American Axle is a crappy company. But I currently view that we are going to see a large increase in auto production to (i) meet demand which we are unable to do right now and (ii) restock to baseline inventory levels. So with the stock at a ~40% FCF yield, I’m interested.
This could be a value trap, but my thesis is simple:
SAAR came way down during COVID, but demand held in
Semiconductor shortages have limited production to catch up, which will sort itself out over time. But it will take time. And this will result in a prolonged auto upcycle
Credit is cheap + average age of vehicles has continued to tick up which tells me there’s room for even more restocking.
US personal savings averaged $3.5 trillion during first 5 months of 2021, nearly 3x the level seen in 2019. We could see a decline in the average age of vehicles in the car parc for the first time in many, many years
Inventory continues to decline. Days supply of autos is now around 20 days compared to long-term averages of 60 days. Auto producers need to meet current demand + restock inventories to some sort of normal level
Add this all together, I think the next 3+ years will need to see above average production to catch up.
Here is SAAR, auto inventories and the average age of cars on one chart:
What is a levered bet on this? Shitty auto suppliers. And that is where American Axle comes in to play (and I’m open / reviewing others). AXL trades for ~4x EBITDA for a reason – when auto production collapses, they get crushed. But on the other side, they can generate great FCF when the cycle is in their favor.
How often do you see sell side pointing out the FCF yield is ~40%?. That is also an appeal here – the FCF yield to equity is quite high and I don’t think expectations are high for this company. At the very least, there is a lot of doubt in this cyclical name that the cycle will be short-lived.
$AXL used to have “a balance sheet problem.” While it might’ve only been 3x levered, it was on a business worth 4x, so it mattered. That’s a 75% LTV, which is pretty high. But they generate cash flow now and will definitely in this market.
I should go ahead and point out why they are not great:
~40% of sales are to GM. If GM needs to take a plant down, like in the case of no semi’s, that won’t be ideal. This also means GM has significant power of AXL. Fiat Chrysler is another ~20%
Pretty capital intensive, as 6-7% of sales is spent on capex in normal times.
Investors view anything related to powertrain parts as secularly challenged from EVs (however, AXL did note it is quoting $1.5bn of new & incremental work, with 80% related to hybrids / EVs). In an EV world, perhaps there is less AXL content needed
So there lies the main risks. The other hard part is where this company should trade. I am not calling for a re-rating. I just think earnings / FCF will likely be much higher than consensus expects for the next 3 years. Leverage is down to 2.5x and once they get to 2.0x or less, I think that FCF will really start accruing to the equity.
If this stock underperforms – I’ll know why. I bought a value trap.
As everyone I am sure is aware, container shipping rates right now are astronomical. The re-opening of the economy and associated supply-chain bottlenecks has created a situation where people will pay up just to make sure their items are actually on that boat!
This has caused blow-out earnings for the shipping lines. Maersk reported a 166% increase in EBITDA for Q1’21 for example.
However, I don’t think this is sustainable and no one else does, probably. Shipping is also a fraught industry to invest in – when times are good, capacity is brought online. These ships are long-lived assets so when times aren’t good, the supply is still there.
There’s alternative however, with a much stronger industry structure, ROEs, cash flow, on and on. That is container leasing. Triton is the largest player in the space after it merged with TAL in 2016.
I like Triton stock because:
Leader in the market – scale in the leasing industry matters and drives much higher margins + lower cost of capital
Fundamentals are in terrific shape
They are signing long leases at high rates – abnormally long and abnormally high (over a decade) – which will give strong visibility into cash flows for foreseeable future
Can flex capex spend with the market – has a history of shutting of capex and buying back stock + dividend
Triton stock trades for ~6x ’21 EPS, 1.3x ’21 BV – historically generated mid-teens+ ROE in normal times. This should improve
The business historically went something like this:
Triton buys containers and places them on lease with shipping companies.
Historically, these would be 5 year leases. However, with limited technological obsolescence (just renting a steel box in most cases), the age of the asset didn’t really matter. So they can pretty quickly re-lease the box, but the lease rate may change
The assets (boxes) last about 15-20 years with pretty minimal maintenance. Maybe slightly more for a refrigerated box, called a reefer (yes the actually name), but the lease rates would also be higher. So historically there’d be 3+ leases involved
End of life – they sell the box for some residual value, which also helps recoup part of their investment. It used to be they buy a box for $2,000-$2,500 and could sell it for ~$1,000. Right now, they can sell the used box for about $1,500, which is pretty nice.
Why do shipping companies lease instead of owning their own containers? It outsources capex in an already capex-heavy industry. It’s off balance sheet financing for them. The shipping lines do still own their own containers (about half of the market), but that’s been trending down pretty consistently over time. It just makes more sense for them to focus on shipping and flex leases up and down with the market.
I don’t think I need to dwell on why fundamentals are good right now or why buying Triton stock at 6x earnings is optically cheap. I’m going to focus on the lease rates and new longer duration contracts being signed right now.
If you are worried about the current conditions being unsustainable, long, contracted lease rates help that. As shown below, Triton is trying to tell investors that not only is it leasing more containers than basically ever…. putting assets to work… the lease durations are now approaching 12-13 years.
If you like SaaS, you’ll *love* container leasing companies.
We’ll have to think about these rolling off in 2031-2033, but meanwhile, the company will be earning above average ROEs.
Here is a chart from their Q1 basically showing lease rates are 1.6x the general average. You can see there was a dip in 2019, but the company pulled back – the size of the bubble indicates how many containers were put on lease (so very few). In a sense, Triton is an asset manager just like a Blackstone – you kind of need to trust that they will be deploying capital when times are good and pulling back when times are bad.
What could go wrong?
I should mention what could go wrong. We have seen this situation before – following the GFC, world trade snapped back and lease rates surged. Unfortunately, they all basically expired in 2015/2016. This was also when we were in a quasi-industrial recession. This was also when steel prices were in the gutter, which makes up most of the price of a box and makes it tough to sell used boxes at a fair price. Hanjin, a major shipping line, also effectively liquidated (in a BK case, most of the time a shipping line will just keep its assets rolling in a Ch. 11 because the containers are critical assets to operating – Hanjin just disappeared.)
In many ways, 2015/2016 was worse that the GFC. I mean, it actually was worse. The GFC wasn’t actually that bad because global trade remained pretty steady.
Even with a trade war, it’s hard to knock off the secular trend of the western countries importing from Asia. If it isn’t from China, it is from Malaysia, Vietnam, and so on.
Did I strike to buy Triton stock in 2015-2016?? No. I was gun shy as I’ve been following the industry for quite some time and they never seemed to generate real FCF (CFO-Capex). It was an asset gathering game.
But then in 2019-2020, when the market wasn’t particularly great, they actually proved they could shut-off capex. They starting generating a ton of FCF and showing signs to shareholders that they care about the stock (they even issued a pref as well to help fund buybacks)
Another sign they care about capital allocation is this fantastic sources and potential uses of cash in their deck:
Basically they are telling you they could buy back 12% of the stock in one year. Share count is down about 15% in 2.5 years, but now I think they’ll be deploying cash into higher ROE opportunities, which is fine by me.
One thing I should mention is typically Triton finances itself through the ABS market. They get 80-85% LTV against the asset value for very long duration. Happy to answer any questions on this, but I’m not too concerned with the ABS market financing.
Triton issued $2.3 billion of ABS notes during the third quarter at an average interest rate of 2.2%. Most of the proceeds were used to prepay $1.8 billion of higher cost notes, which is expected to reduce interest expense by more than $25 million over the next year
They are also diversifying financing – so they just issued an IG secured bond and have talked about moving up to IG ratings. If their cost of capital goes even lower, it will be great for the business in the long run.
Last thing I’ll say is basically Triton is covered by one company. You’d think modeling it would be easy enough, but we are talking about hundreds of thousands of containers, utilization can change, etc etc. However, I think EPS estimates are probably still too low in the long-run. It’s been that way in the short-run, so far, but we shall see. It’s hard for sell side to model operating leverage + high lease rates + deploying cash into such a significant amount of assets.
Today will be a quick idea on Civeo. The bottom line is that CVEO stock trades at ~25% FCF yield, is only ~2.5x levered, and there is a “forced” seller I think is driving down the stock.
Ok – “forced” seller is kinda click bait. The company completed an acquisition a few years ago, giving the seller some stock as consideration. That seller is now blasting out nearly every day, which I get into below.
Civeo provides hospitality services to commodity industries. So think about remote locations where companies are mining precious metals and pumping oil and gas, Civeo provides lodging, food service, and housekeeping for those companies.
Commodity prices generally have been completely bombed for several years now, particularly where the company participates. This includes oil, liquified natural gas, met coal (the coal used to make steel), and iron ore, though demand has still been OK (as I noted in this oil post). The nature of the business also means they typically are in highly commodity driven areas – Australia (given their met coal and other metals help serve the China / Asia demand), Canada (oil sands) and the US E&Ps.
As you can see, the stock has not performed too well in this environment.
The company currently operates around 28 lodges covering 30,000 rooms. They also own a fleet of modular assets that are typically used for short-term stays in the US and Canada.
ANYWAY – if you were to look at the company’s insider transactions, it would look UGLY. The Torgerson’s have sold 3% of CVEO stock (almost $7MM) in near-daily blocks since August 2020.
That is until you realize the Torgerson family were the sellers of a company Civeo bought, Noralta Lodge, for $165MM. Of the total purchase price, $69MM was issued in equity to the holders of Noralta.
This was a little over 3 years ago at this point, so no surprise following a COVID scare + some time since you’ve sold your business that’d you would just want to move on.
The Torgersons still own 11% of the company, so there is a long way to go, but I can’t call the end of this technical factor.
Nearly 25% FCF Yield
The seller is obviously not selling because the value of the CVEO stock looks too rich.
On the latest call, Civeo management guided to $55MM of FCF. This compares to a market cap of ~$230MM. Previously, the company used FCF to delever (after levering up for Noralta), but now that it is at 2.5x, there is a bit more flexibility. As I’ve talked about, I like these busted balance sheet names as they start to improve, but are still in the penalty box of equity holders.
When a stock trades at 25% FCF yield, the market is saying there is high bankruptcy risk. I don’t think that’s the case here. The term loan and revolver mature in 2023 and they generate plenty of FCF to keep lenders happy.
Fortunately, the COVID snapback has caused commodities to rip. If they stay elevated, who knows, but I think it will at least help the company extend contracts on existing lodging facilities and maybe sign some new ones (that will also help any concerns with credit facilities, but again – I’m not concerned there).
Back to the FCF yield guidance – there should be pretty good visibility. You have a set number of rooms available on site, you talk to your customers about need and what they are planning for the year, and you have a general gauge of commodities (are they up or down, is demand up or down) so you can try to win more business. This makes me believe FCF guide is a decent one to bank on.
Last thing I’ll say, the past 3 years the company actually generated $63MM of FCF on average. There was some working capital movements there, but it doesn’t seem unreasonable at all to me.
M&A Target (Seriously)
Using “M&A target” as an investment thesis is weak… yet here we are.
Typically its weak because its like, yeah sure… in SOME scenarios, this COULD get acquired (especially in a deal hungry private equity market), but any time I hear that, it doesn’t come to fruition.
In this case, Target Hospitality received a buyout offer from TDR Capital. Now, it was apparently a really cheap price of $1.50 and now Target Hospitality is trading at $3.40. Target Hospitality currently trades at 7.25x ’21 EBITDA vs. 6.0x for CVEO. HOWEVER, Target is also pretty levered still at 5x EBITDA vs. 2.5x for CVEO. Their cash flow has also been much less consistent.
I also think the capital markets are supportive and perhaps this company would be better suited as a private company, rather than a $230MM public company. Just saying.
KAR auction services, the company that runs used car auctions, looks on sale right now.
KAR has been under pressure from COVID impacts to the business, but unlike other COVID-impacted names (where investors are seeing through the clouds), the stock is still down meaningfully.
KAR reported earnings Q4’20 earnings and guidance last week (on Feb-16) and the stock is down about 24% in the past week.
It seems to me investors do not realize KAR Auction Services current pressures are cyclical, not secular. Today, we’re able to buy a really good business at ~10% FCF yield on depressed earnings.
Why is the stock getting hammered?
For one, disappointing guidance. The company expects EBITDA of at least $475MM in 2021 as they continue to recover from COVID.
Consensus was expecting $566MM – ouch.
Kicking the Can? The other issue with guidance is it is 2H’21 weighted.
In my experience, this can be a “kick-the-can” move for management. In other words, they know 2021 EBITDA has the chance of being lower, but they’ll wait for Q2 earnings to break that news or maybe things will turn around.
Fingers crossed. This isn’t always true, but just my experience.
Management left wiggle room – they did say at least $475MM. They also explicitly said the guide is conservative. That’s not something I’m banking on. I also don’t really care about 2021 earnings in isolation. That’s way too short-term focused in a year that will continue to be impacted by COVID, as noted further below.
Why the weak guide?
Car values are high right now. During the height of COVID, the manufacturers pulled back in the face of a new, deep recession. Plus, they had to reset manufacturing processes during a global pandemic. Lo and behold – demand for cars held in. This is known as the bull whip effect.
Supply < Demand = really high used car prices.
Normally, this would benefit KAR Auction Services, because their auctions would be earnings higher auction fees on cars. But there is clearly lower volume going through the lanes.
Not just from the shortage of cars, but also when residual values are high, you will see less lease returns as the customer decides it’s a good deal to buy out the lease at the value that is better than current market. There has also been less repossessions, another volume headwind.
What is the Street Missing?
Number one, the stock looks cheap when you bridge using the current FCF guide.
Yes, there is risk the guidance, but I don’t actually think KAR’s go forward earnings potential is limited by this year’s factors. The things I mentioned all seem cyclical.
Second, they are caught up on secular changes versus cyclical.
KAR’s earnings are being hit by cyclical issues that I think will abate.
Every investor is trying to see how COVID will change the world and how technology will reshape it. A lot of investors are saying KAR’s barriers to entry have been lowered now that auctions are online. I do not think that is true.
I read one note expressing concern that a survey revealed a lot of dealers are looking to buy and sell cars via online auctions this year. Given KAR Auction Services has a strong physical presence, this caused some concern. Pardon my French, but my response to that is – No Sh*t, Sherlock.
We’re in a pandemic. Of course dealers are looking to buy and sell online. They have to. And this was definitely the case during 2020.
If you read my About Me page, I used to have a dealer’s license. I know a thing or two about buying used cars and I used to go to Adesa all the time. It truly is a great business, which I’ll go into some brief detail later.
But anecdotally, I can tell you buying cars online is not easy. You’re buying a car with limited info, no ability to drive the car to see how it feels, how it sounds, check the oil, etc. The cars I bought online (as opposed to the seeing it in person online) were some of the worst purchases I ever made and I pretty much vowed to never do it again because it was a waste of time.
“But Dilly D”, you’re asking, “can’t this be improved?”
Of course, this could be improved with technology and better disclosure. You need to realize, though, that these online platforms are turning over thousands of cars. And as much as cars may seem like a commodity, used cars really aren’t.
Think about all the options a car has and then fold in a good versus bad service record. The band of prices could easily be +/- 10%, which is thousands of dollars we’re talking about.
But Adesa is also one of the biggest players. And they’ve had an online presence for at least 15 years (just speaking from my memory). They, along with Manheim (a private competitor), do a decent job at it. Adesa also has invested heavily in inspection services to make it better and faster process, as well as other services.
So I’m not too concerned about any upstarts or anything like that. Upstarts don’t have access to the same supply the big players have. And the dealers, like I was, like Adesa and Manheim because they get the supply plus the best prices because they are essentially getting a bulk discount. And you know competition is somewhat limited as a dealer because you have to have a license to access the auction.
This leads me to why Adesa is a great business.
As I was just leading into, Adesa is a great business because it connects sellers with buyers and just takes a fee off the top. The fee goes up or down based on the sale price, but has large enough bands that if used car prices fall, let’s say, 10%, it doesn’t hurt their earnings that much.
Sellers want access to a large supply of buyers who are committed to buy their product (i.e. they are selling to dealers who need the supply). This way, they can offload slow inventory or lease vehicles quickly and achieve good prices for them. This frees up working capital to re-deploy in their business.
Buyers want access to a large swath of cars at good prices that they can sell at a profit. For me, having a wide array of cars to pick from helped me find “hidden gems” that I could quickly turn.
The same note I mentioned above (which was absurd) highlighted online competition from Copart, which has been a “competitor” for forever and is really more a competitor of IAA, the insurance-loss auction spin from KAR. Copart is no doubt a great business, but I think it’s comparing two different markets.
If you compare IAA to Copart, their results during 2020 were much closer to each other than comparing it to KAR Auction Services – just different markets. Copart outperformed KAR and IAA sales were actually up, though they were able to benefit from improved pricing despite volumes being down. Although Copart discusses their “platform” a decent amount, but personally, I’d say it’s a different market.
Here’s another anecdote to explain why they are different markets: I remember being at an auction and a totally smashed Cadillac Escalade came through. The front was actually fine, but the back looked like it was caved in by an 18-wheeler.
I laughed to myself thinking, “I guess someone will try to part this thing” and lo and behold, the bids started to come in at really high levels. I want to say the car sold for over $20,000, despite being crumpled. I was in person, but the bidder was online and you could see the location. The bidder was in Saudi Arabia. That’s when I learned many of these salvaged cars are worth a lot internationally. Buyers can part them out, but some countries also have less strict rules on piecing cars together.
Anyway, as the dollar becomes weaker, this helps a Copart who sells a lot of inventory to these buyers:
Roughly 35% of Copart’s inventory is purchased by foreign buyers:
Back to that absurd sell-side note one more time: They also highlighted online competition from Carvana. Carvana uses KAR to buy and sell wholesale inventory. They do not provide nearly enough volume as a separate wholesale auction to be attractive. It really doesn’t make sense at all.
CarMax and Carvana really want to sell retail… yes, they get trade-ins they want to sell, but they want good prices on those and want to turn them quickly. Carmax has its own auction because its huge, but it still uses KAR to fill inventory. Carmax can use their auction to sell inventory they don’t want anymore quickly.
Adesa provides that for everyone. It’s not really different than the marketplaces investors love today, they just have primarily relied on a physical presence. As stated, I think this will continue to be an industry that needs the physical presence.
B&G reported Q4’18 EBITDA of $59MM compared to $69MM in the prior year. While this was partially impacted by the sale of Pirate Brands to Hershey, it was still a tough comp due to input cost inflation (freight, procurement, as well as mix). As a result, EBITDA was 200bps lower as a % of sales than the prior year.
That said, I think there are a few positive take-aways from this quarter that will keep me grounded. Bottom line, I still think B&G is a long-term compounder. Food sector sentiment is particularly negative right now (especially with the KHC news) and 2019 should be an easier comp from a freight and inflation perspective.
Green Giant Continues to Grow at Attractive Levels, Despite Challenges in Shelf Stable:
Green Giant’s sales increased 4.9% this Q and grew 6.1% for the entire year. This has been mainly driven by new innovations in the frozen food aisle that have countered challenging trends in the canned, shelf stable category (down 8.2% for the year).
Part of the thesis in buying B&G is that these managers are good at buying mature assets, harvesting the cash, and restarting the process (rinse & repeat). They sold Pirates Booty to Hershey for $420MM after they bought it for $195MM in 2013. I continue to think Green Giant was a solid acquisition.
Given there are many other consumer staple brands struggling to date, I think this is an opportunity for B&G. They repaid $500MM of their TL with help of the Pirates’ sale so that also adds some capacity.
Company is managing other mature brands well. Would you have believed me if I said Cream of Wheat increased sales 4.3% this Q? Or Ortega was up 7.2%? Excluding Victoria, which saw a $2.5MM decrease in sales from a shift in promotional activity, I think the company is doing a good job with this portfolio.
Continues to generate significant FCF to support dividend. B&G pays $1.90 dividend which based on the after-hours quoted price currently amounts to a 8.6% yield. Typically, dividend yields that high imply the market thinks there is risk of being cut. Setting aside the fact that the company generated $165MM of FCF this year (reduced a lot of inventory), I still think the dividend is covered.
Using ~66MM shares outstanding, this implies a $125MM cash use.
Based on the company’s guidance range, this implies you are ~1.3-1.4x covered.
Said another way, based on my FCF walk, we would need to see EBITDA decline 17% from the mid-point of guidance for it to be 1.0x covered.
Personally, I’d prefer if the company bought back a significant amount of stock at these levels. Unfortunately, the stigma of keeping a dividend out there forever (which is dumb) prevents that from happening (as the stock would get crushed).