DAN’s 4Q (reported Friday morning 02/15/19) was in-line with estimates that Management provided in Detroit, as was their 2019 guidance (EBITDA $1.125 bn; FCF $275 MM). And Dana’s $2.8 bn equity market cap, which is up 40% YTD (up 28% since our Oct. 31 upgrade) now appears to be in-line with the roughly 10% percent free cash flow yield that Investors ascribe to the more cyclical Auto Suppliers at the peak of the cycle. In other words, DAN’s valuation is no longer as crazy as it was when we upgraded (See our INITIATION, and our UPGRADE NOTE for a deeper dive into what we find compelling about DAN’s businesses, and the company’s strategy).
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We expect the US Dept of Commerce to release a report this weekend asserting that automotive-related imports are a national security threat, thus authorizing the Executive branch to enact tariffs without Congressional approval under the Section 232 statute. We think actual tariff enaction is unlikely given widespread opposition from U.S. constituencies (Auto Dealers are politically powerful; even the UAW has not offered its endorsement). Nevertheless, general uncertainty during the 90-day post-report evaluation period could have stock implications: Slightly negative for U.S. Suppliers, negative for U.S. Dealers and Aftermarket Retailers, negative for non-U.S. OEMs, and neutral for U.S. OEMs.
There were numerous interesting takeaways from the Wolfe Research Auto Conference in Detroit, including revealing insights into recent shifts amongst U.S. New Vehicle Buyers (there may be less risk to industry mix than we perceived), the trajectory of battery costs, insights into Powertrain plans being made by Auto OEMs, and revelations on the Ride-Share business model. All of these have long term implications.
The Market is bracing for challenges as we transition to 2019, including lower Auto Production (particularly in China and Europe during 1H19), higher Rates (which raise concerns about Mix, Pricing), the strong U.S. Dollar, Regulatory Content, unpredictable Government Policy/Tariffs, the burden of increased Spending on Technology with uncertain returns, and in some cases discontinued passenger car products.
Most major U. S. OEMs and Suppliers will provide 2019 guidance in mid- to late-January… at our Detroit Auto Show Conference (Jan 15-16), or when they deliver Q4 earnings late January/early February. Management teams are pulling these forecasts together now. And they are doing so amid an unusually large number of market uncertainties (i.e. China, Europe, and NA production; company specific concerns for Ford (China, UK), JLR (China, UK), GM (discontinuing models), and local Chinese OEMs (declining at a double-digit rate in their domestic market). Based on our discussions with Industry Management teams we suspect that most will incorporate an extra dose of conservatism into their 2019 Guides. We are fine-tuning our estimates for Lear, Visteon, and Autoliv as we intend to take the same tack (e.g. today, we are fine-tuning our 2019 net new business backlog estimates, initially provided in early 2018, to reflect updated market and FX assumptions). See pages 3-6 for more details.
The current auto sales run rate in China, if sustained, would imply a 10% sales/production decline in 2019. Europe won’t be easy either, as production headwinds spill into 1H19. The U.S. has been relatively strong, but we remain concerned about affordability headwinds. Given these uncertainties, we question why OEM/Supplier margin expectations are up from 2nd half 2018 levels.
Bloomberg reported overnight that China’s National Development and Reform Commission is considering reducing the Vehicle Purchase Tax to 5% from 10% on vehicles with <1.6 liter engines (approx. 70% of market). While we don’t believe China’s Central Government wants to do this (as we’ve noted before, we believe automaker consolidation is desired and broad-based stimulus helps the entire market), the consumer may have painted the government into a corner with September retail sales down 13% and first 3 weeks October down 25%. Today’s story probably makes consumers even more reluctant to buy in front of a tax cut, adding more pressure to act; therefore we believe the stimulus is likely to happen.
We’ve met with a broad cross-section of clients since our launch on October 1 and thought it worthwhile to relay some of the feedback. There is broad agreement with our Underweight rating on the core Autos sector, driven largely by affordability concerns in the US which led us to forecast a 1.0-million-unit decline in US volumes. The Auto sector has historically underperformed 70% of the time during peak-to-trend phases.
We’ve been bracing for a tough Q3 earnings season. European Auto production, China Production, and FX headwinds all intensified over the course of the quarter. We’ve been expecting misses/guidance revisions from number of companies in our Universe (Based on the company’s business model and regional profile, Delphi struck us as the most at risk prior to Friday’s pre-announcement). But we’d note that the risks are not equal. BWA already adjusted guidance at their CMD. AXL may even have upside. Our analysis also suggests surprisingly benign results/guidance from LEA, DAN, MGA, and APTV. On the other hand, consensus for GM, F, GT, CTB, ALV, VC, and VNE may require downward adjustments.
DAN’s shares are down -42% YTD; and the company is currently valued at a 5.5x 2019E P/E, 4.3x EV/2019E EBITDA, and a 2019E FCF yield of 13%. This is a remarkable development for a supplier that has achieved such strong operational performance, and which is focused on such a strategic piece of real estate. In fact, while EBITDA has improved 32% over the past 5 years (to $980 MM from $745 MM) and EPS has grown 64% ($2.90 vs. $1.77), the company’s shares currently trade at 2013 levels. This valuation has led us to extensively debate the 12-month outlook for Dana’s shares.
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