Board: Value Hounds
I haven't contributed anything of substance to the Fool in years, and I've been thinking it's time, so here's something I wrote (about something I bought) recently:
TRW Automotive’s history dates to the beginning of the auto industry in the early 1900s, but I haven’t tried to look back past Feb. 2003, when the Blackstone Group took the company--a Northrup Grumman unit at the time--private. A year later, the co. went public w/the sale of 24m shares at $28. Blackstone still owns 15%, and a Blackstone Senior Managing Director acts as Lead Director.
The company is one of the world’s largest auto suppliers, focusing on passive and active safety systems but also providing chassis systems (brakes and steering) and various electronic components and modules. They employ 60k people at 190 facilities in 26 countries, and they do business with every major OEM in the world. Ford and VW made up about 37% of last year’s sales. The EU was 49% of sales last year—vs. N. America’s 32%--but this number dropped to 45% in the first half of this year. Sales to the rest of the world are advancing, and they just built new plants in China and Brazil. The stock, laboring under exposure to Europe and the lingering threat of recession everywhere, is selling at 6.1x trailing earnings and 8x the estimate for this year, providing an excellent buying opportunity.
This is a well-run, industry-leading company in a business (safety) that is contributing ever-more to the things we drive. They’re committed to cash flow generation and to returning value to shareholders. I can’t say when various economies will strengthen—one would have to buy this with a readiness to wait—but when they do, TRW’s stock should advance considerably. I think this is an excellent opportunity for eventual 20+% annual returns, and putting aside the macro environment, I see nothing except a major scandal that could knock the stock significantly lower.
TRW went public in ’04 and now has a market cap of $5.2b. The shares have never split, or paid a dividend, and there are no preferred shares. The share count increased about 25% over the past few years, but this is not a concern. In fact, management recently announced a 2-yr, $1b share repurchase program. Potential dilution due to options and short interest are both trivial.
Current executive management has been in place, and done well, since the turnaround: from ’03 through last year, they put up cagrs of 4.6% in sales, 34% in net earnings, 28% in EPS, and 16% in BVPS. They all also worked for TRW or its predecessor back through the 90s. None owns a significant number of shares except the CEO, who owns 1.6% of shares out. Executive pay has significant performance-based components tied to hurdles set by the board. The top 6 guys last year received packages equaling point-2% of sales. Base salaries comprised 13% of their total compensation.
I couldn’t find any news of scandal attached to senior management, but the co.’s German subsidiary was caught up in the auto components price-fixing investigation the DOJ launched last year. Two Japanese co.s and Autoliv were fined almost $800m; in July, TRW’s subsidiary plead guilty and the co. agreed to a $5.1m fine.
I read all the ARs since the IPO, and the last couple year’s 10-Qs, and didn’t see anything particular not already suggested in the numbers: they were doing a good job of growing and deleveraging the co., they got hit hard by the recession and took big write-downs (like everyone else?) and, in danger of violating their debt covenants, issued another 20% equity. They came through this period in fine shape, though. Even in ‘08 & ’09, they generated FCF equal to 2% of sales (it was over 5% last year), and both margins and the balance sheet are significantly stronger now than they were before.
Management cites, among others, the following risks:
• Developments related to antitrust investigations
• Failure of current expansion efforts, which include the construction of 11 new facilities, including large plants in China and Brazil
• Loss of a major customer. While no one platform (auto) is responsible for more than 4% of sales, their 3 largest customers—VW, Ford, and GM—account for 48% of sales
• Government action and/or economic, social, or legal uncertainties in the emerging markets that are the focus of their expansion effort
• Impairment of Goodwill and other intangibles, which are 20% of total assets
Inside ownership’s thin—the CEO owns 1.6% of shares out, other top management smaller amounts. Blackstone’s another 15%. Altogether, insiders own a bit over 18% of shares out. There has been very little buying and only a steady trickle of selling the shares management receives as compensation. Institutions and funds have been doing more, though not dramatically more, buying than selling of late.
Revenues last year were up 13% over the year before, but the 5% annual growth VL expects going forward is more like the 4.3% annual growth since the IPO. As one of the largest auto parts suppliers in the world, they manufacture a wide array of products and compete with many, many other co.s. There’s essentially no public awareness of the co’s products, but there’s other evidence of their competitive position and flexibility.
Revenue growth going forward should be bolstered by:
--increasing sales in China and Brazil, assisted by the new plants in each country
--the still-increasing array of safety systems and modules that are standard on new vehicles and increasingly required in high-growth/emerging markets
--the eventual, presumably inevitable economic recovery in the EU
Since the IPO, management has increased the co’s profitability (see VL’s ROE figures going back) in part by increasing its reach: in ’03, the EU and North America contributed 91% of sales, last year, only 81%. Sales to China were 10% last year, when as recently as ’07, total sales to the non-EU/N.A. world were just 12.6%.
-- They sell, as I noted before, to every major OEM in the world, but Ford, VW, Daimler/Chrysler, and GM accounted for about 60% of sales last year, just as they did in ’03.
--Where EU sales were 57% of the total in ’07, they were only 49% last year and 45% for the first half of this year.
TRW competes with a variety of other firms in each of its several segments and specifically cites:
--Advics, Bosch, Continental-Teves, JTEKT, Nexteer and ZF in Chassis Systems;
--Autoliv, Takata and Key Safety in Occupant Safety Systems;
--Autoliv, Bosch, Continental-Teves and Nippondenso in Electronics;
--and Delphi, Eaton, ITW, Kostal, Nifco, Raymond, Tokai Rika and Valeo in Automotive Components.
The auto parts industry is quite competitive and involves many players. TRW enjoys no moat beyond its technology and established position in the industry, but these are both considerable. TRW claims a “consistent ability over time to generate sales in excess of industry growth in each of (its) major geographic regions,” and although I can’t verify this, I find it plausible. Sales grew 17% in North America and 9% in the EU last year while vehicle production increased 10% and 6%, respectively. Their sales growth, margins, and returns have all been best-in-class the last handful of years. I looked briefly at a handful of their competitors, and only Wabco, Autoliv, and Borg-Warner—which trade at significantly higher multiples--achieve similar margins and returns.
EARNINGS AND CASH FLOWS
Dilution due to options issuance has been trivial until the past couple of years. At the beginning of this year, the board eliminated the cash component of its incentive compensation and approved a share repurchase program designed to eliminate the dilutive effect of this and last and subsequent years.
In ’04--the year of the IPO—the co. took about $110m in charges for debt reduction and restructuring. In ’08, they took charges of nearly $1b for goodwill, customer relationships, and fixed asset impairment, and restructuring charges. Book value fell by nearly 65% in ’08 (having reached an all-time high the year before), but as of Q2 this year, it was back above its ’07 high (also its all-time high), and LT debt/equity--which had been 99% in ’07 and rose to 247% the next year—had fallen to 41%.
This is a capital-intensive business, but the co. has generated strong and consistent cash flows since the IPO. As a % of sales, FCF ran about 1.5% before ’09, and it has run over 3% since, which VL expects will continue.
The co. has reduced net debt in each of the last 6 years and is now much stronger than when it began in ’04, when LT debt was over 5x equity.
The co. now has $1.35b in LT debt, $966m in cash, ttm EBIT of $961m and ttm CF from operations of $857m. There are $520m in debt maturities in 2014, $174m in 2015, and $661m in 2017.
The pension plan is well-funded and uncapitalized leases are trivial.
Intangibles associated with trademarks and customer relationships are a non-trivial 19% of ttl assets. This is down somewhat from 24% in ’07 and earlier.
The current ratio is only 1.25, but this is as high as it has been since ’07 (as far back as I looked) and so not likely a problem.
MULTIPLES and MF VALUATION
TRW 5 Yr. Avg. Industry Avg.
P/E 6.2 16.4 10.3
P/CF 6.9 5.4 8.8
P/S 0.4 0.2 0.5
P/B 1.8 1.6 2.1
Cash is 16% of BV, goodwill 34%.
The Street expects $5.93 in EPS this year, VL $6.00; next year, they expect $6.51 and $6.60, respectively.
Both VL and The Street expect roughly 10% annual EPS growth over the next 3-5 years. Given the apparent initial success of the co’s efforts in China and S.A. and their recent expansion in both places, this figure could prove conservative if the global economy continues to improve. Note that over the same period, VL expects book value to double—a not-unreasonable expectation given the co’s cash flows and stated commitments.
11 analysts have 9 Hold, 1 Overweight, and 1 Hold recommendations. Their avg. 12-mo. price target is $62.20, about 30% above the current price. VL—which just updated on the co. a few weeks ago—forecasts 12%-28% annual price appreciation over the next 4 years.
The favorable settlement of the antitrust case and the recently-announced buyback program are the only news items of any significance from the past year.