There is no doubt that we are in the midst of a global mining boom. More recently it has become apparent that an agricultural boom is also afoot (take a look at the DE or AG charts). In addition, outside of the flailing US housing market, we are looking at a surge in global construction, led by the developing economies of Eastern Europe, Latin America and Asia. These growing industries need big machinery, and these machines need specialized wheels and tracks. Enter Titan Europe (“TSW”), one of a handful of global wheel and undercarriage suppliers to OEMs such as Caterpillar, John Deere, Case New Holland and the general aftermarket. Despite TSW’s integral position in the value chain, it trades at a substantial discount to these companies at just 5.5x 2007E EBITDA and 10x 2007E EPS (which approximates free cash flow per share). At a comparable valuation to peers, TSW shares would trade at more than twice their current price, as the following chart illustrates:

 

 

Titan Europe manufactures wheels, undercarriage components and assemblies for tracked and wheeled off highway vehicles. Such vehicles include those used in the agricultural, construction and mining industries. Additionally, the company distributes third party tires in its markets and holds a 35.9% stake in Wheels India (NWHL IS), which produces 2/3 of the domestic supply of steel wheels in India (both on and off highway). TSW entered the undercarriage business through the acquisition of Italtractor ITM (“ITM”) in December, 2005. You may have seen TSW briefly mentioned in two VIC write-ups on their former parent, Titan International (“TWI”).

 

 

All of TSW’s end markets, outside of US construction, are better today than they were 6, 12 or 24 months ago. While first half 2007 sales were up only 4%, North American sales were down over 25% due to a unit slowdown and a weak dollar. If you back out the North American business, the balance of TSW’s sales, amounting to ~85% of sales going forward, was up 13%. This international growth opportunity is supported by CNH’s full year 2007 industry unit sales forecast, released on October 23, 2007:

 

 

Likewise, CAT recently guided to full year 2007 North American unit decline of 12% and international growth of 25%.

 

The following is the breakdown of Titan Europe’s business over the last twelve months:

 

 

Based on this breakdown, we can see that exposure to North American construction is now less than 20% (and will be less than 15% in 2H2007). All other facets of the business are firing on all cylinders. The slowdown in US construction in 2007 will be more than offset by strength internationally. Overall construction growth will be accentuated by a resurgence in agricultural spending as farmers around the globe reap the rewards of higher prices from this season’s harvest. Lastly, strong demand for new mining equipment in response to ever higher commodity prices should enable this segment to continue posting double digit growth.

 

While we are conservatively assuming just 5% overall growth next year, the declining importance of TSW’s North American operations combined with continuing international strength could drive 2008 sales growth north of 10%.

 

 

Company Guidance:

Management expects second half 2007 sales growth to exceed that of 1H2007 (while trailing the first half in nominal terms due to European summer holidays) and operating margins to be up to 100bp higher. Reported tax rate will be 36% going forward, and capex should approximate depreciation. On the working capital side, management expects inventory turnover to improve and DSOs to end the year around 2006 levels. These assumptions would provide £5-10m in additional cash flow in the second half. As for 2008, the company has a EUR 50m bond maturing that was acquired in the ITM deal which has a 12% coupon. This will be paid down at maturity on January 22, 2008 with an existing bank facility at approximately a 5% rate, which will save the company £2.5m annually.

 

Synergies:

Titan Europe completed its acquisition of ITM at the end of 2005 which meaningfully expanded TSW’s operations. The company has realized £5m in annualized synergies through the first half of 2007, with incremental synergy expectations of £5m in the second half of 2007, £5m in ’08 and £5m in ’09 based on the following initiatives:

In order to be conservative, our estimates solely reflect incremental synergies per company guidance on top of 2006 actual EBITDA results, despite 5%+ top line growth (i.e. we are implicitly assuming slight core margin deterioration outside of synergy realization). Note that an incremental £1m ebitda in 2008 adds 3% to EPS.

 

Currency:

TSW reported 1H2007 sales growth of 3.5%, but at constant currency, that growth was really 6.5% (again, despite the massive downturn in the US business). The recent strengthening of the Euro vs. Sterling in the past month or so should actually aid translation for the second half of the year, and more than offset any further weakening of the US dollar.

 

NOL:

The company has a EUR 40m in operating loss carry-forwards from the ITM acquisition. Half of these losses are in Italy. In order to accelerate the use of these tax losses, the company has recently moved their Titan Italy subsidiary under ITM Italy. This should decrease cash tax payment for another couple of years, but we are not incorporating these savings into our analysis.

 

 

Wheels – Titan Europe is one of just a handful of companies with the ability to manufacture large wheels for off-highway vehicles. TSW’s primary market is Europe, with growing business in Australia and South America. The company does not currently have a wheel business in North America due to the US being the home of their former parent, Titan International. TWI has chosen to concentrate their wheel business solely on the North American market, leaving the rest of the world to Titan Europe. So within its markets, TSW really has just one competitor, GKN Plc (GKN LN). While just ~5% of total company sales, GKN’s off highway wheel business is ~£200 million in annual sales vs. TSW at £135m. However, GKN has no relationship with TWI, so they do in fact compete in the North American market, where they receive a large portion of those sales. TSW believes it commands a market share upwards of 60% in the European market. Likewise, it is the dominant off highway wheel manufacturer in Turkey and Australia, and owns a minority stake in the only off highway wheel manufacturer currently located in India. The only other global player with scale is Topy Industries in Japan, which sells only to the Asian and North American markets.

 

Undercarriage – With the acquisition of ITM at the end of 2005, TSW became the second largest player in fully assembled undercarriages and components for off highway crawler vehicles. ITM estimates it has ~30% global OEM market share, behind market leader Berco (an Italian unit of ThyssenKrupp) which commands ~50% share. The remaining market consists of small regional players, and CAT, which produces undercarriages internally for its own needs.

 

This dominant global position should both insulate the company from a slowdown in any one market and make the company an attractive candidate for further industry consolidation. Logical buyers of the company would be TWI and GKN. TWI would be able to return to the international market, while GKN would quickly become the global leader (and this high margin segment would become a more important piece of the overall company). It would also make strategic sense for Berco to pursue a deal, but that would more than likely face EU regulatory issues.

 

Titan Europe has a dominant position in the international marketplace for off highway wheels and undercarriage assemblies. In most of its markets TSW faces only one legitimate competitor. TSW will be able to use this market leadership both to take advantage of the current global growth in machine sales and to expand its current business through entrance into new markets and new product lines. We have seldom come across an industrial company with these characteristics that trades at such a substantial discount to both peers and customers.

 

The first thing you will notice looking at TSW is that its stock has done absolutely nothing for two years, while the share prices of its peers on average have more than doubled. We believe there are a few main reasons for this stagnancy:

1989 – Joint Venture formed by Mike Akers (current CEO of Titan Europe) and Titan International.

1995 – JV becomes wholly owned subsidiary of TWI and acquires two manufacturing companies in UK and Germany.

1996 – Titan Europe acquires Titan France

1998 – TWI transfers Titan Italy to Titan Europe

1999 – Titan Europe acquires 35.9% stake in Wheels India and Board representation

2003 – Titan Europe acquires Titan Australia

2004 – Titan Europe acquires Andy’s in Australia

March 2004 – TWI sells 71% interest in Titan Europe through IPO on AIM exchange in London

September 2005 – Joint Venture agreement signed with Turkey’s largest OTR wheel manufacturer JANTSA to provide low cost manufacturing for continued expansion throughout Eastern Europe, the former Soviet Union and the Middle East.

November 2005 – Titan Europe acquires Wheels and Rims Engineering in Australia, including patented Outside Vertical Mount (OVM) wheel design for the global mining industry; this design enables mining vehicle operators to save up to half a day on rear axle tire changes.

December 2005 – Titan Europe acquires ITM, moving the company from a pure wheel manufacturer into undercarriage frames, components and complete assemblies for crawler vehicles (using tracks as opposed to wheels). Acquisition expands market presence to South America and China.

March 2007 – Titan Europe acquires Aros Del Pacifico, the leading manufacturer and distributor of mining wheels in Chile and Peru. Goal to introduce OVM wheels to South American mining market utilizing manufacturing at Aros Del Pacifico and sales force at ITM in Brazil.

 

 

The stock is cheap using our conservative expectations for both top line growth and cost reduction capability. Industry growth outside of North America is working in TSW’s favor, and cost reduction targets appear reasonable. If one makes more aggressive assumptions on industry growth or cost savings, considerable incremental gains in financial performance are likely, translating into a much higher share price. We recommend the purchase of Titan Europe shares at the current discounted valuation.