What You'd Read is Linamar Was a 'Growth Stock'

What You'd Read is Linamar Was a Growth Stock

I frequently say, "Price drives narrative." Recently I had a thought arise out of some rough calculation I was doing about Linamar. I wanted to briefly share the calculation and thoughts surrounding, 'what the narrative would be if the stock was rising.'

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.

Linamar: More Distractions Please

More Distractions Please

I've been thinking about Linamar a lot recently and collected a few short thoughts here.

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.

Auto Parts... Still Picking Up The Pieces

Auto Parts... Still Picking Up The Pieces

When we left our heroes things were finally looking bright. They had finally worked their past the endless disru... Never mind.

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.

*TTM = Trailing 12 Months *MRQ = Most Recent Quarter (on left)

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.