Auto Parts... Still Picking Up The Pieces
This UAW strike now further delays whatever a normalization would look like. The average length of a strike is roughly 41 days. This time feels especially contentious and perhaps especially large in scale. Still it is unlikely to last forever and what I've heard suggested about the impact is that historically, volumes get made up. Still it's a pain for a sector that's faced endless challenges over the last 5 years now.
Maybe the fear of this strike has been why the stocks have remained historically discounted recently. Maybe they'll be irrelevant in 3 months. For now all that can be done is watch the situation hoping for a resolution.
I'm going to discuss Martinrea, Linamar, Wages, Capital Moat & answer a question.
Martinrea
I'll be honest, I was very much enjoying Martinrea's 40000 share per day buyback. At that rate, I'd own the last share of the company in 400 weeks... and I'd be a billionaire. Hard to be too upset with that. Ok so that wouldn't happen & the buyback would max/black out before we got too far into that. Still it was easy to see how things were not only getting better by the day but benefitting from the continued discount when the buyback was running.
There are a number of ways I could measure the "Yield" on the buyback... and maybe I'll write more about this someday... but for now let's call it the earnings yield on the shares begin bought. That means that a 5x earnings company would yield 100/5 = 20%. That's pretty decent prospects for sitting on a cheap stock.
When the strike was basically imminent they paused the share repurchases. I understand why... uncertainty about scope or length... risk to short term guidance & looking like fools when they buyback before a miss. Perhaps some wish to preserve liquidity for if things last longer or some opportunities open up for acquisitions. I get it.
It was interesting that Rob Wildeboer bought another $100k right after the buybacks stopped. My read is that he still liked the value even if it was prudent on the company level to pause.
I honestly don't know how impacted Martinrea has been or will be by the totality of the situation. I'm not surprised that GM and Stellantis are moving towards short term layoffs. It was obvious that they'd be necessary the second UAW decided to be tactical with their implementation of the strikes. As the last few years has shown, if you're missing one piece, vehicles can't ship so if the XYZ -99 engine assembly plant is stalled, anyone assembling any part of those cars is useless.
I hope there's a resolution that doesn't end up sending the companies to bankruptcy in the future as that's not good for anyone's business or employment. Hopefully it comes in a few days or weeks.
I've suspected recently that the potential strike was probably weighing on the otherwise cheap auto stocks recently... and by extension probably keeping the parts manufacturers from rerating back to their fair value. Once that plays through I think there'll be less of an excuse for the low price... on the other hand I'm sure we'll find something. If we don't rerate, hopefully MRE can get back to the aggressive buyback.
Pre-Strike
Martinrea was on pace to be doing quite well. The breakdown of how their free cash flow was set to play out this year meant that more than 100% of it was going to be in the second half.
That should have taken net debt down to near 800M, even with a continued 1.5 months of buybacks.
Their quarterly adjusted EBITDA was coming in in the 150-160M range so the debt was moving to a very reasonable level.
It was a great setup for next year when debt moving below target was to meet free cash flow's ability to compound the cheapness of the stock.
My fair value assessment and outlook hasn't changed much from when I last wrote about them. I can calculate normalization I'm a bunch of different ways but they all seem to give similar fair values of roughly $27 today and hopefully above $30 in 12 months.
Linamar
Linamar has been back to their old ways. They've now quietly put USD$400M to work on acquisitions in the second half of this year to compliment a full capex regime. On one hand it's what should be expected from them and what they did well a decade ago. On the other hand, it's frustrating that they're going out and buying things as prices that look like significant premiums to what they're trading for...(or what my other auto parts stock is trading for).
I'll hold off judgement until we see how the plan comes together (we won't). It looks like they got excited about the structures group they're putting together. Maybe it leads to scale, growth opportunities, synergies and other good stuff... for the time being I think it's fair to ask what kind of returns and immediate earnings power the acquisitions bring in especially considering the first was essentially funded by 6% yielding term debt. I'm sure it makes sense but does it make more sense than buying more of existing businesses at a 20% OE yield?
The whole auto division hasn't been doing well recently and the improvement has been slow. Perhaps that's part of why putting capital there at full price+ has been less exciting. It's almost like, the second they buy them at 1x sales they get lumped in to something the market values at basically 0. I'm not one to appeal to what the market cares about at the moment but I'm having some difficulty understanding the appeal vs some other options. It is understandably hard to plan business around numerous changing prices.
One bright spot has been the industrial segment after the annual price resets. The performance in the agricultural segment has been solid and the volume ramp in Skyjack continues as past capital investments start paying off. Using a midpoint of normalized margins on trailing revenues the operating earnings of the segment should be just above $380M. That could easily be +$400M in 2024. I still contend that's easily $4B in value right there... or ~$64/share. As difficult as this may be to believe, in theory the mobility segment should be even more valuable... or at least generate more earnings. Using the same calculation with the Mobility's normalized margins, they should have $560M of OE. That's before the most recent acquisitions. $600M of earnings power on a go forward basis (not expected to be immediately achieved). That's maybe $9.50 per share in pre-tax earnings power... gotta be worth something.
The unnormalized results were as follows. If you can forgive my backwards charts (most recent quarter on the left).
Note: The MacDon acquisition was near the first data point
You can see results with numbers going back to 2017. As you can see, COVID hit both hard but for a while the supply chain impact on industrial was worse for a while. Mobility rebounded quickly with stimulus before the supply chain broke & inflation bit. As I mentioned above, Mobility 'should' be basically at the top of the historical levels.
The combined picture basically explains why we haven't seen new highs in the stock in +5 years.
This final chart has one added data point which is what things 'would be' with normalized margins in the past year. Adjusting for prior peak stock prices, share counts debt levels, recent acquisitions etc... i could estimate a number... but it doesn't matter until they actually do it.
Basically, the stock tracks earnings. It's also noteworthy that, after the MacDon acquisition there was a significant amount of debt reduction that slowed down the operating earnings growth (IE: operating earnings showed up immediately but the debt burden didn't in those charts, time was needed to reduce that burden)... along with the GM strike, COVID, etc. Again, the clean balance sheet of early 2023 is potential earnings growth.
Linamar was hit hard by the GM strike in 2019. For that reason alone I have on the back of my mind that they may be at increased risk today. That said, given how much value the market is currently putting on the entire mobility business I don't think the share price risk 'should' be significant. Despite whatever I think, history seems to suggest that it's an auto stock when you don't want to be an auto stock and a diversified industrial when you do.
While I could debate the merits of where it goes, Linamar continues to generate relevant amounts of earnings... and even more earnings power relative to their market cap. They're using that to add value by the day. Some days that's buying businesses others it's generating capital. Hopefully the higher interest rate environment is allowing them to get more bang for their buck with purchases.
*Q&A*
In my last post about Linamar, someone commented that LNR's Free cash flow/ EBITDA ratio is erratic and asked what I think about that.
I think that's a good thing that the market will treat as a bad thing. I dislike free cash flow as a metric for the simple reason that absence of free cash flow can be better or worse than the presence of free cash flow. The erratic FCF simply means that sometimes there are good places to spend capital investing in PP&E... and sometimes there are less. This means they invest when there's something to do but don't for no reason. That's the theory at least. Capital investment getting a 1% return get just as removed from Free cash flow as capital investments generating a 20% return. One you do all day, the other is never worth it and drains resources. It's good that they're not forcing poor investments... but the market prefers stability and consistency.
Wages
One thing that suppliers pointed out when asked threats to wages in response to UAW results is that they were actually ahead in that regard. They saw the wage pressure in 21 and 22 and were already eating that expense vs expectations. The prior union contract was actually locking UAW below market. That's why the UAW offer and ask look exceptionally high. (The 20% offer vs 40% ask).
The wages that UAW employees received before the raise they're about to get would be considered quite high in Canada and astronomical in Mexico. This is one of the holdups in the whole "reshoring" initiative. Wages and availability of labor make it cost much more. The half answer is Mexico... probably why they're doing well. I'd love to throw Canada in the 'we could be a good idea' ring but our wages aren't that much more favorable than the US (I mean +30% is big but much less than other places) and cost of living & union culture isn't helpful. A more elaborate solution might be automation. The higher wages go the more that makes sense. Don't get me wrong, it can work in Canada and even the US but it obviously means higher prices.
Capital Moat
It sounds a bit ridiculous to consider... a moat in a low margin, cyclical, metal bending industrial. It is until you realize that all businesses have some kind of moat. Today, although not a traditional moat, I'd suggest looking at how capital can be a moat.
I mean, "I can get 6% guaranteed, why would I want to spend a lot of money and take lots of risk to try to earn 10% on money I'm going to put towards a new auto parts business?" Martinrea vocalized this point well a few conference calls ago when they said, "now with these interest rates our ROIC hurdle his higher." In other words it would stand to reason that the returns on capital in capital heavy industries would increase with increased competition... from treasuries.
I get why value investors seem to love higher rates. It's worse for economic growth and the consumer but when it comes to the random/average business (aka value stocks) it makes their investments and cashflows more valuable (even if their valuation decreases). It's more expensive to compete. Don't get me started on the topic of inflation. It's not a full, lasting or permanent moat but, for the time being it should work to partially offset the decreased demand from higher financing cost for autos.
Disclosure:
At the time of this article I own both $LNR.TO and $MRE.TO as well as have sold some puts so many be buying more later this year.
Not investment advice, please see (Can Do Investing: Ground Rules) page for more information.
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