Description

Company Overview

TS Tech is the primary supplier of seats to Honda (Honda owns 22.6% of the company). It provides close to 80% of Honda’s seats globally and > 85% of sales are seats (other sales are derived from interior parts such as trims). 93% of sales are to Honda with a handful of Japanese companies and Volkswagen representing the remainder. We have very good visibility into TS Tech’s position on new models and we see TS Tech’s share remaining stable in the coming years. In the 03/15 fiscal year, roughly 16% of (net) sales will be generated in Japan, 47% in North America, 23% in China, and 13% in Asia/Europe (most significantly Thailand and the UK). In terms of operating profit, Japan will generate roughly 18% before corporate elimination, the Americas (almost all North America) 37%, China 37%, and Asia/Europe 7%.

TS Tech trades at 9x 03/15 EPS with approximately 35% of the market cap in net cash, implying it is < 6x P/E ex-cash. We see TS Tech as a 4% topline growth company (a bit below Honda unit growth) and > 7% bottom-line grower over the next several years at constant currency. The company trades at < 8x 03/18 and at that time will have > 60% of the market cap in net cash. TS Tech had reached a share price of ~¥4,000 yen but then sold off to ~¥2,200 (since rebounded to ~¥3,000) on Honda recall issues in the US, lower than expected growth in China and a collapse in Thai auto sales. This has resulted in modestly down operating earnings in the 03/15 fiscal year. Honda suppliers have been punished with low multiples. A range of other auto suppliers in Japan all trade in the 10-14x multiple range with an average near 12x, and this is with balance sheets without the net cash of TS Tech. Once momentum is reestablished at Honda and its suppliers, we see a quick revaluation.

Over the next year TS Tech could easily trade at 12x 03/16 consensus (we are slightly higher) for 35% upside. On a two to three year basis, we see 50-80% upside in our base to bull cases at 12x 03/18. This all assumes no further weakening of the Yen relative to the USD and RMB. A weakening of the Yen to 130 Yen/$ (and the same move against the RMB) would add 20% to our estimates. Shares can close to double (+85%) at 12x 03/18 at 130 Yen/$ without taking into account the cash.

To generate 25% downside the shares need to be on 7x consensus 03/15. They would then trade at book value with close to 50% of the market cap in cash. The risk-reward is very asymmetric at these levels. This is too cheap to ignore for what is a relatively stable auto parts supplier that stays profitable and generates cash through the cycle.

Investment Case

Honda is entering a strong product cycle where TS Tech is well positioned

Honda has had a tough year between recalls in the United States due to the airbag issue and a stale, expensive model lineup in China. Despite these troubles, Honda will still manage to grow production this fiscal year in the low single digit range (from 4.4m units to ~4.6m units). From here we expect a mild acceleration in Honda’s production as it unveils attractive full model reworks of its three main global platforms – Accord, Civic, and CR-V – and a new China specific sedan (the Crider) along with Chinese variants of various SUV platforms. We see a close to 6% CAGR in Honda’s unit production.

For the upcoming product cycle TS Tech is on every model except the Fit in China (it was chosen, instead, to focus on the new Crider). It has also gained back share on mini cars in Japan (the W-NGN) where it had previously ceded share (to its main competitor Tachi-S). Honda typically uses other suppliers to meet surge demand. As a result, upside to Honda’s estimates does not all flow through to TS Tech. In the future we do not anticipate major shifts in TS Tech’s market share. It is overinvesting D&A significantly by 2x this year and last and will continue to do so for the foreseeable future. The company is investing in expansions along with Honda (e.g., Mexico and China) and increasing its level of automation (to offset the standard down pricing in the industry). None of its competitors have the scale or reach of TS Tech. Discussions with Honda reveal they are pushing out suppliers that are unable to co-locate with Honda. A key example is Mexico where TS Tech is expanding in lock step with Honda.

We see topline growth of around 4% per year for TS Tech. This is just below our projected Honda unit growth as we allowing for some price erosion and mild share shifts. Honda suppliers are trading at a 2+ multiple point discount to other Japanese suppliers given concerns about Honda’s flagging sales. Any pickup in Honda sales and sentiment will redound to TS Tech’s benefit.

Margins will remain stable

Margins have improved in recent years from the 3-6% range (3% in in the depressed 03/10 fiscal year) to > 8%. Most of the margin improvement has been driven by North America where operating margins increased from 0-2% to > 7%. This margin expansion occurred due to TS Tech moving production from the US to Mexico. Margins in other regions have been within historical ranges, with the exception of Asia/Europe. There margins are down significantly this year due to the crisis in Thailand (auto sales are down 50%). This year margins will be ~8%, down from last year’s peak 8.6%. We see a rebound driven by some improvement in the Americas due to new models and recent productivity investments and a rebound in Asia/Europe from a depressed 5% back to 10% (below historical levels). Compared to other Honda auto suppliers these margins are at the higher end of the range but do not standout as unreasonable. On average Honda suppliers have margins > 7.5% with several suppliers > 9%. Honda’s margins have been between 6% and 7% in recent years but are expected to exceed 7% in coming years (historically margins were 7-9%).

As mentioned above, the company has been investing well above the level of D&A the past two years and plans to continue to do so over the next several years. In addition to new PP&E in low-cost areas, these investments have increased the level of automation in TS Tech’s factories. Furthermore, Honda continues to standardize the three main global platforms, which is helping it and suppliers to reduce costs.

There is considerable scope for balance sheet deployment

TS Tech has ¥76b in net cash on the balance sheet (¥2b in debt) versus a market cap of ¥207b. We estimate > 60% of the cash is held abroad and would face taxation if it were to be brought back to Japan. The company charges royalties from its Japan segment to the rest of the world and it has been trying to increase the royalty rate as a way of repatriating cash to Japan. Its main method of cash return has been dividends. It currently sports a 2.0% dividend yield. It’s target to increase its dividend payout to 20% of earnings, which would equate to a 2.3% yield. The company realizes it has considerable excess cash. It has not historically been willing to buyback stock as it does not want Honda’s share of the company to get much larger than the current 23%. We have heard that international investors have been pressuring the company to do more. Even with capex well in excess of D&A, we see the net cash balance getting to > 60% of the market cap. The company will be forced to either issue a special dividend or buyback stock. This would be a significant catalyst for the shares. The average auto part supplier trades at a 2+ turn multiple premium to TS Tech (depressed on Honda concerns), and we believe this gap would quickly close on any change in balance sheet management.

TS Tech can expand with other OEMs

As a byproduct of its heavy investment with Honda, Honda has given its blessing for TS Tech to expand with other OEMs. Currently in Japan, TS Tech only produces motorcycle seats for Suzuki, Yamaha and Kawasaki and car seats for Suzuki. Its first major win with a foreign OEM was the third row seat on the Volkswagen Touareg. Other opportunities have been slow to develop, but we believe some of the high capex can be explained by the company’s pursuit of new OEMs and platforms. The company does not list M&A as a key use of cash, but this might also be a possibility.

Catalyst

-Rebound in Honda sales in North America and China

-Stabilization in Honda sales in Thailand

-Stable to higher TS Tech margins

-Evidence of cash deployment at TS Tech