There is Reason to Believe in Meritor

By Tom Gibbs - May 10, 2012 | Tickers: VOLVY, DDAIF.PK, MTOR, NAV, VLKAY | 0 Comments

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There has been a considerable amount of newfound focus on the global automotive industry as sales volumes revamp alongside the rise in discretionary income spending, players within the industry continue to right-size their operations and become more profitable, and emerging markets become increasingly more competitive.  The consumer market for light cars and trucks, however, is not the only niche that is experiencing dramatic post-recessionary growth.  The commercial market for heavy vehicles, which was not only hit harder than the consumer market but also continues to experience hesitant investor confidence, is now ripe with potential investment value.

Troy, Michigan-based Meritor (NYSE: MTOR), a global supplier of integrated systems, modules, and components to OEMs and after-market commercial vehicle manufacturers, is but one of these potential knockouts. 

Serving several commercial niches – truck, trailer, off-highway, military, bus, and coach markets – Meritor supplies a broad portfolio of axle, brake, and suspension solutions to key, high-volume manufacturers including Daimler (NASDAQOTH: DDAIF.PK), Scania (NASDAQOTH: VLKAY), Volvo (NASDAQOTH: VOLVY) and Navistar (NYSE: NAV).  There are a multitude of drivers behind the continued success of the corporation:

Beautification of Income Statement and Balance Sheet

Not only has Meritor’s top line appreciated by 60% since trough levels in 2009 (compared to the trailing twelve-month period), but the meat within its financial statements has also drastically improved. 

First, the corporation has taken huge steps to improve its cost structure.  Similar to most players in the auto industry on a historical basis, Meritor has traditionally been burdened with excess capacity, too many workers for the given job, and an unattractive unionization rate.  Since the merger of Meritor and Arvin Industries in 2000, the corporation has gradually cut its workforce from more than 30,000 worldwide employees to slightly more than 10,000 currently.  Some of the largest cuts, however, were conducted in recent years – cut rate between the three years ended 2011 was double the rate during the five years ended 2008. 

The level of unionized workers based in the U.S. and Canada also fell from a historic high of around 15% to only 2.5% over the same time period.  As a result of the cuts, an increasing amount of top line growth is falling to the bottom of Meritor’s income statement.  Five-year (2007-2011) SGA/Sales average of 6.5%, with a high of 8% in 2010, compares with 5.7% over the past twelve-month period.  A continued focus on streamlining operations will yield further improvement in cost structure.

Meritor has also prettied-up its balance sheet since the troublesome 2009 period, and its net debt position has been cut by 36% over the past three years.  Interest coverage (operating income/interest expense), as a result, has since improved by close to 55%. 

Industry Rebound

None of these cost-cutting measures would exemplify their full potential if the commercial market for heavy vehicles was projected to remain in a state of stagnation.  Thankfully the opposite is expected.  The recent J.D. Power Global Automotive Forecasting report highlighted that global heavy commercial vehicle sales hit 3.3 million units in 2011, and the researcher projected that sales would rise at a 4.1% CAGR to hit 4.03 million units by 2016. 

Diversified Business

Meritor, as well as most other players in both heavy commercial and light consumer vehicle markets, has been the victim of pessimistic outlooks in the European sector.  Although there is good reason behind mid-term macro worry in the space, Meritor has also not been commended for its ability to grow business outside of Europe. 

Total Asia/Pacific and South American-based sales, which only represented around 7.5% of total company sales in 2000, have since come to represent nearly one-third of Meritor’s top line.  Likewise, the contribution rate from these emerging markets has been growing at an increasing rate over the past several years.

Meritor has intentions of hitting the $1 billion revenue mark in the Asia/Pacific market – up from around $650 million in 2011 – within the next five years.  The continued shift away from the mature North American and European markets alone should be an intangible catalyst behind Meritor share price appreciation as pessimism surrounding the stock diminishes. 

Unreasonably Cheap

Meritor is growing at such a strong post-recession rate that it has become unreasonably inexpensive – on just about every metric one can utilize.  The company recently reconfirmed its 2012 financial guidance, and expects to hit an EBITDA margin between 8.2% - 8.6% and EPS between $1.08 - $1.39 per share on $4.8 billion in annual revenues.  This compares with $4.6 billion in revenues in 2011 (reconfirms J.D. Power industry estimates as well), with 85 cents per share in net income and a 7.5% EBITDA margin. 

Based on the corporation’s and average analyst estimates, Meritor sells for 4.9x 2012’s EPS and a mere 3.7x 2013 estimates. 

For a corporation that is –

1. Selling at a near 75% discount from 2011’s high price per share
2. Showing consistent improvement in top and bottom line growth, and net debt and cost structure positions
3. Continually diversifying into emerging, higher margin markets

– there is reason to wonder why Meritor is not on more investors’ watch lists. Even if the corporation operates in an industry that is not prone to enjoy blowout year-over-year growth, it is unlikely to project Meritor hovering around existing market valuations for long. 

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