Garrett Motion: Chapter 11 Bankruptcy And Undervaluation

May 25, 2022 7:18 AM ETGarrett Motion Inc. (GTX)15 Comments3 Likes
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Summary

  • Garrett has shown strong improvements on its balance sheet since its emergence from the Chapter 11 bankruptcy.
  • Even though the leverage is high, the trajectory shows that it is likely to change in the near future.
  • The company is extremely undervalued with almost as much cash on its balance sheet as its market cap.
  • I am bullish on the stock with a medium-term horizon of 2 years because the stock seems to have priced in all the downside but not the upside.

Automotive turbocharger turbine 3d render on white no shadow

NosUA/iStock via Getty Images

Investment Thesis

Garrett Motion Inc. (NASDAQ:GTX) has been subject to significant volatility during 2021, underperforming the market by 9% in the previous year and 12% YTD.

Garrett Motion stock
Data by YCharts

The company emerged from its Chapter 11 bankruptcy, predominantly caused by Honeywell (HON), in April 2021 and is now cleaning its balance sheet. Here's a great article expanding on the bankruptcy emergence.

The company has recently seen a decline in YoY sales, but there is still a lot of room to grow despite the headwinds; the real value in the stock lies in its extremely attractive valuation metrics due to the smashed price tag, which has ingrained the headwinds into the stock's value but hasn't priced in the company's long-term trajectory.

I am bullish on the stock, expecting a great return with a time horizon of 2 years as I expect the company's post-dilution 2023 performance to start reflecting its true value.

The Company

GTX operates in the turbocharger and electric-boosting technologies industry, catering to the automotive industry's light and commercial vehicle OEMs, the independent aftermarket, and automotive software solutions. The company boasts expertise in product delivery for internal combustion engines (ICE) with gasoline, diesel, natural gas, and electric powertrains and is now developing turbochargers for hydrogen-powered ICE vehicles.

Geographically, 50% of the company's sales in the MRQ emerged from Europe, followed by 31% from Asia and 17% from the US. Alternatively, the OEM market accounts for almost 87% of the company's revenue, with only 12% from the aftermarket and 1% from other sources. The European market is the biggest turbocharger market globally, with 2 out of 3 vehicles equipped with turbochargers. The equipment ratio is expected to expand to 3 out of 4 cars in 2022.

Garrett Motion revenue share by region and market

Author

Data Source: GTX 10-Q filing

GTX Topline Growth

Due to the company's recently resolved Chapter 11 circumstances, investors would be more interested in knowing about the company's idiosyncratic risks and rewards than the systemic risks and rewards. The company has shown a 10% YoY revenue decline in line with a 10% decrease in its sales volume from about 3.8 million in Q1 2021 to 3.4 million units in the MRQ. This decline in its MRQ results is attributable to the overall decline in global vehicle production due to the semiconductor crisis.

Garrett Motion Net Sales Bridge: Q1 2021 – Q1 2022

GTX Investor Presentation

The Russia-Ukraine crisis has further caused a slowdown in global vehicle production, leading to cut downs in annual production estimates for 2022 and 2023. According to IHS Markit, the global vehicle production supply chain will set the upper limit for sales instead of demand because of supply chain constraints pertaining to the Russia-Ukraine situation. This is because of the supply shortages of the Ukrainian-built electrical wiring harness and semiconductor materials, including Ukrainian neon gas and Russian palladium.

The same report iterates that switching the electric wiring harness supply could take 3 to 10 months because of wait times on machinery and multi-month staff training times, putting European manufacturers, especially at risk because 45% of the wiring harness is normally exported to Germany and Poland. At the same time, about 67% of the global palladium production is used in vehicles and around 40% of the global production is from Russia. Suppose the geopolitical situation moves to a point where Russian palladium becomes inaccessible. In that case, it will halt the overall supply chain, potentially making it the biggest supply constraint of the automotive industry.

These constraints will likely overflow into 2023 and affect the annual turbocharger demand as they did in the current quarter. However, the current estimate of 80.6 million units will be an almost 2% YoY growth against 2021's 79.1 million units.

Global vehicle production estimate 2022

S&P Global

Source: S&P Global

GTX still has the potential to grow its market share given its highly innovative R&D function and growing adaptability in the electric vehicle market. Despite the cutbacks on global vehicle production estimates, GTX has a lot of room to grow as, according to the company's SEC filings, the industry trend is going on an upward trajectory with higher turbocharger market penetration because of increasing global vehicle fuel efficiency and emissions standards. This is in line with estimates from multiple sources that iterate that turbocharged vehicles have risen from 5% to over 50% during the previous decade.

The company had $3.63 billion in net sales in 2021 and expects between 1% and 6% topline growth in constant currency for 2022, which is extremely reasonable considering the overall macroeconomic situation in light of the above.

Going by the estimates, the company's topline growth isn't very impressive, but profitability metrics are much more positive. Since its emergence, the company's return on investment has grown sequentially, creating more wealth for shareholders per dollar of investment. On a TTM basis, the company has returned over 3 times the industry median on its assets and over 9 times on total capital.

GTX Profitability Summary

Seeking Alpha

Valuation

Garret's valuation is what makes it an amazing deal. The company's short-term prospects may seem underwhelming at first glance, but it is indeed an industry leader, and its medium to long-term prospects are very promising. Therefore, trading at a significant discount allows the stock's intrinsic value to hold a material upside potential.

Trading at the industry metrics, the stock shows a median intrinsic value of about $20.5 with the current financial figures, but this doesn't incorporate the effect of a complete future dilution. However, even if 100% dilution is considered at face value, the intrinsic value goes down to about $19.

Following the topline trajectory, the company has a forward PS of 0.1x and an EV-to-Sales ratio of 0.4x, undercutting the industry medians of 0.87x and 1.04x by 87.5% and 61.2%, respectively.

GTX Valuation Summary

Seeking Alpha

Moreover, the company is currently trading at a far lower market cap than its quarterly revenue, and its cash position almost completely encapsulates its entire market cap.

Garrett Motion market cap and revenue
Data by YCharts

The company's book value of negative $5.5 may seem poor, but it has been consistently improving and has been almost halved in the previous 2 quarters from negative $9.73 in Q3 2021.

Garrett Motion book value per share
Data by YCharts

One More Thing

The company had a YoY EBITDA margin decline of 1.5% but had sequential growth of 1.2%. The company is moving closer toward achieving an EBITDA of $600 million in TTM, which will trigger the automatic conversion clause of the 247.8 million series A convertible notes.

Garrett Motion EBITDA Q1 2022

GTX Investor Presentation

This will cause considerable dilution in its common stock, almost 3.8 times its currently issued 64.5 million shares. Following the estimates, the company may reach the $600 million target by the year-end. Else the stock will be converted automatically by April 2023.

Additionally, the company redeemed over 217 million shares of its Series B Preferred Stock for $197 million in February 2022, leaving remainder obligations of $272 million toward Honeywell to be paid by 2027, with the earliest payment of $18 million due in 2024.

Garret has paid over $400 million in debt from Q3 2021 to Q1 2022, showing that the company is on its way to clearing its balance sheet and turning those poor leverage metrics upside down far quicker than initially anticipated.

Conclusion

Garret is a great company with a tainted past because of the Chapter 11 bankruptcy. Despite the Chapter 11 filing having more to do with financial restructuring than indicating financial troubles, the word "bankruptcy" itself carries a negative image that brings a storm of scrutiny and criticism to a stock. This results in stocks being more exposed to being priced relevant to their imminent risks than rewards, often leaving an unrealized upside potential in the stock.

In March, I covered Chesapeake Energy (CHK) stock, which had also recently emerged from a Chapter 11 bankruptcy. It has now gained over 26% since publication because of the aforementioned reasons.

GTX stock is significantly undervalued because the market is in a downtrend and sell-offs are more likely to target companies wherein investors are fearful. The high leverage on GTX's balance sheet definitely seems something to be cautious about, but the trend and the long-term prospects suggest that now might just be the time to follow Warren Buffet's advice once again,

Be fearful when others are greedy and greedy when others are fearful.

This article was written by

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"A fade is a contrarian investment strategy that involves trading against the prevailing trend."  We look at low-cap stocks that are not covered by mainstream investment firms in search of early opportunities spanning a variety of investment philosophies. The best opportunities are found when looking where others won't. Let us know if you want us to cover any specific tickers and we'll be sure to take a look! Formerly Moonshot Equity Analysis.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. Business relationship disclosure: This article was researched and written by Waleed M. Tariq.

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