Titan Europe Plc TSW LN
October 30, 2007 - 1:01pm EST by
lindsay790
2007 2008
Price: 2.25 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 188 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Titan Europe Plc: BUY
(Ticker: TSW LN; Recent Price: £2.25; Market Cap: £188 mm)

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:
 
 
2007E
2008E
2009E
 
 
 
 
EBITDA - Capex
36.3
42.7
46.8
 
 
 
 
Multiple
10.0x
10.0x
10.0x
Peer min 10x (median 16x, mean 20x)
Implied Price per Share
3.18
4.15
4.87
 
 
 
 
Upside Potential
42%
84%
116%
 
 
 
 
 
 
 
 
 
 
 
 
EPS (equivalent to FCF per share)
0.22
0.29
0.32
 
 
 
 
Multiple
14.0x
14.0x
14.0x
Peer min 14x (median 18x, mean 20x)
Implied Price per Share
3.14
4.03
4.47
 
 
 
 
Upside Potential
40%
79%
99%
 
 
 
 
 
 
 
 
 
 
 
 
Book Value
161.0
177.9
196.6
 
 
 
 
Multiple
2.0x
2.0x
2.0x
Peer min 2x (median 4x, mean 4x)
Implied Price per Share
3.84
4.25
4.69
 
 
 
 
Upside Potential
71%
89%
109%
 
 
 
 
* Peer group includes TWI, GKN LN, CAT, CNH, KMTUY, TEX, DE, AG, KUB, BUCY and JOYG
 
 
 
 
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”).
 
Why is TSW a great investment opportunity?
 
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:
 
 
World
North America
Western Europe
Latin America
Rest of World
Agricultural Tractors
0-5%
0-5%
0-5%
35-40%
(0-5%)
Combine Harvesters
15%
5-10%
(0-5)%
70-75%
15-20%
Light Construction
10%
(10-15)%
10-15%
30%
25-30%
Heavy Construction
10-15%
(10-15)%
15-20%
35-40%
25-30%
 
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:
 
Division
 
 
Market
 
 
Destination
 
Wheels
35.5%
 
Agricultural
19.8%
 
United Kingdom
6.0%
Undercarriages
64.5%
 
N. American Construction
18.3%
 
Continental Europe
55.9%
 
 
 
International Construction
43.9%
 
North America
18.3%
 
 
 
Mining
17.0%
 
South America
4.3%
 
 
 
Other
0.9%
 
Rest of World
15.5%
 
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%.
 
Results & Projections
 
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:
  1. Manufacturing and overhead synergies – company has shut down two factories (one each in Italy and Germany) and consolidated offices in several countries
  2. Consolidated buying – TSW now buys twice as much steel, and will get better terms for it
  3. Cross selling opportunities – while TSW and ITM share a couple of key customers, most are mutually exclusive, meaning they are selling either wheels or undercarriages, but not both – but why not both?
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.
 
 
2006
1H2007
2H2007E
2007E
2008E
2009E
Income Statement (in £ millions)
 
 
 
 
 
 
Revenues (excluding JV)
368.0
199.8
184.4
384.2
403.4
423.6
% Growth
4.1%
3.5%
5.4%
4.4%
5.0%
5.0%
 
 
 
 
 
 
 
EBITDA (excluding JV)
44.4
25.4
25.9
51.3
58.8
63.8
% Growth
 
8.3%
23.8%
15.6%
14.6%
8.5%
EBITDA Margin
12.1%
12.7%
14.1%
13.4%
14.6%
15.1%
 
 
 
 
 
 
 
Net Income from Recurring Operations
10.9
9.3
9.5
18.8
24.1
26.8
% Growth
 
69.7%
75.9%
72.8%
28.1%
11.1%
Earnings Per Share
0.133
0.111
0.113
0.225
0.288
0.320
 
 
 
 
 
 
 
Cash Flow and Valuation
 
 
 
 
 
 
Cash From Operations
40.6
26.4
26.7
53.1
60.3
65.3
Changes in Working Capital
(16.8)
(9.6)
6.6
(3.0)
0.0
0.0
Cash Interest Paid
12.9
5.2
4.3
9.5
6.5
6.5
Cash Taxes Paid
4.7
0.9
5.3
6.3
13.6
15.1
Cash Tax Rate
31.3%
6.1%
36.0%
20.7%
36.0%
36.0%
Net Cash Flow from Operations
6.2
10.7
23.6
34.3
40.3
43.7
Capex
13.0
7.5
7.5
15.0
16.1
16.9
Free Cash Flow
(6.8)
3.2
16.1
19.3
24.1
26.8
FCF Yield
 
3.4%
10.2%
10.2%
12.8%
14.2%
 
 
 
 
 
 
 
Dividend
3.1
3.3
1.8
5.1
7.2
8.0
Payout Ratio
28%
36%
19%
27%
30%
30%
Dividend Yield
 
2.6%
 
2.7%
3.8%
4.3%
 
 
 
 
 
 
 
Cash
17.0
25.8
40.1
40.1
57.0
75.8
Debt
137.9
147.5
147.5
147.5
147.5
147.5
Net Debt
120.9
121.6
107.3
107.3
90.4
71.7
Investments (mostly Wheels India)
10.7
11.3
11.3
11.3
11.3
11.3
Enterprise Value
298.8
298.9
284.6
284.6
267.7
249.0
 
 
 
 
 
 
 
P/E
17.3x
12.8x
10.0x
10.0x
7.8x
7.0x
EV/Revenue
0.81x
0.80x
0.74x
0.74x
0.66x
0.59x
EV/EBITDA
6.7x
6.4x
5.5x
5.5x
4.6x
3.9x
EV/EBITDA - CapEx
9.5x
9.6x
7.8x
7.8x
6.3x
5.3x
Price/Book
1.3x
1.2x
1.2x
1.2x
1.1x
1.0x
 
With Whom does Titan Europe compete?
 
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.
 
So why has the stock gone nowhere?
 
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:
  1. Titan Europe currently trades on the junior varsity AIM exchange in London and has little analyst coverage. This has led to an extremely marginal following, with 50% of shares locked up by five 5%+ institutional holders. These issues have led to a dearth of liquidity outside of large institutional block trades through the company’s broker (Seymour Pierce).
    • The company is expanding its brokerage relationships and will soon list on the London Stock Exchange. TSW recently adopted IFRS reporting with Interim 2007 results which was its last hurdle to a formal listing on LSE.
  2. Ivano Passini, the former head of ITM, resigned from the Board on November 3, 2006 per the recommendation of the remaining directors. His 8% personal holding became a massive overhang on the shares.
    • Earlier this month, Passini sold out of his entire position over two trading days in block placements to existing investors.
  3. Since the ITM acquisition, working capital management has proved an elusive concept.
    • We give the company a mulligan on 2006 results as they transitioned to new products and additional markets while attempting to consolidate both corporate and manufacturing overhead in Europe. However, the increase in working capital in their interim 2007 reporting period was disappointing, although explainable. Of the ~£9m increase, £5m can be ascribed to excess inventory in the US due to the abrupt slowdown in the construction market and “several million” was due to pre-buying steel ahead of second half price increases.
A Brief History of Titan Europe
 
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.
 
Risks
  • Titan International could begin to sell down its stake, creating another overhang roughly twice as large as that of Passini. TWI has stated that it has no intention of selling its stake anytime soon as management sees TSW as a great long-term investment and TWI has no need for the cash (note that TSW CEO Mike Akers was recently placed on TWI Board, while TWI CEO Maury Taylor is currently Chairman of both TWI and TSW).
  • European manufacturing is highly unionized. Company has not had a strike in recent years, but this remains a risk. The union presence also limits TSW’s ability to shut down capacity should the industry experience a downturn (note that the company was able to close down a unionized ITM facility in Italy within 8 months of the acquisition, so management does have experience).
  • Currency – company reports in Sterling, generates around 75% of sales in Euros vs. 60% of costs; remaining costs/sales in GBP, USD, AUD and BRL.
  • Raw materials / Commodity prices – the largest cost for the company is obviously steel, which it is able to pass through to customers on a 3-6 month lag; also exposed to corn and wheat prices, which are currently driving the boom in new agricultural machinery and base metals prices, which are driving the growth in mining activity.
  • Import pressures – company acquired minority interest in Wheels India to import Indian OTR wheels into the European market, which has not been a competitive issue to date. Both quality issues and large size/weight of these wheels has prevented any large scale exporting from low cost Asian countries to date, but the company is starting to see small scale exports of undercarriage components coming out of China, but not complete assemblies, which is its main business.
Catalysts
  • Formal listing on London Stock Exchange – company is currently pursuing listing and it should be completed by year end. Last hurdle to listing was a move to IFRS, which was completed with interim 2007 results this past summer.
  • A listing on the varsity exchange will also expose TSW to European income investors, as shares currently boast a 2.7% dividend yield, which should grow to almost 4% in 2008 at a constant payout ratio.
  • Incremental analyst coverage – once listed on LSE, management believes they will have coverage picked up by several large investment banks, which should increase the company’s investor base.
  • New OEM contract for OVM mining wheels – A large OEM is currently testing OVM wheels which enable mining workers to change inside rear tires without taking off outside wheels first, dramatically increasing efficiency; could be a $40m opportunity in 2008.
  • Realization of planned synergies – company looking for £10m cost savings in 2007 (£5m already realized in the first half), with an incremental £5m in 2008 and 2009.
  • Maturity of Eurobond in January 2008 – company acquired this 12% debt with ITM acquisition, which will be replaced with 5% bank debt (already in place) at maturity early next year.
  • Normalization of working capital – ITM was not a financially healthy company at the time of acquisition, so it has taken more time than expected to normalize working capital accounts, but company plans to be back to pre-deal turns by end of this year. A return to those levels could add up to £10m in cash flow in the second half.
Bottom Line
 
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.

Catalyst

* Formal listing on LSE
* Further dividend increases (current yield is 2.7%)
* Incremental analyst coverage
* New OEM contract for OVM mining wheels
* Realization of ITM acquisition synergies
* Replacement of 12% Eurobond with 5% bank debt in Jan '08
* Normalization of Working Capital
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