Description

Dana Inc. is a diversified auto supplier with exposure to light vehicle markets (mainly North America at over 70%) as well as medium/heavy duty trucks and off-highway vehicles.  The stock currently trades at 4.2x 2020 earnings on fears that the end markets deteriorate materially.  In addition, with $2.3bn in net debt and a little over $1bn in EBITDA the balance sheet is moderately levered.  In a more moderate macro scenario, however, the company has the potential to generate significant fee cash flow over the next six quarters which should help delever the balance sheet and increase equity value.  At current prices the market cap is just over $2bn with the stock at $14.62, down from a recent peak of $20. 

The business is split into four divisions including light vehicle (over 40% of revenues) commercial vehicle (just under 20% of revenues), off highway (over 25% of revenues) and Power technologies (just under 15% of revenues).  The company makes driveline products including axles, driveshafts, gearboxes, transmissions and other components across the above listed end markets.  The Power Technologies division focuses on thermal management solutions and mainly serves the light vehicle market but also sells products to medium/heavy duty trucks and off-highway. 

The stock peaked in early 2018 at over $30 (6.8x EV/EBITDA incl. pension underfunding) on the heels of mid-teens organic topline growth benefitting from ramping sales within light vehicle as well as strengthening commercial vehicle and off-highway sales.  In 2018 organic growth continued in the low teens but the stock traded down with most cyclical companies despite estimates holding essentially flat.  So far in 2019 organic growth slowed to 3% and the company still sees close to 10% topline growth for the year (with the benefit of acquisitions).

At current levels, the stock seems to be overly discounting the potential profit loss of a decline in class 8 truck builds as well as a roll in light vehicle sales.  Class 8 truck orders are currently expected to fall over 25% in 2020 down from historic highs in 2019.  Class 8 trucks make up less than 50% of their commercial business with below average margins meaning exposure is really about 10% of total revenues, so 30% decline, while material, may be manageable in the context of current valuations.  The company faced a similar situation in 2016 when Class 8 truck builds also fell by 30% (from 320k to 230k) resulting in an estimated $220MM decline in commercial vehicle sales (based on 10-K disclosures, after accounting for a program that was transferred to light vehicle).  Margins improved during that period (although off of a smaller base) and the company expects that should be the case again given the margin profile of their Class 8 business. 

The North American light vehicle market flattened out but has remained relatively stable this year.  The company continues to benefit from the mix shift to trucks as their exposure to passenger cars is limited. Ford is the largest customer within the division with over 40% of sales and the two largest platforms are the Ford Super Duty and FCA’s Jeep Wrangler.  I have seen figures that put exposure to each of these platforms at just under 10% of consolidated sales or $800-$900MM each.   The Super Duty platform doesn’t seem to be as much of a concern as the Wrangler where there is no shortage of articles about falling sales figures (as they anniversary redesign launch in early 2018) and rising inventory levels.  Given the big jumps in early 2018, I would expect the rate of declines to slow as you move into 2020 (FCA has referenced stock reductions happening in 2019).  Partially offsetting the potential decline here is backlog contribution which is expected to deliver $200MM in sales in 2020. 

The Off-Highway segment has shown stable growth since bottoming in 2016 while also benefitting from acquisitions in 2017 and now again in 2019.  End market mix includes the agriculture, construction and mining industries with over 50% of revenues coming from Europe.  While markets slowed in 2019, the company has managed to hold organic sales relatively flat in the first half of the year (total segment sales are up on an acquisition).  As they move into 2020 they should have an estimated $150MM tailwind from an acquisition done in Q1 2019. 

Clearly each end market has some risks associated with it but it appears that those risks are already reflected in the stock.  Major debt maturities don’t start until 2022 with the revolving credit facility, and unsecured debt begins to mature in 2023 and beyond.  The major covenant listed in the most recent 10-Q  is a first-lien net leverage ratio limit set at 2x, and given $923Mm outstanding it appears that there is ample cushion, especially if near term projections hold.  The company guided to $275MM in free cash flow (after adding back $60MM in voluntary pension contributions which were all made in the 1H) for 2019.  Given that they burned $71MM in 1H, that leaves expectations for close to $350MM of cash flow in 2H, which can be used to reduce debt. 

If the company can manage to hold revenues relatively flat free cash flow is set to improve meaningfully.  The $275MM from 2019 can potentially jump to $465MM with a big portion of the improvement coming from areas they can control.  Capex steps down $35MM, integration costs decline $55MM and $30MM of incremental cost savings/synergies from the recent acquisition flow through (the remainder of the increase comes from lower working capital build and other margin improvements).  Assuming they come close to that free cash flow generation, the yield on existing equity values jump from just under 15% in 2019 to over 20%, which, if used to pay down debt can significantly improve equity value.

Catalyst

Free cash flow and debt paydown