Wabco WBC
December 30, 2007 - 11:56pm EST by
nha855
2007 2008
Price: 49.75 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 4,414 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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Description

Public Market Overview   Key Fin 2006 2007 2008 Key Multiples 2007 2008
Stock Price as of 12/30/2007 $49.75 Sales 2,015 2,335 2,639 EV/EBIT 11.8x 10.1x
FD Shares 67.1 EBIT 248 288 336 EV/Sales 1.5x 1.3x
Market Cap 4,414 EPS $2.05 $3.06 $3.81 P/E 16.3x 13.1x
Net Debt 40 FCF 150 181 200 P/Book (current) 5.7x
EV 3,390
Ownership       Returns   2007 2008
% of Insider Ownership NA ROTC 97.2% 97.5%
% of Short Interest 2% FCF Yield 6% 7%
RECOMMENDATION
WABCO is a BUY. I believe WABCO’s intrinsic value is $71, which translates to 43% upside. I believe the risk/reward range is between $46 (8% downside) and $80 (61% upside).
 
THESIS
I believe WABCO is a BUY for the following reasons:
1.       WABCO is a market leader in an industry with high barriers to entry
2.       WABCO is well positioned for growth due to positive secular trends and new market opportunities (presenting additional revenue sources and potential for margin expansion)
3.       WABCO is attractively valued – inexpensive on absolute valuation (EV/EBIT multiple and DCF), inexpensive to its history (its parents’ history, in this case), and inexpensive to peers. Given its high growth (double digit EBIT growth) and stellar ROTC (~100%), I believe WABCO is worth $71, which translates to 43% upside
 
SUPPORTING POINTS
Market Leader in Industry with High Barriers to Entry
WABCO is a leading provider of advanced auto parts products and solutions (specializing in braking, stability, suspension and transmission control systems) to commercial truck, trailer and bus OEMs.
 
·          Innovation Leader: WABCO dominates in a sub-sector where innovation is a key demand driver. Contrary to popular belief, the auto parts industry goes beyond the typical commodity products. Commercial vehicle OEMs, more than ever, are seeking ways to build more fuel efficient, more reliable and safer vehicles. OEMs have, thus, been increasing technical content – by sourcing technically advanced products from players such as WABCO – in commercial vehicles with each successive platform introduction. To meet such demand, WABCO maintains a strong innovation pipeline (examples of franchise products include: pneumatic anti-lock braking systems (ABS), electronic braking systems (EBS), automated manual transmission systems and air disk brakes).
 
·          Captive Audience: WABCO’s customers are loyal to the company in part due to the high switching costs of finding a new sourcing partner. Advanced auto parts products are typically built into the vehicle during the early stages of the vehicle’s development cycle.  As such, WABCO has been able to develop long-standing and collaborative relationships with its customer base. In addition, commercial vehicle OEMs are averse to switching to a new sourcing partner due to stringent safety regulatory requirements and the risk of sourcing from a new player lacking a proven track record.
 
WABCO has successfully built a large moat around its castle filled with crocodiles (strong innovation pipeline) and snapping turtles (captive customer base). Not surprisingly, WABCO’s products are included in 2 out of 3 commercial vehicles with advanced control systems.
 
Well Positioned for Growth
·          Positive Secular Trends: Key value propositions of WABCO’s products and solutions are that they reduce overall vehicle operating costs and improve vehicle safety. As such, WABCO has been a beneficiary of two secular trends – growing demand for higher efficiency vehicles and increasing stringency in safety regulation. Commercial vehicle OEMs have been responding to the growing demand for more efficient and reliable vehicles as rising fuel costs put pressure on commercial vehicle operators (drivers, fleet owners). Further, the bar-on-safety has been rising over the years, requiring higher levels of compliance from OEMs. In Europe (where WABCO’s business is most weighted) and in Asia (where WABCO’s business is growing the fastest), regulatory oversight is even more prevalent than in the US.
 
·          New Revenue / High Margin Opportunity: The aftermarket currently represents a small part of WABCO’s business (22% of sales). However, the aftermarket presents a large opportunity as increasing number of vehicles in use have WABCO products in them, which drives demand for replacement parts and services. Not surprisingly, WABCO’s aftermarket business has grown twice as fast as the OEM business in the past 3 years. WABCO has stated its intention to beef up the aftermarket business, which should benefit the company in several ways. First, the aftermarket business will not only bring in additional revenue stream but will help to leverage fixed costs in the business (aftermarket business does not require much additional expenses as the products being sold are already part of the company’s product mix). Second, aftermarket business often commands higher margins because aftermarket customers are more fragmented than those in the OEM business (regional fleet owners, auto body repair shops, and individual truck owners).
 
·          Share Repurchase: The company has announced a share repurchase program, whereby it will repurchase $500M (11% of market cap), which should provide some near-term support for the stock.
 
VALUATION
My valuation consisted of several methods: (1) EV/EBIT multiple (Exhibit 2), (2) DCF (Exhibit 3), (3) historical P/E multiple of parent company (Exhibit 1), (4) P/E multiples of peers (Exhibit 4).
 
My final derivation of the intrinsic value (Exhibit 1) was determined by a weighted average calculation of the four methods with substantial weights given to the absolute valuation methods and smaller weights given to the relative valuation methods. This resulted in an intrinsic value of $71, presenting 43% upside to the current price.
 
In combination with the valuation, the healthy returns (ROTC in 100% range) and strong margin potential (double digit EBIT margin over the last 5 years) of this business lead me to believe that WABCO is an attractive investment opportunity.
 
RISKS TO THESIS
Like most opportunities, WABCO is not without its share of potential risks:
 
·          An unfavorable outcome in its pending litigation with the European Commission Investigation (this is a litigation that WABCO has inherited as a result of its previous affiliation with American Standards)
·          A rise in warranty claims of its products or solutions (which historically has been in the range of 1.1%-2.6% of sales)
·          A significant mismatch between supply and demand as WABCO’s products typically require long lead times and thus the company needs to plan for capacity in advance
    2007 2008   Derived Price
           
Absolute Based on EV/EBIT  
High $80.36
Mid $76.72
Low $60.05
   
Absolute Based on DCF $67.54
   
Historical P/E (of ASD) + 10% Premium EPS  
3-Yr Mean 14.3x $3.06 $3.81 $54.44
2-Yr Mean 12.1x 3.06 3.81 $46.06
1-Yr Mean 13.3x 3.06 3.81 $50.67
   
Relative P/E EPS  
Comp High 16.5x $3.06 $3.81 $63.03
Comp Mean 15.3x 3.06 3.81 $58.16
Comp Low 13.4x 3.06 3.81 $51.12
   
   
Fair Value Calculation         Weight
Absolute Based on EV/EBIT 45%
Absolute Based on DCF 45%
Historical P/E (of ASD) + 10% Premium 5%
Relative P/E         5%
   
Derived Intrinsic Value $70.55
   
Price as of: 30-Dec-07 $49.75
   
Upside / (Downside) to Intrinsic Value 42%
Margin of Safety         29%
Low Mid High
EBIT ('09) $366 $385 $405
EBIT 2yr CAGR 13% 16% 19%
Multiple 12.0x 15.0x 15.0x
EV 4,387 5,779 6,082
- Net Debt (Trainling ('06)) 40 40 40
+ Cash Build ('07-09) 667 667 667
Equity Value 5,013 6,406 6,709
FD Shares ('07) 69 69 69
Intrinsic Value $72.66 $92.84 $97.24
Discounted '07 @ 10% $60.05 $76.72 $80.36
% Upside 21% 54% 62%
Fiscal Year Ending December 31,
2002 2003 2004 2005 2006 2007 2008 2009
Free Cash Flow  
NOPAT $190 $147 $151 $213 $248 $285
Depreciation & Amortization     32 40 49 57 64 72
Gross Cash Flow $222 $188 $200 $270 $313 $357
Change in Working Capital         15 (8) (7) (8)
Cash Flow Before Investment $215 $262 $306 $350
Capital Expenditures         (65) (82) (106) (118)
Operating Free Cash Flow $150 $181 $200 $231
 
NOPAT Growth -22.3% 2.7% 40.7% 16.7% 14.7%
 
WACC and Growth Assumptions    
  WACC 10.0%  
  Terminal Growth 5.0%  
       
DCF Valuation    
  PV of Free Cash Flows $1,828 40.2%
  PV of Terminal Value 2,722 59.8%
  Implied TEV $4,550 100.0%
  Plus: Excess Cash & Equivalents 35  
  Less: Debt 75  
  Less: Preferred 0  
  Equity Value $4,660  
  Avg. Diluted Shares Outstanding 69  
   
  Equity Value per Share $67.54  
  Recent Price $49.75  
  Potential Upside/(Downside) 35.8%  
Price Mkt Cap EV EPS
(2007)
P/E
(2007)
EPS
(2008)
P/E
(2008)
EBIT
(2007)
EV/EBIT
(2007)
EBIT
(2008)
EV/EBIT
(2008)
Implied EBIT Margin (2007) Implied EBIT Margin (2008)
Johnson Controls Inc JCI $40.07 23,922 28,482 $2.10 19.1x $2.53 15.8x 1,817 15.7x 2,134 13.3x 5% 6%
BorgWarner BWA $93.64 4,916 5,546 $4.80 19.5x $5.66 16.5x 422 13.2x 494 11.2x 8% 9%
Autoliv Inc ALV $62.08 4,414 5,468 $3.84 16.2x $4.63 13.4x 523 10.4x 604 9.0x 8% 9%
Mean           18.3x   15.3x   13.1x   11.2x   8%
       
WABCO WBC $49.75 3,338 3,390 $3.06 16.3x $3.81 13.1x 288 11.8x 336 10.1x 12% 13%
Actuals Expected
    2002 2003 2004 2005 2006 2007 2008 2009 2010
Sales   $1,057 $1,358 $1,724 $1,831 $2,015 $2,335 $2,639 $2,958 $3,242
COGS 768 972 1,252 1,313 1,464 1,693 1,911 2,140 2,341
Gross Profit $290 $386 $471 $519 $552 $641 $728 $819 $900
 
SG&A 141 176 213 234 255 288 318 351 381
Product Engineering 52 64 66 74 72 93 106 118 130
EBIT $115 $166 $213 $236 $248 $288 $336 $385 $429
 
Other Expense, Net 9 17 0 5 11 14 16 18 19
Net Interest Expense (Income) - Related Party (7) (4) (5) (6) 6 0 0 0 0
Interest Expense 0 3 3 4 5 (3) (11) (11) (12)
EBT $112 $149 $215 $233 $226 $277 $331 $378 $421
Income Taxes $31 $37 $23 $87 $88 $72 $86 $98 $110
Net Income $82 $112 $191 $145 $138 $205 $245 $280 $312
 
Shares - Basic   67.1 67.1 67.1 67.1 67.1 67.1 64.4 58.5 56.3
Shares - Diluted 69.0 69.0 69.0 69.0 69.0 69.0 66.3 60.4 58.2
                     
EPS - Basic   $1.22 $1.67 $2.85 $2.17 $2.05 $3.06 $3.81 $4.78 $5.54
EPS - Diluted   $1.19 $1.63 $2.77 $2.11 $2.00 $2.97 $3.70 $4.63 $5.36
Expected
    2005 2006 2007 2008 2009
Cash And Equivalents   $40 $35 $47 $53 $59
Accounts Receivable 145 204 236 267 299
Inventories 116 138 160 180 202
Deferred Taxes 19 15 15 15 15
Other Current Assets 29 36 36 36 36
Total Current Assets $349 $427 $493 $550 $610
 
Net PPE $260 $300 $324 $366 $412
Long-term Investments 79 85 85 85 85
Goodwill & Other Intangibles 312 344 314 279 241
Other Intangibles 40 37 39 39 39
Deferred Tax Assets, LT 14 42 42 42 42
Other Long-Term Assets 42 42 42 42 42
Total Assets $1,095 $1,277 $1,339 $1,404 $1,471
 
Excess Cash / (Required Funding) 0 0 185 396 643
 
Accounts Payable 128 147 170 192 215
Accrued Exp. 136 177 205 232 260
Short-term Borrowings 7 18 18 18 18
Curr. Income Taxes Payable 39 66 66 66 66
Other Current Liabilities 55 69 69 69 69
Total Current Liabilities $365 $476 $527 $576 $627
         
 
Long-Term Debt $37 $57 $57 $207 $557
Minority Interest 10 11 11 11 11
Pension & Other Post-Retire. Benefits 323 366 366 366 366
Def. Tax Liability, Non-Curr. 18 19 19 19 19
Other Non-Current Liabilities 32 32 32 32 32
Total Liabilities $785 $962 $1,013 $1,212 $1,613
 
Common Stock 298 306 306 306 306
Additional Paid In Capital 0 0 $0 ($150) ($500)
Retained Earnings 0 0 $196 $423 $686
Comprehensive Inc. and Other 12.8 9.2 9.2 9.2 9.2
Total Shareholders' Equity $311 $315 $511 $588 $501
 
 
             
Key Statistics  
Cash And Equivalents 2.2% 1.7% 2.0% 2.0% 2.0%
Accounts Receivable 7.2 9.2 9.2 9.2 9.2
Inventories 8.1 8.6 8.6 8.6 8.6
 
Accounts Payable 8.9 9.2 9.2 9.2 9.2
Accrued Exp. 7.4% 8.8% 8.8% 8.8% 8.8%
             
 
             
Total Debt $44 $75 $75 $225 $575
Debt to Captal 12.5% 19.3% 12.8% 27.7% 53.4%
 
Net Debt 5 40 (157) (224) (127)
             
ROTC Calculation          
EBIT $236 $248 $288 $336 $385
EBIT Margin 13% 12% 12% 13% 13%
 
Current Asset 349 427 493 550 610
- Ex-Cash 1.50% 12 5 12 13 15
-Current Liab 365 476 527 576 627
+ Curr Port of LTD 7 18 18 18 18
Net Working Capital (21) (36) (29) (21) (14)
Net Fixed Assets 260 300 324 366 412
Total Capital Employed 238 264 296 344 398
 
ROTC 99% 94% 97% 98% 97%
             
Expected
2004 2005 2006 2007 2008 2009
Net Income $191 $145 $138 $205 $245 $280
Depreciation & Amort. 32 40 49 57 64 72
Amort. of Goodwill and Intangibles 38 36 33 38 43 48
(Gain) Loss From Sale Of Assets 0 0 2 0 0 0
(Income) Loss on Equity Invest. (9) (10) (5) 0 0 0
Stock-Based Compensation 0 0 3 0 0 0
Other Operating Activities 9 (10) (16) 0 0 0
Change in Acc. Receivable (28) 8 (38) (32) (31) (32)
Change In Inventories (17) (8) (10) (22) (21) (22)
Change in Acc. Payable (2) (1) 5 23 22 23
Change In Other Working Capital 4 (7) 15 28 27 28
Net Cash from Operating Activities $218 $195 $175 $297 $350 $397
 
Capital Expenditure (58) (62) (65) (82) (106) (118)
Sale of Property, Plant, and Equipment 1 1 0 0 0 0
Sale (Purchase) of Intangible assets (11) (8) (8) (9) (9) (9)
Net Cash from Investing Activities ($68) ($70) ($73) ($91) ($115) ($127)
 
Short Term Debt Issued $8 $5 $20
Short Term Debt Repaid (7) (8) (9)
Short Term Debt, Net 1 (4) 10 0 0 0
Long-Term Debt Repaid (0) (0) (53)
Long-Term Debt Issued 0 0 65
Long-Term Debt, Net (0) (0) 12 0 150 350
Share Issuance, Net 0 0 0 0 (150) (350)
Total Dividends Paid 0 0 0 (9) (18) (16)
Other Financing Activities (143) (107) (133) 0 0 0
Net Cash from Financing Activities ($143) ($111) ($110) ($9) ($18) ($16)
 
Foreign Exchange Rate Adj. 1 (1) 2 0 0 0
Misc. Cash Flow Adj. (0) 0 0 0 0 0
Net Increase/(Decrease) in Cash $9 $13 ($5) $197 $217 $253
Cash & Equivalents at Beginning of Period   27 40 35 232 449
Cash & Equivalents at End of Period $9 $40 $35 $232 $449 $702
 
Total Cash & Equivalents (B/S) 40 35 232 449 702
               
  Check:   (0) (0) (0) (0) (0)
               
 
Capex / Sales -3.4% -3.4% -3.2% -3.5% -4.0% -4.0%
 
FCF Yield 4% 4% 3% 6% 7% 8%
 

Catalyst

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