American Axle's (NYSE:AXL) share value has gone up by 40% in a year. The company is a manufacturer of driveline, drivetrain systems and chassis modules in the US. American has remained a top performer in the industry since a long time: the company's revenue growth has averaged 12.7% over the past three years, while the industry has seen its top line increase at a far lesser rate of 3.6%. With the macro environment proving favorable for American, this trend is expected to sustain ahead.
In this article, I will evaluate the company's financial strength by reviewing its performance in the latest quarter. Later, I will discuss factors to support my quantified upside of the company.
First Quarter
During the period, American achieved revenue growth of 13% as the top-line figure surged to $969 million. The year-over-year increase came on the back of healthy industry conditions which led to higher sales in the domestic light-truck market. The company also attained significant leverage through its partnership with General Motors (GM), which helped in shipping more components of full-sized pickups and SUVs.
Gross margin went up by 160 bps to 15.8% as well, owing to an increase in production volume and manufacturing efficiencies. SGA expenses, however, went up by 41 bps to 7% of sales because of costs associated with the up gradation of ERP system and higher employees compensation.
The net result was an earnings figure of 68 cents per share, which not only beat the analyst' estimate of 58 cents by a wide margin but also came 54% above the profit reported in 2014. Looking ahead, the earnings momentum is expected to sustain due to the reasons discussed below.
Market Expansion
The sale of light vehicles is forecast to grow at a CAGR of 5.1% over the next six years. The reason behind is that rising urbanization is developing countries, together with economic recovery leading to better standard of living in developed economies, is pushing consumers to either buy new vehicles or replace their old ones.
Given the prospects of solid revenue generation, automotive firms in the Western world are rapidly growing their distribution capacity and network channels in countries such as China and India. Their expansion is consequently driving the demand of component suppliers, as they are also growing their output in order to cater the widening customer base of vehicle manufacturers.
While the macro environment will give a tailwind to every player in the sector, several factors indicate that American will stand out as a winner. First, the company is adding new contracts in order to extract a bigger share of market growth: this year, American will begin providing both front and rear axles for Jaguar Land Rover. Then in Thailand, the company will launch if first driveline program with Ford (F) in order to support its rear-wheel drive SUVs. For Mercedes, American will not only deliver components for the upcoming C-Class and E-Class vehicles, but will also expand its offerings to include rear axles for several SUV variants in the Chinese market.
Expansion projects such as these are vital for the company's success over the long term because American is heavily reliant on GM at present; though the company generates nearly 65% of its revenue from GM right now, the new contracts will ensure that American's sources of income become diversified in the future. The move will hence reduce the volatility in earnings, in addition to ensuring that the company is less affected through fluctuation in the demand of vehicles manufactured by GM.
Secondly, American is in a better position to benefit from market uptrend because of its technologically-advanced driveline system. The company's latest innovation, Eco Trac, operates in front-wheel drive mode under typical driving conditions, which improves the vehicle's fuel economy in comparison to other all-wheel-drive systems. The product also has the ability to automatically sense torque and change the amount of power delivered to the wheels in order to maintain traction, which is why several car manufacturers including Fiat Chrysler (FCAU) plan to use it on their upcoming models during the current fiscal year.
Bottom Line
Industry growth, addition of new contracts, and increasing acceptance of Eco Trac have led the analysts to believe that American's earnings will grow by 30% to $2.78 per share by the end of 2015. The growth in earnings will ensure that the stock-price trend sustains ahead.
American also remains undervalued through several metrics that investors tend to rely on: the company's trailing P/E of 11.5x is below the 20.3x industry average, while the forward P/E of 8.7x is also below the industry average. American's price-to-sales multiple of 0.5x is 37% lower than the industry average and the price-to-cash flow ratio of 5.1x is well below the 15.2x industry average. Adding the fundamentals reveal that the company is undervalued by 82% (see table above). Therefore, American holds a buy rating.
