Undervalued American Axle Has Lots Of Upside

| About: American Axle (AXL)
This article is now exclusive for PRO subscribers.

Summary

Acquisition of Metaldyne Performance Group provides less reliance on GM and accretive acquisition opportunities in new markets.

Axel has growing revenues, a strong balance sheet, and loads of free cash flow.

The company is cheap on an Acquirer’s Multiple® of 6.04.

One of the cheapest stocks in our All Investable - Deep Value Stock Screener is American Axle & Manufacturing Holdings, Inc. (NYSE:AXL).

American Axle & Manufacturing Holdings, Inc. (AAM) is a Tier 1 supplier to the automotive industry. The company manufactures, engineers, designs and validates driveline and drivetrain systems and related components and chassis modules for light trucks, sport utility vehicles (SUVs), passenger cars, crossover vehicles and commercial vehicles.

In addition to locations in the United States (Michigan, Ohio and Indiana), AAM also has offices or facilities in Brazil, China, Germany, India, Japan, Luxembourg, Mexico, Poland, Scotland, South Korea, Sweden and Thailand.

A quick look at the company's share price over the past twelve months shows AAM has dropped 3.82% overall and currently trades at $19.11, just 4% off its 52 week high of $19.88.

(SOURCE: GOOGLE FINANCE)

Q3 2016 Results

AAM recently released its Q3 2016 results on November 3, 2016.

Third quarter highlights included:

  • Net income in the third quarter increased to $61.7 million compared to $60.9 million for the pcp. Results reflected the impact of a $3.4 million asset impairment charge and $0.7 million of acquisition related expenses.
  • Net sales in the third quarter of 2016 increased to $1 billion compared to $971.6 million for the pcp. Non-General Motors (NYSE:GM) sales were $307.7 million in the quarter compared to $321.6 million for the pcp.
  • Gross profit increased to $181.2 million as compared to $158.3 million for the pcp. Gross profit included the impact of the $3.4 million asset impairment charge.
  • Gross margin increased to 18.0% compared to 16.3% for the pcp.
  • Adjusted EBITDA increased to $156.7 million, or 15.6% of sales compared to $149.2 million, or 15.4% of sales, for the pcp.

"AAM's third quarter financial results continued to reflect strong production volumes and solid performance in our global manufacturing operations," said AAM's Chairman & Chief Executive Officer, David C. Dauch. "Our year-to-date financial performance positions AAM to achieve record sales and profit in 2016."

Growing Revenues

A quick look at AAM's income statement below for the trailing twelve months shows that the company has continued to improve its revenues, growing 5% from $958 million in Q4 2015 to $1 billion in Q3, 2016, while increasing its gross margins to 18% and operating margins to 10%.

Quarterly Income Statement (values in 000's)
Quarter: 3rd 2nd 1st 4th
Quarter Ending: 9/30/2016 6/30/2016 3/31/2016 12/31/2015
Total Revenue $1,006,900 $1,025,400 $969,200 $958,400
Gross Profit $181,200 $191,400 $174,000 $159,800
Operating Income 101,300 111,500 $98,400 $87,100
Net Income $61,700 $71,000 $61,100 $62,900

(Source: Company Reports, SEC.gov)

Strong Balance Sheet

A quick look at AAM's balance sheet below for the trailing twelve months shows that the company has $433.9 million in cash and cash equivalents and total debt of $1.40 billion. Whenever you see a company with total debt in excess of its cash & cash equivalents it's important to take a look at the company's statement of cashflows (below) to ascertain whether it has lots of free cashflow to pay down this debt, if necessary.

Quarterly Balance Sheet (values in 000's)
Quarter: 3rd 2nd 1st 4th
Quarter Ending: 9/30/2016 6/30/2016 3/31/2016 12/31/2015
Current Assets
Cash and Cash Equivalents $433,900 $388,400 $262,000 $282,500
Current Liabilities
Short-Term Debt / Current Portion of L/T Debt $3,400 $3,400 $3,400 $3,300
Long-Term Debt $1,401,000 $1,403,300 $1,382,100 $1,375,700

(Source: Company Reports, SEC.gov)

With a current market cap of $1.46 billion and debt in excess of cash totaling $971 million that means AAM has an Enterprise Value of $2.4 billion. With operating earnings* of $402 million that means AAM has an Acquirer's Multiple® of 6.04.

The Acquirer's Multiple® is calculated as:

Enterprise Value / Operating Earnings*

The Acquirer's Multiple® uses operating earnings in place of EBIT and EBITDA and is constructed from the top of the income statement down, where EBIT and EBITDA are constructed from the bottom up.

* The Acquirer's Multiple® uses the CRSP/Compustat merged database "OIADP" line item defined as "Operating Income After Depreciation."

Solid Free Cashflow

Now let's take a look at AAM's statement of cashflows (below) for the trailing twelve months to determine its free cashflow position.

Quarterly Statement of Cashflows (values in 000's)
Quarter: 3rd 2nd 1st 4th
Quarter Ending: 9/30/2016 6/30/2016 3/31/2016 12/31/2015
Net Income $61,700 $71,000 $61,100 $62,900
Net Cash Flow-Operating $107,500 $157,300 $26,200 $109,500
Cash Flows-Investing Activities
Capital Expenditures -$53,000 -$55,100 -$50,600 -$61,400
Net Cash Flows-Investing -$58,500 -$51,300 -$50,000 -$56,200
Cash Flows-Financing Activities
Sale and Purchase of Stock -$100 -$1,400 -$3,500 -$1,000
Net Borrowings -$3,200 $21,200 $4,600 -$134,500
Other Financing Activities $0 $0 $0 $0
Net Cash Flows-Financing -$3,300 $19,800 $1,100 -$135,500
Effect of Exchange Rate -$200 $600 $2,200 -$900
Net Cash Flow $45,500 $126,400 -$20,500 -$83,100

(Source: Company Reports, SEC.gov)

As you can see, for the trailing twelve months AAM has $400 million in operating cashflow and $220 million in capex, which leaves the company with $180 million in free cashflow to pay down any excess debt, repurchase shares or pay dividends. What you'll also notice is that the company did spend $6 million on repurchasing its own shares and paid back debt of $138 million while issuing new debt of just $25.8 million.

In terms of the company's overall financial position. AAM has growing revenues, solid margins, a strong balance sheet and loads of free cashflow.

AAM's acquisition of Metaldyne Performance Group, MPG

On November 3, 2016 AAM issued a joint press release announcing that the company has entered into a definitive agreement to purchase MPG. Under the terms of the agreement AAM will acquire the outstanding shares of MPG. The combined entity will bring together two complementary Tier-1 organizations to create a global manufacturer of component modules and sub-systems across multiple engine, transmission and driveline applications.

What I like about the transaction is that both AAM and MPG do have very similar management cultures in terms of their focus on process excellence as well as being 'straight shooters'.

The combined entity will make AAM less reliant on General Motors as a customer and the North American light truck and SUV segment as a key end market, while increasing its global footprint, most notably in Europe and Asia.

In addition to receiving MPG's expertise in powertrain technologies, the transaction also expands AAM's product portfolio into critical engine and transmission applications that are key to advancing power density and light-weighting initiatives and, increases AAM's participation into the commercial vehicle and industrial markets.

In terms of financial benefits, AAM's Chairman & Chief Executive Officer, David C. Dauch said:

Due to this acquisition, we will achieve a stronger financial profile with attractive margin performance and a powerful cash flow generation potential. The new company will start with close to $7 billion of annual sales. Factoring in the implementation of achievable synergies, the combined entity will have the potential to generate more than $1.2 billion of EBITDA and over $400 million of positive free cash flow.

Details of the Transaction

AAM has agreed to purchase all outstanding shares of MPG in a cash and stock transaction, valued at approximately $1.6 billion. For each share of MPG, shareholders will receive $13.50 per share of cash and $0.05 share of AAM equity.

This implies a 6.8 times EBITDA multiple based on estimated 2016 EBITDA, and a 5.5 times EBITDA multiple considering achievable synergies of between $100 million to $120 million. AAM estimates that MPG shareholders will own approximately 30% of AAM's common stock, after the closing of this transaction. Of this total ownership by MPG shareholders, MPG's controlling shareholder American Securities will own approximately 23% of AAM's common stock. AAM expects the transaction to be accretive to AAM's EPS and cash flow in the first full year of ownership.

AAM has fully committed debt financing in place to fund the cash portion of the purchase price and to support the liquidity needs of the new entity. The company also plans to issue approximately 34 million shares of new AAM equity to MPG's shareholders in connection with this transaction.

Debt Load of the New Entity

As mentioned in the Q3 2016 earnings call transcript here at Seeking Alpha, the issue of course will be the combined debt load of the new entity which is expected to be around $4 billion but AAM believes that the combined earnings power should generate over $400 million of free cash flow on an ongoing basis post close. That being the case, that cash flow will continue to de-lever the business, and its anticipated that by the 2019 timeframe to be around two times levered based on the back of that cash flow.

Update on GM's Next Generation Full-Size Truck Program

In the Q3, 2016 results AAM also announced it is making significant efforts to backfill the impact of GM's recent sourcing action on the next generation full size truck and SUVs.

AAM reported it would not retain all of GM's next generation full size truck program. At that time it was estimated that AAM would retain approximately 75% of the sales content provided to GM on the current full size truck program in the next generation program. Based on GM's current design and program direction, AAM now estimates it will retain approximately 65% of the sales content provided to GM on the current full size truck program.

However, as a result of its commercial successes in 2016, AAM announced it has covered approximately 90% of the sales lost in the next generation sourcing transition with new and incremental business that will launch in 2018, 2019, and 2020 calendar years.

Summary

There's a lot to like about AAM. The company has growing revenues, a strong balance sheet and loads of free cash flow. AAM is cheap on a number of multiples including a P/E of 5.84, a P/B of 2.87, a P/S of 0.38, and my favorite, an Acquirer's Multiple of 6.04.

While no-one can predict what will happen regarding the synergies with MPG, what is obvious is that the agreement does reduce AAM's current reliance on General Motors and opens up new markets in Europe and Asia with an expanded portfolio.

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.