Description

NN, Inc. (NasdaqGS: NNBR) Investment Report

Summary 

NN, Inc. (“NNBR” or “Company”) is one of the cheapest stocks in the industrial sector. To put that statement in context we see 2023 EBITDA of $90 million and the current enterprise value is $466 million so the EBITDA multiple is 5.2x. CHEAP! The Company has gone through a massive transformation to deleverage after undergoing a huge shift in its portfolio of owned segments. The effort to deleverage was a result of too many high-priced acquisitions which were undertaken by prior CEO Richard “Dick” Holder. Following the replacement of Dick Holder, with new CEO Warren Veltman there has been a complete transformation of the corporate structure. We have found the new management team to be both good operators and very straight shooters – they have nearly eliminated all the crazy EBITDA adjustments that Dick Holder had used to portray his lackluster performance as superior.

NNBR manufactures high-precision components and assemblies primarily for the electrical, automotive, aerospace and defense, medical, and general industrial end markets.  The Company has 28 manufacturing locations worldwide in 5 countries encompassing two business segments: Power Solutions and Mobile Solutions. NNBR’s business model relies on precision manufacturing which can achieve extremely high tolerances.  The manufacturing know-how and precise machining is driven by the legacy focus on delivering very high-quality components to automotive OEMs.  NNBR is a mission critical supplier for its customers which leverage its facilities to manage their supply chains more effectively – something of a growing importance in the post-COVID environment.  The Company maintains its competitive advantage via four pillars: (1) best-in-class high precision components and assemblies (2) strong reputation and steady foundational business (3) key partner in the supply chain and (4) adds strategic value throughout the life cycle.  The Company then drives these competitive advantages through engineering and a unique manufacturing process that optimizes cost and quality for customers.

Recently, the Company has been over-penalized for a combination of high financial leverage and out-of-favor exposures to the internal combustion engine (ICE) – which only makes up less than 20% of our estimate of fair value.  The Company tried to address some of these concerns with increased disclosure which was unveiled at an Analyst Day in April 2021.  This followed the sale of its Life Sciences division that has allowed the Company to dramatically reduce its leverage.  These moves have helped focus NNBR on two segments – Mobile Solutions and Power Solutions.

The one key fact about NNBR that is hiding in plain sight is an ability to take know-how from the Power Solutions segment where they have a deep understanding on electrical connectors and batteries and use that knowledge to win business as Mobile Solutions sees its end customers slowly evolve their product portfolios away from ICE focused vehicles to fully electric and hybrid offerings.  To further capitalize on this opportunity NNBR is adding additional sales engineering talent as well as three recently announced directors (added to the NNBR board) that all have a focus on electric vehicles and smart grids.  This focus on skating to where the puck is going is completely unappreciated at a 5x EBITDA multiple.  Further, due to the deleveraging, NNBR will be able to get back on the acquisition path to find complementary tuck-in targets to further expand its capabilities and customers.

Mobile Solutions: Manufacturer of highly complex, system critical components for fuel systems, engines and transmissions, power steering systems, and electromechanical motors on a high-volume basis.  Select key products include:

• Emissions Control

• Electric Power Steering 

• Fuel Injector 

• 4-Wheel Drive

• Electric Motors 

• Sensors

• Breaking 

• Appliances

• Compressor Shafts

• Power Tool Shafts

• Diesel Engines 

• Industrial Motor Shafts

• ATV Power Steering 

Additionally, the Company sells to established customers such as Bosch, Denso, Nidec, Emerson, Fiat, and Delphi in the following end markets: 

• CAFE Technologies 

• Electrification Technologies

• Fuel and Electronic Power Steering Systems 

• General Industrial

The end markets for Mobile Solutions are growing 6% to 7% per year.

Power Solutions: Provider of high-precision metal and plastic components, assemblies, and finished devices used in applications ranging from power control to flight control and for military devices.  Some of the most common products include:

• Residential Smart Electrical Meters 

• Class 1 Hand-Held Surgical Instruments 

• Patriot Land-Based Missile Defense System 

• Low and medium Voltage Circuit Breakers

• Automotive Airbags

• F-35 Hydraulics System 

• Battery-Electric Locomotive Battery Packs 

• High Voltage Connectors for Hybrids and BEVs

• Custom-Plated Copper Tab for High-Power EV Connectors

• Battery Stack Bus Bars and Assemblies for Industrial and On-Highway Applications 

Additionally, some of the key customers in this business segment are Itron, Siemens, Sensata, Ethicon, and Raytheon.

The end markets for Power Solutions are growing 8% to 9% per year.

Recent Company History and Situational Improvements 

Over the past few years, the Company has made several key changes in order to best position itself to capture the upcoming opportunities. In 2019, the Company appointed Warren Veltman as CEO and Tom DeByle as CFO, followed by consolidating the Mobile and Power leadership teams in order to capitalize on cross-segment efficiencies.  Management then made moves to optimize its operational footprint, reduce SG&A costs, eliminate the quarterly dividend, and decrease capital expenditures, all of which improved cash flow by ~$32 million.  Lastly, the Company identified the unsustainable capital structure that led to customer and supplier concerns that inhibited operational goals and set a target leverage of ~2x-3x.

In 2020, the Company took immediate action with respect to COVID-19 to ensure the safety of employees, continued service to our customers, while reducing expenses, capital expenditures, and working capital by ~$16 million.  Management then conducted a review of strategic alternatives to identify the best option to support long-term growth and success. Lastly, the Company strengthened its balance sheet and enhanced financial flexibility by significantly deleveraging through the sale of Life Sciences for $825 million.  The Company received $757 million net, of which they paid down $700 million in debt, bringing down the leverage ratio to 2.3x compared to 5.4x a year ago. 

Recently, NNBR has continued to upgrade its Board with three new additions so far this year: 

1. Dr. Rajeev Gautam: President and CEO of Performance Materials and Technologies of Honeywell. He has been responsible for the development and commercialization of products across multiple applications and industries and can offer insights for both the mobile and power solutions businesses. 

2. Joao Faria: President of the Vehicle Group/eMobility at Eaton Corporation, a global power management company providing energy-efficient products and services. He brings manufacturing and engineering experience to the Board, with a specific focus on the electric vehicle market. 

3. Dr. Shihab Kuran: Founder, president, and CEO of Power Edison – a company focused on providing innovative renewable energy including stationary and mobile energy storage solutions for the grid. He brings global experience in a broad range of technical and executive roles within the energy industry, including specific focus on renewable energy and smart grid technology.

As a result of these efforts, the Company has drastically improved its conditions and has shown earnings momentum in recent quarters; for instance, Q1 2021 results were well above consensus while Q4 2020 results also beat the consensus by large margins with Mobile sales up 12% YoY. Additionally, Management expects Mobile demand to continue, highlighting a strong Q2 and stable demand for power. Additionally, on June 15th, NNBR named Mike Felcher, Chief Accounting Officer since 2018, as Senior Vice President and Chief Financial Officer effective July 1, 2021. Moreover, on June 17th, President and CEO Warren Veltman disclosed a purchase of 20,000 shares.  

Valuation Catalysts

There are several valuation catalysts propelling the Company forward, as seen in the valuation model below. First, diversity of its end markets with uncorrelated cycles will enhance business stability.  As alluded to above, the Company has transitioned from a primarily automotive end market dependent business to more balanced cyclical industrial via the acquisition of Autocam (2014), Precision Engineered Products (2015), Caprock (Precision Plastic Components) (2015), DRT (2017) and simultaneous divestiture of the PBC business (2017).  It is important to note that, historically, NNBR has overpaid for acquisitions diluting returns for shareholders, but the underlying ROIC suggests potential for high returns from organic growth going forward. 

Secondly, the Company has developed a powerful mid-term growth algorithm: 

• Grow revenue 6-8% annually.

• Assumes growth mainly within existing customers. 

• EBITDA: 20% growth annually.

• Use cash flow generated and EBITDA growth to rapidly de-lever.

• FCF: strong cash conversion.

• Use margin expansion to drive cash flow without large increases in required capital. 

Additionally, NNBR’s management has laid out a plan to fully utilize NNBR’s global presence.  Since the Company has global infrastructure with manufacturing operations in key markets all around the world, NNBR will seek to operate in the same region as customer location, which lowers the risk of tariff impacts, among other advantages.  Secondly, the Company plans to pass through raw materials cost to customers as commodity prices have spiked on fears of inflation.  The timing of this cost pass through can cause some short-term variability but most contracts will re-price within a few months. 

Power Solutions

The Company believes it can capitalize on several “mega trends:”

• Transmission and Distribution: Expanding distributed energy resources (DER’s) will require Company-produced products and/or components such as inverters, storage sensors, and metering/control devices.  Additionally, the US is in the midst of generational infrastructure modernization, where aging infrastructure will require substantially updating. 

• Smart Cities, Homes, and Factories: Demand for usage efficiency driving smart meters and smart sensors across residential and industrial. 

• Automation/Robotics/Sensors: There is a need for increased manufacturing efficiency and flexibility in order to drive automation advances, specifically due to the proliferation of vision systems, robotics, and co-bots. 

Due to these factors, the Company believes it can achieve 5-6% annualized growth in smart meters, 5-7% in switch gears, and 4-5% in transformers. The Company is a little less optimistic in residential devices and equipment, only modeling about 3-5% growth in switches, breakers, sensors, and appliances.  Nevertheless, non-residential automation and controls has the highest growth prospects, with relays, sensors, and controls expected to grow at a 6-7% growth rate. 

Mobile Solutions

The Company believes its CAFE end market can achieve 3-5% annualized growth given the increased global attention towards “e-mobility” and autonomous driving technology.  Additionally, technology advancements go hand-in-hand with a desire for increased power density (e.g., electric vehicles) and increased pumping pressure and precision. NNBR also believes that its “Off-Road” and “Power Generation” end markets will achieve similar growth, powered by a continued increase of disposable income & the rise of an Asian market for ATVs and growth in China/India & Urea Dosing Systems, respectively.  NNBR is most optimistic about its HVAC market, modelling roughly 5% growth due to rising construction activities and the push for connected home devices. 

Valuation

The following DCF and SOTP analysis is based on Management guidance and segmenting the two business units, as they independently achieve different multiples. We believe NNBR projections are conservative, as this group was embarrassed by its inability to hit numbers historically, so, going forward, they want to build a culture of surpassing expectations.

Discounted Cash Flow (DCF) Analysis: Implies $12.41

Sum of Total Parts (SOTP) Analysis: Implies $12.50

Appendix: Peer Sets:

Catalyst

• Continued beat and raise quarters
• Tuck-in acquisitions
• Reduction of SG&A as company move HQ out of Charlotte
• Sale of business if peer multiples are not achieved