Introduction & Thesis
In this article, we'll be taking a look at the fundamentals of Meritor Inc (MTOR), which looks severely overvalued at current prices and multiples, in comparison to its industry peers. Meritor’s book value metrics, leverage ratios & nonexistent dividend yields don’t justify the 40% upside in the stock’s price since the start of 2019, which points to a disconnection between the price chart and the fundamentals.
Background & Methodology
In order to analyze the Auto & Trucks OEM industry, I selected a range of debt & price ratios, to identify strong value stocks, and applied those metrics to the OEM industry. I will shortly explain why I choose these ratios.
- Debt to Current Asset ratio: It gives us a quick understanding of the debt load and liquidity of a company, and easily represents the ability of a company to withstand its debt load with short-term assets.
- Current Ratio: Helps us gauge the liquidity strength of a company & is an effective management indicator. It’s interesting to compare it across companies in this case (but it isn’t that interesting on a standalone basis).
- EPS Growth over the last 5 Years: A synthesis of management performance & shareholder value growth over the last 5 years.
- PE Ratio: The earnings ratio is extremely useful in any analysis, and lets us compare companies on an apples-to-apples basis.
- PB Ratio: Is of significant importance when trying to find undervalued/overvalued common stocks.
- Dividend Yield & Occurrence: What can be more reassuring then steadily growing, re-occurring dividend payments? And what can more unpleasant that an erratic and bumpy dividend history?
I then selected the industry peers using SA’s list of comparables for the Automotive Original Equipment Manufacturers, which provides a very concise and accurate list of competitors, in addition to the current stock screener I use, with industry filter applied. I narrowed it down and obtained the following shortlist:
- AXL – American Axle & Manufacturing Holdings
- DAN – Dana Inc.
- MTOR – Meritor Inc.
- TEN – Tenneco Inc.
- BWA – BorgWarner Inc.
After extrapolating or calculating these ratios for each company of my universe, there were striking differences between the ranges of values I was getting for that particular industry in terms of price & ratio fundamentals.
In particular, Meritor Inc. was the best performing stock since the beginning of the year for that group, with the second-highest amount of red signals coming from my table. In fact, that single stock single handily overperformed the S&P by twice over!
S&P ETF - Red / MTOR – Green // Data by tradingview.com
The above & below tables, calculation, and imported data can be found here - OEM_Industry_Comps_Table.xlsx
When we first take a look at the Total Debt to Current Assets ratios for the industry, an important liquidity metric, we can clearly see that our 1.10 threshold isn’t met for any of the firms in the OEM universe.
Even though MTOR holds one of the lower values of Debt to Current Assets Ratio of 1.80, the company still appears to have a leverage problem which could cause some volatile earnings in times of economic uncertainty (recession signals have turned red more than ever in this late expansion stage of the economic cycle, and consumer cyclical stocks should only be considered as addition to portfolios only if they are trading at extremely safe leverage numbers).
I set the current ratio (current assets over current liabilities) threshold for firms with 50% more short assets than current liabilities, as short term headwinds are also to be considered with care when looking at the OEM industry. That conservative filter doesn’t favor MTOR with a thin 15% more ST assets than liabilities but puts other competitors like (BWA) or (DAN) appear compelling under this lens.
A downward sloping trend appears for MTOR’s current ratio from 2016 to 2019. Another contradictory signal that contrasts with the important increase in Meritor Inc.’s share price since Jan 2019.
When looking at leverage & liquidity, MTOR’s degrading current ratio & mediocre total debt to current assets don’t really add up to financial safety & wellbeing.
The increase in the price seems odd when compared to the degrading nature of its ratios. But could there be more to it? Let’s take a look at management performance based on EPS growth.
2 - Earnings growth
Since Meritor Inc.’s 5Y EPS growth isn’t available, we could take a look at the quarterly EPS growth over a long period. The results don’t look very promising here as well. Infrequent quarterly EPS growth appear but don’t justify themselves as stable and recurrent. Compared to AXL’s triple-digit EPS growth since 5Y ago, for example, MTOR still looks pale in comparison to most of its industry peers.
A real disconnection looks more and more evident, between Meritor’s EPS based performance & share price increase.
It would be evident that a company which doesn’t deliver value to its shareholders through earnings growth, and where management can’t keep up with its competitors, shouldn’t see this kind of share price increase.
But could there be more? Could trading multiples or safe dividends justify this increase?
3 - Price multiples
The answer looks like “maybe” at first glance when looking at MTOR’s current PE multiple of 6.8. However, the Auto OEM industry as a whole isn’t what one would call a high growth industry, which justifies the multiples of most of these companies.
When looking at the price to book ratio, Meritor Inc.’s share price is trading at almost 5 times its book value per share, which looks severely overvalued compared to its peers, especially when looking at Tenneco (TEN) and American Axle Corporation (AXL), which trade at less than their books values, or DAN & BWA which trade above the defined conservative threshold for PB, but still less than half of MTOR’s multiple.
Again, in term of PE & PB multiples, but mostly in terms of book value per share, MTOR can only be stored in the “overvalued” labeled drawer of stocks, and its share price increase makes even less sense now.
But could dividends, the last man standing, justify even slightly the overly enthusiastic increase in share price?
4 - Dividends
Well… it doesn’t.
As we can see above, “stable & growing” aren’t the first words that come to the mind when looking at Meritor’s dividend payments over the years. The 10 years hiccup in dividend payment, although halted in 2019, is not enough to make the argument for a safe and regular dividend payer.
Meritor Inc. is indeed overvalued, and this can be particularly noticed when comparing it to its Auto OEM industry peers.
When looking at Meritor's less than average EPS growth performance, its degrading leverage & liquidity indicators, and its overpriced book value per share multiple, we can only make a case for an overvalued and overbought company at current prices, most notably after looking at its performance since the beginning of the year.
With ramping fears of the next global recession, and the implosion of US-Chinese negotiations, it would be almost “suicidal” to add MTOR to your portfolio, would it be for its valuation (mostly the argument today), or because of the growing macro-economic tensions and worries.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in MTOR over the next 72 hours.