- American Axle posted better fourth quarter results, in line with the outperformance of most suppliers, and growth in its small EV revenue backlog.
- The company has partnered with China's Inovance Auto to provide 3-in-1 e-drives, leveraging Inovance's capabilities in power electronics and AXL's capabilities in gearboxes.
- Management has done a good job of taking costs out of the business, and capex needs should be relatively modest over the next three to five years.
- The long-term competitiveness of AXL in vehicle electrification remains my primary concern. While there's a case for AXL trading to the mid-teens or higher, I'm not sold on the long-term viability of the model.
Writing about American Axle (NYSE:AXL) six months ago, I said that I saw upside into the low double-digits on improved operating leverage and recovering passenger vehicles builds. The shares have since risen about 45% since then (into the low double-digits at $11.42), outperforming names I liked better like BorgWarner (BWA) and Valeo (OTCPK:VLEEY), but not keeping pace with Dana (DAN). I attribute at least some of this outperformance to the outsized operating leverage at American Axle relative to many other companies, as well as underappreciated execution on costs.
American Axle is a tough stock to evaluate today. I’m not that impressed with American Axle’s positioning for electrification, and the company’s still-high debt limits the company’s ability to do much through M&A. On the other hand, the company has made meaningful cost efficiency improvements and if capex can stay in the $300M area for a while, there’s good FCF potential in the near term.
So much comes down to how revenue holds up. With a gradual decline in revenue starting around 2024/2025, these shares would still have solid upside from here, but as with Tenneco (TEN), the high level of leverage means that even small changes in modeling assumptions drive big changes in the fair value.
Building The EV Story, But Is It Too Little Too Late?
Traditionally a developer of axles, driveshafts, and power transfer units, American Axle has staked its electric vehicle future on e-drives (systems that incorporate an inverter, motor, and gearbox into a unit) and components like gears, shafts, and differentials.
Although e-drives are going to be essential components for electric vehicles, there’s a great of deal of debate as to how profitable they will be for auto suppliers like American Axle. Some auto OEMs are going to try to do it all themselves, while others will insource some components (like motors or gearboxes) and outsource others. Still others will operate more or less as they usually have, outsourcing all or most of those components.
Specific to American Axle, early returns on its e-drive platform haven’t been all that exciting, with pretty modest power/weight, peak power, and peak torque performance compared to offerings from companies like Valeo, BorgWarner, and Nidec (OTCPK:NJDCY). Moreover, the company lacks internal capabilities in areas like power electronics where I believe more long-term value and competitiveness will lie – power electronics are the hardest e-drive component to internally develop from scratch, gearboxes the easiest.
American Axle recently announced a partnership with China’s Inovance Automotive to develop and sell 3-in-1 e-drives that will use American Axle’s gearboxes and Inovance’s power electronics. Who will supply the motor part is unclear; both companies have some capability here, so I don’t know how this component will be handled. Although this deal answers some of American Axle’s challenges, Inovance hasn’t really gained any traction outside the Chinese market and American Axle will of course have to split the proceeds.
American Axle also has an investment in REE Automotive, an EV startup that is going public through a SPAC merger. REE is a developer of “skateboard” EV platforms that integrate drive components into the wheel arch – a fairly familiar design at this point, and one readers may recognize in GM’s (GM) Ultium chassis platform.
Source: REE Automotive
I remain skeptical that this is going to be enough. American Axle announced 20% year-over-year growth in its EV backlog, but it’s only $90M, and the company hasn’t scored many major wins. Making matters worse, American Axle has long been a GM-heavy supplier (39% of ’20 revenue), and with GM not only insourcing for its EVs, but making its platform/components available to other OEMs, American Axle is looking at a major customer becoming a competitor as GM attempts to become an all-EV company over time.
Better Margins And Cash Flows In The Meantime
Credit where due, American Axle has done a very good job trying to make the company leaner and more efficient from a cost and capex standpoint. EBITDA margin actually improved in 2020 (though the GM strike in the prior year period had a meaningful impact), and the company should be able to generate EBITDA margins above 16% for the next three to five years, with some upside possible if volumes come in better than I expect.
On the cash flow side, management has also tried to get more efficient with its capex spending, and I believe capex may be able to support the business on $250M to $300M in capex spending over the near future, helping push free cash flow margins into the mid-single-digits.
In the short term, American Axle’s high leverage to pickups, SUVs, and CUVs (typically the most profitable products for automakers) should be an asset, as OEMs will prioritize those models during this semiconductor shortage. These models may also still offer a somewhat slower/longer path to electrification, though many OEMs have accelerated their development/launch timelines for electric SUVs and pickups.
The major unknown here is how American Axle’s revenue develops beyond the next five years. There will still be enough production of vehicles with conventional powertrains over the next five years to sustain healthy cash flow, but as electrification takes more and more new-build share in 2025 and beyond, the company’s position in that ecosystem becomes more critical.
At this point, I still see American Axle as a net loser in that shift, as I just don’t see a compelling technology package here – the partnership with Inovance will help in China, but without meaningful improvement/innovation in its EV offerings, I don’t see how American Axle beats out suppliers that have invested more resources into technology (BorgWarner, Dana, Valeo, et al) for whatever business remains outsourced to suppliers.
If the pace of 2025 and beyond decline is relatively gentle, these shares could still have upside to the mid-teens, and the shares are definitively undervalued relative to what the market typically pays for auto suppliers with similar near-term EBITDA prospects. If the drop-off is more severe, and my that’s my primary concern, the value shrinks significantly. This is also the problem with high financial leverage – fairly small changes in modeling assumptions produce big changes in the outputs.
The Bottom Line
I completely acknowledge the long-term modeling uncertainty here, as well as the likelihood of relatively better near-term performance. While I can model out scenarios where these shares still look pretty attractive, I’m simply not confident that American Axle has assembled what it will take to stay relevant in the EV shift, and I feel more comfortable with companies/stocks where I think the EV tech/product portfolio is more competitive.
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Analyst’s Disclosure: I am/we are long BWA, FR.FR. 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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