HARMAN INTERNATIONAL INDS HAR
March 23, 2012 - 3:25pm EST by
beep899
2012 2013
Price: 47.25 EPS $2.08 $2.90
Shares Out. (in M): 72 P/E 25.0x 20.0x
Market Cap (in $M): 3,416 P/FCF 0.0x 0.0x
Net Debt (in $M): -382 EBIT 0 0
TEV ($): 3,035 TEV/EBIT 0.0x 0.0x

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  • Auto Supplier
  • Management Change
  • margin expansion
  • Cyclical

Description

Harmon International is the world leader in design and manufacture of auto dashboard infotainment systems with 22% share, twice their nearest competitor. Auto-related sales are ~73% of revenue. Remaining revenues are derived mainly from professional level recording and performance audio equipment.

Though the company operates predominantly within a cyclical industry, the company is benefiting from two factors. First, is the secular growth of dashboard infotainment as the systems penetrate beyond their luxury auto roots into sub luxury autos. Current penetration of infotainment systems in global auto production stands at around 20%. Thus Harman sales should grow faster than the overall auto market for year to come. (The company believes penetration can reach ~80%)

Second, the company will also benefit from margin improvement thanks to changes made by the new CEO, Danesh Paliwal. He's cut costs across the board, but even more important he's changed the business model from designing a customized infotainment system for each auto to designing off a scalable platform. FY2012(Jun) is the first year higher margin scalable platform backlog is entering into production/revenues and as it builds up it should drive improving margins for the next three to four years.

Based on company backlog, a stable auto industry (i.e., no recession), earnings and margins are on track to grow as follows:

 

2011 (JUN)

2012 (JUN)

2013 (JUN)

Revenue

               3,772

               4,379

               4,655

Revenue growth

12.1%

16.1%

6.3%

Operating margin

5.0%

7.3%

8.6%

Earnings

               $2.08

              $2.90

               $3.85

Earnings growth

 

40%

33%

 

Because it is perceived as a technology company within the auto sector the company gets a premium multiple (a la GNTX and BWA). Focusing on valuation since the bottom in 2009 and since EBITDA recovered post crisis, the stock has traded between 7x and 11x EV/EBITDA.

Based on my estimates for FY2013 (ending June 2013) and a the low-end historical 7x EV/EBITDA, I see fair value for the stock around $65.75 or 39% above the recent price of $47.25. Harmon’s enterprise value as of December 31st, 2011 is as follows:

Price

             $47.25

 Shares

                    72

 Market cap

               3,416

 Debt

                  387

 Cash

                  769

 EV

               3,035


 

The company reports in three segments:

     

Infotainment

 

Navigation and multimedia dashboard computers.

 

Lifestyle

 

Branded audio for auto, primarily

 

Professional

 

Professional recording and broadcast equipment.

 

   

As of FY2011(Jun), revenue and operating income break down as follows:

Segment

Revenue

% of Total

Op Inc

% of Total

Op Margin %

Infotainment

2089

55%

                    77

41%

3.7%

Lifestyle

1087

29%

                  102

54%

9.4%

Professional

596

16%

                    91

48%

15.3%

Total

3772

100%

                  188

100%

5.0%

 

Harmon is the share leader for dashboard infotainment at ~22%, twice its nearest competitor.

INFOTAINMENT

 

2011

                        Mgmt 2016 Goal

Harmon

 

22%

26%

 

Denso

 

11%

   

Delphi

 

10%

   

Aisin

 

9%

   

 

The business is driven by contract wins with auto OEMs and specifically the amount of revenue in backlog and the margins contained within the backlog.

Danesh Paliwal, the new CEO since 2009 has rebuilt the business from the ground up and while he has certainly benefited from a rebound in worldwide auto SAAR since the bottom in 2009, he has made important changes including cutting costs, moving production to lower cost countries, moving to a scalable platform, and properly pricing business at the time of bidding. While the rebound in auto sales and the cost cutting impacted the bottom line immediately, the benefits of the scalable platform and properly priced contract bidding take years to flow through to revenues as business bid today can take years before it gets into actual production.

The best of this backlog, that which is based off the scalable platform and with operating margins in the range of 8% to 10% is just beginning to hit revenues in FY12(Jun). The table below details the likely flow of scalable backlog into Infotainment Segment revenues over coming years.

Infotainment Backlog by Type & Margin

2010

2011

2012

2013

2014

2015

2016

Scalable @ 8-10% OP%

 

0%

0%

6%

26%

44%

51%

56%

Customized, post 2009 @ 5% OP%

 

8%

11%

14%

31%

36%

42%

40%

Customized, pre 2009 @ 2% OP%

 

92%

89%

80%

43%

20%

7%

4%

                 

Implied Infotainment margin

 

2.2%

2.3%

2.9%

5.0%

6.6%

7.3%

7.7%

 

The case for higher firm-wide margins is bolstered by the fact that in addition to the fact that it is priced properly, historical operating margins have been above 10%. Granted, worldwide SAAR was higher then too, but the revenue HAR had then is in line to slightly lower than the revenue it has now.

FY (JUN)

 Revenue

 Op Margin

     

LTM

4,157

6.0%

Trailing 12 mos oper. Margin is only at 6%

2011

3,772

5.0%

     

2010

3,364

3.7%

     

2009

          2,855

-3.3%

     

2008

4,072

4.7%

     

2007

3,551

11.1%

Still below peak margins prior to recession.

2006

3,248

12.5%

     

2005

3,031

11.6%

     

2004

2,711

9.4%

     

2003

2,229

7.5%

     

2002

1,826

5.7%

     

2001

1,717

5.8%

     

 

Using trailing run rate revenue at Dec 2012, each  additional percentage gain in operating margin

 
 

could add  an additional

$0.43

in add'l earnings

       
 

off a TTM earnings base of

$2.26

therefore, lots of upside potential from margins

   
               

 The math that gets to the additional upside from margins is as follows:

     

 Revenue, TTM 

                      4,157

 (TTM revenue as of 12/31/11)

       

 Add’l EBIT

                           42

 (additional 100 bps margin)

       

 Tax rate

               25%

           

 Net Income

                           31

           

 EPS

                $0.43

           

 Shares

                           72

           
               

 In current FY, 2012 (Jun) we're beginning to see some of the improvement flow through to the bottom line.

 Full year 2012 revenue should grow 

16.1%

         

 But with OM% growing from 

5.0%

to

 7.30%

     

 Earnings are going to grow from 

 $2.08

adjusted for one times, to

 $2.90

   
 

an increase of

40%

yoy

       
               

 In FY2013, ending Jun 2013

           

 Management is guiding revenue to grow roughly

6.3%

based on current contracts/backlog.

 

 an OM% to expand from 

7.3%

to

8.6%

     

 which should drive EPS of aprox.

 $                     3.85

or

32.5%

higher yoy

   
               

And we should get three or four more years of at least some margin expansion.

     

Further upside comes from a stronger recovery in the auto market.

       
               

VALUATION

           

 

From 2002 until 2008 the stock traded at a minimum EV/EBITDA of 10.0

   

 

After EBITDA recovered following 2009 the stock traded between 7x and 11x EV/EBITDA with one exception.

 

The exception was summer 2011 when it dipped as low as 4x as it got crushed with all auto stocks.

 

 

It now trades at ~8x. I think 7.0x to 8x is the right multiple at which to value the shares

 

 

as it has generally traded there post the 2009 bottom when the auto market is perceived as new-normalizing.

 

This thesis includes an assumption that the sub-par, uneven new normal growth continues.

 

 

If you foresee a recession the stock needs to be avoided or sold.

     

 

             

 

                             

 

Using a 7.0x EV/EBITDA multiple and based on

       
 

CY2012

we see HAR fair value at

$57.49

   

and based on

FY2013e (Jun)

we see HAR fair value at

$65.75

   
             
             
 

FY2011 (JUN)

FY2012e (Jun)

CY2012

FY2013e (Jun)

   

 Revenue

3772

               4,379

4,517

               4,655

   

 EBITDA

                         333

                  456

                  499

                  563

   

 EPS

 $                     1.90

              $2.90

               $3.33

               $3.85

   

 Debt

 

                  387

                  387

                  387

   

 Cash

 

                  892

               1,043

               1,194

   
   

 

 

 

   
   

 

 

 

   

Fair Value Enterprise Value at EV/EBITDA

 

 

 

   

multiple of

                          8.0

3645

3995

4503

   
 

                          7.5

3417

3745

4222

   
 

                          7.0

3189

3495

3940

   
   

 

 

 

   

Fair Value ($)

                          8.0

                57.48

             64.32

             73.44

   

stock price

                          7.5

 54.32

             60.86

             69.55

   

at multiple:

                          7.0

           51.16

             57.49

             65.75

   
   

 

 

 

   

Shares

 

                    72

                    72

                    72

   
             

 

           
       
 
   

 

         
             

 

RISKS

A recession in auto sales is the most obvious risk. Next would be a significant drop in European auto sales beyond that already assumed. However, do not be fooled by the company’s high European/German revenue as the company’s actual SAAR into Europe is ~35%. (Company does not report breakdown of SAAR, but it is available from IR if asked. They have an excellent IR with a fellow who has a consulting background and undestands how to help the buyside.)

Another risk as outlined by a recent sellside initiation is that smartphones/tablets will take over as the “brain” of the auto infotainment center. However, it can’t happen any time soon.  The auto infotainment system is critical to operating the car. It has to control half a dozen apps at the same time to direct HVAC/entertainment/back up radar, etc, etc. and at high speeds, extreme conditions, etc, and without fail. Smartphone apps are always crashing and can't do this.  Also, what if you get out of your car and you lose your phone, your phone is stolen, or you drop and break your phone? Now what? And what if its negative 20F outside or 110F and your stranded or can’t get the heat or a/c working. Etc, etc. Smartphones are not an issue.

 

Catalyst

Worldwide auto market maintains stable growth. HAR continues to win new contracts and existing backlog continues to show margin improvement as it flows into revenues.
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