TITAN INTERNATIONAL INC TWI
October 24, 2012 - 2:32pm EST by
werd725
2012 2013
Price: 18.50 EPS $0.00 $0.00
Shares Out. (in M): 42 P/E 0.0x 0.0x
Market Cap (in $M): 783 P/FCF 0.0x 0.0x
Net Debt (in $M): 171 EBIT 0 0
TEV ($): 954 TEV/EBIT 0.0x 0.0x

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  • Manufacturer
  • High Barriers to Entry, Moat
  • M&A Catalyst
  • Tire
  • Auto Supplier
  • Agriculture
  • Mining

Description

I realize that the earnings announcement is tomorrow morning, so this is a little tardy, which is why I wanted to get this out there as soon as possible, as I expect a good conference call.  However there are longer term drivers of the stock beyond tomorrow's report.
 
Recommendation: BUY

Titan International (TWI) is an attractive long investment due to misplaced concerns over the company’s agriculture and mining end markets.  Moreover, the company will be announcing what I believe will be a very accretive transaction during their third quarter earnings call.  Despite challenges in their end markets, the company should be able to drive EBITDA meaningfully higher, before any synergies from the Titan Europe acquisition.  Based on expected 2014 EBITDA of $380 million and a 7x EBITDA multiple, I calculate a target price of $38, 90% higher than current levels.

 

P/E LTM

9.2

P/B

1.8

P/E NTM

7.7

P/CF

12.9

EV/EBITDA

4.6

EV/Sales

0.6

 

Business Description

Titan International Inc. (TWI), based in Quincy, IL, manufactures wheels and tires primarily for off-highway applications including farm machinery, construction, and mining equipment.  The company operates five manufacturing facilities in the U.S. and one in Brazil.  In 2011, approximately 65% of sales were agricultural equipment, 21% earthmoving/construction, and 14% consumer.  Over 80% of the company’s revenue is generated in the U.S.

 

Titan operates in three segments: agriculture, earthmoving/construction, and consumer.  TWI is the leader in North American agricultural tires, with over 40% market share.  Tires are made and marketed under the Titan and Goodyear brand names, which together account for 50% of tires sales to OEMs.  Major agriculture customers include Deere (18% of sales), CNH (11% of sales), AGCO, and Valmont.  The company is also the segment leader in wheels (90% market share), and is the leader in replacement agriculture tires with mid-to-high 30% market share.

 

Titan entered the mining tire segment (part of earthmoving/construction) with a $100 million investment in 2007.  The first mining tires, giant 57-inch and 63-inch, were introduced in 2008.  The company has subsequently filled out the lineup with smaller mining tires.  Unlike agriculture tires, mining tires are usually sold directly to mines or through distributors.  Mining trucks generally do not come with tires installed at the factory level.  Mining tires typically last about 9 months, providing a high-margin annuity-like revenue stream. 

 

Titan is one of the few incremental sources of off-the-road (OTR) tires and therefore is in a position to pick up incremental business, particularly at Caterpillar.  Though mines are no longer hoarding tires, as they were in 2007-2008, tire supply is still one of the major constraints in maintaining or increasing production in most OTR applications.  CAT has remained a small customer due to the lack of a historical relationship, but earlier this year Titan announced a new agreement to supply CAT with OTR tires for the next three years.  The company expects this business to exceed $100 million.

 

TWI has a three-pronged growth strategy:

  1. Continually change the OEM tire product standards to improve customer performance and reliability, which effectively makes it more costly for uncommitted competitors to remain in the business.
  2. Improve product design to increase TWI’s share of aftermarket sales.
  3. Opportunistically acquire competitors’ tire production assets

 

There are significant barriers to entry into the company’s core large specialty tire market, including: specialized production, exclusive tooling equipment, niche markets with high startup costs, scarce production machinery (highly specialized for extremely large tire sizes), and reputation with customers.  TWI is the only company to produce both the wheels and the tires for the markets it serves.  This has contributed to its dominance in the North American agriculture OEM market.

 

TWI currently generates about 60% of its tire revenue from OEM production, with the remaining coming from the aftermarket.  Wheel revenue is approximately 85% OEM and just 15% aftermarket.  For new OEM tire/wheel sets, tires typically make up 2/3 of the cost of the completed unit.  Aftermarket sales are moderately higher margin than sales to OEMs. 

 

Titan’s main costs are rubber (50% of tire COGS), carbon black, and steel (50% of wheel COGS).  OEM contracts have raw material pass-through clauses that operate on a minor lag.  To counter rising raw material prices in the aftermarket, TWI has instituted a series of aftermarket prices increases over the past two years.  There is currently no deep market to hedge rubber or steel prices.

 

TWI has built its business by acquiring niche assets embedded in larger companies that get little focus from the parent.  Typically, Titan is the only willing buyer of the noncore assets and therefore is able acquire them at very attractive prices.  The company has made 12 acquisitions since it IPO’d in 1993.  Most recently, Titan bought Goodyear’s Latin America business in April 2011.  This followed the purchase of Goodyear’s North America farm business in 2005.  The company paid $99 million for the Latin America business – $57 million for the assets and $42 million in prepaid North American royalties – or about 3.3x trailing EBITDA.  The assets included a manufacturing facility in Sao Paulo.  Titan will be able to leverage the Goodyear factory footprint by bringing existing molds down to Brazil and adding lines of tires in other sizes under its own brand name.  Goodyear is the number two player in the Latin America farm tire market behind Pirelli, but once was number one.  Also as part of the agreement, Titan agreed to produce consumer tires for Goodyear at cost, totaling ~$250 million annually.

 

Titan is also interested in purchasing Goodyear’s European  farm tire business based in Amiens, France.  At the time of the Latin America purchase, the two companies agreed to the purchase of the European business for $31 million, contingent on Goodyear successfully restructuring the existing Works Council labor force prior to the sale.  Titan needs headcount reduced from 1300 to below 600.  After Goodyear threatened to close the plant entirely, the labor union has shown a willingness to re-enter negotiations.  This business would give TWI distribution rights for Eastern Europe, Russia, and Africa, and could add $200 million to agriculture segment sales.

 

Investment Thesis

Earlier this year, Titan launched and all-stock tender offer for Titan Europe (TSW), of which they already own 20%.  The offer is 1 share of TWI for every 11 shares of TSW.  The offer recently met the 80% threshold and TWI expects to issue 6.241 million additional shares of TWI stock.  TWI spun out TSW back in 2005 because they needed cash, so they are intimately familiar with the business and the assets.  TSW operates mostly in the construction market, but also has facilities located near mines in South America, Africa, and Australia, which would be extremely beneficial for TWI.  Meanwhile, TWI and TSW essentially do different things for the same customers in different parts of the world.  So by doing the same things for the same customers in both North America and Europe, Titan thinks that they can essentially double the business they do for such clients (got all that?).  Finally, Titan Europe only produces wheels and undercarriage, not tires.  They currently buy tires from TWI and ship them from North America.  TWI would like to acquire European tire assets so that they can sell an integrated wheel/tire set, one of the major contributors to their North American success.  Hence, the Goodyear Europe potential acquisition becomes even more important.

 

TWI shares have been hit by worries over its North American agriculture and mining end markets, as well as the impact of its mining tire capacity expansion on margins.  However, even in a down year for farm equipment production, TWI can shift product to the aftermarket, which would be accretive to margins.  While recent results have been strong, Titan has left some margin on the table.  TWI has supplier agreements with OEMs that require the company to first satisfy that channel.  OEM demand has been very strong and Titan has been unable to ramp capacity fast enough to meet both OEM and aftermarket demand.  Since Titan has been unable to fill more-profitable aftermarket demand, any slowdown in OEM demand could easily be replaced with higher margin aftermarket sales.  OEM agriculture sales are currently ~60% of the mix, whereas they are usually only 50%. 

 

Meanwhile, mining is such a small business for Titan that they benefit more from increased penetration than they do from overall mining capex trends.  Titan will likely sell 5,500-6,000 mining tires in 2012 at an average selling price of $30,000-35,000.  Taking the high end of that range ($210 million) puts mining at about 12% of total revenue.  As mining continues to grow, earthmoving/construction margins will likely move higher as utilization increases.  Finally, Titan has leverage to a housing recovery through its position in construction tires, where incremental margins are 25-30%.  Major construction/earthmoving customers include Terex, Kubota, Volvo, CAT, and CNH.  Total order backlog as of January 31, 2012 was $542 million versus $227 million a year earlier.

 

Valuation

I expect the agriculture business to remain more or less flat over the next two years with margins expanding slightly.  Meanwhile, I expect earthmoving/construction revenue and margins to ramp dramatically on the back of increased mining penetration and a residential housing recovery.  I think that $300 million in EBITDA by 2014 is a reasonable assumption, up from $175 million in 2011.

 

One of the more interesting aspects of this situation is that nobody on the Street has included Titan Europe in their numbers.  Because of the quiet period surrounding the offer, management has not been able to give any color on the deal or even update their guidance for the past two quarters.  I calculate that TSW did $28 million US dollars in net income last year, which, including the equity dilution, would have been accretive to GAAP earnings in 2011 by $0.26.  Assuming no revenue or cost synergies (of which there are likely lots), I calculate $80 million US dollars as a reasonable run rate for TSW EBITDA. 

 

 

So, assuming a total run rate of $380 million and applying a 7x EBITDA multiple, I come to an enterprise value of $2.66 billion.  After adjusting for both TWI and TSW cash and debt, this equates to an equity value of $38.66 per share, or 93% above current levels.

 

 

Risks

  1. Concentration in North American farm equipment.  Certainly, the OEM market for North American farm equipment looks peaky.  However, given that crop prices are expected to remain relatively stable, declining OEM sales should be offset by higher margin aftermarket sales.
  2. Increasing raw material costs.  Rubber and steel are the two biggest input costs in the manufacturing of tires and wheels.  TWI has contractual OEM pass-throughs, but they can lag up to 90 days.  There is also no deep market to hedge rubber and steel prices, so TWI relies on its ability to be able to implement price increases in the aftermarket, at which they have been successful over the past two years.
  3. Imports from China.  Imported tires from China have generally been less durable than domestic tires.  Farmers in particular are conscious of the brands they use.  In 2007, at the behest of Titan, the US Commerce Department initiated an investigation into Chinese tire practices.  In 2008, the US issued a duty on imports up to 44%.  The anti-dumping penalty is coming to an end, but it is my understanding that it pertained more to passenger/on-highway tires, which are more commoditized.
  4. Risk of labor strikes.  Approximately 50% of the company’s employees are members of the United Steelworkers Union.  The collective bargaining agreement at the company’s Bryan, Ohio and Freeport, Illinois facilities expired in November 2010.  The collective bargaining agreement at the company’s Brazil facility expired in May 2012.  Those employees are working without a contract under the terms of the company’s latest offer.  The collective bargaining agreement at the company’s Des Moines, Iowa facility expires in November 2012.  The two parties are currently negotiating new agreements, but because the jobs tend to be the best paying in the area, workers are reluctant to strike.
  5. Execution and integration risk related to Titan Europe acquisition.  This is somewhat mitigated by the fact that Titan used to own and operate the assets up until 2005.

 

Catalysts

  1. Better than expected earnings.
  2. Potential guidance update – they have not updated guidance in two quarters because of the quiet period surrounding the Titan Europe offer.
  3. More discussion of the company’s Titan Europe acquisition – none of the sell-side analysts have Titan Europe in their numbers because they have not received any guidance from management.

 

Conclusion

The market is skeptical of future estimates for Titan due to concerns over the health of the agriculture and mining markets.  However, the company should be able to at least offset a decline in agriculture OEM sales, and at better margins, with aftermarket sales.  The main driver of the mining business over the next few years will be market penetration, coming from such a low base, not overall mining capex trends.  Further, the acquisition of Titan Europe will be accretive to both EBITDA and earnings – none of which is in the estimates due to a lack of communication from management.  This does not include any revenue or cost synergies, of which there will surely be a sizeable amount.  Finally, the Latin America acquisition, as well as the potential acquisition of Goodyear Europe should drive further growth and diversify the business away from North American agriculture.  I believe a normalized level of EBITDA for TWI is $380 (including Titan Europe), which equates to over $38 per share using a 7x EBITDA multiple.

 

 

 
Note:  this does not constitute a recommendation to buy or sell.  I or my firm may hold a position in the security and may trade that position without disclosing that information or updating this analysis.  This post is merely for educational purposes.  Do your own research.
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  1. Better than expected earnings.
  2. Potential guidance update – they have not updated guidance in two quarters because of the quiet period surrounding the Titan Europe offer.
  3. More discussion of the company’s Titan Europe acquisition – none of the sell-side analysts have Titan Europe in their numbers because they have not received any guidance from management.
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