More Distractions Please
1: Cheapness
I think Linamar currently is in the 'obviously cheap but who cares' category. Single digit multiple, somewhat ok metrics in tough, slow moving, low margin industries. If you told me a company with low margins ok ROIC & ROE and almost no capital returns deserves to trade at 7 or 8 times earnings, I'd say 'meh, ok, I wouldn't fight you on that.' if that were my thesis (that the multiple should get to 9 instead of 7 so I could flip to something else) I wouldn't find it particularly interesting.
What I've been focused on because I believe it's eventually likely is a return of the old Linamar. While a 10% company is somewhat average and justifiably uninteresting... A mid to high teen ROE company isn't. I think as they prove they can once again be that company, not only does the value grow faster than average but the prospects also become much more interesting from an investment perspective. Ie: multiple expansion. You can get better decade returns from a 15% ROE company starting at 1.5x book (10x earnings) than a 10% ROE company at 0.8x Book (8x earnings). Of course both depend heavily on starting and ending multiples.
That said
A 15% ROE company turns $100 into $404 in a decade. Or if the 100 is valued at a premium... $150 to $606.
A 10% ROE company turns $100 into $259 in a decade. Or if the 100 is valued at a discount... $80 to $207.
Without a change in multiple (read, someone willing to pay more when you sell to them) everything reverts back to ROE.
Point being, you get multiple expansions when you deserve it... If you deserve it. My thinking is that Linamar will normalize to a place where if proves it deserves it.
2: Agriculture Division
The recent Bourgault acquisition opened up some operating details of Linamar's agricultural division. I don't know that people would have called the transformational 2018 acquisition of MacDon a "distraction" but it was a step away from the auto business that they had plenty of success with for decades. Since the stock has essentially done nothing since the acquisition, I was wondering if;
A: the market didn't like the move because it made the company less appealing in some way... Like a distraction.
B: if the market would be right in that assumption.
The conclusion I came to is essentially no. They spent $1.2 Billion on MacDon (financed entirely by reasonably low cost debt). I don't have all the refinance terms, exactly amortization, capex or year by year details so I smoothed a few things out.
Effectively in the decade following the purchase of MacDon (2028), they're on track to have that $1.2B completely pay itself off, plus fully pay for the Salford & Bourgault acquisitions (another $880M)... And generate +400M per year in EBIT.
That assumes essentially 225M from MacDon (192 today... Assumes 4% CAGR vs 15% CAGR since acquisition). $45M from Salford (35? today... They didn't really comment on that aside from saying they paid a higher multiple than the other two... So naturally I assume less growth) and $130+ from Bourgault ($76M today and a suggestion that they plan to double that in 5 years). That end point, with everything paid off and cash-flowing would likely be worth multiples of the initial capital used to expand their presence in the space. In fact, the earnings alone would probably support the debt capacity to purchase 'another MacDon eq.'
In a microcosm, this is something like 15% compounded in a segment that arguably increases the quality, diversity and sustainability of the business. If that's a distraction, I'll take more distractions please.
3: The auto business...
Linamar's mobility segment has undoubtedly been the problem recently. In the last 12 reported months, they've had sales of almost $6.8B yet operating earnings of only $332M. That's a 4.9% EBIT margin. The segment left $245M on the table via underperformance versus what it should have. Now, that's not all purely failings, there was some launch costs associated with future sales growth... And I'm not sure I'd call all the issues (inflation, automakers strike, supply chain issues etc) "failings" so much as failing to go as hoped.
That leads me to my next point, that $6.8B of TTM sales will probably be significantly higher next year. Linamar acquired both Mobex and Dura-Shiloh's battery enclosure business and should launch the better part of a billion dollars worth of sales in 2024. It wouldn't surprise me to see in the range of $8B in mobility sales in 2024. That should in theory allow for $680M in EBIT if they could achieve a normalized margin. While I expect better than the $392M of a 4.9% margin is possible, I don't know that a full normalization will be achieved immediately. The tiny delta being $4.50/share in EBIT...
4: Leverage
Linamar was running for a few years with leverage below their target of 1.5x EBITDA. Bourgault took them to 1.4x... still below but almost there. I think that utilizing the balance sheet will help them be more effective with their resources. Remember, the MacDon point mentioned above essentially all came from extending the balance sheet and using 100% debt. In this case the 3 acquisitions should theoretically add ~150M of EBIT... Although nearly half of that will be offset by interest. Still after amortization that's 1-2% return on equity that otherwise wouldn't be there. If you can get some growth out of those assets, the value could easily be well beyond the initial earnings accretion... Ie MacDon... And perhaps Bourgault.
I don't know if any acquisition is as value accretive as their own shares at this share price (figure, buying a 15% yield for 0.75 on the dollar) but that's a situation that can change.
5: Capital Budget
When I started writing about Linamar, I mentioned one positive being that they had a lot of capital to deploy. They did (Dura, Mobex & Bourgault... Plus a lot of capex). The market didn't care. Should it? Remains to be seen.
TTM Capex was $722M + ~$1.2B in acquisitions. (Crazy to think that's basically half their market cap spent in 1 year) Hopefully it shows up.
NTM capex sounds like it'll be nominally slightly lower... Maybe $650M-$700M. I think that should compare against over $1.5B in EBITDA. If that turns out to be the case, it leaves maybe $800M in capital for acquisitions, deleveraging, or buybacks. As much as I'd love that to mean buying back 20% of the shares, for multiple reasons, it won't. Still, it could be something like another Bourgault side acquisition + 4% of the shares outstanding... Without even getting all the way up to the leverage target.
Conclusion
Maybe I'm wrong about the normalized earnings power... Maybe they can't 'fix' the margin. I don't think that's a disaster based on the trailing 8x earnings. Even if the imbedded growth from the acquisitions and launches doesn't show up or offsets declines elsewhere. The reason I think I'm stuck on this company is firstly that I can see so clearly the path to better results. Secondly, that would mean the company is a good one... Which isn't in the price... But really, doesn't need to be. If it's the company I think it is, the valuation that gets tacked on it is less consequential. If they can regularly generated 15% ROE 5x 10x 15x it's the same thing longer term. A diversified company able to grow teens.
Thirdly, maybe it takes longer, maybe it doesn't happen... Owning an ok company at 8x earnings isn't a disaster.
I think the discussion will remain the same while the share price remains under all time highs...
"Who cares about the low multiple"
"Discount to book value... So what"
Price drives narrative and an 8 year consolidation dictates a big "who cares." I looked back recently at presentations from when Linamar first went to $70, $80, $90. They were over-earning. They literally told people in the presentation. "Margins should be 5-7%... They were 7.7% in 2014 8.5% in 2015, 8.7% in 2016." That's 10-25% above the top of the range. Oddly, the market didn't really listen or care. Last Quarter they said their net margin should be 7-9%... In 2022 it was 5.1% & in 2023 it was roughly 5.7%... which would need to increase by 20-25% to get back to the bottom of the normal range. Again, however, the market doesn't seem to listen or care. Symmetry. They wouldn't over earn forever (I mean probably). They won't underearn forever (I mean probably).
My suspicion is, at some point, the market will change its mind on what it's worth... But that remains to be seen.
The path to 'good' returns from today is pretty simple. Mean revert the margins & mean revert the valuation. There is a logical reason why they should happen at the same time (as the company proves it's a better company it attracts investors willing to value it higher). I can't guarantee any of that but I'm just saying we don't need years of 30% revenue growth to be fairly valued. We don't need to win the AI space race. We don't need commodity prices to hit all time highs. You can, quite simply model for yourself what you think will happen and what that makes the company worth.
You can model based on book value / ROE
You can model based on revenue & margins
If you want to confuse yourself you can even model based on free cash flow.
You can give any multiple you want. My model includes an ~$86 Book (today vs last Q) and is based around the sales idea i mentioned above (LTM + acquisitions + Capex - business leaving)
6x forward earnings at 10% ROE? ~$51
8.5x forward earnings at 12% ROE? ~$87
10x 2025 earnings at 15% ROE? ~$170
15x 2025 earnings at 15 then 20% ROE?... Best not say.
5% margin on $9B sales at 7x earnings? $51
6% margin on $11B sales at 8x earnings? $85
8% margin on $11.5B sales at 6x earnings? $89
10.5% margin on $11.25B sales at 4x earnings?$76
Maybe it even deserves a real multiple.
Based on my assumptions, my fair value target is relevantly higher. That said, fair value is somewhat reflexive. Prove it and my assessment could easily be 33% lower than the market's. Fail to and my assessment might need to be trimmed by 33%. I think Linamar is probably a three digit stock. Refinement beyond that really depends.
The other day, I saw a list of 'hidden gems' in Canada. The companies were good and all but the measure of hidden gem was stock performance... I was thinking, are they really hidden when everyone sees the stock go up. In an alternative world where stocks were measured by the value of their assets per share + dividends... Linamar's +15% CAGR over the last decade, despite all the disruptions was roughly as good as most of the 'hidden gems' whose stock went up and is valued at 2-4x as much.
Disclosure:
At the time of this article I own $LNR.TO Linamar
Not investment advice, please see (Can Do Investing: Ground Rules) page for more information.
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