Superior Industries: It's Not Just About China
Summary
- Superior Industries had a very poor 2019, with declining sales and profitability.
- Management is guiding for a soft sales environment in 2020, but believes profitability should improve due to cost cuts.
- However, the Wuhan coronavirus is likely to dent demand in 2020, which would likely impact SUP's financials substantially.
- With lots of debt due over the next few years, SUP could face a liquidity issue if the coronavirus gets worse.
The last few months have not been kind to Superior Industries(NYSE:SUP), which has dropped 46% from its recent peak of around $3.80. While it may seem tempting to buy the dip, it could turn out to be very dangerous to do so, as we believe that SUP will have a high chance of filing for bankruptcy if the coronavirus outbreak gets worse.
2019 results
Even without the coronavirus situation, 2019 was a pretty horrible year for the auto industry and for SUP. A strike at GM and soft conditions in the overall auto market led to an 8% decline in shipments for the full year. The lower shipments, along with higher energy costs and plant inefficiencies, led to lower adjusted EBITDA, which was offset by cost savings.
In 2020, management guided for unit volumes to continue to decline due to a soft production environment, but they do believe adjusted EBITDA will start to grow, aided by an improvement in mix and cost rationalization initiatives.
Looking to 2020, while we expect a softening production environment, we remain committed to effectively executing our order book, enhancing profitability and driving cash flow through earnings, working capital and a disciplined approach to capital expenditures.
The balance sheet hasn’t improved much, with long term debt still remaining in the $611mil range. This excludes the $300mil in preferred stock that SUP will need to pay in the next few years. At the moment, SUP has $78mil in cash, which helps short term liquidity but isn’t enough to pay their long term obligations.
Don't underestimate the risk
During the conference call, SUP repeatedly emphasized that they don't have operations in China and that very little of their supply chain would be affected by the coronavirus.
Just to frame the implication for our business on the coronavirus. So, first and foremost, from an exposure standpoint, we do not have operations in China. We don't ship product directly into China. So, that's first. Second, in terms of from a supply chain, we actually have very limited exposure there. We have some tools and some indirect material. The team has done a great job of putting in place mitigation plans, and resourcing tools where it makes sense.
Source: Q4 2019 call
While we do agree with this, considering most of their supply comes from Poland, we are more worried about demand from automakers. Many of SUP’s largest customers are located in Germany or the US, both of which have rising numbers of infected people. If things get worse, factories would likely be closed and auto sales are likely to decline, leading to lower demand for SUP’s products. This is what happened in China:
China's passenger vehicle sales recorded 4,909 units in the first 16 days, down from 59,930 vehicles in the same period a year earlier, data from CPCA showed, the first major figures to demonstrate just how hard the epidemic is hitting the world's biggest auto market.
Also, while we did mention that SUP has signed contracts with automakers for a large portion of their production capacity over the next few years, we recently found that these contracts don't require minimum purchases and are subject to market demands.
The contracts we have entered into with most of our customers provide that we will manufacture wheels for a particular vehicle model, rather than manufacture a specific quantity of products. Such contracts range from one year to the life of the model (usually three to five years), typically are non-exclusive and do not require the purchase by the customer of any minimum number of wheels from us. Therefore, a significant decrease in consumer demand for certain key models or group of related models sold by any of our major customers, or a decision by a manufacturer not to purchase from us, or to discontinue purchasing from us, for a particular model or group of models, could adversely affect our results of operations, financial condition and cash flows.
We believe there will be a sharp demand drop for SUP’s products over the next few months, which management clearly hasn’t factored into their outlook. If China's numbers are any indication, SUP is in a lot of trouble. Of course, there is still currently a lot of unknowns regarding the outbreak, but from what we’ve read, it is very likely that the situation in the US and Europe would get much worse over the next few months.
Valuation
Although SUP is now trading at a much lower market cap than before, the worsening COVID-19 situation in Germany, as well as the company’s high debt levels, means that catching this falling knife right now is incredibly risky. We believe that SUP actually has a fairly high chance of bankruptcy over the next few quarters if the COVID-19 situation worsens and auto demand around the world drops substantially due to its high debt load.
Even if things turn out well, SUP’s valuation isn’t extremely attractive. In 2019, it generated around $169mil in adjusted EBITDA, and at the current EV, this represents an EV/EBITDA multiple of just 5.3x, which isn’t incredibly low for a cyclical auto supplier with declining revenues.
Takeaway
In conclusion, SUP should be avoided at all costs. The company can’t even maintain revenues in a decent economic environment, so things would likely be a lot worse in a downturn. With a massive debt load and a weak sales environment, the outlook for SUP is definitely not good.
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