AXL is a compelling long investment because its business is highly levered to the ongoing rebound in US housing. The significant restructuring done during the financial crisis is underappreciated and will help generate much greater earnings at lower volume. Furthermore, AXL’s expansion beyond its home turf in North America represents another significant growth driver and is fully supported by backlog that AXL has already won. Operational hiccups in 2H12 have clouded the positive story but management recently indicated these issues have successfully been resolved. As AXL performs in 2013, we believe both earnings and multiples will move higher and see 55% upside over the next 12 months to our price target $21, based on 7x 2014 EPS of $3.01, 8.4x 2014 FCF of $2.53, and 4.9x EBITDA of $577m.

Hopefully the write-up below provides the key details. For further info we'd recommend #1 II ranked autos research team at Deutsche Bank who best understands the story in our opinion.

Investment Thesis

1. High leverage to the ongoing rebound in US housing which in turn drives sales and production of pickups and light trucks. Historically, GM’s North America sales and production volume are 92% and 96% correlated to US housing starts (see our chart here http://bit.ly/18hHMex). It's important to note that while total US light vehicle sales has rebounded to low 15m and is just 10% shy of the ~17m peak in 2001-05, volume of full-size pickups and SUVs are still very depressed (GM NA production volume in 2012 was 56% of the peak in 2003). While we don't expect housing starts or production volume to return anywhere close to peak, historical correlation suggests meaningful upside to production volume assuming housing starts normalize to a higher rate.
2. Positive transformation underappreciated. AXL used to have very high labor cost (100% UAW, $70 all-in hourly wage). The financial crisis triggered a significant restructuring where AXL bought out most of its UAW workforce and moved production to Mexico, resulting in annual cost savings of $250m. As a result, despite depressed volume in 2010 and 2011, AXL was able to generate EBITDA margin of 15%, well above the ~13% margin achieved during the peak of the housing cycle and vehicle production volume in the middle of the last decade.
3. High growth rate from expansion beyond North America into new geographies. AXL’s new business backlog of $1.25b will flow into revenues over the next 3 years ($400m in 2013, ramping to $950m in 2014, and $1.25b in 2015), representing a high 2012-15 CAGR of 13% on top of any growth related to US housing. Note that total 2012 revenues was $2.9b.
4. Temporary operational hiccups successfully resolved. High start-up costs related to new business in Brazil hurt margins from a normal 15% EBITDA margin in 2010 and 2011 to 9.4%in 2H12. However, management recently indicated at the BofA last month that these issues have successfully been resolved.

Business Description

• AXL is a Tier 1 auto supplier of driveline and drivetrain systems (e.g. axles, driveshafts, transmission parts, etc) primarily for pickups and other light trucks in North America (80% of total revenues, mainly from GM).
• AXL used to be a captive supplier of GM and until it was spun off in 1994. Since then AXL has increasingly diversified to other OEMs but GM remains the largest customer representing 73% of revenues in 2012, followed by Chrysler at 10%. The remaining 17% comes from other OEMs such as Volkswagen, PACCAR, Ford, Tata Motors, and Nissan. Geographically, 82% of 2012 revenues came from NA, 7% from LatAm, 7% from Asia, and only 3% from Europe.
• AXL historically had horrible FCF but this should dramatically improve as past spending to positively transform the company has been completed. In the first half of the last decade, AXL incurred very significant CapEx to modernize its plants after years of neglect inside GM (CapEx averaged 8.2% of sales in 2001-06). The plants are now in good shape and total CapEx, even including significant growth CapEx to support its international expansion, should be ~5.5% in 2014 and fall to 5% thereafter. AXL also spent $300m to buy out UAW workforce during the crisis (discussed above) and its cost now is highly competitive. Finally, last year AXL contributed $170m to fund its pension and has satisfied funding requirements for at least the next 5 years. In any case, the remaining YE’12 pension liability of ~$100m (on an after-tax basis) was manageable and will likely fall with any increase in the discount rate from the current assumption of 4%.
• Note that AXL has significant deferred tax assets ($274m at YE’12 from NOLs, tax credit, and capital allowance carryforwards). This will allow AXL to pay a low cash tax rate of ~7.5% through 2020.