Note: All figures in C$ (Canadian dollars) unless otherwise noted.
Linamar (OTCPK:LIMAF) (TSX:LNR) will report Q1/16 results on May 4, 2016, after market close. Themes to look for in the quarter will be the Montupet acquisition and an expected increase primarily in European content per vehicle and vehicle production metrics, trends in sector growth relative to global economic performance, and updates on global plant expansions including the recently formed GF Linamar LLC JV.
We estimate Q1/16 continuing EPS of $1.79, just shy of consensus $1.82 EPS estimate. While likely not materially different on the operations side, the slight difference from consensus in our EPS figure may be from the higher interest expense since we are also modeling the $1.16bn plus acquired debt that Linamar took on to finance the acquisition.
We are modeling Linamar's post-acquisition pro-forma financial estimates based on Montupet's most recently available 1H/15 financial statements. Based on this information, as of Q1/16, we estimate that Linamar will have cash of ~$430mn and ~$1.4bn in net debt, with a net-debt-to-equity ratio of 0.6x.
We did not forecast EPS prior to the Montupet acquisition, but assume that even if the acquisition may have been slightly dilutive to near-term EPS, Linamar's ability to generate cash to pay down the acquisition-related debt will turn the acquisition EPS accretive in the medium term, particularly as interest payments are reduced. We model consecutive $100mn year-end payments of the debt, with an increasing cash balance trend.
Current valuation levels are at 7.6x 12m forward P/E, compared to an average three-year low of 9.6x, providing value-minded investors with an attractive entry point for a high-quality auto and industrial parts and machines manufacturer. However, this discounted multiple may be reflective of recently slowing organic growth coupled with the uncertainty of incoming EPS benefit of recent JVs and acquisitions meant to boost growth and solidify Linamar's share in several markets.
Our BUY rating is based in part on current, relatively low valuation levels. Our 12-month C$78.50 target price is based on a weighted 60% DCF implied C$77.21 per share price, and 40% 12m forward P/E implied C$80.95 per share price. Our weighted target price implies a 36.2% return (including dividends).
Q1/16 Earnings Preview
We rate shares of Linamar Corp. a BUY. Our rating is based in part on current valuation levels, which are at 7.6x 12m forward P/E compared to an average three-year low of 9.6x (Figure 2), providing value-minded investors with an attractive entry point for a high-quality auto and industrial parts and machines manufacturer. In our view, this discounted multiple may be reflective of the recently slowing organic growth, coupled with the risk of incoming EPS benefit of recent JVs and acquisitions meant to boost growth and solidify Linamar's share in several markets. Compared to peers, Linamar currently trades at a slight discount (Figure 3) to the sector, but in our view, a proper execution of the company's growth strategy may result in a modest premium valuation.
Our 12-month C$78.50 target price is based on a weighted 60% DCF implied C$77.21 per share price, and 40% 12m forward P/E implied C$80.95 per share price. Our weighted target price implies a 36.2% return (including dividends).
Our DCF is based on a two-stage free cash flow to the firm (FCFF) model. The first stage is based on explicit growth and profitability estimates between 2016 and 2018, which taper to the long-term values in our terminal year of 2019. The second stage uses a conservative long-term FCFF growth rate of 1.75%, with a 9.8% weighted average cost of capital. Our P/E multiples valuation is based on a justified 12m forward P/E of 10.4x, based on an estimated 10.9% cost of equity and 1.75% earnings growth rate. We note that our justified multiple is in line with Linamar's one-year average P/E.
The main risk to our investment thesis is execution and potentially unrealized growth from Linamar's recent JV and acquisition strategy. With slowing organic growth, the company has recently entered into a JV and completed large acquisitions in order to boost its market share and improve the bottom-line growth. We model the benefit of these initiatives with a 10% two-year CAGR EPS growth to 2018. However, potentially slowing global growth may stall the resulting top-line growth and translate to downward EPS revisions.
Investment risks also include but are not limited to manufacturing sector-related operating risks, foreign exchange and sovereign risks for overseas operations, and contract uncertainty and price risks from OEM purchase orders, for example.
Pro-Forma Financial Statements
Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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