Value Investors Club / TENNECO INC (TEN)

Description

Investment Thesis

There is nothing unique about this analysis of Tenneco – no hidden assets, no creative view about a market

misunderstanding and limited new information from bdon99’s well-written report last year. Simply put, Tenneco

trades at a cheap multiple (~8x 2015E EBIT / ~7x 2016E EBIT), near a 52-week low and remains a secular growth

story. Management recognizes the cheapness and has accelerated its share repurchase plan.

Overview

Tenneco is a Tier 1 supplier of clean air and ride performance products and systems used in light vehicles (72%),

commercial trucks, off-highway and other vehicle applications (13%) and aftermarket (15%). The company’s market

positions are #1 or #2 in most regions.

The Clean Air division (69%* of revenue / 63% of EBIT) supplies products to reduce tailpipe emissions of criteria

pollutants and noise (mufflers and resonators). These products are analogous in many ways to pollution control

systems added to power plants. For example, Tenneco’s diesel particulate filters reduce particulate matter emissions

by up to 90% (when used with catalytic converters) and the company’s SCR (selective catalytic reduction) systems

cut nitrogen oxide emissions by up to 95%. Similarly, CO2 regulations have led to increasing demand for various

Tenneco components (manifolds, maniverters, modules, exhaust valves and other lightweight materials).

*Split of 69% - 56% light vehicle, 10% commercial truck and off-highway and 3% aftermarket.

The Ride Performance division (31%* of revenue / 37% of EBIT) includes shock absorbers, struts, vibration control

components and suspension systems. Tenneco manufactured over 94 million shocks and struts in 2014. These products

ensure the vehicle’s tires remain in contract with the road, specifically via control of vertical loads on tires (10K

explains it better). This segment exhibits some countercyclical trends due to aftermarket (~40% or revenues).

*Split of 31% - 16% light vehicle, 3% commercial truck and off-highway and 12% aftermarket.

In 2014, the company’s products were included on eight of the top 10 North American light truck models and nine of

the top 10 passenger car models in Europe. GM, Ford, Volkswagen, Daimler and Fiat represented 15%, 13%, 8%, 6%

and 5% of 2014 revenues, respectively.

From a geographic standpoint, revenues are split between North America (49%), Europe, South America and India

(37%) and Asia-Pacific (15%).

Drivers

-SAAR (North America, Europe, South America, India and Asia-Pacific)

-Commercial and off-highway production; European production remains below 2007 levels (9%)

-Focus on India, China and Thailand

-F-150 (3Q-4Q 2015 benefit)

-FX (strong dollar continues to impact performance)

-Increasing content per vehicle and penetration of adjacent markets

-R&D spending ($126, $144, $169 million in 2012-2014) + expenses reimbursed by customers

-Strict vehicle emission standards + mandated diesel emission control and noise regulations

-Added regulations in US and Europe

-Emerging markets moving towards western standards

-Aftermarket tied to fleet size, age and miles driven offset by improved longevity of parts

-Raw material prices, principally steel

-Anti-trust investigations in Europe

Capital Structure
AR Securitization	$237
Bank Debt & Other Debt	$455
6.875% Sr Nts	$500
5.375% Sr Nts	$225
Total Debt	$1,417
Net Debt	$1,165
Minority Interest	$71
Market Capitalization	$2,808
Enterprise Value	$4,044

Both bonds trade above par. There is an opportunity to refinance the 6.875s when they become callable in December

as they trade in the 104.5 area. Potential savings of $9 million (pre-tax) are not factored into my analysis.

Financials	2012A	2013A	2014A	2015E	2016E
Revenue	$7,363	$7,964	$8,420	$8,225	$8,636
EBITDA	$648	$707	$785	$780	$860
EBIT	$443	$502	$577	$560	$635

Clean Air Revenue	$4,926	$5,444	$5,811
Clean Air EBIT	$334	$381	$418

Ride Revenue	$2,437	$2,520	$2,609
Ride EBIT	$176	$204	$248

EBITDA and EBIT are adjusted to add back restructuring charges and other nonrecurring expenses. Certainly an

argument can be made that restructurings are a way of life for auto suppliers. The segment EBIT is pre-corporate

allocation. Capex + WC typically exceed D&A so cash flow is lower than earnings.

Growth in clean air subsystem content should exceed vehicle production growth due to increasing environmental

standards. The Ride Performance division does not have the same content story and should grow more in line with

vehicle production, with expense leveraging through increased volumes.

More specifically as it relates to the Clean Air unit, new light vehicle regulations (Tier 3 / Euro 6c) starting in 2017

and phasing in over five years in North America and Europe should provide some tailwinds. China, despite the

slowdown should still be a secular growth story due to its sheer size and pollution issues (added focus on particulate

matter via diesel particulate filters), and as environmental standards (NS4 - only ~45% in compliance) are increasingly

enforced. Beyond China, emerging markets should continue to catch up to Western regulation standards.

From a commercial and off-road perspective, capacity utilization at Tenneco is in the 50% range, so there is plenty of

incremental margin potential when the cycle turns as only material and labor are required to support additional

volumes. The company has significantly outperformed industry production in the commercial and off-highway

business due to added content on several programs. For example, in 2Q, management estimated global OEM

commercial and off-highway production declined 25% yoy, whereas Tenneco value-add in this space declined only

4% (constant currency basis). Beyond this, locomotive, marine and stationary engine applications are parallel

businesses that are being targeted and represent further upside.

On the margin front, there is upside from a few items –1) Previous restructuring programs which should eliminate

costs (further in 2016), 2) start-up costs associated with new clean air plants (US & Poland) and an expansion (UK)

should abate as the plants ramp up for incremental business and 3) Discontinuance of Marzocci business ($7 million).

Valuation

At current prices, the shares trade at 5.3x/4.5x EBITDA (2015E/2016E), 7.3x/6.1x EBIT and 10.6x/8.5x EPS.

EBITDA/EBIT multiples are 0.3x-0.9x higher after stripping out minority interests. This compares to historical

multiples of 5.0x-5.5x and PE in the ~12x area. Industry peers trade at 6x/5x EBITDA and 11x/9x EPS.

If multiples revert to a more normalized valuation, I believe shares can appreciate to low $60s or 30%+ above current

levels in 2016. Add to this a recovery in commercial and off-road (down 50%) and margin improvement in Europe

and upside is even greater.

Additionally, management recently mentioned potential inorganic growth opportunities. Since leverage is at the low

end of target levels and management believes the shares are undervalued, I expect M&A to be debt financed and

highly accretive.

In January 2015, the Board approved a $350 million share repurchase plan over a three year period. As a result of the

weak share price, the company accelerated this plan and expects to complete it by the end of 2016. At current prices,

this represents 12% of outstanding shares.

Risks

-Missing 2H 2015 guidance

-Presentation RBC conference noted weaker China (13% of 2014 revenues) since 2Q call

-FX (Euro, RMB, Real)

-Loss of any OEM customers; pricing pressure; reduced content on platforms

-Alternative technologies (electric vehicles)

-Anti-trust penalties

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Catalysts

-Share buybacks

-Acquisition (low end of target leverage ratio)

-Value is a catalyst?

show sort by

			2015	2016
Price:	46.18	EPS	4.35	5.48
Shares Out. (in M):	61	P/E	10.6	8.5
Market Cap (in $M):	2,808	P/FCF	16.5	11.2
Net Debt (in $M):	1,165	EBIT	560	635
TEV (in $M):	4,044	TEV/EBIT	7.3	6.1