Value Investors Club / TOWER INTERNATIONAL INC (TOWR) (TOWR)

Description

INVESTMENT THESIS

Tower International (“Tower” or the “Company”) is an auto parts supplier focused on metal body structures, chassis, suspension and lower vehicle systems for OEMs. The Company trades at a substantial and unwarranted discount principally due to its legacy post-reorg profile. Cursory and stale research coverage overlooks several favorable recent developments that have meaningfully improved the business. The implied upside if TOWR traded in-line with the auto supplier sector is +100% from the current price. At 4.7x EV/ EBITDAP and 8.3x P/E with over a 10% current FCF yield and a 17% 2016 FCF yield, the stock is very attractive on an absolute basis as well. Near-term catalysts include: 1) revenue growth and margin expansion from recent business wins; 2) improved balance sheet and potential share repurchases from JV sale proceeds and FCF; 3)investor awareness that TOWR is no longer an over-levered, slow growth business and has limited exposure to aluminum; and 4) potential sale.

COMPANY OVERVIEW & RECENT DEVELOPMENTS

Background: Tower filed for bankruptcy in 2005 following a series of debt financed acquisitions that over-extended its balance sheet. While in bankruptcy, Cerberus took over, replaced the management and put in place the current team. The Company emerged in 2010. Cerberus subsequently sold the last of its shares in 2013.
Tower’s primary customers are Ford (22% of 2014 rev), VW (15%), Chrysler (14%), Volvo (9%), Nissan (8%), Fiat (7%), Daimler (6%) and Toyota (5%). The Company is a direct supplier for 170 models to vehicle types as follows: small cars (31% of 2014 rev), large cars (28%), light trucks (18%) and NA framed vehicles (18%). Its larger platforms include: Ford Focus, Ford F-Series, Ford Explorer, Jeep Cherokee/ Durango, Jeep Wrangler, Honda Accord, Toyota Camry and Volvo V40/S60/XC60. In 2014, NA accounted for 52% of rev, Europe 37%, Brazil 7% and Asia 4%. In Q1’15, Tower generated 70% of its EBITDA in the Americas (>90% of which was in the US) and 30% internationally (>90% in Europe). The Company currently has 27 facilities (US-12, Europe-10, Brazil-3, China-2, Mexico-1).
Tower’s structural body products (59% of rev) include rails, body pillars, sills and exterior body components such as hoods, doors, panels and fenders. Tower’s complex assemblies (25% of rev) include door-to-pillar and floor pans. Its lower vehicle frame parts (16% of rev) include chassis, cradles and some full frames. These components are structurally critical to the safety and performance integrity of a vehicle.
New Business: On the Q1 call Tower announced it had just won a contract that will start later this year and is projected to contribute $70M of revenue next year with ongoing annual revenue of $70-$140M thereafter. This is the third large win for Tower since last February. These programs are projected to collectively contribute $270-$340M of incremental annual revenue and $40-$50M of annual EBITDA. This equates to a 25% increase off the current EBITDA base. It should also be noted this is higher margin (15% EBITDA) business than Tower’s 10% historical margin. These programs are budgeted to require $100-125M in launch costs and capex implying an approximately 40% ROIC.
Asset Sales: Tower is selling two of its Chinese JVs for $95M which equates to 6.3x EBITDA. These transactions enable them to exit a highly competitive and less stable market at a multiple that is two turns higher than where TOWR currently trades. The Company expects to receive $43M after-tax once the transactions close in Q3. The proceeds will be repatriated to the US with the stated intent of paying down debt.
The first JV is a 60% owned supplier to VW in China being sold to a strategic. The second is a 51% owned parts manufacturer for Geely and Fiat. Tower also has a third Chinese JV (80% owned) which generates approximately $75M revenue and an estimated $8M in EBITDA. This will be the Company’s only remaining asset in Asia so it appears likely this non-core entity will be sold as well. If acquired at the same multiple as the other JVs, the implied EV would be $50M.
Improved Balance Sheet: The structure of Tower’s leverage is favorable, primarily consisting of a $420M L+300 (with a 1% LIBOR floor) term loan maturing in 2020. The Company has been consistently paying down debt from FCF and asset sales, enabling Tower to reduce its leverage ratio (net debt/ LTM EBITDA) from 2x last year to 1.5x currently and is expected to decline to 1.4x by year-end.
Outsourcing Trend: TOWR is benefiting from the ongoing secular shift of outsourcing by the OEMs. Since 1995 the amount of structural metal components and assemblies thatare outsourced has doubled but it is estimated that OEMs still produce ~60% internally. Two of the three new wins are from OEM moving work externally. Outsourcing is driven by OEM’s higher cost structure and desire to reduce capex and increase flexibility. Tower’s labor cost is 20-30% less than that of the OEMs, not to mention the union factors OEMs must contend with if they want to reduce headcount. The components that TOWR produces are very heavy, thus close proximity to the OEM’s factory is critical. Transportation expenses reduce the likelihood of losing business to foreign competitors in lower cost jurisdictions. In several instances Tower actually co-locates in the OEM’s facility. Being embedded in the supply chain makes switching costs high. Production agreements typically last as long as a vehicle model is manufactured. Tower is a supplier to over 170 different models, mitigating concentration risk.
Tower’s primary competitors are Martinrea (MRE.TO), Magna (MG.TO) and Gestamp. The Company’s exceptionally high performance (11/1M parts defects in 2014) has positioned it well to continue to win new business and drive above-industry organic growth. For what it’s worth, Tower was also recently ranked #1 on the 2015 Forbes list of “Most Trustworthy Companies” in NA.

MANAGEMENT

CEO Mark Malcolm has a reputation as a straight shooter in the auto industry. He was brought in by Cerberus when the Company was in bankruptcy. Malcolm was formerly at Ford in various financial roles (Controller of Ford Motor Credit, Director of supplier purchasing, CFO of Visteon, etc.). He is an industry veteran who has a close relationship with the OEMs and appears to be well regarded and trusted by them. Company guidance is typically conservative and measured. His cap allocations decisions have been sound and he has shown a clear willingness to divest non-core assets and create value. Selling TOWR is likely the end plan. If the stock does not perform, that outcome may come sooner. Malcolm owns 3% of S/O, insiders collectively own 4%.
CFO Gouin worked with Malcolm at Ford. Several other members of the team including the COO also previously worked at Ford/ Visteon and all came on following the bankruptcy.

FINANCIAL PERFORMANCE & DRIVERS

Revenue and EBITDA Growth: Management’s 2015 revenue guidance of $1.95B is predicated on $100M net new business, flat pricing, +2% NA volumes, flat Europe volumes (IHS estimates) and a 1.05 EUR/USD exchange rate. This implied 5% decline in revenue vs 2014 is primarily due to currency translation and the Italian facility sale. These exchange rate assumptions are conservative. If the current 1.14 EUR/USD rate holds then revenue will be ~$50M higher. The Company is projecting an organic NA revenue CAGR of 6-8% through 2018. Again this appears quite conservative as the new contracts alone should result in +10% annual NA growth. 2015 EBITDA guidance of $190M is based on a neutral cost structure. As the higher margin new contracts ramp next year EBITDA should grow to $220M and to $245M in 2017 assuming no further wins and flat contribution from the existing work.
Cost structure: 75% variable/ 25% fixed; 60% materials (steel, al, etc.), largely passed along to customers; 15% direct labor, 20% fixed overhead and 5-6% SG&A.
FCF Profile: Mcapex runs at $80M. TOWR has $263M in US NOLs ($168M Fed, $75M state) and will not begin paying US taxes until 2018-2019. Current year FCF will be burdened by $30M of upfront spending for new business, $25M of which is tooling in working capital that will be reimbursed by the customer once production begins. Only a portion of these costs will benefit 2015. Adjusting for these upfront costs, TOWR should generate $60M of levered FCF this year and close to $100M next year.

CATALYSTS

Increased institutional engagement and awareness that TOWR is no longer an over-levered, slow growth business. Management should be able to help the sell-side focus on this disconnect in the near-term.
The Company has expressed an interest in supporting the stock’s frequently erratic price swings with buybacks. Once capital has been deployed to support the new business programs this year, TOWR will be in a logical position to initiate such a share repurchase program.

VALUATION

At the current stock price of $28 per share, TOWR has a market cap of $598M (21M fd s/o) and EV of $951M ($463M in debt and cap leases, $113M in cash excluding disc ops cash, $45M pension liability and $43M after-tax cash to be received from the JV sales). This equates to 4.8x forward EBITDAP of $200M, 2-3 turns of EBITDAP less than its closest peers at 6-7.5x (MRE.TO and MG.TO), the auto supplier industry average multiple of 8.2x and TRW’s recent sale to ZF Friedrichshafen for 7.5x. Critics and sell-side’s valuations for Tower are predicated on outdated information. They contend TOWR should trade at a discount due to its peers due to: 1) “lack of secular growth themes” and 2) higher financial leverage. They are anchoring their valuations on historical post-crisis trading ranges which do not reflect the current reality. Over the last year, the Company has won three large contracts that when ramped will add $270-340M in annual revenue beginning in Q4. This now makes TOWR’s growth profile more attractive than the industry average. Meanwhile the Company’s debt pay down has reduced its leverage ratio from 2x last year to 1.5x currently and is expected to decline to 1.4x by year-end. Contrast this with Martinrea’s leverage ratio of 3x with equivalent organic growth as TOWR, Magna with less than a turn of net debt but is expecting revenue to decline in 2015 and the industry average leverage ratio of 1.8x. Tower generates a 24% ROIC vs the peer average of 23%. Given its strong growth prospects and focused operations, one could argue TOWR should trade at a premium to its peers. Regardless, the current 7-8x peer multiple implies $50-60 per share for TOWR, 80-115% upside to current.

On an absolute basis, TOWR is a sound business at a low quality business price. The Company is trading at a 10% FCF yield (unlevered) and a 17% FCF yield based on 2016 guidance with a 22% ROIC. Even absent any hard catalysts, deployment of excess cash flow into debt pay down and high returning programs will drive organic growth in the equity. TOWR continues to focus its operations on its NA core and away from the more turbulent Asian market. As the existing disconnect between perception and reality becomes more apparent it should lead to meaningful upside.

RISKS

Tower has not had any exposure to the recent headline recalls, but may become subject to potential future recalls.
Even if auto sales plateau or trend lower, TOWR should be able to offset these volume declines with new business as OEMs continue to outsource. In the event of a more protracted pullback, TOWR has the ability to cut capex to below $50M and maintain ample FCF to service its debt. In a 2009 scenario, TOWR’s EBITDA downside would be $140M based on the current contract mix.

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

Catalyst

1) revenue growth and margin expansion from recent business wins

2) improved balance sheet and potential share repurchases from JV sale proceeds and FCF

3) investor awareness that TOWR isno longeran over-levered, slow growth business andhas limited exposure to aluminum

4) sale

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			2015	2016
Price:	28.05	EPS	3.36	0
Shares Out. (in M):	21	P/E	8.3	0
Market Cap (in $M):	600	P/FCF	9.9	5.8
Net Debt (in $M):	353	EBIT	0	0
TEV (in $M):	953	TEV/EBIT	0	0