Tenneco reported much weaker than expected 4Q18 EBITDA (significant earnings declines in each of the legacy Tenneco businesses) and weaker than expected 2019 guidance before the open on Thursday (2019 VA margin guidance of 10.4% corresponds with 2019 EBITDA in the $1.6 bn range compared with consensus of $1.7+ bn). The risk/reward for this stock was set up poorly heading into the print, as there was limited disclosure/transparency into quarterly pro formas for the Federal Mogul acquisition (this was the first quarter to include FMO), there were adverse trends within all three legacy TEN segments (margins were down materially), and TEN is now saddled with relatively high leverage (3x net debt/EBITDA). Tenneco’s shares fell 15% for the day.
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After 2.5 frenetic days at CES, we’d report the following key takeaways: 1) Multiple industry leaders are acknowledging (primarily behind the scenes) that deployment of Level 4 / 5 Autonomous Driving technology without safety drivers is farther away than most public targets. At the same time, demand for consumer-targeted safety / convenience systems (primarily Level 2+) continues to accelerate. 2) Reinforcement of the narrative that the next generation of high-volume internal combustion engine / transmission families will be the last one for many automakers.
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.
Goodyear reported an in-line 3Q18 on Friday morning (10/26/18) (Segment Operating Income (SOI) of $362 MM compared with WRe at $350 MM). And as we expected, Mgmt. lowered their full year 2018 earnings guidance. That said, the magnitude of the downward revision to 4Q surprised us, and we identified several new risks to 2019. Adjusting our 2018E / 2019E SOI to $1.3 bn / $1.42 bn from $1.38 bn / $1.6 bn, and our 2018E / 2019E FCF to $100 MM / $400 MM from $360 MM / $465 MM.
On Friday morning (10/26/18) Tenneco reported 3Q18 adjusted EBITDA of $207 MM, close to WRe of $213 MM, and 3Q17 of $212 MM. At a high level, TEN achieved very strong (+7% yoy) organic growth, which almost completely offset yoy earnings headwinds from commodities and FX. The EPS beat was driven by a relatively low tax rate (22% vs. WRe 27%). But the Street was nonetheless relieved by this result, and TEN’s shares rallied 6.6% (on the back of a 37% YTD decline).
China’s Auto Industry has been on an impressive ascent due to the growing middle class for the past 10+ years. This market was sustained through the global financial crisis. And it has grown through more recent challenges (including a 40% China Equity Market Correction in 2015). But as we have discussed in several reports, there is once again major uncertainty about the outlook for this market. After rising 5% during the first 5-months of this year, the retail sales market has fallen by 3%, 6%, 7%, and 13% in June, July, August, and September. Yesterday the CPCA reported a 23% decline for the 3rd week of October, bringing the month to-date to -25%.
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.
TEN has been expecting growth of 6-8% in 2019E (400-600 bps GoM), and 5%-8% in 2020E (300-500 bps GoM), driven by tightening emissions standards, and a trend towards increasingly sophisticated suspensions. And they’ve achieved relatively high returns (22.8% avg ROIC) over the past 5 years. But TEN’s share price has not responded… In fact, while EPS is up ~ 87% since 2013, the company’s shares are slightly down. On a pro forma basis we estimate that they are trading at a 4.7x EV/2019E EBITDA multiple. The key issue, in our view, is that investors view Tenneco as an Exhaust company in a world that will eventually shift towards EVs.
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