Automotive supplier TRW Automotive (TRW) reported a much stronger than expected second quarter Tuesday. Earnings fell 14% year-over-year to $1.72 per share (excluding special items); however, earnings were $0.18 per share higher than the consensus estimate. Reported revenue was roughly flat at $4.2 billion, but grew 8% on a currency neutral basis. Strong demand from North American auto production continues to drive solid results in spite of declining auto volumes in Europe. We continue to think shares are incredibly undervalued at current levels.
Management pointed to strong production in North America as the primary driver of growth, with production increasing 27% year-over-year during the second quarter. Though production from the Big 3, Ford (F), GM (GM) and Chrysler, only grew 7%, Japanese manufacturers were coming off of supply-chain issues, explaining why production growth at Toyota (TM) and Honda (HMC) outpaced other manufacturers. TRW believes production and demand should remain healthy during the back half of 2012, and we agree. Sales in the US will likely be around 14.5-15.0 million units, and the company sees further upside in production as OEMs work to bring new products to market and replenish inventories.
Although European production fell 7% year-over-year, the firm's primary European customer is Volkswagen (VLKAY), which saw production increase 2% in the second quarter. European exposure accounted for 43% of TRW's revenue during the second quarter. The company sees production in Western Europe falling 10% in the third quarter. The firm also pointed to China and Brazil as areas of strength, though overall demand in both regions remains somewhat tempered.
Free cash flow year-to-date is down compared to last year, but the reduced cash flow generation can be attributed almost entirely to capital investments and changes in working capital. Management also reiterated that they continue to explore ways to return cash to shareholders. The firm mentioned the fourth quarter of 2012 as a target (for either a share buyback or dividend), but we wouldn't be surprised if management waited for further clarity on the tax treatment of dividends following the election before acting. Still, we think shares of the supplier are worth at least $42 per share (with upside to $68 per share), suggesting they look cheap on a discounted cash flow basis. We like the firm as an idea to gain exposure to the North American auto recovery (within the supply chain), though we continue to believe Ford has the best total return profile in the automotive space.
Additional disclosure: F is included in our Best Ideas portfolio.