Description

Strattec (STRT) is a conservatively managed, underfollowed auto supplier selling directly to OEMs that makes locks, keys, door handles and other related products for various automotive applications. It’s about a $200 million market cap but only trades about $1.3 million worth of stock per day. Covid (and to a lesser extent UAW strikes) caused a major slowdown in production during 2020 for STRT and across the automotive market, but that allowed the company to permanently cut costs like a lot of companies by trimming the workforce. Year-to-date the company is tracking for their best operating margin since 2005. The stock is starting to screen quite cheaply for the first time in a while as one-time non-cash pension settlement charges from 2019 and covid effects from 2020 come out of trailing earnings, and I think this is a good time to play the positive momentum in the stock as the company harvests some of the gains from capital investments made over the past several years. I expect earnings per share to be close to $7 for FY2022 with the stock trading at under $50.  

STRT was originally a spinoff of Briggs and Stratton in 1995, and has been cash flow positive every year since except for 2009. In 2014-15 the stock got a little ahead of its skis when the company had outsized earnings for several quarters after GM announced recalls for ignition switches in several million vehicles in 2014. It temporarily looked like a “growth story,” but that hypothesis was broken once the recall revenue tailed off. Today GM is still the largest customer, with Ford and FCA (STLA) as number two and number three. Most of their revenue comes from SUVs and trucks, but their highest content per vehicle typically comes from minivans where they can sell two power doors, a power hatch, and locksets. Auto industry stocks have enjoyed a nice run as a reopening trade but have recently cooled off because of the bottleneck coming from semiconductor chip shortages. STRT does use semiconductors in some of their products, but it isn’t as core to the business as OEMs and other suppliers. They have already seen the effect of the bottleneck Q1 (fiscal Q3) and expect their sales volumes to be hurt by 10% or less (vs. OEMs talking about 15% or so) in the near term. My understanding is that it’s hit Ford the hardest with production getting hit the hardest for this current June quarter with the balance of the year expected to pick back up. STRT management has mentioned that from what they are hearing, the shortage won’t be fully worked through until the end of calendar 2021. Reopening demand has been solid the past few months (April SAAR was above 18mm for the first time since summer 2017), and I think it will stay high for a while, barring a recession, as dealerships start to build inventory back up, rental car agencies stabilize, and consumers upgrade to EVs. The company also has international exposure through their VAST JV. VAST contributed $0.48 to EPS for the first 9 months of FY2021, and the company believes that there will be tailwinds from a newly developed plant in China that will ramp up through the end of the year.   

Historically the company’s sales growth has tracked pretty closely with their customer growth plus a few hundred bps. 

The one analyst with estimates is expecting sales growth for 2022 in the single digits whereas sell-side consensus estimates for the major OEMs expect mid-double digits growth. I think there’s some upside to those numbers for STRT. The company has recently won business for its new power tailgate product on a few major pick up models including the GMC Sierra and most recently the F-150, and has indicated that early rates of customer adoption are about twice what the OEM had projected (20+% vs 10%). They’ve also recently won business for power doors on the Kia Sedona and Hyundai Starex. Design wins can last 4-6 years and the only big programs coming up on renewal are the Ford F-250 in 2022 and the Dodge Ram in 2024. 

As the industry has shifted away from traditional physical key/ignition systems, the company has had to invest in additional technology and manufacturing capabilities, resulting in elevated levels of capex and R&D expense. 

For the next year or so, the company expects to stick around maintenance capex levels of $10 million, which at a $500 million top-line and 8% operating margins should have the business throwing off $25+ million in free cash flow. In FY 2020, despite revenues down 20%, they still generated free cash flow of $13 million. They’ve mostly been using free cash to pay down their credit facility, especially post-dividend halt—net debt has gone from a peak of $43 down to $8 since June of 2018. Capex levels ramp up on new design wins, so it’s possible they could invest in a new program at the expense of near term cash flow, but most likely the next year or two will be a nice cash flow harvesting cycle. Not all of their incremental investment has paid off, they dissolved a side-project, STRATTEC Advanced Logic in FQ4 2020, which sold commercial biometric locks. The company probably burned a couple million dollars on that venture as an effort to try and diversify away from auto-related sales, but it didn’t pan out. But I think they've done a good job navigating the analog to digital transition for locks and keys in automobiles. They will likely bring the dividend back, but they have indicated the plan currently is to raise cash to keep opportunities open. I wouldn’t be surprised to see an acquisition in the coming quarters, but I would expect it to be pretty small relative to the size of the current business.

My take is that this is a good, not great business with a defensible moat, low-double-digit ROIC and a growth rate equal to industry growth plus a few hundred bps through a full cycle. Currently, Sidoti is the only broker providing coverage (and even they are doing so on a sponsored basis, meaning STRT has to pay to be covered). I think as the company continues to execute and the stock goes higher, it will draw more eyes and attention and could catch an even higher multiple. It has an outside shot of getting into the Russell 2000 this year (projected cutoff in the 220-240 mil range). I also expect the dividend to be reinstated within the next 2-4 quarters. Ultimately, you’re getting what I think is a better than average auto supplier at 8x a forward earnings estimate that I think is a little low, while the rest of the industry trades around 14x. 

Risks

It’s an auto supplier.

It’s a cyclical business.

Catalyst

Dividend reinstatement

Index inclusion: Russell 2000 rebalance add if stock breaks to new 52 week highs.