Description

Tecumseh Products (TECUA)

Taking into consideration an enormous tax refund on the way, we think the stock is a potential double with minimal downside risk from here. There is also $10+ of tax-effected NOL value investors get for free. Investors could see a major catalyst if a large shareholder (descendant of company founder) renews a past call to sell the company. 

(Note: TECUA was previously recommended on VIC in 2006, although tickles879 may not be laughing as the price was then $17.76.  The TECUA business and balance sheet are considerable simpler now and the stock is 2/3 the price)

Tecumseh Products makes compressors, which are a key component of refrigerators, freezers and air conditioners.  It sells into both the commercial and residential markets under the brand names Tecumseh, Peerless and Little Giant.   Major competitors include Whirlpool, Emerson, ACC, Cubigel, Copeland and Danfoss.  We have not included an extensive description of the company's core business as that information is widely available and the elements outlined below are the more "under the radar "aspects of the investment case.  We are happy to discuss the business in more detail in Q&A and there is some quarter to quarter sensitivity to copper and steel prices although the 10K does a reasonable job in framing the timing issues.

The Herrick family (descendants of the company's founder) controls a ~33% voting interest in the company (and has a ~5% economic interest).  Todd Herrick (grandson of the company's founder) stepped down as CEO in January 2007 after clashing with the board over the management of the company.  James Wainright, previously VP of Global Operations at Tecumseh Products, assumed the CEO role in December 2009. On March 10, 2008, the Herrick family wrote a 13D urging the company to initiate a sale process to strategic or financial buyers. 

We think TECUA is not getting the respect it deserves for two reasons:

(1) the market doesn't realize that over the next 2 years TECUA will receive ~$76.5 million ($3.85 per fully diluted share) in tax refunds from the Brazilian (and to a lesser extent Indian) governments related to Value Added Taxes previously withheld  (see company financials).  TECUA has the potential for incremental tax refunds above that $76.5 mm, which we ignore for conservatism.  The company already received $45 million in tax rebates from Brazil in Q4 2008.

(2) it's a $215 million market cap company with zero street coverage and nobody paying attention

Here's how we get to our $23 target:  Management has given detailed guidance for 2010, which we actually think is conservative.  Nevertheless, our 2010 estimates are generally consistent with that guidance.  We use revenue of $920 and ebitda of $42M.  2010 revenue and ebitda reflect a substantial, albeit unsustainable rebound from depressed results in 2009.  To be clear, given management cost reduction actions, we do expect the margin improvement shown in 2010 to continue even on modest revenue growth. We assume revenues grow 4% in 2011 and 2012 to get to ~$994 mm of revenues in 2012.  Based on our diligence, we also assume EBITDA margins can at least revert back to near-2007 levels of 5.9% by 2012, which gets us to $58.4 mm of EBITDA in 2012.  For reference, Whirlpool and Lennox International had 2009 actual EBITDA margins of 7.8% and 6.9%, respectively (according to Bloomberg), suggesting our margin assumptions are achievable.  The company has a restructuring plan underway to relocate some product lines to lower cost countries and believes EBITDA margins as high as 8% are achievable over the next two years, but we do not give the company credit for this yet.  A modest 5.0x our 2012 EBITDA estimate gets you to a total enterprise value of $292.  Adding back in ~$170 mm of pro forma net cash in 2012 implies an equity value of $462.  On only 20 mm fully diluted shares, we get to a price target of ~$23.  Tangible book value per share is ~$19.87, so our $23 target implies a 1.16x Price / Tangible Book Value multiple.

Even if you assume that EBITDA margins instead contract to 2008 levels of 3.1% (instead of expanding from 2010's expected level of 4.6%), on similar revenue numbers you get a downside 2012 EBITDA of $31 mm.  Applying a ridiculous 2.0x EBITDA multiple to that depressed EBITDA estimate still gets you to about the current $11.50 stock price.

Looking at it another way, TECUA is a free-cash-flow positive business trading at $11.56 with $2.08 of net cash today (assuming exercise of an in-the-money warrant) and ~$3.85 of cash on the way from tax rebates through 2012.  After receiving tax refunds and generating organic free cash flow, we expect TECUA to end 2012 with ~$8.54 in net cash per share, which implies a pro-forma "net" stock price of $3.

In the past, FCF differed from GAAP earnings, confusing some investors.  This was primarily due to asset sales, movements due to a US defined benefits pension plan (since reverted to defined contribution plan) and changes in deferred taxes.  In the future, FCF should closely mirror GAAP earnings.

Taking our $58.4 mm 2012 EBITDA estimate and subtracting out $15 mm of capex and $4.7 in net interest expense gets you to Free Cash Flow before net working capital changes of $38.7 mm or ~$1.95 per share (we assume TECUA still won't be paying a material amount of taxes in the foreseeable future and net working capital changes should be minimal here).  So basically, you're paying $3.06 for a stock that should throw off $1.95 per share of free cash flow in 2012 (on top of $1.30 of free cash flow in 2011). $3.06 "net" stock price on $1.95 per share of free cash flow means TECUA is trading at 1.6x free cash flow. 

Excluded from our valuation above (but included in the free cash flow #s for 2011 and 2012), TECUA also has substantial tax loss carry-forwards that will offset future taxable income including the following (at 12/31/09):

• $540 mm worth of US Federal carryforwards (at a 35% tax rate these alone are worth >$10.00 per share)
• $209 worth of US Federal Capital Loss carryforwards
• $252 worth of US State carryforwards
• $122 worth of Brazilian carryforwards

CATALYSTS

• Receipt of tax refunds and cash build over next two years should force TECUA's balance sheet to pop up on more stock screens.
• Potential strategic or financial acquirers may take notice. In March 2008, in a 13D filing, the Herrick family foundation pushed for a sale of the company. There is potential for a renewed sale process.
• We believe sell-side Analysts could pick coverage in the next twelve months, which should help focus investors' attention
• If all else fails, value will accrete to shareholders as management pays a dividend and then, later potentially repurchases stock at extremely attractive prices
• Even if no catalysts hit, it's tough to see how shareholders lose money from current levels

RISKS

• Rapid increase in copper prices beyond what the company (and competitors) can pass through
• Rapid appreciation in the Brazilian Real
• New competition and product launches
• Management equity ownership is minimal and management is earning generous compensation
• Downturn in end markets and destocking

Catalyst