Description

As a result of the recent market turmoil, Exide stock has fallen over 50% for little reason.  XIDE is currently trading at 4.5x LTM EBITDA and as I will explain in this write-up, I believe the company will end their current fiscal year trading below 3x EBITDA.  With Peers such as JCI, ENS and CHP garnering multiples in the 8 – 9x range, I believe XIDE should garner a 7.5x multiple and is worth $29 per share, or a triple from here.

What do they do?

Exide manufactures batteries for Transportation, Network and Motive Power markets globally.  Network and Motive Power, which collectively are called Industrial Energy, are 43% of total EBITDA while Transportation makes up the remaining 57% of EBITDA.  Network Power is primarily exposed to standby power applications such as power for telecommunications towers and data centers.  These businesses have nice secular growth themes that should remain intact even in an economic slowdown or recession (we will continue to use more data and mobile communication devices).  The growth in Network power should more than offset any slowdown in motive power which is more exposed to general economic conditions (batteries in forklifts).  Transportation North America is a virtual duopoly with JCI that is mostly an Aftermarket business (over 85%) so a low SAAR or economic slowdown will probably help volumes (you keep cars longer and have to replace the battery, no matter how often you drive the car).  In Europe, the company is more exposed to OEMs and I would expect that growth will slow from 2-4% to 0-2%.  In fact, JCI on their recent restructuring conference call, stated that the continued strength in Eastern Europe should offset declines in Western Europe (they were very bearish on NA OEM). 

What went wrong and how have they fixed it?

I am not going to go into the sordid details of their Chapter 11 filing as the reasons for that failure are not pertinent to the present (I was an advisor on that bankruptcy - amalgamation of assets, over levered, poor management, no internal controls, lack of systems integration etc.), but I would like to focus on the issues post emergence and what the company has done to fix them.  At the beginning of 2007, the company had one serious issue, Lead prices were skyrocketing.  From 2006, lead prices increased 8x.  This caused significant financial problems for XIDE as it emerged with a reasonable debt level.  Further complicating the issue, it is our understanding that their man competitor, JCI, had long term tolling agreements for lead that allowed them to purchase the commodity for below market prices.  As a result, even though lead prices were going up, XIDE could not pass these increases on to their customers.  Exide raised equity capital to address the liquidity concerns and once the JCI tolling contracts ended, were able to secure contracts that included a lead pass through mechanism.  As a result, EBITDA is now returning to levels that approximate the pre-Chapter 11 results. 

Inventory Opportunity

Since the beginning of this year, Lead prices have fallen from the $3,000/ton range to the $1,800 range.  This move takes the price of Lead back to levels from early 2007.  Since that point, net working capital has increased by greater than $200mm.  Over the next couple of quarters, this capital will return to XIDE.  Although prices started trending down prior to this quarter, Q1 is seasonally an inventory build quarter and the company holds 60 days of inventory, so one would expect to see precipitous declines in inventory levels over the next couple of quarters.  Assuming management is not capable of further managing net working capital (which, ex cash and ST debt, is 590mm), Net Debt will fall from current level of $580mm to $380mm or 1.4x LTM leverage.  As I will explain below, I believe the company will generate 95mm of FCF this year, bringing net debt down to $285, or 1x leverage.

EBITDA and Free Cash flow

LTM EBITDA is 276mm.  Compares for the next quarter is very favorable as last year they had not had the full benefit of their pricing actions (lead pass through).  As a result we would expect EBITDA in the back half of the year to increase by 40-50mm (Q2 benefit should be half of that amount – 20mm increase).  The company has announced a major restructuring of their underperforming transportation Europe division (the former manager of that business, whom they let go a couple of weeks ago, refused to cut costs) which will result in $12mm of incremental EBITDA.  In addition to this, the company is spending $100mm on Capex with $65mm of that capex discretionary and management will not accept discretionary capex projects unless they can generate high 20%’s rates of return.  Assuming a 20% rate of return, that should add $13mm in EBITDA.  As a result, I would expect EBITDA in the next fiscal year to grow to $350mm.  FCF, excluding working capital benefits, should be roughly 115mm (325mm of EBITDA – 100mm of capex – 65mm of cash interest – 46mm of cash taxes = 115mm), providing a free cash flow yield of 16%. In the next fiscal year, the numbers get even better – FCF grows to $145mm or a FCF yield of 20% (350mm in ebitda – 100mm of capex – 45mm cash interest – 59mm in cash taxes = 146mm). 

Catalyst