Description

Hayes-Lemmerz (HAYZ) is the world’s largest manufacturer of automotive wheels. It also supplies automotive brake components and aluminum structural components. The company has a strong global presence with roughly one-third of its sales and half of its EBITDA coming outside of the US. Almost two-thirds of its 2002 EBITDA of 228.5 mil came from wheels, one-third from components and 3% from various other products.

On June 3rd, the company exited bankruptcy after an 18 month stay. Debt was reduced 2 bil, down to 750 mil. The rest of the new capital structure includes a 10 mil preferred (convertible to common at 18.50), 17.5 mil in minority interest, and a market cap (based on the 11.55 stock price) of 346.5 mil – total EV of 1.13 billion. Based on an estimated EBITDA of 250 mil this year, the company currently trades at an EV/EBITDA multiple of 4.5.

Bankruptcy

In the late 90s, Hayes made a series of acquisitions that increased its international footprint as well as expanded its product offerings beyond its traditional wheel business. These acquisitions led to a ballooning of the company’s debt level. And, in 2000/2001, some of the company’s acquisitions began to underperform partly due to a volatile automotive production environment. In May of 2001, the company’s accounts receivable securitization program could not be renewed, furthering the dire liquidity situation. A failed bond offering and a couple of restatements later, and the company was forced into bankruptcy in December of 2001.

Now 18 months later the company has finally emerged (after a few speed bumps along the way). Besides debt reduction, Hayes exits bankruptcy with new senior management, a restructured plant base, and a somewhat more integrated company. Hayes entered bankruptcy a loose federation of acquired companies, rather than one synergistic corporation. And, while the company still has a way to go to fully integrate itself, progress has been made toward actually combining the acquired companies. To be sure, operational efficiencies are still there to be found. This may be a blessing in disguise, as significant improvement may lead to financial outperformance.

So, we now have company that is still capital intensive and still has some operational inefficiencies. That isn’t too great. However, we also have an industry leading company with less debt that is focused on improving internal operational performance rather than looking to make acquisitions (similar to Laidlaw). It is this internal focus that should allow Hayes to generate solid, if not spectacular, results going forward. And, solid results are all that are needed to make the stock a compelling investment, in my opinion (see valuation below).

Recent Results

In its last quarter before exiting bankruptcy, the company generated sales above plan due to high volumes and a strong Euro, but EBITDA below plan due to lower than expected prices and higher than expected expenses, including one-time reorganization items. Cash flow was decent, if not spectacular, hindered somewhat by working capital adjustments caused by changes in payment terms. Overall, the quarter was on plan to slightly below plan, although the company seems confident in reaching its year-end goals. The key factors to me were the low gross margins and the below plan SG&A expense. To a certain extent, these cancelled each other out for the quarter. And, I expect SG&A will continue to come in below plan. However, if gross margins do not improve, the outlook for the company is not as strong as I believe it is. It is something that needs to be monitored.

Valuation

As stated above, Hayes currently trades at a 4.5 EV/EBITDA multiple. Superior Industries, Hayes’ main competitor, trades closer to a 6.0 EV/EBITDA multiple. Now, Superior, in my opinion, should trade at a premium as it has no debt, has demonstrated strong cash flows for years and focuses on aluminum wheels – the fastest growing wheel segment. It also pays a dividend. The being said, the valuation spread seems a little wide to me, especially considering Hayes is over twice as a big as Superior based on total sales. A 5 multiple gives you a $16 stock, 5.5 gives you $20. Multiples should also expand for the industry if/when auto production numbers start to show some strength.

From another perspective, FCF for the current year should be roughly 45 mil if the company can execute somewhere near its projections. With a 347 mil market cap, the stock is currently offering a 13.0% FCF yield – not too bad. FCF is supposed to dip in 2004 as strategic cap ex creeps up, so the current FCF yield does not get me as excited as it might. However, if the company executes close to plan, FCF expands substantially beyond 2004, making the current stock price look quite cheap. I estimate ‘normalized’ FCF for the company somewhere near 60-65 mil, although an argument can be made it is closer to 80 or 90 mil (difficult to get a real firm number due to the historical acquisitions and restatements). While I am more comfortable at the 60-65 range, operational improvements and well allocated cap ex could find the company at the 80-90 level sooner rather than later. Anyway, a 10% FCF yield on 60 mil gives you a 20 stock, the same as a 5.5 EBITDA multiple. So, from my perspective, if Hayes executes at or close to plan, you have a stock worth 20 or so, with the potential for a 25 or 30 stock if operations and efficiencies improve. The downside, in my opinion, is fairly limited as the company should be self-funding with decent EBITDA in even a worse case scenario.

Risks

Weak Automotive Sales
HAYZ’s fortunes are obviously closely tied to the auto manufacturers fortunes. If the industry slides into a prolonged slowdown, Hayes would have difficulty meeting POR projections, and the company could vastly underperform.

Low Gross Margins
As stated above, the company’s last reported gross margins were below plan. The company needs to find a way to increase margins in order to be successful. Operational efficiencies and increased volume should help Hayes achieve this, but it is something that definitely needs to be monitored.

Large Market Share Losses
Superior Industries has proven to be a strong competitor. While Hayes dwarfs it in total sales, Superior margins are substantially higher than those of Hayes and Superior is a powerhouse in the aluminum wheel market. While Hayes could do just fine with moderate market share losses, the company would be in serious jeopardy if it finds it cannot compete.

Conclusion

Through acquisitions, Hayes Lemmerz grew itself into on of the largest suppliers of automobile components. Unfortunately for the past equity holders, those acquisitions burdened the company with too much debt for its industry. However, upon emerging from bankruptcy, the company still has the industry presence along with a vastly improved capital structure and a somewhat more efficient and integrated company. The company still has some issues, and its success still depends upon the difficult automotive industry, but the company does not need to improve substantially (if at all) for an investment in the stock to work out. And, if the company can operate somewhat more efficiently, improving margins somewhat, the stock is exceptionally undervalued. In many ways, the Hayes argument is similar to the Warnaco argument – an interesting, but not terribly exciting, situation with limited downside and the potential for 75%-100% appreciation over the next 12-24 months.

Catalyst

Emergence from bankruptcy.
Execution near or above projections.
NASDAQ listing.
Valuation.