Tecumseh Products: Hot Brazil Fuels Dramatic Recovery

Includes: TECU, WHR
by: Alan Brochstein, CFA

Seven months ago I shared an instablog on one of my favorite stocks for 2010, Tecumseh Products Class A shares (TECUA). I am a little late following up as I had promised, but the story is even better today than it was then and the price isn't substantially different. It remains in a bottoming process (click to enlarge):


Tecumseh makes compressors used in HVAC and refrigeration/cooling. Based in Michigan, the company operates plants in the U.S., France, India and Brazil. Overall, sales are about 80% outside of North America. The company operates in essentially a duopoly with Whirlpool (NYSE:WHR) in Brazil, though there has been some encroachment in recent years. According to the 2009 10-K, the company does about 20% or so of its sales there and about 1/3 in Latin America.

For the past two quarters, sales have boomed for Tecumseh, growing in excess of 50%. Even stripping out currency gains (Brazil), the company has grown 43%. While the company "raised" its targeted sales growth from 10% to 15% for 2010, the outlook, if believable, would be harsh. With such strong growth already, management is suggesting that the back half of the year will be down 16% from last year's 2nd half and 15% from H2-2008. I believe that it is conservative posturing.

As I described previously, the company went through a vicious proxy fight for control of the Board, with the Herrick family taking back control. This protracted fight, along with inventory destocking and the collapse in end-market demand, left the company extremely vulnerable to the deteriorating environment. I first learned of the story when they hired an industry leader from Parker Hannifin's Sporlan subsidiary, Mike Noelke, to serve as EVP, Global Sales, Marketing and Engineering. I credit him for helping to spark some of the recent success, with a focus on improved customer focus paying quick dividends. I think that we can expect this management team, which has been in place less than a year, to continue improving its processes. They also have a new product cycle that kicks in next year.

TECUA (13.72) and TECUB (12.81) have a combined 18.5mm shares, implying a market cap (based on B shares being converted to A shares) of about $250mm. Sales will most likely be $900mm or so (above recent guidance). The company has no net debt. Its Enterprise Value to Sales ratio of about .28 compares very favorably with other small-cap industrials. Of the 124 Industrials in the Russell 3000 with market caps between $100mm and $1billion, the average EV/S ratio is .54. My expectation is that the stock can attain a level of 25 over the next year, a modest premium to its tangible book value as well as in line with its earnings power.

Disclosure: Long TECUA in Top 20 Model Portfolio