Description

Superior Industries was previously written up by max78 in Oct 2012.  The author makes a lot of good points which I agree with so I advise you give it a read for more back ground on the story. Even though the stock has appreciated 17% (plus dividend) and the story has changed quite a bit, I still think it’s a good buy with some short-term catalysts on the horizon and safe place to be in a market pull back.

I like the stock here for a number of reasons:

-        Future margin expansion

-        The resignation of the CEO

-        Corporate Governance changes

-        New 105b1 plan

-        Gabelli is getting demanding

Margin expansion

In previous conference calls, management has talked about various investments the company is making to improve capacity constraints since the company is operating at 100% capacity utilization. The announcement of a new manufacturing facility in Chiuahua Mexico has gotten the most attention and from the market’s reaction investors don’t like the idea. To review, the company is spending $130M to construct a new production facility with capacity of 2-2.5M units annually, an increase of 20%. The new capacity will allow for increased top-line revenue as well as margin expansion from not only lower costs compared to the US facilities but also lower costs from a more optimal production level.  In addition, the company is also spending $35-40M in cap ex enhancements to improve capacity utilization and efficiency in the existing facilities.  These investments will slowly improve margins in 2014 and the top and bottom line in 2015 and 2016.  At least , the investments will get more attention than the cash sitting on the balance sheet.

Production costs are increasing for Superior’s competition.  A majority of the competition is from Chinese companies and labor rates in China have been increasing for a few years now. According BofA Merrill Lynch research, Mexico labor rates are about a fifth lower than China.  In addition, the Chinese companies have to incorporate greater shipping costs and rates are starting to rise.  These increasing costs will make should make it more difficult for the competition to further aggressively compete on price.

Resignation of the CEO

On Oct 14 2013, Steven Borick resigned as CEO and President of the company effective March 31, 2014 or the announcement of the hiring of a successor to either President or CEO. Mr. Borick had been running the company since 2005 and Chairman since 2007. He will remain Chairman.  I see this as good news because the company was run so conservatively under the Borick Legacy.  With new leadership, Superior has the capacity to reward shareholders by making more shareholder friendly capital allocation decisions, something the company hasn’t been known for in the past.  Unfortunately, the company hasn’t named the new CEO but the announcement may serve as a positive catalyst for the stock in Q1.

 Positive Corporate Governance

In the 2013 proxy, shareholders voted to reduce the size of the board from 9 members (7 independent) to 7 members (5 independent). In addition, the shareholders also voted to declassify the board over a two year period beginning in 2015. I see the smaller, declassified board more effective to make faster decisions, less potential for disagreement and more shareholder friendly.  Although these are not huge “game –changers”, they are steps in the right direction towards a more shareholder friendly company.

Share Buybacks, a dividend Increase and a new board member

On Dec 12, 2013, the company issued an 8-k announcing the adoption of a pre-arranged stock trading plan. On March 27, 2013, the board authorized a $30m stock repurchase program and as of Dec 13, the company had repurchased 273k shares for $5.3M leaving $24.7M available. I see the 10b5-1 plan as a disciplined way to continually repurchase shares and signals to the market that management is taking steps to return capital to shareholders. Given the shape of the balance sheet, the company can be much more aggressive in capital allocation.

The buyback shows a sign of changing mindset. That being said, the buyback could also be a sign of weakness and more to appease shareholders because 2013 was a relatively poor year for the company and the Activists have been making noise.  The quote below taken from the Q3 2012 conference call clearly articulates the change in mindset of management. 

Q3 12 conference call “I'd rather spend the capital in building additional capacity than buying back stock, but I also want to continue to share with our shareholders in our dividends, and so we're looking at all of that also as we move forward.”

In December, the company announced a 12.5% increase to the dividend per share, raising it to $.72.  In addition, the company announced the addition of James McElya to the board. Mr McElya will be replacing Kerry Shiba, the CFO, and brings relevant industry experience to the board.  McElya held a 17-year career with Cooper-Standard Holdings, Inc., a publicly traded company that is a leading global supplier of various products for the automotive industry.

Gabelli is getting demanding

Mario Gabelli and his firm have been a shareholder since 2005.  Recently Gabelli has been getting more aggressive in its opinion of management and in November 2012 nominated a director to the board. The company interviewed the candidate and concluded he had relevant experience and expertise. Instead, the board nominated Sheldon Ausman (age 79), a former Arthur Anderson Managing Partner, to the board. Gabelli’s nominee only lost due to a major shareholder withholding votes for the candidate. Since last year, Gabelli has increased its position from 10% to 13%.  As history suggests, Gabelli is a persistent activist and usually gets what he wants in the end.  Further, given Superiors lagging stock performance I foresee more frustrated investors to vote against management.  Another potential short-term catalyst will be news from Gabelli and his ideas for the shareholder meeting in May.

 Low expectations

What drew me to this idea and also what I like most about a long position in SUP is the lack of expectations for the company.  The company is not widely followed by the street and given the long legacy of being ultra conservative company under the Boricks, future surprises can draw investor interest.  For example, the company’s bullet balance sheet with no debt and real estate value can be used as a lever to unlock shareholder value.  Without the control of Mr. Borick, the next ten years can possibly look very different than the past ten years.   

Valuation

Superior’s stock has lagged the market and its industry but the company’s financial performance has also lagged.  Not surprisingly, valuation is relatively cheap at 7x EBITDA and just 1.1x price to book. With a little margin improvement from either revenue growth (operating leverage) or cost savings from plant improvements and the new production facility, or both, will substantially move the needle in the bottom line. According to my model, if the company can increase production to 14.5m units at flat pricing and increase gross margin to 10% from 8% now, operating profit will double from $27M (LTM) to $56M.  As for EBITDA, I have modeled EBITDA increasing 46% from $54M to $79M.  At the end of 2016, I have $60M still on the balance sheet resulting in an EV/EBITDA multiple of 6x.  My assumptions seem easily achievable given the automobile market doesn’t tank and competition pricing pressures decrease.

Risks

The lack of financial leverage and overcapitalized balance sheet make the stock less risky than most auto part stocks. That being said, without a catalyst the stock will underperform a bull market, as we have seen in 2013.   On the flip side, a near-term slowdown in car sales could be a good thing for Superior because it will reduce capacity utilization and will help increase margins.

Catalyst