 5% CAGR from 2011 to 2016. Looking closer, the business as part of TriMas had been a victim of under-investment until 2012 when management began to dedicate additional resources to building new low-cost manufacturing facilities and rationalizing the production footprint – over the 2012 to 2014 period a cumulative ~$45MM was deployed on capital expenditures, well above the ~$5MM per annum maintenance levels. Segment operating margins that had been as high as 10% bottomed at 7% in 2014 before beginning to recover. Following this restructuring period, management set forth three very clear financial goals at the time of the spin-out: (1) improve Operating Margins to 10% - first at the Segment level by 2017 and then at the Enterprise level (or EBIT) by 2018, (2) reduce total leverage over time to below 2.0x, and (3) drive 3-5% annual organic growth. Management has executed on the first goal with impressive speed, hitting the segment level operating margin target of 10% in FY2016 (ex-Westfalia acquisition). The other goals were also achieved/progressed in 2016 with 4.2% growth on a constant-currency basis, and with leverage levels reduced towards the long-term target (on a pro forma basis for Westfalia acquisition and related financing).
Management recently re-iterated their planning period targets, and still anticipate hitting their Enterprise level operating margin target (EBIT margin) of 10% by the end of 2018 (and on a reported LTM basis by early 2019). To get there, management has identified multiple major work streams related to the integration of the Westfalia acquisition as well as meaningful cost savings initiatives in the Americas segment; these include, but are not limited to, shifting European manufacturing from multiple locations into a new Romanian facility, shifting North American production into a new Reynosa, Mexico facility, rationalizing distribution centers, re-sourcing some inputs from lower-cost partners in China, and consolidating dozens of brands. Pairing that off against the low end of organic revenue growth targets would imply ~$90MM in EBIT or ~$120MM in adjusted EBITDA within the next two years. Notably, this does not account for further acquisitions (which are part of the companies stated strategy) or any revenue synergies from the Westfalia transaction despite meaningful cross-selling opportunities between legacy Horizon and the acquired Westfalia. At the current $14.00 share price (~$640MM EV), this represents a <6.0x EV/run-rate EBITDA multiple for a business that is growing organically >GDP, with EBITDA margins of ~12-13%, and high FCF conversion given modest ~2% maintenance capex intensity and a rapidly deleveraging capital structure (with the ability to re-finance remaining debt at lower rates). It is worth noting that management also “beat” every financial guidance target that they provided the market last year, surpassing growth and margin targets for the legacy business throughout 2016.
Share Price Sell-off and Opportunity
The biggest issue facing shares currently is a lack of faith in management; the management team provided 2017 guidance that was between 10% and 15% below sell-side expectations depending on the chosen financial metric and, more specifically, provided additional financial data on the recently acquired Westfalia that implied 2016 earnings were lower than originally communicated. Adding to this are fears that input costs could rise from both increasing steel prices and from a re-negotiation of NAFTA. Due to the aforementioned, shares are down nearly 50% from their highs reached in December; a sell-off not commensurate with the actual operating performance of the underlying business.
· The Westfalia acquisition was announced on August 25, 2016, at a purchase price of €167MM (or $189MM at 1.13 EUR/USD). It was communicated at the time that the purchase multiple was 9.9x FY2016 EBITDA pre-synergies and 4.0x post-synergies, equating to US$19.1MM current EBITDA and an implied US$28MM in EBITDA synergies. What was not made clear at the time was that the “9.9x EBITDA purchase multiple” was based on the acquired asset’s IFRS based accounting that allows for the capitalization of R&D, an item that is expensed under US GAAP. While the full amount of that R&D on a US GAAP basis was not known with certainty at the time of the transaction (full year statements would not be completed for another ~6 months), it would later be disclosed this line item totalled to ~$5MM, meaning like-for-like EBITDA was actually closer to ~$14MM or an implied 13.5x purchase multiple. This figure was meaningfully lower (~25% lower) than investors and sell side analysts had used to base their forward models off of, so when it was later disclosed investors, rightfully, felt misled.
· Management spent a great deal of time on the Q4/2017 conference call and again a week later in a ~25 minute presentation at the Roth institutional investor conference explaining both the nature of the backwards looking discrepancy, as well as how it does not change their forward outlook for the asset and the target 4.0x purchase multiple after synergies remains the same. Management emphasized that while the EBITDA multiple they communicated to the market had different interpretations under IFRS and GAAP, they had always viewed the acquisition price on a cash flow multiple. Of course, cash flow doesn’t change whether you expense or amortize R&D. Another point of confusion was the description of the Westfalia deal as “accretive to earnings in year one”; while the deal would have be accretive in year one at the time of the acquisition announcement on a static capital structure, it is clearly not after accounting for the subsequent equity raise. While the raise was completed a full 5 months following the deal announcement and 4 months following the close of the transaction, its main purpose was to reduce leverage from the acquisition. Despite management’s firm stance on the financial targets for the consolidated business, analysts have clearly lost faith – the consensus operating margin estimate for 2018 is 7.3% vs. managements stated goal of 10% by approximately that time. At a 3% annual revenue growth that 270 basis point delta represents a meaningful $25MM difference in operating earnings by 2019, a ~$65MM EBIT estimate vs ~$90MM figure implied by management’s guidance. While it would not be wise to flatly assume the executive suite’s outlook will be achieved, this does leave a wide margin of safety on the forward numbers.
· Partially corroborating their confidence, management purchased nearly 20,000 shares or over $250,000 in dollar value of stock in March at prices between $13.60 and $14.60
· As it relates to rising steel prices, management has emphasized on a number of occasions that they are able to manage input costs in a number of ways. They have described the process for purchasing inputs months in advance, and using that visibility to reprice certain products to reflect that cost inflation. Looking at the order of magnitude, despite the ~30% increase in US hot-rolled band prices in the last 6 months, management saw a total impact of ~$1MM in inventory purchases, representing a very manageable impact. Management also has the ability to source materials from regions outside of the US, where steel prices have been declining and remain at or below multi-year averages.
· As it relates to a renegotiation of NAFTA, as a material component of Horizon’s labour COGS originate out of Mexico, the Company would be the victim of more a more onerous tariff regime. We estimate that the proposed U.S. corporate tax reduction from ~35% to ~20% would likely not entirely offset the tariff associated headwinds. However, we believe certain natural hedges and strategic responses should serve to mute the overall impact of such an event. For one, Horizon stands to benefit from changes in foreign exchange rates as the U.S. dollar strengthens relative to the Mexican Peso (and other major trade nations), thereby improving components of labour and material costs. The company also has the ability to pass along a component of cost inflation to the end consumer – particularly since Horizon is the only global supplier of many core towing products.
Conclusion and Valuation
Our internal forecasts arrive at 2018 EBIT margins of 8.0% based on top line growth of 3.5%, ahead of current street estimates but below managements targets. At $14.00 this implies shares are currently trading at 6.8x 2018 EV/EBITDA or a 10.4% FCF yield, well below both recent valuation levels (~8.5x forward EBITDA) and comparable RV and automotive aftermarket companies (~7.5x forward EBITDA). While we don’t expect shares to respond until the company can show the market they are making progress on integration savings from the Westfalia acquisition, over-time Horizon shares have the opportunity to benefit from both strong earnings growth and multiple reflation. Based on our 2018 EBITDA estimate of $96MM and after accounting for free cash flow including one-time spending to support synergies, our one year target assuming shares trade at 7.5x EBITDA is ~$19.00/share, representing ~35% upside. That increases to $21.00/share or ~50% upside in the event the multiple reaches 8.0x forward EBITDA, which would more accurately reflect the strong competitive position of the business, high-teen ROICs and >5% FCF margins following completion of integration activities.
- Consecutive quarters of integration execution with synergies showing up in reported results will return credibility to management team
- Margin expansion from volume leverage and cost restructuring in Europe and Americas
- New wins OEM wins in Asia Pacific or elsewhere
- Further M&A activitiy following modest deleveraging
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