Description

Titan International is the world leader in tires for Agriculture and Mining / Construction.  Though there is very little going right in their end markets today, at a different point in the cycle it is not hard to envision making a double in the stock from today’s price. 

Probably not a big surprise to anyone that the stock is down.  Agriculture, their largest end market, is not doing well.  Mining is making the agriculture business look robust.  Consumer, their smallest segment that doesn’t really move the needle, is performing OK. 

They have roughly $350m of debt in excess of cash.   

They have done acquisitions recently, in places like Europe, Latin America, and to show they have a sense of humor, Russia.  Those economies have taken a turn for the worse since the acquisitions were completed.  The acquisitions also added debt to the balance sheet. 

They have heavy exposure to commodity prices which they pass along to their customers.  As rubber and steel prices fall, margins get squeezed.  Customers are quick to note the falling price in commodities, but are never going to look forward to price increases.  Price cuts happen far faster than price increases.   

Completely uninterested yet?

Titan International is the leading manufacturer of wheels, tires, wheel and tire assemblies, and undercarriage systems and components for off highway vehicles. 

Agricultural Segment – Sold directly to OEMs, independent distributors, equipment dealers and Titan’s own distribution centers.  Agricultural tractors, forestry equipment, combines, skidders, plows, planters, and irrigation equipment all require wheels and tires that Titan produces. 

Earthmoving / Construction – Loaders, plows, graders, levelers, scrapers, dump trucks, haul trucks, backhoes, etc all require wheels and tires that Titan produces. 

Consumer – Light truck tires / wheels and trailer tires / wheels in Latin America and in Russia.  Also a few products for ATVs, golf carts, turf and golf applications.   

OEM customers include AGCO, Deere, CNH, Hitachi, Kubota, and Liebherr Group.  41% of sales are to OEM customers. 

Larger tires have higher margins.  They are selling less larger tires at the moment (think mining and big ag tractors), impacting margins negatively.  Large mining trucks and ag tractors aren’t exactly flying off the shelves at the moment.    

In 2012, Titan earned $2.00 of earnings on $1.8B of revenue with a 10% operating margin.  We are currently trading at 5x peak earnings.  Today, Titan has an operating margin of 0.2% for the first nine months of 2014, adding back an asset impairment and inventory writedown.  Gross profit was 8.1% of sales compared to 14.7% last year, and down from 16% two years ago.  I won’t go so far as to say this is the trough, but we are almost certainly closer to a trough than a peak.  I should also point out that while operating and net income have been lackluster, Titan keeps producing free cash flow, to the tune of $30m YTD.       

Contrary to popular belief, this is a very difficult business to break in to.  There are very few competitors.  Molds for tires, plant and equipment, supply chain, and distribution infrastructure would all require capital.  No one appears to be anxious to enter this business at the moment.  Inventory levels at the equipment dealers are a factor and they are working through this.  60% OEM and 40% aftermarket over the last few years.     

Ag, mining, and construction companies have severely cut back on maintenance capex.  Let’s face it, tires probably aren’t at the top of the list until they are at the top of the list.  It can be delayed, but it can’t be forgotten.  Perhaps we are now on the verge of some demand plus pent up demand. 

Titan has been on an acquisition spree as of late. 

2011 – Goodyear Tire & Rubber Co’s Latin American farm tire business.  Paid $100M

2012 – Planet Corp Group – Australia – Titan National

2012 – Titan Europe.  6.25 M shares of TWI ($122M) plus 5.6M for partial shares.               

2013 – Voltyre-Prom – A leading producer of agricultural and industrial tires in Russia.  Jan 2014 took interest to 99%.  Titan holds a 30% interest in the partnership.  Partnership paid $100M.

These acquisitions added revenue in the $300-$400m range, at the time of purchase, certainly not now. 

What is currently wrong:

1. Raw material costs (rubber and steel) have fallen, impacting margins because of delayed pass through. 

2. Ag and mining in general is in a downturn.  Look at iron ore, coal, wheat, corn, soybeans, etc.  If their customers aren’t making money, they are not buying new equipment.    

3. Margins at all time lows

The good news is that all of this can change.  Commodity prices aren’t going to be low forever, and tires do need to be replaced. 

It is not pie in the sky assumptions to see $2B in revenue with operating margins in the 8% range (they have been north of 10%).  Under that scenario, Titan would earn $1.48. Cash flow from operations would be somewhere in the neighborhood of $170M.  Cap Ex should run around $50M annually, for free cash flow of $120M. 

15x multiple X $1.48 = $22.  The stock is currently around $10.

12x multiple X $120 = 1440 / 54 sh out = $26

[The views expressed are those of the author and do not necessarily represent the views of any other person. The information herein is obtained from public sources believed to be accurate, reliable and current as of the date of writing.  The author will not undertake to supplement, update or revise such information at a later date.  The author may hold a position in the securities discussed.]

Catalyst

Passage of time for the cycle to play out.

Right size for an acquisition.