What You'd Read is Linamar Was a Growth Stock
I was curious what the net debt to EBITDA was, live, on a run rate, post Bourgault basis. After all, between the Dura-Shiloh, Mobex and Bourgault acquisitions, they seem like they should be capped out on the balance sheet side.
Depending on how I calculate it, I could see sales in the $11.1B-$11.3B range (excluding additional acquisitions which seem likely at some point in the year).
Assuming less margin expansion than I believe we eventually get, let's round down slightly to $1.5B in EBITDA (~13.5% Margin)
At a target of 1.5x net debt to EBITDA, that would be a balance sheet capacity of $2.25B
Net Debt at the end of the year was $1.118B
The Bourgault acquisition adds $640M
Net: $1.758B
Quick math shows they would have $492M in balance sheet capacity remaining. However, once we add in the retained earnings, that number increases significantly by the end of the year. This was a higher number than I expected given where I thought they were. I'll get back to why that is.
As I was running through the accounting;
Approximately half of EBITDA goes to CapEx (mostly offset by amortization), which, at a level of 6-8% of sales or half of around EBITDA margins, "Supports the double digit sales growth." The rest is split between Tax, Interest and Dividends with some remaining. I won't call the remainder, "free cash flow" because of what comes next. The remainder can be used to pay down debt, make acquisitions or buy back shares. The following is a rough approximation as all components fluctuate.
What started 'bugging' me was that Linamar had spent much more than the remainder and still had more than the remainder to go in the following year... Despite discussing balance sheet capacity near the target after the Bourgault acquisition.
If the capital expenditures supported double digit growth and the acquisitions were at a similar level of returns, then assuming steady margins, you get ~14.5% EBITDA growth. Except, 14.5% EBITDA growth isn't 14.5% balance sheet capacity growth. The balance sheet capacity is 1.5x EBITDA. 14% is actually 21%. Rerunning the numbers, we can see how the growth flows through to balance sheet capacity... Which enables further growth by acquisitions, which enables...
Blue: Before
Red: After adjusting for Balance Sheet
The main difference is the ~20% of EBITDA which shows up in balance sheet capacity which is neither earnings, nor free cash flow. That adds $300M to the available capital, increasing it from ~$350M to ~$650M. If the $750M in CapEx brings 10%, an additional $650M in capital deployment would mean closer to 18.5%. The interesting part is that if you look at what Linamar has achieved in the past when it comes to revenue growth in un-disrupted times, it fluctuates more than math but has been in that range. It moves below as they digest more acquisitions in a given year and above as they deploy the balance sheet capacity. Through this lens, Linamar generates about $50m in balance sheet capacity per month. The obvious intrinsic assumption is that leverage effectively remains at the target. In reality, it fluctuates... And recently has been below their target.
If I wanted to estimate the full picture of how much they should have to spend by the end of the year (or live for that matter) I still need to deduct the retained earnings from the net debt. Using a range of assumption I can come to roughly $1B to spend on acquisitions over the next 9 months (*Excluding the EBITDA that comes with incoming acquisitions). In historical terms that another MacDon (which is 1/3 of their industrial business) or roughly the three acquisitions from the last year which added ~$850M in mobility sales & ~$500M in industrial sales.
Going through the numbers I couldn't help but reflect on how this compared to some other stories out there. Companies whose stock price seems to gradually, perpetually creep higher. "Compounders." The things where 12x EBITDA looks cheap because 3 years out you have a great company trading at a 15% EBITDA yield and people aren't as concerned about a company being immediately overvalued. This is neither my prediction, nor my value assessment, however, if you were to ask me why it traded at +3x book in 2015 (like Danaher does today... By the way, over the last decade, DHR took book value from $34 to $72.5 while Linamar took book value from $23.5 to $86) or +2x book in 2007 or +5x book in the late 90s, I'd say, "Well, if you want be optimistic about growth runway & not running into economic hardship, the math doesn't have a problem with paying 2-3x book." Overall, this wasn't a piece advocating for multiple expansion. I prefer holding cheap stocks to fully priced ones. I also have grown to be deeply skeptical of the multiple expansion thesis. This was intended to look at a mechanic of how they should be able to hopefully piece together solid increases in fundamental value such that I won't care if the multiple is 8x trailing earnings or 16x forward. It sometimes seems like the deciding factor between 'Compounder' & 'Conglomerate Discount' becomes: is the stock at all time highs?
I must point out that, while I believe this type of growth is possible most years, Linamar operates in industries which can have significant setbacks (Covid and GFC for instance). That's why the multiple, at ~3.6x EV/EBITDA, seems reasonable to some today... And 3.1x EV/EBITDA seemed reasonable months ago. I can't speak to how low the multiple can go. I can say that they're one year of executing away from it being back to roughly the cheapest it's ever been.
Messy Margin
I think the reason why Linamar has been in virtually no 'compounder' discussion that I've seen is due to the variability of the margin.
When the operating margin (EBIT) goes from 6% to 12% (as it did from 2012 to 2016), you're compounding earnings growth... Even if you're not growing revenue.
If your margin goes from 12% to 8% you could be growing the top line nicely and still barely have any earnings growth to show for it.
One looks like a fantastic company... Growing top line nearly 20% and getting much more dropping down to earnings. That's the type of thing that moves your stock from $20 to $85 in 3 years.
The other is a valid reason for your stock to go nowhere for a decade as the multiple declines by half. Put it together and the stock looks far more inconsistent than it has been.
Math
If you wanted to calculate the value of a company looking forward at EBITDA growth, it's truthfully not too difficult to calculate for yourself despite this seemingly scary equation.
(Sales) X (EBITDA Margin) X ((EBITDA growth rate) ^ (Number of years)) X (EBITDA multiple for equity*) ÷ (share count)
On a calculator it would look something like
11300×0.16×1.18^3×2.5÷61.6 = 120.56
You could also replace the first two numbers with your predicted EBITDA
1500×1.185^4×3÷61.6 = 144.05
You can play around with margins depending on what you view as normal, length, and multiple. Note: the multiple I used was 2.5 & 3 times on the equity... This excludes the additional 1-1.5 times on the debt. Maybe you feel like Linamar is worth 'splurging' on 4 times EBITDA on the equity portion. Maybe you think growth will be slower or more margin will recover or won't. I used small numbers for both years and multiple because if I wanted to assume that rate of growth, I didn't want to assume it would continue indefinitely without issue. That said, that calculation neglected the dividend which adds 1-1.5% per year.
Free Cash Flow
I've had the discussion about free cash flow in this industry surprisingly often. I know many people like to live and die by it. I don't love it in general & in this case exemplifies why. Every dollar they earn (excluding tax) can either be 'free cash flow' or capex. If they see a must have acquisition then can simply allocate to that and spend less on growth capex. Alternatively if there are organic growth opportunities that offer better returns at a given time, they can easily spend on that. Them simply doing what offers the best returns makes the "free cash flow" picture volatile. They could have $1B in FCF one year and $0 the next while adding far more value the second ($0) year.
This may explain why the measurement of this company could get out of whack. People like FCF, others like earnings. If FCF is out and earnings are facing temporary margin issues, how should it be measured. EV/EBITDA is an option although also volatile and there's a lot of depreciation & amortization. Book is probably best (be it 0.5x book, 2x book or whatever) except, I can make the argument that as brands on old and partially amortized cost basis's become a larger portion of the earnings, book would progress towards being less relevant.
Results Thoughts
While I'm here spewing random thoughts about Linamar, I suppose I can make a few comments about results and fundamentals.
The responses I saw around last quarter's results were quite positive. I appreciated the step in the right direction however didn't feel like we saw enough to expect a margin normalization in 2024. That absence was enough to keep me from getting excited or overly optimistic. I hope we can progress in that direction as the year plays out. With that in mind, I recognize there may still be some areas with room for improvement. I had in mind the possibility of +$12 in EPS being a normal number. Moving up above $10 as a guestimate is the right direction but not a cure for the general lack of care about the company by the market.
Peers have continued to lament the soft industry outlook predicted by industry analysts. A reduced volume environment isn't one where you'd expect the best margins... Or... Obviously, volumes. Running with strong growth in a depressed environment isn't terrible.
Peers have also been quick to point out the weakness in EV demand and how that's causing OEMs to shift plans. I'm cautiously optimistic about how that impacts Linamar. Firstly, they're quite effective at pivoting capacity and operating flexibly. Secondly, they have plenty of ICE and propulsion agnostic products. Thirdly, customers reaching out with a change of requests seems like an opportunity to revisit discussions around proper margins.
Despite the general industry gloom, US auto sales have been creeping higher when compared to last year. They remain around 10% lower than where they were in the 5 year stretch pre-COVID. For a thin margin, volume business, that's a big deal.
For industrials, the Bourgault acquisition plus capacity expansion within Skyjack are likely the two most significant positive growth factors. There's some concern about the Agricultural side. I don't know if it's justified. I believe there's room for market share improvement from MacDon and Salford, however the industry may not be the most supportive. My assumption is that ag will be flattish excluding the acquisition... However it sounded like they were hopeful that their segments would outperform that.
I wonder how far along they are in the medical device progression and if we could eventually see a relevant acquisition in that area or if there's a new manufacturing market which they could enter.
Hurdle
I don't know if it would make a difference but with management's push to convince the market about synergies between the mobility and industrial I had a thought. What I could see the market being concerned about is the lowest common denominator. By that I mean, let's say you have 2 business, one you can spend unlimited capital for 1% returns... Let's call this Fauxbility and a second business what earns very high returns 100% or something and cashflows on investment with limited capital needed and less reinvestment opportunity... Call it Windustrial. The high return business is worth a lot more because it can return plenty of capital to shareholders and grow... However, if it's dumping all its profits into the low return business, all those benefits are nullified as those profits are wasted on things less valuable than paying shareholders.
As I've stated in the rest of this article, I don't believe that to be the case with Linamar. Still, I think it's worth thinking about whether they should be talking about their hurdle rates for returns on invested capital in the business that's seen as the drag. Having innumerable investment opportunities only helps if the returns are good.
On the acquisition front, it's tough to measure IRRs in the same way. Some businesses are bought for value, others for longevity. My opinions about their past acquisitions vary. I think Mobex was likely much better than Dura. I like Bourgault from a long term perspective but think in the short to medium term they'll get no recognition for the value.
I would hope that if they're going to go the acquisition route and target 1.5x net debt to EBITDA, that they TARGET 1.5x, especially with multiples where they are for possible acquisitions. (There are some companies out there that I wouldn't mind them throwing a premium at to buy out with the current pricing environment.) By that I mean try to have debt at that level as opposed to that level being a soft cap. This might not be the case if we were at the point in the cycle where they were already firing on all cylinders and auto volumes had peaked.
Costs
I think costs and inflation are normalizing. It's a mixed bag of factors that are probably helping and hurting. As old business is replaced with new, improvement is likely. When it reaches normal and how high margins go remains to be seen. Small margin improvements can mean significantly more dropping to the bottom line when talking about slim margin operations.
Summary
Linamar grew their topline revenue 23% in 2023 & 21% in 2022. Numbers which still don't fully reflect the $1B in acquisitions and $750M of capital expenditures they made in 2023. I expect high teens growth in 2024 with upside potential from acquisitions or auto recovery. Why the equity portion of such a company is worth below 3x EBITDA isn't a question to which I have a good answer. My big failing so far has been a failure of imagination when thinking about multiple contraction. Based on how the stock seems to act, my guess would be that we don't see any relevant multiple normalization at least until the share price hits a technical breakout (aka All time highs). It's too quick to forget about good results and meander to a lower multiple only for subsequent good results to regain less. This assessment would probably mean they'd need clear vision on north of $15B in sales & $2B in EBITDA in order to reach all time highs. Does that make sense when comparing the company with what it looked like the first time they hit those $80-$90 prices? No. It's my gut feeling. Granted, ATHs are a significant distance from where we are. The good news is I think that distance isn't astronomically difficult to bridge. Launch business, Auto volumes recover, make acquisitions to get up to the leverage target & it's closer than it sounds. The stock looks inexpensive however I believe there are many scenarios where it's both insanely cheap and being measured incorrectly.
While the market isn't caring, I do. I watch the value being added and reflect on how much value is added every month. That $30-$50M of capacity that can go towards the next acquisition. The +$50M going towards organic growth. The fact that the decision to buy the brands gets better by the day as they simultaneously amortize and grow. That temporary margins & arbitrary multiples can change are far more variable than intrinsic value. This takes me to a place where I see a lot of reasons for Linamar to do quite well in the coming years.
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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