Adient: An Undervalued Niche Growth Opportunity

| About: Adient plc (ADNT)

Summary

Adient is an undervalued spin-off opportunity providing a 60% margin of safety at the current price.

The firm is the global market leader in automotive seating with a 36% market share.

Adient also dominates the market in China with a 45% market share.

The company has identified opportunities to moderately expand margins in the mid-term.

The balance sheet is currently highly leveraged which will magnify shareholder returns.

Adient (NASDAQ:ADNT) is the largest global automotive seating supplier, supplying seating globally to all the major automakers. The company has a 34% market share of the global automotive seating market and a 45% market share in China through its strategic joint ventures in the region. Adient is the market leader across all major seating components and systems including:

- Complete Seating

- Trim: Cut & Sew

- Trim: Fabric

- Metals & Mechanisms

- Seating Foam

- Headrests/Armrests

The company's $17 billion in revenue is highly diversified by both manufacturer and geography. The following are the firm's largest clients:

Manufacturer

% of Revenue

Ford

14%

Volkswagen

10%

Chrysler

10%

General Motors

8%

Toyota

8%

Nissan

8%

Mercedes

7%

[Figures as provided in Information Statement]

While Adient's geographical breakdown is as follows:

Region

% of Revenue

Europe/Africa

35%

China

30%

Americas

29%

Asia/Pacific

8%

[Figures as provided in the Information Statement]

There are three factors that are likely to generate significant shareholder value in the next 2-3 years.

1. Growth in China

Adient has a dominate position in the Chinese market with a c. 45% market share and Joint Venture revenue of $6.6 billion. The company was an early market entrant into China successfully adopting a strategic partnership approach.

Adient is now the largest supplier of just-in-time seating in China, operating 17 joint ventures and 60 manufacturing locations across 32 cities. It partners with all the major auto groups in China, resulting in broad market penetration relative to its seating competitors.

The Chinese automotive market is forecasted to grow more rapidly than developed markets at 4.2% per annum to 2020 and 3%-5% for the next decade. Adient plans to leverage its market-leading position in China to outpace market growth and continue to increase market share. The company aims to increase market share to c. 55% in China by 2021. In addition, China provides a platform for further growth in Asia including India, Thailand and Indonesia.

The Chinese business has been extremely profitable for Adient. Since 1997, they have invested $150m in China and received dividends back in excess of $1 billion.

2. Margin Expansion

Adient outlines in their Investor Presentation how they plan to achieve a 2% improvement in operating margin in the mid-term by:

  • Operating a leaner cost structure particularly with regard to SG&A costs. The company's average SG&A costs over the last three years have made up c. 5.2% of sales whereas Adient's main competitor, Lear, has had average SG&A costs of 3.1% of sales. Adient believes it can reduce SG&A costs as a % of sales by 2% which will be partially offset by a 0.5% increase in SG&A in China as a % of Sales resulting in a net 1.5% improvement.
  • Adient has also identified an opportunity to consolidate its Metals operating units to reduce costs by 1%-2% as a % of sales. This improvement will be partly offset by an increase of 0.5%-1.5% in innovation investments. The net cost reduction is therefore forecasted at 0.5%.

The above optimizations will result in increased earnings in the short to medium term continuing the firm's upward trend in profitability.

3. Deleveraging

The company is forecasted to generate substantial earnings and free cash flow in the near term that will be used to pay down debt thereby further increasing earnings and transitioning the company from being highly levered to investment grade.

Adient has total debt of c. $3,592m generating interest expense at c. 3.5% per annum. The debt is medium to long-dated and can be broken down as follows:

Loan

Due

Amount ($)

Coupon

Term Loan

2021

$1,500

LIBOR + 1.75%

Senior Unsecured Notes

2024

$1,100

3.5%

Senior Unsecured Notes

2026

$900

4.875%

[Figures as provided in the Information Statement]

The company has cash of $643m resulting in Net Debt of $2,949m. Leverage is forecasted to decline materially in the next 2-3 years reducing interest expenses and increasing earnings, return on capital and ultimately shareholder returns.

Financial Forecasts

The below table forecasts improvements in the firm's operating performance based on sales growth of 3.1% and 1.2% respectively in 2017 and 2018, a slight uplift in Operating Margins from 4.8% in 2016 to 5.4% by 2018 and total debt reduction of c. $790m alongside the resulting drop in annual interest expense.

In addition, I have estimated income of $300m, $380m and $350m in 2016, 2017 and 2018 respectively from Joint Ventures in China. Finally, Adient will benefit from a reduced tax rate of c. 10%-12% as a result of being newly domiciled in Ireland.

2016

2017

2018

Sales

$16,300m

$16,800m

$17,000m

Operating Profit

$783m

$770m

$915m

Operating Profit Margin

4.80%

4.58%

5.38%

Income from Joint Ventures

$300m

$380m

$350m

Adjusted Net Income*

$830m

$914m

$1,027m

Adjusted EPS

$8.16

$9.01

$10.17

Total Debt

$3,592m

$3,200m

$2,800m

*Net Income has been adjusted to exclude restructuring costs and net income attributed to non-controlling interests.

Company Valuation

Assuming Adjusted EPS growth of c. 10% in 2017 and 2018, a conservative P/E of 14x forecasted Adjusted EPS for 2016 would provide an attractive entry point below $114.25. The current share price is $46.58 providing a margin of safety of c. 60%.

Further Information

The following sources were used in writing this article and may be of interest to the reader conducting further research.

  1. Information Statement
  2. Investor Presentation

Legal Information and Disclosures

This memorandum expresses the views of the author as of the date indicated and such views are subject to change without notice. Elenchus Capital Management Limited has no duty or obligation to update the information contained herein. Further, Elenchus Capital Management makes no representation, and it should not be assumed, that past investment performance is an indication of future results. Moreover, wherever there is the potential for profit there is also the possibility of loss.

This memorandum is being made available for educational purposes only and should not be used for any other purpose. The information contained herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Elenchus Capital Management believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based.

This memorandum, including the information contained herein, may not be copied, reproduced, republished, or posted in whole or in part, in any form without the prior written consent of Elenchus Capital Management.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ADNT over 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.

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