Description

Summary: Tecumseh Products Company stock (TECUA) is an attractive turnaround story, with the potential to triple from current levels in the next 2-3 years. It has been mentioned before on VIC, but 2011 is lining up to be an inflection point making this a timely investment.  Positive factors include new management, potential double-digit revenue growth (troughed in 2009), meaningful incremental margins, significant cash tax receipts expected in the coming quarters (~50% of current equity value expected in next 2-3 years, over a third of which is expected in the next 2-3 quarters), a healthy balance sheet (currently net cash), and a below-book valuation (book now $22.59 vs $11.75 stock price). We see these factors limiting the expected downside and giving significant expected upside at current levels, with the Street largely ignoring the company's story to-date given its lack of coverage and the predecessor company's profitability issues.

Tecumseh Products Company manufactures hermetically-sealed air compressors for both commercial and residential use. The company recently restructured and brought in a turnaround management team. They divested all poorly-run divisions, and kept only the air compressors segment, which is now their focus. Air compressor sales troughed at approximately $735MM in 2009. The company is on track to do approximately $920MM of sales in 2010, and management has expressed that they reasonably target $1,200MM of sales by 2012 from secular growth and market share recapture (driven by a reorganization of their product lines). At this level of sales, management expects to operate at an approximately 8% EBITDA margin, or roughly $100MM of EBITDA by 2012 (note the company's 2010 EBITDA margin will be approximately in the 3% range). Incremental sales and continued cost take-outs like getting their Indian facility up and running will be the key drivers in restoring the EBITDA margins.  As the topline and the business recover, and management begins to report higher earnings / become more visible to investors, it seems reasonable that the Street will re-rate the stock and increase its EBITDA multiple to a reasonable industry level of approximately 5.0-6.0x. In a strategic situation, it seems reasonable this could increase to approximately 7.0x+. Combined with expected 2012 net cash of approximately $100MM (details below), you can get an expected upside ranging from approximately $30-40+ / share in the next 1-2 years. The below-book valuation, combined with the tax receivables, provide meaningful downside protection, in our view, given the visible growth of the business.  At these levels there is a lot of cushion to management's targets.  Even if sales only grew to $1.1 bn which seems conservative given the current trajectory and industry forecasts and Ebitda margins only made it to 5% which is below where it was before many of the cost take outs, that is still $55 in EBITDA with substantial net cash on the balance sheet - should yield something like a $25 stock give or take if management is completely off.

From Brazil / India income tax refunds, as well as European VAT refunds, the company expects to collect a lump sum of approximately $50MM in early 2011, as well as roughly $15MM per year for the next 2-3 years. Combined with the company's current net cash position of approximately $15MM, and taking an overly conservative approach, even if you assume the business is cash flow breakeven for the next 2-3 years (management expects them to be nicely cash flow positive), they should have a net cash position of approximately $100MM by 2012, which represents just under half of their current equity value.

The Street seems to be largely missing the opportunity as it is an uncovered, small-cap company, that is finishing two-years of negative earnings and restructuring. Management has historically been inaccessible, but should now be expected to become more Street-friendly as the business turns around, and this should act as additional support for increasing the valuation. In addition, given this is a turnaround management team with significant equity stakes that recently re-upped their contracts but who probably will be looking to move on to the next opportunity as the turnaround plays out, there is a likely possibility management would be willing to sell the company should a buyer approach.  Furthermore, representatives of the family trust that hold the high vote shares were 13D filers and were trying to get the company sold before the current turnaround team was brought in, so it seems at higher prices they might be advocates for a sale as well.  Cash could be returned to shareholders in the form of highly accretive buybacks or potentially some interesting M&A opportunities.

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