Dana: Past The Worst On Costs, But Volumes In 2023 Are The Next Worry

This has been an interesting year for Dana (NYSE:DAN). This large supplier of driveline, thermal, and sealing products to the passenger vehicle, commercial vehicle, and off-highway markets has done well on revenue, boosted by strong commercial truck and off-highway equipment demand, but has been hit hard by input cost inflation and unrecoverable costs tied to erratic production schedules at their OEM partners.

With all that, the shares are down about 10% since my last update; not terrible relative to the market, but also not all that exceptional relative to the sector. Looking ahead, Dana should see some cost-related tailwinds in 2023, but will also likely see growing headwinds from weaker commercial and off-highway markets. Even with those concerns, I believe Dana is an undervalued play on long-term commercial vehicle electrification and margin recovery across its segments.

 

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Dana: Past The Worst On Costs, But Volumes In 2023 Are The Next Worry

Serious Margin Challenges At Dana Prove Too Spicy For The Street

 

I pushed my luck.

Writing about Dana (NYSE:DAN) in March of last year, I was encouraged by the strong performance of this light truck and commercial vehicle supplier during the pandemic, as well as its underrated leverage to electrification. Unfortunately, input costs and issues tied to OEM production schedules hammered the business, especially in the second half of 2021, and sent the shares down about 30%, worse than the 20% to 25% declines for most commercial vehicle suppliers like American Axle (AXL), Cummins (CMI), CVG (CVGI), Meritor (MTOR) (pre-deal), and so on.

The margin weakness is disappointing to be sure, but I don’t believe it necessarily reveals any fundamental weakness in the business or its management, as I believe the circumstances of the last six to 12 months are far from typical. Moreover, I still see a meaningful electrification opportunity here and a pretty compelling valuation that can drive double-digit future annualized returns.

 

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Serious Margin Challenges At Dana Prove Too Spicy For The Street

Dana Starting To Deliver On Its EV Opportunities, And The Street Has Noticed

With the company finally getting credit for its leverage to EV opportunities in passenger vehicles, commercial trucks, and off-road machinery, Dana (DAN) has done quite well since my last update, rising about 65%. With a growing backlog and outperform on content-per-vehicle growth in EV projects, I believe Dana’s story is getting stronger.

Even after a strong run I still like these shares. While I might lean more strongly toward BorgWarner (BWA) or Valeo (OTCPK:VLEEY) just on the basis of relative valuation, I like Dana’s broad vehicle exposure, particularly as there is less risk of OEM insourcing electric powertrains on the CV/off-highway side. Moreover, pickups and SUVs remain high-priority profit centers for auto OEMs, and a strong market for Dana.

Given all of the above, I think Dana can trade toward $30 over the near term and still offers a high single-digit long-term total annualized potential return.

 

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Dana Starting To Deliver On Its EV Opportunities, And The Street Has Noticed

Dana Still Worth A Look On Better Decrementals And Recovery Potential

Up another 25% from my last write-up on the company, I still believe Dana (DAN) has more upside from here. Not only is Dana leveraged to recoveries in autos, trucks, and other commercial vehicles, but the company's surprisingly strong decremental margins so far lends a lot of credibility to management's past comments about the resilience of its margin and cash flow structure. Further down the road, Dana has a portfolio of electrification technologies that should enable it to preserve its business as manufacturers and customers shift to electric powertrains.

Low single-digit revenue growth and low-to-mid single-digit FCF margins can support a fair value in the high teens, though the near-term margin-driven EV/revenue fair value is more in the mid-teens. Either way, I think these shares offer appealing potential here even with the risk of a protracted downturn in the company's major markets.

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Dana Still Worth A Look On Better Decrementals And Recovery Potential

Dana Has Nearly Doubled From Its Low, But A Lot Of Panic Is Still In The Price

I’m approaching modeling for companies like Dana (DAN) with roughly the same mindset as dinner at a certain relative’s house – I don’t know exactly what’s in store, but I’m sure it’s not going to be good. Commercial vehicle markets like Class 8 trucks were already going to be weak in 2020, and now it looks as though double-digit declines in auto production are at least plausible, suggesting to me that a low-to-mid teens year-over-year decline in revenue, with meaningful decremental margins, is not an unreasonable expectation for 2020.

What follows is likewise highly uncertain, but it seems like there’s still panic playing into the outlook – I saw one sell-side analyst recently cut expectations for Dana such that the company wouldn’t recover to 2019 revenue levels until 2027 or later, and that just seems implausibly bleak to me. Uncertainty and fear is the order of the day, but I believe Dana’s business can withstand this shock, and I think this is a name to consider for more aggressive investors.

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Dana Has Nearly Doubled From Its Low, But A Lot Of Panic Is Still In The Price

Dana Slogging Through Some End-Market Challenges, But The Longer-Term Outlook Is Better

While I’ve thought Dana (DAN) shares looked undervalued, I also thought that the choppy trends in many of the company’s end-markets, including heavy-duty trucks and off-road vehicles, would add volatility to these shares. Since my last update, the shares have traded over $20 and below $12, and while the company’s capabilities in electrification are getting more recognition, the outlook for 2019 is still dicey and management has been cutting back guidance.

Dana isn’t a good name for nervous investors, but I see a lot of value here. I think the Street may be overestimating the negative impact of lower Class 8 truck builds in 2020, and likewise may be underestimating the potential uplift of electrification in busses and medium-duty trucks in the relatively near future. Although Dana isn’t my favorite auto/truck supplier in terms of pure quality, the valuation is hard to ignore.

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Dana Slogging Through Some End-Market Challenges, But The Longer-Term Outlook Is Better

Tenneco Pounded Down On Weak Execution, High Leverage

I wasn’t all that fond of Tenneco (TEN) when I last wrote about it in the fall of 2018, but even though I had issues with the company’s unimpressive operating performance and weak leverage to vehicle electrification, I didn’t expect the 75% drop in the share price that followed. Management credibility is arguably at an all-time low now, and with weak trends in light vehicle builds and a weakening outlook for many commercial vehicles, Tenneco’s back-end-loaded second half guidance seems perhaps ambitious even with a meaningful revision after first quarter earnings.

It’s tough to reconcile the magnitude of the share price drop with the actual underlying performance (unimpressive as it has been), but net debt is now close to 3.5x expected EBITDA and the spin-out of DRiV has been postponed by at least six months. I can understand why deep-value/contrarian investors may want to give this a look (especially as I think auto/vehicle parts stocks are undervalued as a sector), but I’m concerned about the company’s long-term competitiveness and the fact that net debt now exceeds over a decade of estimated free cash flow in my model.

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Tenneco Pounded Down On Weak Execution, High Leverage

Dana Caught Up In Several Cross-Currents

I was puzzled by Dana’s (DAN) valuation back in October, thinking that the shares looked undervalued even factoring in a weaker near-term outlook for light vehicles and an eventual end to the heavy truck boom. Lending some support to my notion that stocks don’t move up just because they’re cheap, the shares are more or less in the same place now (down about 5%), albeit with a steep drop into the close of 2018 and a rally in the interim.

Now Dana is in the middle of that light vehicle slowdown, and heavy trucks in North America are enjoying an extended peak, but orders have been plunging. Meanwhile, heavy off-road machinery has been looking a little wobbly lately. So even though Dana has built up a strong electrification portfolio that management believes will help drive revenue to over $10 billion in 2023, nobody seems to believe that today. With the shares undervalued even at lower long-term growth rates, valuation remains a head-scratcher and I’m increasingly tempted to take a flyer on this name.

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Dana Caught Up In Several Cross-Currents

With Or Without Federal Mogul, The Street Just Doesn't Care About Tenneco Now

If you wrote up a list of outperforming auto and commercial vehicle component stocks, it would look for all intents and purposes like you were writing in invisible ink. A few companies like Aptiv (APTV) and Magna (MGA) have been less-bad than average, and Allison (ALSN) and tiny Commercial Vehicle Group (CVGI) are up strongly over the past year, but for the most part, this has been a pretty awful sector as investors have written off the passenger vehicle market for the near term, priced in the commercial truck fall-off, and continued assuming that internal combustion engines are doomed.

There might be a little hyperbole there, but not too much, and Tenneco (TEN) certainly continues to get almost no benefit of the doubt. Although second-quarter margins and margin guidance weren't great, the Street seems to be pricing these shares for ugly future margins and cash flow. Likewise, the idea that spinning off the Ride Performance and Aftermarket business will unlock any value seems to be largely dismissed at present. I really can't say that Tenneco is a top-notch idea now, but sector-wide valuations seem to be washing out, and this is a name worth watching for an eventual recovery opportunity.

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With Or Without Federal Mogul, The Street Just Doesn't Care About Tenneco Now

Dana Looks Pinned Under The Wall Of Worry

I was tentatively bullish on Dana (DAN) in late May of this year, but auto and commercial vehicle suppliers continue to weaken in the market, and the shares are down another 15% since then. Maybe I’m missing something big here, but I see Dana as a company with at least decent ongoing leverage to passenger vehicles, an improved position in electrification, and a solid global presence in commercial/off-road vehicles, particularly with the Oerlikon (OTCPK:OERLY) transaction. And yet, the Street continues to price this one as if there’s going to be serious long-term erosion in the business.

I freely admit that Dana doesn’t have the greatest operational track record with respect to margins, FCF generation, and/or ROIC, but the company has improved in recent years and is seemingly getting no credit for that. In a market where many auto and commercial vehicle suppliers appear to be trading below long-term fair values investors certainly have choices, but I continue to believe this name is worth a look.

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Dana Looks Pinned Under The Wall Of Worry

Is Dana's Curious Valuation A Buying Opportunity?

Novice investors ask, "is it cheap?", but veteran investors know that the right question is often "why is it cheap?", and that certainly is a valid question to ask about Dana (DAN). Plenty of auto and commercial vehicle suppliers have ugly year-to-date charts, and while Dana's negative 30% performance is bad, it's not dramatically worse than Tenneco's (TEN), Commercial Vehicle's (CVGI), or Meritor's (MTOR).

Dana has exposure to weakening trends in light and commercial vehicles, and some risk from electrification, and yet the valuation is kind of a head-scratcher. Unless sell-side expectations are significantly off-base (and the market's valuation seems to be a strong vote that they are), these shares should trade somewhere in the high $20s to low $30s. It's certainly true that Dana doesn't have a great history with margins or overall performance, but it seems like the Street is pricing in some low expectations, and value-oriented and contrarian investors may want to take a look.

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Is Dana's Curious Valuation A Buying Opportunity?

Dana Doing The Right Things And Reaping The Benefits

Finding an undervalued stock with a solid story behind it is always good, but finding that story getting better with time is even better. That's what appears to be happening with Dana (DAN), as this diversified supplier of components for passenger, commercial, and off-highway vehicles continues to execute well on its plan to grow content, improve margins, and position itself for the evolving demands of its end-markets.

It can be deceptively easy to get caught up in and taken along with Wall Street's short attention span-driven boom-and-doom cycles. With that in mind, I've been cautious about fundamentally overhauling my long-term growth and profitability assumptions for the business. I do like Dana's prospects for value-adding M&A, margin self-improvement, and leveraging a better mix (including more power tech products down the line), but I don't believe Dana is going to suddenly become a FCF-generating machine in an industry where mid-single-digit margins are generally the best that even great companies (like Cummins (CMI)) can do. To that end, while a fair value in the $20s seems reasonable, and I'm comfortable modeling exceptional cash flow growth, today's valuation already seems to be pricing in a lot of progress.

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Dana Doing The Right Things And Reaping The Benefits

Meritor Pursuing Bold Goals As Markets Bottom Out

There's a marked contrast between the passenger and commercial vehicle sectors now, with ample worries that the former is peaking and growing hopes that the later is bottoming out. As a commercial components player, the prospect of improving market conditions is bullish for Meritor (NYSE:MTOR), although 2017 is likely to still be a challenging year.

What's more interesting about Meritor is the bold targets that management has laid out for growth over the next few years, including 20% outperformance relative to the underlying markets. Although I don't believe Meritor will get there without M&A (which I don't model), it has been building a much better track record for itself in recent years, and I don't dismiss the possibility that the company will do better than expected. That said, today's price already seems to assume meaningful improvement at the company, and it may make more sense on a risk/reward basis to wait in the hopes of temporary disruptions or disappointments creating a more opportune entry price.

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Meritor Pursuing Bold Goals As Markets Bottom Out

Modine Looking To Break From Its Past

Modine Manufacturing (NYSE:MOD) has some work to do. Not only have the shares been lackluster performers compared to broadly-defined peers like BorgWarner (NYSE:BWA), Dana (NYSE:DAN), Valeo (OTCPK:VLEEY), and Lennox (NYSE:LII) for some time now, the weak history with respect to margins, revenue growth, returns on capital, and cash flow suggests that that underperformance is not unreasonable.

Management hasn't been sitting still, though, and there is perhaps a more bullish outlook now. Multiple restructuring efforts have seen several plants closed over the past decade and tens of millions of dollars taken out of the cost structure more recently. What's more, management significantly accelerated its mix shift away from vehicles with what looks like a logical and reasonably priced deal. If these improvements can move the company close to a 10% EBITDA margin, there may be an argument that the shares are undervalued, though the lackluster free cash flow generation is a risk factor that I wouldn't ignore.

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Modine Looking To Break From Its Past

Seeking Alpha: Allison Transmission A Stand-Out In Multiple Ways

In a vehicle parts/components sector that has seen many stocks rocket up over the past year, Allison Transmission (ALSN) doesn't look so appealing with its stock "only" up about 25% over the past year. That comes in spite of Allison owning exceedingly rare market share in its end markets and still having significant global under-penetration to fuel future revenue growth.

While it is true that Allison's cash flow is complicated by net operating losses carried forward and intangible asset amortization, the base operating margin and cash flow generation are still quite good for the sector. Although Allison is not a huge value today, and the EV/EBTIDA looks expensive without adjustments, upside from energy and on-highway markets could lead to higher expectations and the relative valuation (not to mention quality) makes Allison a name worth following.

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Allison Transmission A Stand-Out In Multiple Ways

Seeking Alpha: Federal Mogul Could Still Have More Under The Hood

If you bought Federal-Mogul (FDML) shares in March or April of this year, then you certainly deserve to bask in the success of taking a major gamble that paid off handsomely. Shares of this heavily indebted auto parts company have nearly tripled from the April lows as a recovery in the auto parts business, the ongoing support of Carl Icahn, and a successful rights offering have all provided a little extra breathing room.

As crazy as its sounds, there could still be room for this stock to run. Both sides of the business are growing ahead of vehicle production rates, and a shift towards more emerging market sales and a focus on efficiency-improving/emissions-reducing products fits with what vehicle makers want these days. In addition, the company is already in the midst of transitioning production to lower cost regions, while further debt reduction should reduce both the company's interest burden and its cost of capital. Even with the huge move in the stock, a continuation into the high teens or even low $20s is not out of the realm of possibility, suggesting 20% to 40% potential even from here.

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Federal Mogul Could Still Have More Under The Hood

Investopedia: Segmenting The Business Doesn't Solve Federal-Mogul's Biggest Challenges

Although the passenger vehicle market has stayed relatively healthy in the United States, slowdowns in Europe and emerging markets have left many auto parts companies drifting this year. In the case of Federal-Mogul (Nasdaq:FDML), it could be argued that macro pressures have hidden some of the cost improvements the company is trying to make, while the weak performance of the aftermarket business has likewise weighed on the numbers. Although Federal-Mogul likely can do better from here, investors should not lose sight of the risks that accompany the stock.

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Investopedia: Industry At A Glance - Auto Parts

It doesn't seem so long ago that investing in anything related to the automotive sector seemed to be an invitation for a capital loss. Companies struggled with excess capacity, high debt and nonviable cost structures, and more than a few companies at least flirted with bankruptcy (and some made the commitment to it).


Now, though, is seems like a new industry. Many companies have worked to strip costs out of their operating structure and emerging markets have become a major growth opportunity. Though investors should not assume that this industry has shaken off its traditional cyclicality, opportunities could still be available in the sector.

BorgWarner (NYSE:BWA)
Auto part companies do not get much credit (or valuation) for technological innovation, but that seems a little unfair in the case of BorgWarner. Diesel turbochargers and dual clutch technology are both significant growth opportunities, particularly if diesel passenger vehicles become as popular in the United States as they are in Europe. BorgWarner used to pay a dividend and that could resume again as the company shores up its balance sheet. Investors should also note that BorgWarner has less exposure to U.S. automakers than many names on this list.



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Investopedia: Johnson Controls Seeing Multiple Recoveries

Passenger vehicles and non-residential building are two sectors that have seen some pretty ugly conditions in recent memory, and that certainly showed up in a 25% revenue decline for Johnson Controls (NYSE:JCI) in 2009. Economic conditions have turned around, though, and the company has seen a strong rebound in its results. Now with signs of life in the building efficiency segment, could even better results be on the way for shareholders? 

A Mixed Fiscal Second Quarter 

Like so many other companies this quarter, Johnson Controls gave investors a mix of good news and some disappointment in its fiscal second quarter results. Revenue jumped 22% and was comfortably above even the high end of the range, as all units posted solid progress. The auto business led with over 25% growth, but even the building efficiency segment saw better than 18% improvement from last year. (For more, see Johnson Controls Sitting Well.)

Margins were more problematic, though. Gross margin ticked down 20 basis points, due largely to commodity inflation and product mix. Segment income did improve by over 30% and all segments did show year-on-year improvements in their operating margins. Unfortunately, analysts had expected even better improvement, particularly in the building segment. So while patient shareholders may not be too bothered or disappointed with 30% segment income growth, the short-term trading tenor may be negative. 

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