Tower International (NYSE:TOWR) had a strong Q1 2013 with earnings that came in above street estimates. Additionally, the company guided to higher revenue and profitability for full year 2013. These results sent Tower's stock price to a 52-week high of $20.92. In this report, we show that a fundamental valuation of Tower International indicates that the company's stock is now slightly over-valued.
Tower International is the world's leading supplier of engineered stamped structural metal components to original equipment manufacturers (OEMs). Products include body-structure stampings, frame and other chassis structures, as well as complex welded assemblies. The company is well diversified geographically with operations spread across 30 production facilities in North America, South America, Europe, and Asia. As of December 31, 2012, the company had approximately 9,000 employees.
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Quarterly Revenue Trend (visualized using www.thinknum.com)
Tower has four primary product segments:
- Body structures and assemblies: Body structures form the basic upper body of the vehicle and include the exterior of the vehicle - body sides, doors, hoods, etc. These components are critical for the outward appearance of the vehicle requiring flawless finishing.
- Chassis, lower vehicle structures and suspension components: These components make the "skeleton" of the vehicle and are critical to overall performance (noise control, handling, and crash management). These products include SUV full frames, automotive engine and rear suspension cradles, floor pan components, and cross members that form the basic lower body structure of the vehicle. These heavy gauge metal stampings carry the load of the vehicle, provide crash integrity, and are critical to the strength and safety of vehicles.
- Complex assemblies: These products are comprised of multiple components and sub-assemblies welded to form major components of the vehicle's body structure and include front and rear floor pan assemblies and door/pillar assemblies.
- Other: The company also manufactures other products for automotive, aerospace, and defense industries.
The size and growth of the company's markets is primarily a function of global light vehicle production and the company's platform mix. According to IBIS, the market size for metal stamping in the US is approximately $27 billion (IBIS 2012). Since the US market comprises approximately 20% of global vehicle production, we can estimate the total market size for Tower's products to be approximately $135 billion. The market for metal stampings in the US is projected to shrink at approximately 1.7% annually from 2007 to 2017. Extrapolating this market shrinkage to the global market, we arrive at a $114 billion market size by 2017. The projected decline in market size is primarily a function of a move towards smaller cars that use less of the structural components that Tower manufacturers.
IHS Light Vehicle Production (source: here).
Supplier Power: Very Low
The company purchases both manufactured components and raw materials for use in its manufacturing process.
- Manufactured components: The company purchases hot- and cold-rolled, galvanized, organically coated, stainless and aluminized steel from a variety of suppliers. The company continuously monitors its vendor base for the best sources of supply and works with those vendors to attempt to mitigate risks that could jeopardize the company's supply base.
- Raw materials: The company's primary raw material is steel. Sources of steel for the company include OEM resale programs, steel producers, and open markets. Since steel is a commodity, the financial health of its suppliers are not important as the company could always shift a majority of their steel purchases to the open market.
Competition: Very High
Tower's largest competitors are vertically integrated OEMs that produce a majority of their structural metal components and assemblies internally. The company believes that due to the large capital expenditures associated with internal production of these components, OEMs will benefit from outsourcing this production to companies such as Tower.
Tower's major external competitors include Magna International (NYSE:MG), Gestamp Automocion, Martinrea International (MRE), Gruppo Magnetto, Benteler Automotive, Thyssen Krupp (TKA), Sungwoo and MS Auto Tech.
Buyer Power: Very Low
The company's customers have a high degree of power given their large size. In particular, the company's top five customers represent approximately 64% in annual sales. OEMs typically build in annual price deflators in their supply contracts with automotive suppliers to incentivize these suppliers to reduce costs.
Barriers to Entry: Very High
The capital expenditures required to build a manufacturing plant to produce structural metal components and assemblies can be substantial. As a result, there is low risk of new entrants into the market.
Substitutes: Very Few
There are no reasonably priced substitutes for Tower's products (alternatives such as carbon fiber too costly on most vehicles).
Tower's only publicly traded pure-play competitor is Martinrea International Inc. (MRE). I include Magna International as its Cosma division is a direct competitor to Tower.
- Martinrea: Martinrea produces and develops metal parts, assemblies and modules for the automotive sector. In FYE 12/31/2012, the company reported $2.9 billion in sales with an EBITDA of $203.2 million. The company is based in Vaughan, Canada.
- Magna: Magna designs, develops, and manufactures automotive systems, assemblies, modules and components. In FYE 12/31/2012, the company reported $30.8 billion in sales and $2.4 billion in EBITDA. The company is headquartered in Aurora, Canada.
Sustainable Growth Rate
Tower's 2011 SGR was 8% as compared to a revenue growth of 20%.Similarly, over the past 5 years the company has had an average SGR of -50% as compared to a revenue growth of 1%. As revenue growth has been trailing SGR, the company is generating cash deficits and is faced with four choices: slow growth, increase financial leverage, increase retention rate, and raise additional equity (McDonald 2011). The company currently has high leverage relative to its peers (please see table above) and thus increasing leverage is not a preferred option. Increasing its retention rate is also not an option as its current retention rate is 100%. Barring a decision by management to maintain slow growth, the company needs to raise equity financing.
Projected Equity Requirements
Assuming a steady-state SGR of 13%1, the company would need to raise equity such that the new equity ratio (NER) is approximately 18% so as to match the SGR and revenue growth rate. With a beginning equity of $98 million and an NER of 18%, the company would need to raise approximately $18 million in new equity (approx. 0.87 million new shares at current price of $20.06).
Strengths & Weaknesses
- Emerging markets exposure: The company has a significant proportion of its sales (29%) to companies in the emerging markets (South Korea, South America and China). This is a positive as the company is likely to benefit from higher light vehicle production in these rapidly growing markets.
- Strong management team: Mr. Mark Malcom, CEO and Mr. James Gouin, CFO have worked in various capacities in the auto industry and have a combined tenure of over 50 years. Mr. Malcom worked at Ford Motor Company for 28 years most recently as Executive Vice President and Controller of Ford Motor Credit. Mr. Gouin had a 20-year tenure at Ford and most recently served as their CFO of Ford's North America operations. They have both been with the company since 2007.
- Low financial leverage: OEM's typically favor global automotive suppliers with strong balance sheets. Following the recent recession, the company has improved its performance and reduced debt thus reducing its leverage from a high of 5.5x in 2009 to 2.9x in FYE 12/31/2012. The company's reduced leverage puts it in a good position to benefit from OEM's choosing financially healthy auto suppliers.
- High operating leverage: Due to the company's high fixed cost base, increasing revenues result in margin expansion. This was evident in 2010 as global light vehicle production increased with revenues increasing only 22% while EBITDA went up by 49%.
- Customer diversification: The company's top five customers account for 64% in sales with no single customer contributing to more than 20% of sales. This ensures that the company is not over-exposed to the financial health or purchasing patterns of one single OEM.
- Favorable vehicle platform mix: 43% of the company's revenues come from small cars with only 13% coming from SUV platforms. As a result, the company is better able to withstand increases in gasoline prices which typically discourage SUV purchases.
- Eurozone exposure: OEMs in Europe contribute approximately 35% to the company's revenues thus exposing the company to the negative impact of the austerity measures currently being employed in many European countries. According to the IMF, these austerity measures are likely to result in slower economic growth in countries like Greece, France, Spain, and Portugal (IMF 2012).
- Consolidating trend in auto supplier industry: Consolidation and bankruptcy of auto suppliers has resulted in fewer and stronger competitors for Tower. This enables these Companies to take advantage of volume discounts from sourcing their raw materials in bulk that putting Tower at a cost disadvantage.
- High operating leverage: Like other auto suppliers, Tower has a high fixed cost base thus resulting in downside risk during economic downturns. In 2009, the trough of the last downturn, while revenues were only down 25%, EBITDA declined by 41%. Due to the high operating leverage and the fact that the company's business is both cyclical and seasonal, the business cannot support high financial leverage.
- Unionized labor force: 64% of the company's labor force is unionized. While there have been no work stoppages since the inception of the company in 1993, the unionized labor force constrains the company thus limiting the extent to which it can reduce wages to cut costs. Additionally, any strike could negatively impact the company's operations.
The two key growth drivers for Tower International are:
- Global light vehicle automotive production: Tower supplies automotive components to OEM manufacturers in all major vehicle-producing regions. The company's revenue growth is therefore a function of global light vehicle automotive production.
- OEM outsourcing trend: Due to the capital-intensive nature of manufacturing metal stampings and other structural components, the company believes that OEMs will continue to outsource the production of these components to reduce costs. This trend is a positive for Tower as currently most structural components are produced by vertically integrated OEMs.
Principal factors that warrant out attention on the company
- Since the company's voluntary Chapter 11 filing in 2005 and the downturn in 2008/9, the company has aggressively cut its cost structure to enable it to be profitable at low global light vehicle production volumes. Given the cyclical nature of the automotive industry, this places it at an advantage relative to its competitors.
- The company's high exposure to Asia and South America is attractive for equity investors as it represents significant growth potential as these markets overtake North America and Western Europe in vehicle production.
Tower is a challenging industry. Although it has been able to cut costs, its performance has been hampered by its exposure to the sluggish automotive markets in North America and Europe. The company is in need of equity financing to growth its business over the next 2-5 years. These negative factors outweigh the strengths of the company as reflected in the valuation above which shows a DCF equity value per share of $15.14, 25% lower than the current price of $20.06.
* Publicly available data goes back to 2007/8, the onset of the recent financial crisis. As a result, it is difficult to estimate the company's growth potential over the long-term. I therefore assume that 2011's SGR reflects the steady state growth potential of the company.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.