Description
Hawk ($65mm mkt cap) is a leading supplier of friction products and powder metal precision components for industrial and agricultural customers that is growing ebit (excluding non-recurring charges) 50%+ organically due to significant operating leverage and growth from it customers. The company derives 80%+ of its revenue from products for which it is the sole source provider. In 2005 the company will also begin to benefit from a plant move whose annualized cost savings will increase eps by $0.15. Based on analysts’ estimates, HWK is trading at only 12.1x 2004E eps and 8.8x 2005E eps, with 2005E eps expected to increase 38%. However, not reflected in these estimates (which we believe are too low anyway) is a likely $65mm debt refinancing which would add another $0.10 of eps and reduce implied p/e’s based on analysts’ estimates to 10.4x pf 2004EPS and 7.9x pf 2005.
HWK has 3 operating segments:
1) friction products- 60% of rev- supplies friction materials for brakes, clutches and transmissions used in construction vehicles, agricultural vehicles, trucks, motorcycles and race cars, and brake parts for commercial and general aviation.
2) precision components- 34% of rev- provides powder metal and metal injected molded components used in pumps, motors, transmissions, anti-lock brake systems and other applications for industrial equipment, lawn and garden equipment, appliances and trucks.
3) performance- 6% of rev- engineer, manufacture and market premium branded clutches and transmissions for the performance racing market.
HWK is the preferred supplier to many of the world’s largest OEM and the company derives 80%+ of revenue from products for which it is the sole source provider. The company has over 40yr relationships with many of its largest customers including caterpillar, cnh, eaton, deere, and dana. No customer accounted for more than 8.5% of sales in 2003, although the company’s top five customers account for 26% of revenue. The company has a diversified product list, with over 5,000 total products, none of which accounted for more than 5% of sales.
The company is in the process of moving a friction plant from Ohio to Oklahoma that will generate annualized pretax cost savings of approximately $2.5mm ($0.15 of eps) once the move is completed in Q1 2005. The savings result from labor and utility savings as well as government incentives. As part of this move the company will incur $2mm of non-recurring charges in 2004 and $3-3.5mm in 2005. Most of these charges will be cash and have been excluded from all ebit and eps figures mentioned here unless otherwise noted.
HWK has $65mm of 12% HY debt that is callable at par in December of 2004. The company is actively in discussion with bankers about refinancing this debt and we believe they can refi in December for at least 250pbs less than they are currently paying. (With LTM ebitda of $28mm and $96mm of net debt, hwk is levered 3.5x, but by year end we believe ratio will be closer to 3.0. Capex = depreciation normally, but a few million higher this year with the plant move). While I believe they will refi in december, HWK is also contemplating not refinancing immediately since they believe by mid to late 2005 their credit ratios will be even better so they may be able to refi at an even more attractive rate than they can now. Regardless of when they refi, its clear that it will be largely accretive to equity holders. Assuming they can refi in December 2004 for 250bps less, this increases eps by $0.10 or ($65mm*.025)*(1-48%)/8.8 fd shares. Note the company’s est. full year effective tax rate is 48% and they are working with consultants to lower it.
HWK does a poor job on an investor relations front, but are very user friendly if you call them. The company’s guidance (which we believe is too low) is somewhat confusing so to summarize they believe 2004 rev will increase 10%-13% (recently raised from 6%) and 2004 reported ebit (after restructuring charges) will increase from 55%-60%, recently raised from 10-15% even though steel prices have negatively impacted margins. These EBIT figures include a restructuring expense of $1.9mm in 2003 and $2.1 in 2004E. In other words, the co is really guiding (using 60% growth) to $19.5mm of 2004 adj. ebit (excluding charges). adj. ebit= ($10.9*1.6)= $17.4 of reported 2004 ebit..add back 2.1 of restructuring charges yields $19.5 of adj ebit. The $19.5mm represents a 52.4% increase over the $12.8mm (10.9+1.9) of adj. ebit (excluding restructuring) in 2003. We believe management is overly conservative because it wasn’t that long ago that the company was in financial difficulty and because they realize the benefits of underpromising/overdelivering. Specifically, based on our recent conversations with management and our channel checks with end markets (construction, agr, truck, aerospace), we believe revenue will be significantly higher than management’s estimates and, even with steel prices continuing to be a negative impact on margins, that the company will exceed its published guidance.
Management, who is very impressive for a company of this size, owns 20+% of the stock so they are highly incentivized to enhance shareholder value. Furthermore, Ron Weinberg, Chairman, CEO and President, is 63 years old and I believe now that the turnaround is taking form, in the near future he will sell the company. One negative note is that through management’s ownership of $1.5mm of preferred stock they essentially control the board. There has also been some selling by insiders, however when we realize that this was an illiquid $3 stock earlier this year its understandable that some people would take some money off the table.
The following table illustrates HWK’s products and customers (note: this table is also in the 10k if formatting makes it difficult to read here):
Selected Key Principal Selected
Customers
Business Segment (and Years as a Products Sold Applications
Customer)
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Friction Products Caterpillar (55 Brake Linings Tractors, Motor
years) Graders and Wheel
Construction Transmission Discs Loaders
Allison
Transmission (55 Lift Trucks and
years) Mining Trucks
Dana Clark Hurth
(35 years)
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Agriculture John Deere (45 Brake Linings Tractors
years)
Transmission Discs
CNH (40 years)
AGCO (35 years)
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Truck Eaton (30 years) Clutch Buttons On-highway Trucks
ZF Meritor (2 Transmission Discs
years)
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Aerospace Aircraft Braking Brake Linings Commercial
Systems (35 years) Airliners
BFGoodrich (35 Commuter Planes
years)
Parker Hannifin Military
(20 years) Helicopters
Bombardier (10
years)
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Powersport and Hayes Brake (20 Brake Linings Harley-Davidson
Specialty years) Motorcycles
Bombardier (15 Snowmobiles
years)
AM General Hummer
TRW (10 years)
-------------------------------------------------------------------------------
Precision Eaton (29 years) Powder Metal Gears Hydrostatic
Components Transmissions
Electrolux Home Rotors
Products (20 Fluid Power
years) Transmission Controls
Components
Parker Hannifin Construction
(20 years) Hubs, Bearings, Equipment
Spacers and
MTD (20 years) Structural Components Industrial Pumps
Haldex Barnes (18 Gasoline Pumps
years)
Truck
Hydro-Gear (15 Transmissions
years)
Lawn and Garden
Sauer-Danfoss (15 Equipment
years)
Honda (8 years)
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Catalyst
Presentation at Roth conference next week
Refinancing HY debt
Posting continuing strong quarterly results