Below is my valuation of Linamar (OTCPK:LIMAF). At a current share price of $23.59 I determine whether this company is a buy or a no buy.
My models are based on value investing principles therefore I do not use a DCF as my weapon of choice. My models include no growth and no terminal value. Instead, I calculate an EPV and NAV to reach an Intrinsic Value.
Linamar is Canada's second largest auto-part manufacturer. After a few dismal years since 2009, the company has done extremely well in 2013 (mostly because it was extremely undervalued to begin with).
Linamar's strong financial performance in 2012 suggests that its management is performing well. In 2012 management achieved an operating margin of 6.83% and asset turnover of 1.33x, its best performance in the past 2 years. It also managed to recover after 2009, achieved year-over-year growth in EPS. In my opinion Linamar is looking more attractive than competitors such as Magna International (MGA) and Westport Innovations (WPRT).
Linamar has a diverse business model, which enables the company to remain strong even when a particular product line or geographic region suffers. This has enabled the firm to keep operating margins somewhat stable despite its cyclical industry. Furthermore, Linamar is geographically diverse with operations in North America, Europe, and Asia. It seems like Linamar is targeting a corporate structure of 31.1% debt (going back to 2002), which gives them WACC of 8.48% according to my calculations.
Demand for auto parts is driven by new car sales, which are strongly affected by interest rates, by the economy, and by car replacement rates. When the economy is bearish consumers do not buy new cars as frequently and use their old cars for longer. Company profitability depends partly on the difficulty of manufacturing products and partly on demand volume, since many costs are fixed. Small companies can compete successfully by focusing on a small number of products or some highly technical ones.
Once a company has started to produce parts for a car manufacturer, client switching costs become quite high as switching equipment would result in costly downtime for factories as well as major investment costs. High switching costs partially offset the cyclical risk.
Strategic Valuation Analysis
The largest factor contributing to Linamar's potential is the excess capacity currently experienced by the industry and firm itself. As North American OEMs continue to lose market share to producers overseas, Linamar's existing capacity utilization will suffer.
Additionally, OEMs are increasingly rationalizing their supplier bases, so if Linamar cannot maintain strong customer relations, their revenues will shrink dramatically. The wave of discontinued business lines and asset divestitures demonstrate the recession obviously has had a measurable impact of the success of the firm.
While I think the CEO, Linda Hasenfratz, is a very good CEO, some investors are disagreeing. The same goes for the company's board of directors who The Globe and Mail called "The most unpopular corporate directors in Canada. Either way, Ms. Hasenfratz and her father (Chairman and founder of the firm) own close to 30% of Linamar so there is no chance that they are going away.
The company's production facilities are up to par, but Linamar may experience competitive disadvantage if anything happens to the Canadian Dollar (this is obvious but is an important point). When interest rates rise in Canada my calculation show that they won't have a problem paying their debt.
Valuation, Liquidity & Intrinsic Value
At the beginning of 2012 the stock was trading around $13.00. This was a massive buying opportunity and the intrinsic value of the firm is much higher. Since then a few good quarters have put Linamar on the map and the market has caught up with he appropriate valuations. Investors who bought in last year or in 2009 have made a fortune.
Linamar gives a dividend of $0.08/share which now totals 1.35%. This was obviously much better when the stock price was trading at $13/share, but it is important to note that the firm will likely keep these dividends going. As management owns most of the firm they have a huge incentive to keep paying themselves.
One risk of Linamar is their liquidity. The average daily volume for the stock is about 100,000 shares (about 2.3million in value). This may be a problem for institutional investors. However, if you are an individual investor who is not planning on spending more $2.3million, there is little to worry about.
My calculations suggest that Linamar's Intrinsic Value is $21.00 per share. What is interesting about this is that I do not use growth in my models, or add a terminal value to my EPV calculations. As a result my valuations often come in much lower than a non-value investor. I believe that growth is something that is highly speculative and so I do not pay for it. However, Linamar's current stock price is $23.74 which suggests that the market is barely valuing growth in this company if at all. If you are not a value investor and like growth than this is a great time to come in.
As I mentioned above my Intrinsic Value is $21.00/share. In order to reduce risk I always use a 2/3 margin of safety which gives me an entry price of $14.00. ( $21.00 * 2/3 )
After careful analysis Linamar is not a buy for me as the stock price of $23.74 is much higher than my entry price of $14.00. However, if you do use growth in your models this company is worthy of at least a valuation of your own.
Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.