Description

Executive Summary

• Trimas (TRS) is an industrial conglomerate trading at a significant discount to its intrinsic value.
• Investors have kept TRS in the penalty box for past mistakes and headwinds (bad M&A, operational mishaps, negative absorption from down cycle in certain end-markets), despite:
  • A new, effective CEO is now behind the wheel and improving operations;
  • Operations within its formerly-troubled Aerospace segment are improving, and have runway yet to go;
  • Improving Energy end-markets, and;
  • A host of available strategic levers to enhance shareholder value (and signs that management intends to capitalize on them).
• We believe TRS’s Packaging business justifies nearly the entire Enterprise Value of TRS, if given a multiple consistent with other high-margin peers.
• With the robust, less cyclical, and therefore more leverage-able cash flows of the Packaging business, TRS could conceivably support the entire net debt of the company with this business alone.
• This would leave the remaining three business with zero net debt and a host of strategic and capital deployment levers to further enhance shareholder value. We estimate these businesses will do ~$100mm in 2020E EBITDA after an appropriate allocation of corporate overhead.  
• Such a step would force the market to value TRS’s cyclical segments on their normalized earnings power.  

Why it’s Cheap

Industrial conglomerate TRS combines two well-worn pages in the value investing playbook – “New(ish) CEO undertaking operational turnaround”, and “Underperforming division(s) obscuring high-quality business”. The stock has some of the hallmarks of a good, niche, value investment as well:

• It’s under-researched, decidedly un-sexy, and has a low profile bordering on obscure;
• It’s hard to find: A simple application of the “right” P/E to consensus earnings for TRS does not yield the “right” answer. Screens won’t help you find it, the sell-side has little incentive to push it, and management doesn’t do a particularly great job of getting the story out there (although they’re improving in this arena);
• There is positive optionality in the out-years that the market is ignoring;
• It has disparate businesses in terms of quality and/or cyclicality, with valuation multiples landing squarely on the lowest common denominator, and;
• It takes some real work to unwrap. There are four segments to be researched – and who wants to bother with that for a ~$1.2 billion market cap company?

Background

TRS was created by Masco Corporation executives in 1986 as an industrial business acquisition vehicle. We came to know the Company in 2015 when they spun-off their towing products division as Horizon Global (HZN, which we wrote-up here on 12/8/2015). Post-spin, Trimas has four remaining verticals (metrics refer to 2017):

• Packaging – 42% of sales, ~60% of EBIT – consumer dispensers (for soap, lotions, Purell® hand sanitizer, etc.), consumer product packaging, enclosures for industrial cylinders/drums
• Aerospace – 22% of sales, 20% of EBIT – primarily fasteners (#3 behind Arconic and Berkshire Hathaway-owned Precision Castparts)
• Engineered Components – 16% of sales, 12% of EBIT – steel air and gas cylinders, sold to customers such as Praxair and Air Liquide
• Energy – 20% of sales, 7% of EBIT – gaskets, bolts, fasteners sold into refining, petrochemical, oil field

TRS’s Historical Mishaps

The historical issues at Trimas can largely be categorized as either cyclical, self-inflicted, or poor capital allocation:

• Cyclical - In summer '15, Trimas began facing cyclical oil & gas-related headwinds both within its Energy segment, and its smaller Arrow Engines business within Engineered Components. Energy serves primarily downstream petrochemical plants and other refinery customers, but also has some upstream customers. Energy sales and EBIT from 2012-16 were down 16% and 69% respectively, before rebounding in 2017 (where adjusted EBIT was up ~$3mm on nominal sales gains thanks to cost efforts). Arrow Engines serves upstream oil and gas customers at the well-site. Weakness here partly explains the Engineered Components 2016 segment EBIT being more than 45% below 2014 levels.
• Self-inflicted - The self-inflicted wounds were mainly in Aerospace. TRS struggled when Boeing switched to a more just-in-time ordering pattern. This change made big distributors (like KLX) destock, which caught TRS flat-footed. TRS couldn’t reconstitute its supply chain quickly enough in response to these changes. They began missing delivery times and incurring huge one-time costs to fulfill orders. Another example is in the Energy segment, where the prior CEO led and aggressive and ill-timed expansion into international markets, adding overhead at the worst time. Amato has begun to reverse this.
• Capital allocation – Over 2013-14, TRS’s former CEO led an aggressive push into Aerospace M&A. Some believe it was an imitation of Precision Castparts (which had in-sourced some machining and other functions), but Trimas lacked the scale to do it effectively. Trimas also bought more commoditized fasteners businesses that have diluted margins. All told, TRS spent ~150% of its cumulative 2012-16 adjusted net income on M&A (with ~84% on Aerospace deals). Over that period, Aerospace sales increased 123%, while EBIT declined 15%.

Together, these headwinds sent TRS shares down ~38% from July ‘15 to low of ~$15 in Feb. ’16 (and down 54% from its October ‘13 high). At its lows, the sell-side could only muster a single buy out of 8 analysts.

New CEO cleaned up operational issues

These struggles precipitated a CEO change in the summer of '16. New CEO Tom Amato has a history of shareholder value creation. Previously, he was one of the chief architects of the merger that formed the Metaldyne Group (MPG, a 2014 IPO), which was sold to American Axle (AXL) in 2016 for $3.2 billion. Amato had previously worked for MascoTech, which owned Trimas at the time. Since re-joining TRS, Amato has focused mainly on Aerospace. He is fixing the operations, improving on-time deliveries, changing plant managers, and restoring customer confidence.

We believe these efforts within the Aerospace division have the potential to drive upside towards normalized segment EBIT margins of 20%+ from 10% in 2016 (we are modeling Aero segment EBIT margins of ~18.5% in 2020). This normalized margin includes the smaller machined components business acquired a few years ago, which is likely operating at a loss, and which on the Q417 call management announced it would be divesting.

This divestiture tempered TRS’s FY18 sales growth outlook by ~50bps, but will be margin accretive and help better reveal the improvements TRS has been making in the Aero segment. This machined component business and also some standard fastener business lines have both been obfuscating higher-quality businesses, which consistently produced 24-29% margins for many years prior to the Company’s margin-diluting acquisitions.

Aerospace EBIT margin % was 14.2% in 2017 (400bps improvement vs. 2016, and ahead of plan). Further upside to 20%+ margins is not contemplated in sell-side earnings estimates despite TRS’s strong progress to-date and recent strategic actions, offering one layer of potentially significant positive optionality.

Finally, last quarter management encouragingly started reporting non-cash intangible amortization at a segment level. What this revealed is this expense fell disproportionately on Aerospace due to the historical acquisitions in that segment. These enhanced disclosures, therefore, have helped better highlight the quality of, and recent improvement in, the aero business, which had EBIT margins ex-these noncash intangible amortization expenses of 20.2% in Q417.  

Strategic Actions Next up

On the Q417 call, beyond divestment of its small, loss-making machined components Aerospace business, management also announced a change to its segment reporting. We often are suspicious when we see segment reporting changes, as management teams often use this tactic to obscure challenges in their end markets. We don’t believe that to be the case here.

TRS will be consolidating its Energy and Engineered Components segments into one called Specialty Products. We believe this move could be the precursor of strategic actions involving this new segment (either a spin or sale to strategic). The cyclicality of the Energy segment is one of the biggest reasons TRS has traded with a persistent and large conglomerate discount (adding on to the previously discussed self-inflicted problems in Aerospace). It would make sense then that management feels combining Energy with a more stable cash-flow generative business, and possibly even realizing the value of the combined entity, would serve to diminish the conglomerate discount.

Three spin options – take your pick

We believe the reconstituted Specialty Products segment, Aerospace, and Packaging could all be spun, and support the standalone costs of being a public company.

A spin-off of Aerospace would be a likely acquisition target for competitors Precision Castparts, Arconic, or the PE-backed Consolidated Aerospace Manufacturing.

Packaging’s stability and very high margins would garner a high multiple and an ability to lever the equity to increase returns. This is where the financial engineering comes into play, as the current interest rate environment would enable a cap structure for Packaging that is not available to Trimas overall. In fact, based on peer leverage and EV/EBIT multiples, we believe Packaging could support ~140% of consolidated net debt with an enterprise value that is 86% of the current TRS Enterprise Value. Similar to an Aerospace spin, this transaction would also lend itself to a potential take-out down the road. Our calculations are laid out below:

Packaging has been the stalwart for TRS, with robust and reliable EBIT margins of ~23%. It enjoys diverse end markets, strong customer relationships, regulatory and intellectual property barriers to entry, and terrific cash flow. But it has been difficult for anyone to be excited about this performance, given the rate at which all other EBIT was evaporating.

To illustrate, the chart below compares the EBIT (indexed to 100) of Trimas to its peers since 2012. Incredibly, despite Packaging EBIT growing, and despite spending nearly 50% of the current market cap on M&A, through 2016 TRS’s total EBIT is down 35% over a period where peers are +2%.

In 2017, however, TRS almost doubled the EBIT growth of its peers (15% vs. 8%), as its Aerospace initiatives took hold. Despite the dramatic EBIT improvement, especially relative to peers, investors (perhaps scarred from past mishaps) have been slow to catch up with the improving fundamentals or to reward TRS. Skepticism has ruled the day – with TRS’s multiple not re-rating over the last 12 months. TRS’s NTM P/E discount vs. peers has closed over the last year, as its peer multiple has come back to them. Estimates, however, do not reflect TRS’s “catch up” opportunity relative to its peers as it continues to improve operations, enjoy cyclical recovery, and add further value through strategic actions. We believe TRS should capture a premium to this peer group, given the potential for its ongoing self-help initiatives and corrections of past mistakes to generate above-average earnings growth relative to its referenced peer group.  We are estimating TRS will grow EPS at a high-teens CAGR from 2017-20E.

Further, only one analyst (JPM) has moved from hold to buy, leaving the other 6 remaining analysts still at a “hold” rating – and likely in a position where they will be playing catch-up at some point to TRS’s improving fundamentals.

Valuation

In effect, an investor in Trimas is paying almost nothing for the non-Packaging businesses, which comprised 62% of sales as recently as 2014 (adjusted for the HZN spin-off) before cycling down. On top of that, Trimas made a $360m acquisition (30% of the current market cap) of Allfast in the Aerospace segment. Allfast was acquired just as the Aerospace division suffered its operational problems. This adds to the lack of visibility into normalized earnings.

Our sum-of-the-parts for Trimas incorporates the following assumptions:

In the above, while we capitalize corporate expenses as part of our SOTP analysis, a strategic acquirer of any or all of the businesses would look through these expenses.

We also think it’s prudent to value Aerospace and TRS overall on a NTM P/FCF and NTM EV/EBITDA less capex basis, given D&A for TRS has been ~140% of capex (beg. in 2013) due to intangible non-cash amortization associated primarily with large Aerospace acquisitions. Also, TRS has a history of solid FCF conversion.

Using our SOTP, NTM P/FCF, and EV/NTM EBITDA less capex methods, we calculate a range of 2020 target prices of $47-53 on a SOTP basis. This equates to an IRR of 39-49% through the end of 2019 when 2020 earnings should be discounted. Our scenario of a separation of Packaging from the other businesses, perhaps leaving the stub with net cash and some borrowing capacity to repurchase shares, would lead to additional upside via effective capital deployment. Even absent a spin, TRS could enhance shareholder value through share buybacks or M&A by using both FCF and maintaining ~2x leverage (something these businesses can comfortably support).

Risks

• Higher steel costs/tariffs – Steel is the major raw material input, and is present in all TRS’s product lines (Aero fasteners, Engineered Components steel cylinders, Energy fasteners and engines, and Packaging steel drums). In Packaging, however (as the segment’s historical earnings indicate), TRS should have little problem passing through higher steel costs. In Aero, price escalators should also allow them to mitigate higher steel costs. In Engineered components and Energy it is less clear.
• Packaging volumes – Packaging experienced some softness in the 2H17 in the home, beauty, and health segment. We believe this is temporary, but if it becomes more prolonged, this would weigh on shares. Management indicated home, beauty, and health should be flat in FY18 with strength in food and beverage and Asia making up for this temporary softness.

DISCLAIMER

This report (this “Report”) on TriMas Corp. (the “Company”) has been prepared for informational purposes only. As of the date of this Report, we (collectively, the “Authors”) hold long positions tied to the securities of the Company described herein and stand to benefit from an increase in the price of the common stock of the Company. Following publication of this Report, and without further notice, the Authors may increase or reduce their long exposure to the Company’s securities or establish short positions based on changes in market price, market conditions, or the Authors’ opinions with respect to Company prospects. This Report is not designed to be applicable to the specific circumstances of any particular reader. All readers are responsible for conducting their own due diligence and making their own investment decisions with respect to the Company’s securities. Information contained herein was obtained from public sources believed to be accurate and reliable but is presented “as is,” without any warranty as to accuracy or completeness. The opinions expressed herein may change and the Authors undertake no obligation to update this Report. This Report contains certain forward-looking statements and projections which are inherently speculative and uncertain.

Catalyst

• Strategic actions - sale or spin of Packaging, Aero, or Energy/Engineered Components.
• Activist involvement – as we note, we contend a Packaging spin is the best path forward for shareholder value creation. Our discussions with management suggest this isn’t something they’re really thinking about at the moment. TRS seems ripe for an activist to come in and advocate for the most value-enhancing alternatives.
• Continued improvement in investor communications - Q417 marked a step forward in this department with a breakout of non-cash intangible amortization by segment plus better delineation of corporate costs. We expect the management team to continue improving communication around its operational improvements, and more importantly its strategic options.