'Buy low' refers to stock valuations, not proximity to the ground, but it turns out that a leading player in vehicle underbellies, American Axle & Manufacturing Holdings, trades at a down-to-earth price with plenty of upside potential.
Key concerns surrounding the Detroit-based company'high debt, heavy reliance on General Motors (ticker: GM) for orders, and exposure to a near-term slowdown in North American vehicle demand and to the long-term rise of electric cars'appear overstated or misplaced.
The valuation is alluring: Over the next five years, American Axle could generate enough free cash to cover its entire stock market value of $1.9 billion.
American Axle (AXL) was born in the mid-1990s when the father of current CEO David Dauch formed an investment group to buy some factories that GM was shedding. The factories forged metal and made so-called driveline components'mechanical parts that deliver power to the wheels. Those aren't as exciting as engines and transmissions; gear heads generally don't boast about their axle specifications.
'When we do our job right, no one complains,' says Dauch. The lack of attention might help explain why Axle trades for just 4.5 times this year's projected earnings, a 74% discount to the S&P 500 index, versus, say, 10.4 times earnings for engine maker Cummins (CMI) and 11.1 times for transmission player BorgWarner (BWA).
But consider some features of American Axle's inconspicuous work. It has long specialized in beefy pickup trucks, sport-utility vehicles, and crossovers, like the Chevy Silverado, Cadillac Escalade ESV, and Jeep Cherokee, and its sales for key platforms can run from hundreds of dollars to as much as $2,500'far more than it would make on simple passenger cars. The big-vehicle tilt is especially favourable now, because while U.S. vehicle demand appears to have peaked, trucks, SUVs, and crossovers are still selling briskly, and taking a rising share of the market.
Ironically, axles and such might also prove more future-proof than systems with greater complexity. 'Today, the vehicle doesn't move without the engine, transmission, and axle,' says Dauch. 'In the future, electric vehicles might do away with the engine and transmission, but you'll still need the axle.'
In fact, as driving goes electric, axles could see more action. American Axle has developed systems it calls eDrive units, each of which combines an electric motor, gearbox, and electronics to replace some of the functions of engines and transmissions. These can be built into the front and rear axles. The company is said to have a supply deal for Jaguar's first entry into all-electric cars, the 2019 I-PACE, which promises a 240-mile range and a zero-to-60 speed of 4.5 seconds. Dauch says electric vehicles can bring in sales comparable to the most lucrative truck platforms'and eventually, expand American Axle's market to include more sedans. Already, the company says products for hybrid and electric cars make up more than 5% of its backlog through 2020.
Last year, American Axle completed a takeover of Metaldyne Performance Group, which makes components for engines and transmissions, for $3.3 billion, including cash, stock, and the assumption of debt. That helped diversify the business away from GM, which this year will bring in an estimated 40% of revenue, versus 66% in 2015. The deal also added modestly to exposure in Europe and Asia, but it left the company highly leveraged.
At the end of last quarter, American Axle had nearly $4 billion in long-term debt, offset by $341 million in cash and equivalents. This year, the company's management says revenue is likely to total $7.1 billion to $7.2 billion, of which 17.5% to 18% is expected to turn into adjusted earnings before interest, taxes, depreciation, and amortization, or Ebitda, tweaked for things like acquisition and restructuring costs. Take the midpoints of those numbers, and adjust the debt for the cash, and the result is a debt/Ebitda ratio of about 2.9. Management says it can get that figure below two by 2020, assuming that U.S. vehicle sales hold steady, or by 2021 if sales slide.
Steel tariffs could pinch, but little of American Axle's steel comes from China, and much of it is bought on agreements that allow the company to pass cost increases on to its customers. A bigger threat might be an adverse outcome in the renegotiation of the North American Free Trade Agreement with Canada and Mexico, since 40% of American Axle's revenue last year came from products made in central Mexico. But those concerns seem more than discounted in the stock valuation.
On Thursday, American Axle hosted its first investor day and rang the closing bell at the New York Stock Exchange. The company's shares didn't respond. Perhaps investors will pay more attention as leverage shrinks, or as more electric vehicles are launched. If not, American Axle will be left with plenty of options, including massive share repurchases.
Wall Street is already starting to notice. In April, Morgan Stanley analyst Armintas Sinkevicius double-upgraded American Axle stock from Underweight to Overweight, with a $21 price target (22% above recent levels), pointing out that excitement over Auto 2.0'electric, self-driving cars'appears overdone, and that there is still plenty of money to be made from supplying Auto 1.0 components.
A rise to that price in a year would put American Axle shares at about six times earnings. Just five years ago, the stock traded at close to 10 times earnings.
Whether the electric-car future rolls in quickly, slowly, or not at all, now seems like a good time for value investors to rotate into axles.
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