Adient is the recent spin out of Johnson Controls and began regular trading this past week. JCI shareholders received 0.01 shares of ADNT for every 1 share of JCI creating approximately 93.5 million shares of ADNT. We think the company exhibits many of the characteristics that frequently cause spins to outperform including the fact that the company was capital constrained within JCI and the new-co should be free to bid on new business helping the topline grow beginning in FY 2019. We also think the valuation is somewhat obscured by the fact that FY 2017 (beginning Oct 1 2016) is a transition year with only $250 mn of estimated free cash flow due to two large one-time items but which we expect will be meaningfully higher higher in FY 2018
Background: Adient is the largest automobile seating supplier with a 34% global market share in an industry where size and scale are an advantage due to high fixed costs. The automotive seating industry had been under pressure approximately four years ago as OEMs began cutting costs in seats - an easy and indentifiable target since they are one of the most expensive outsourced part to the auto manufacturing process. Margins in the industry for companies such as ADNT and LEA were under pressure although margins have since improved with supplier attempting to move up the value chain to end markets such as fabrics, leather and metals. The industry continues to trade at low EBITDA and P/E ratios due to constant pressure by OEMs but our sense is that the market appears to have reach an equilibrium and expect margins to remain stable for the foreseeable future.
Chinese Joint Ventures: One of ADNT's competitive advantages is that it is the largest suppler of automotive seats in China though its 17 joint ventures which have grown at a 26% CAGR since 2000 compared to industry-wide growth of only 2%. The company has a first mover advantage in China and currently has a 45% market share which generates about $7.0 billion in sales with an estimated 12% EBITDA margin. As an aside, the reason for the perceived drop-off in FY 2016 sales is related to the deconsolidation of the Chinese JV YFAI in FY 2015.
Valuation: An initial valuation of ADNT yields and equity price of $47-$56 based on 4.75x-5.25x FY 2017 EBITDA of $1.575 billion which is an inline multiple to best comps Lear and Magna. However, we think this is only a baseline view and that there could be significantly more upside when investors begin to value the company on FY 2018 financials and on either a P/E of FCF basis which reflects the value of the company's low 10%-12% estimated cash tax rate. We think FY 2017 is likely a transition year for the company and that FY 2018 could show 50 basis points of EBIT margin improvement (based inpart on management's guidance of 200 bps of increased margins by 2020) and lower capex due to reduced cash restructuring charges at the end of one-time IT start-up costs. At current prices, we estimate the stock is trading at 4.4x FY 2018 estimated earnings of $10.15 per share, and at a 14% free cash flow yield compared to comps trading at a 10% yield or lower. We estimate that an inline 10% yield with LEA would generate an equity price of ~$62.00 per share. Alternatively, we think investors could value the company's EBITDA ex-china at a 5x multiple and place a P/E multiple on the higher margin and higher growth Chinese-based JV earnings. In this case, we estimate FY 2018 EBITDA ex-China of $1.279 billion which by itself equal an equity value of approximately $36.00 per share after the $2.9 billion of net debt. We estimate that Chinese/Hong Kong based auto companies (Ningbo Huaxiang Electric, Weichai Power, Fuyao Glass, Weifu High Tech, Huayu) are trading at 8x earnings and assuming an inline multiple on the estimated $380 mn of Chinese earnings would equal additional equity value of $29.00 per share for a total value of $65.00 per share.
Risks: We think the main risk is the company's initially high 1.9x leverage ratio although we do think the company can delever relatively quickly. Other risks include potential Chinese margin pressure and potentially peak US SAAR.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise do not hold a material investment in the issuer's securities.
1. Valuing on FY 2018 financials
2. Valuing on either a P/E or FCF basis
3. Valuing Chinese JV earnings independantly from non-Chinese EBITDA