Cash stories have been a compelling story line in the auto suppliers’ space for quite some time now, and for good reason – there is no shortage of automotive suppliers that offer low levels of leverage combined with respectable free cash flow prospects.
Industry wide graphical view
Before we discuss which companies are viewed as the best cash stories to invest in, we need to have some idea about where the industry is going in terms of its cash resources by exploring what are the debt levels, how are cash flows coming, how much of them are being distributed to the shareholders and so on. The following four metrics will help us to get a glimpse of the cash-related situation in this industry:
a) Net debt/EBITDA
b) Free cash flow (FCF) margins (calculated as FCF/sales)
c) FCF yields
d) Net cash (debt)/market cap (a good relative metric in terms of comparing according to the size of the companies)
The following four graphs show the situation on a pair axes:
In the first graph, a negative value means that the company’s cash resources exceed its debt (i.e. under-levered). It is interesting to note that several players in this industry are under-levered.
The next graph shows that most of them offer decent free cash flow margins:
The next graph shows that the FCF yields are also high for most of the players:
The last graph shows the net cash (debt)/market cap ratio for these players:
Which companies come into the limelight?
In addition to the low leverage and solid cash flow profiles available, a number of suppliers have also demonstrated a willingness to return cash to shareholders. In particular, BorgWarner, Dana Holding Corporation (NYSE:DAN), Delphi Automotive, Lear Corporation (NYSE:LEA), and TRW Automotive Holdings Corp. (NYSE:TRW) are the most compelling “return of cash” stories. Given that these stories are not new to investors, it will be worthwhile to consider the stage we are in for each of these stories.
Is the cash story at Lear over?
For Lear Corporation (NYSE:LEA), the cash story is largely reflected in the current stock price (the stock is up 30% since the start of the year), and not much upside related to cash is expected in the future. Activist investors Marcato Capital and Oskie Capital were appeased when Lear accelerated its prior $1 billion share-buyback program and instituted an additional $750 million program. Moreover, Lear Corporation (NYSE:LEA) increased the rate of acceleration on its $1 billion buyback program, effectively retiring ~12 million shares shortly after the 1Q print via a repurchase agreement with a financial institution. Although free cash flow improvements can be seen over the coming years, it’s highly possible that this is largely reflected in the stock price.
The only outstanding question for Lear Corporation (NYSE:LEA) revolves around leverage –Lear is expected to have a largely flat net cash and net cash/ EBITDA position by the end of 2013, and hence, further upside to the cash story for Lear Corporation (NYSE:LEA) can be realized via increased leverage. However, increased leverage is unlikely given the company filed for bankruptcy at just 1.5x leverage in 2009.
TRW still has more room to run
While the cash story at TRW Automotive Holdings Corp. (NYSE:TRW) is well known, it still has more room to run. Indeed, TRW currently has a $1 billion share-buyback plan outstanding, and has signaled that this plan is not a one-off event; rather, it is the initial step in delivering increased shareholder value on a consistent basis over time, with additional steps to follow. Although this plan is well known by investors, a significant incremental opportunity exists to accelerate share repurchases should TRW Automotive Holdings Corp. (NYSE:TRW) boost its leverage profile, which is currently at 0.1x net debt / ’13 EBITDA, using the proceeds from a debt offering toward share buybacks or dividends.
TRW Automotive Holdings Corp. (NYSE:TRW) could conservatively lever up to 1.0x EBITDA, and could even arguably approach 2.0x (the company has signaled in the past that any level of leverage above 2x net debt / EBITDA would have to offer an exceptionally great opportunity.)
Moreover, should the outstanding antitrust litigation be resolved positively for TRW Automotive Holdings Corp. (NYSE:TRW), it could face an additional opportunity to accelerate share buybacks, given the removal of a major overhang and source of uncertainty.
Dana is the most under-appreciated in the group
Dana Holding Corporation (NYSE:DAN) is the most under-appreciated “return of cash” story within the group. Although return of cash to shareholders (particularly via execution of buybacks) has been very measured by management, at times to the frustration of some shareholders, it was comforting for the investors to hear in earnings call of 1Q’13 that capital allocation is a priority for management and the board. The evaluation of boosting the size and pace of the buyback is a possibility. In short, investors are urged to be patient – the return of cash will eventually occur.
Some $150 million worth of buybacks are expected in 2013. However, this estimate might prove to be conservative, especially if Dana Holding Corporation (NYSE:DAN) does not use the funds towards bolt-on M&A. Moreover, with net cash / ’13 EBITDA = 0.3x, and the company offering an impressive free-cash-flow yield of 10%, best amongst all suppliers, Dana Holding Corporation (NYSE:DAN) can offer significant “dry powder” for buybacks. The Street sees potential for reductions in the diluted share count via either repurchases of the common stock or the preferred shares.
Final words
Ultimately, the cash story seems to be largely complete for Lear, in the middle innings for TRW Automotive Holdings Corp. (NYSE:TRW), and finally, very early for Dana. On these basis, I recommend investors buy Dana Holding Corporation (NYSE:DAN) and TRW and hold Lear Corporation (NYSE:LEA).
The article 2 Stocks to Buy, 1 to Hold in the Auto Space originally appeared on Fool.com and is written by Zain Abbas.
Zain Abbas has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Zain is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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