American Axle Is One of the Cheapest Stocks

Posted 22 Jun 2018 04:57 PM Edited 22 Jun 2018 05:00 PM

'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.


GE Booted From the Dow, Time to Buy?

Posted 21 Jun 2018 05:24 PM Edited 21 Jun 2018 05:25 PM

GE Booted From the Dow, Time to Buy?

Shares of General Electric (GE) are lower on Wednesday, after S&P Dow Jones Indices said it was dropping the struggling industrial giant from the Dow Jones Industrial Average next week, to be replaced by Walgreens Boots Alliance (WBA).

It's a  "slap in the face" for a stock that's been a part of the Dow for more than a century.

So you might think that bulls are thin on the ground today; but William Blair's Nicholas Heymann is out in defense of the stock: He reiterated an Outperform rating, writing that GE is finally on the road to recovery.

He writes that he came away from management meetings with "a sense of optimism with continued progress" at the company, as GE sells assets to bring down its debt load. He believes the company is at an inflection point for investor sentiment and it's making "significant progress" with regulatory reviews, which may even be resolved this year. Nor is he much bothered by the fact that it was dropped from the Dow: "GE's stature as a predictive component of the DJIA has steadily declined over the past decade, and thus the change could be viewed as long overdue."

In fact, he sees five reasons why GE can bounce back near term. First, high oil prices are good for its stake in Baker Hughes (BHGE). Second, the company is moving closer to resolving lawsuits and GE Capital's "portfolio liquidation will enable resolution to be fully self-funding." Third, its aviation and health-care businesses--and potentially GE's oil and gas businesses--are doing much better than expected, opportune for the company as they account for more than 70% of GE's estimate earnings and free cash flow this year. Fourth, the company's cash-generation and previous cash uses are all expected to materially improve this year, while assets sales in excess of $20 billion will support liquidity and the dividend. And finally, he sees GE as well positioned to reduce its unfunded pension liability in 2018.

Managers at most U.S. publicly traded companies would likely give their eye teeth to have their companies' shares added to the venerable Dow Jones Industrial Average, which first was published in its current form in 1896.

How Companies Fare After Being Kicked Out of'or Added to'the Dow

Recent history, however, suggests that stocks exiting the index do better one year after their removal than those that were added.

S&P Dow Jones Indices, which publishes the index, said Tuesday that General Electric (GE) will be removed on June 26 before trading opens. It will be replaced by Walgreens Boots Alliance (WBA).

Since 1999, 17 stocks have joined the venerable 30-member index and 17 removed. According to the WSJ Market Data Group, the average performance one year after being added to the Dow is minus 8%, while the return is almost flat'negative 0.6%'after ejection. The performance differential is especially notable more recently: The last five changes have seen a 3% rise for additions and a 43% rise for those stocks exiting.

For the companies that have been removed from the Dow, much of the bad news is probably already reflected in the price. At Wednesday's close of $12.88, for example, GE shares are near lows not seen since the 2008-09 financial crisis. For stocks that have been added, prices could represent a near-term top. However, in Walgreens' case, at $68, the price was not much above its 52-week low. Walgreens' heyday was a decade or more ago.

When a stock is put into the 30-member Dow, it's a signal to many that the company has arrived in the highest echelon of the U.S. corporate elite. A Dow company is typically a global giant. A removal from the index, by contrast, is considered a black mark on a company's status.

The Dow, which took its current form in 1896, is unusual in that it is weighted by the stock prices of its components, not their market values. Because of that, GE's low share price made it increasingly inconsequential to the index. GE's weight was just 0.36%, meaning that if its share price dropped to zero, it would have had an impact of less than 90 points on the Dow.

With the change, the index's longest-tenured component will be removed after 110 straight years in the list. Following GE's removal, that title will shift to Procter & Gamble (PG), in the index since 1932, according to Bespoke Investment Group.

It should be noted that despite the average moves after one year, individual performances have been all over the map, Bespoke wrote in a recent report. Alcoa (AA), for example, rose 90% one year after its removal from the Dow, while Bank of America (BAC) fell by the same amount after its addition in early 2008.