1. Deutsche Bank
Markets Research
Global Emerging Markets
Brazil
Capital Goods
Industry
Latam Autoparts
Date
4 September 2013
Initiation of Coverage
An owner's manual
We are initiating coverage of the Latam autoparts industry, composed of five unique companies,
all of which are leaders in their fields (but some are weak cash generators). We believe the
industry is undergoing a transformational phase, driven by: 1) global trends that demand local
supply (and lower cost), 2) support from local governments, 3) consolidation and 4) technological
advances. We believe these trends, as well as the companies' sustainable competitive
advantages and top notch management, should partly isolate the sector from macro volatility.
We initiate coverage on Autometal (Buy, top pick), Iochpe (Hold), Randon (Sell) and Marcopolo
(Sell). D/G Mahle to Hold.
Five unique companies, leaders in their fields; initiating coverage
Bernardo Carneiro, CFA
Research Analyst
(+55) 11 2113-5685
bernardo.carneiro@db.com
________________________________________________________________________________________________________________
Deutsche Bank Securities Inc.
Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should
be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should
consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST
CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 054/04/2013.
2.
3. Deutsche Bank
Markets Research
Global Emerging Markets
Brazil
Capital Goods
Industry
Latam Autoparts
Date
4 September 2013
Initiation of Coverage
An owner's manual
Five unique companies, leaders in their fields; initiating coverage
________________________________________________________________________________________________________________
Deutsche Bank Securities Inc.
Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should
be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should
consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST
CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 054/04/2013.
Bernardo Carneiro, CFA
Research Analyst
(+55) 11 2113-5685
bernardo.carneiro@db.com
Table Of Contents
Summary Page 03
Autometal Page 11
Randon Page 26
Marcopolo Page 42
Iochpe-Maxion Page 58
Mahle Metal Leve Page 73
Source: Deutsche Bank
Top picks
Autometal (AUTM3.SA),BRL18.61 Buy
Source: Deutsche Bank
Companies Featured
Autometal (AUTM3.SA),BRL18.61 Buy
Randon (RAPT4.SA),BRL11.55 Sell
Marcopolo (POMO4.SA),BRL6.55 Sell
Iochpe (MYPK3.SA),BRL28.65 Hold
Mahle Metal Leve (LEVE3.SA),BRL26.99 Hold
Source: Deutsche Bank
We are initiating coverage of the Latam autoparts industry, composed of five
unique companies, all of which are leaders in their fields (but some are weak
cash generators). We believe the industry is undergoing a transformational
phase, driven by: 1) global trends that demand local supply (and lower cost), 2)
support from local governments, 3) consolidation and 4) technological
advances. We believe these trends, as well as the companies' sustainable
competitive advantages and top notch management, should partly isolate the
sector from macro volatility. We initiate coverage on Autometal (Buy, top pick),
Iochpe (Hold), Randon (Sell) and Marcopolo (Sell). D/G Mahle to Hold.
Important global trends in the auto industry fueling Latam autoparts
Brazil and Mexico rank among the ten largest global vehicle manufacturers and
should continue to benefit from 1) automakers transferring production to EMs
and outsourcing to suppliers to focus on R&D and design; 2) governments and
consumers demanding cleaner and smaller vehicles with lower fuel
consumption and 3) the technology progress on turbo charging, lighter
materials and hybrids – all being introduced in Latam and expanding.
Proprietary investment methodology: five criteria in seventeen tenets
Autometal, Randon, Marcopolo, Iochpe and Mahle are unique companies and
do not compete with each other. We developed an investment approach in
which we compare them in 17 tenets grouped in five different investment
criteria. Each stock scored differently on 1) qualitative, 2) quantitative, 3)
growth, 4) momentum and 5) valuation topics.
Valuation and risks: FCF yields, implied IRR and M&A multiples add to the DCF
Our PTs are based on 5-yr DCF models, but are cross-checked in a broad
valuation approach to increase confidence in our recommendations as well as
for sanity check purposes. We believe FCF yields, implied nominal IRRs (vs. 9%
and rising risk free rates) and M&A multiples are key valuation techniques.
Autometal: Now a global enterprise with multiple growth options, reasonable
FCF, a short track record but discounted valuations. PT of R$26/share, 6% FCF
yield (ex-Mahindra) and 19% nominal IRR support our Buy rating.
Randon: Brand equity, market leadership but weak financials (ROIC < WACC),
poor FCF, volatile track record, and too much optimism on the stock at the
moment. PT of R$9.5/share, 4% FCF yield and a 4% IRR justify our Sell rating.
Marcopolo: A very competitive company with strong financials, solid FCF but
growth mostly linked to short-lived government stimulus. PT of R$5.5/share, 3-
4% FCF yield, 3% IRR and a cross-check with M&A multiples justify our Sell.
Iochpe-Maxion: Global leader, great management but weak financials, volatile
earnings, poor FCF and fragile balance sheet. PT of R$28.5/share, 4% FCF
yield, 6% IRR and a low fair value through M&A multiples justify our Hold.
Mahle Metal Leve: We transfer coverage and downgrade to Hold from Buy.
Solid FCF and dividends, healthy balance sheet but moderate financials (low
ROIC and short track record). PT of R$30/share, 5% FCF yield and 7% IRR.
Downside risks: Worsening competitive environment, client concentration,
auto industry downturn, overpayment in acquisitions, unions and labor as well
as stricter environmental requirements. Upside risks: positive FX rate impact
on exports, prolonged boom in commercial vehicles, shorter CCC, efficient
governments and a rebound in the European economy.
5. 4 September 2013
Capital Goods
Latam Autoparts
Deutsche Bank Securities Inc. Page 3
Summary
Industry Overview
Brazil is the world’s seventh largest auto manufacturer, Mexico is the eighth
Emerging markets have been increasing share in the global auto industry as
they not only have growing consumer markets and improved credit availability
but also lower production costs and improving quality standards. According to
ANFAVEA (Brazilian Association of Automakers) and OICA (International
Organization of Motor Vehicle Manufacturers) total global output of vehicles
reached 84m units in 2012 and Brazil produced 3.3m (China is the largest
world manufacturer with 19.3m units last year). In the commercial vehicles
segment (trucks and buses) Brazil produced 4% (170,000 units) of the world
output of 4.2m units in 2012, which was headed by China (1.9m units)
followed by Japan (594,000 units).
Figure 1: Global Production of Light Vehicles, 2002 Figure 2: Global Production of Light Vehicles, 2012
3,287
12,280
10,257
5,469
3,148895
1,792
1,805
585
2,629
16,847
China
USA
Japan
Germany
South Korea
India
Brazil
Mexico
Thailand
Canada
Others
19,272
10,329
9,943
5,649
4,558
4,145
3,343
3,002
2,483
2,464
18,953
China
USA
Japan
Germany
South Korea
India
Brazil
Mexico
Thailand
Canada
Others
Source: ANFAVEA, OICA and Sindipecas Source: ANFAVEA, OICA and Sindipecas
Underlying growth opportunities insulated from GDP and macro volatility
Three trends are worth highlighting in global auto parts: 1) OEMs (i.e.,
automakers) transferring assembly lines to EMs from DMs in search for lower
production costs while they focus on R&D and know-how; 2) automakers
downsizing by outsourcing production to Tier 1 suppliers (Tier 1 companies sell
systems and modules to OEMs while Tier 2 sell small parts to Tier 1s) so they
concentrate on innovation, assembly and marketing; and 3) consumers
demanding smaller cars that consume less fuel and adapt to stricter
environmental rules, which should encourage demand for smaller and lighter
parts, primarily of aluminum and plastic.
While U.S. automakers are gradually transferring their production to Mexico
(nearly 80% of Mexican’s production is destined to exports, mainly to U.S) and
partnering with local suppliers including Autometal, Brazil is experiencing
substantial expansion in its automotive industry. Several automakers
announced nearly R$35bn in green field or expansion of existing plants for
2012-2016 and this should increase business for local based auto parts. Based
on research conducted by VW Group, total production capacity of passenger
cars in Brazil should increase 44% by 2016 compared to 2011 (an incremental
capacity of nearly +1.7m units) primarily by Asian OEMs. Japanese Toyota, for
6. 4 September 2013
Capital Goods
Latam Autoparts
Page 4 Deutsche Bank Securities Inc.
instance, is constructing an engine manufacturing plant in Brazil with a total
R$1bn budget overseen by new management in Latin America who recently
announced enthusiastic growth plans for Brazil (it holds 4% of the market but
1H13 sales soared vs. 1H12).
Figure 3: Inhabitants per Vehicle
1.3 1.6 1.7 1.7 1.8 3.3 3.6
5.5
14.4
0
10
20
30
40
50
60
70
USA Canada Spain Japan UK Russia Mexico Brazil China
2001 2011
Source: PriceWaterhouseCoopers and Sindipecas * Data considers both passenger and light commercial vehicles
OEMs going abroad, suppliers need to follow
Tier 2 manufacturers produce the necessary 20,000 to 30,000 parts that
compose a car while Tier 1 companies produce the 100 modules, on average,
required for each car. The largest global Tier 1 players are Bosch, Faurecia, and
Denso among dozens of others whereas Tier 2 manufacturers are local and
very fragmented, lacking economies of scale, financial strength, and limited
technologies. Tier 1s usually follow their customers in establishing local
footprints to preserve their relationships and as such, Brazilian and Mexican
players are concerned with potentially higher competition amid the arrival of
Asian automakers, which could bring together their suppliers. For instance,
Chinese JAC and Shacman are building their facilities in Brazil with a total
investment budget of US$600m and expect to start producing light and
commercial vehicles by the end of 2014. As they start with low output, most
autoparts should be imported given the very high costs and low productivity
associated with low volume contracts.
The automotive industry’s superior dynamism stems from increased demand
for innovation, high tech content and less fuel consumption, which together
determine the market share of each player. In the Brazilian light vehicle
segment, Fiat is the largest producer, accounting for 24% of total licensed cars
in 2012. Volkswagen and General Motors follow with 23% and 19% of the
market, respectively. There are fewer manufacturers in the truck and buses
market with nearly six big ones producing various types of vehicles (light,
semi-light, medium, semi-heavy, etc.). Volkswagen MAN dominates the
market with a 30% share in 2012 followed by Mercedes-Benz with 25%
market-share, Ford with 16%, and Volvo with 11%.
7. 4 September 2013
Capital Goods
Latam Autoparts
Deutsche Bank Securities Inc. Page 5
Figure 4: OEM Evolution in Brazil
Source: ANFAVEA and Volkswagen
Despite general optimism, “Brazil cost” is a major issue
OEMs and suppliers in Brazil are struggling with rising production costs,
namely 1) inefficient and weak logistics; 2) rising labor costs and scarcity of
qualified engineers; and 3) heavy taxes. According to 2011 data from Roland
Berger, Unicamp and Price Waterhouse Coopers, labor costs per hour in Brazil,
in Euro terms, are six times higher than in China and twice as costly as in
Mexico. When including fringe benefits, it costs EUR 12.9/hour to manufacture
a vehicle in Brazil vs. EUR 2.2/hour in China, 17.7 in U.S. and EUR 6.5 in
Mexico. A total of 400,000 engineers graduate annually in China compared to
30,000 in Brazil and the Brazilian government spends US$2,000 per
student/year on education, a fraction compared to Germany and Japan.
Figure 5: Electricity Energy Costs Figure 6: Import and Export Costs
Source: FIRJAN and Volkswagen Source: FIRJAN and Volkswagen
8. 4 September 2013
Capital Goods
Latam Autoparts
Page 6 Deutsche Bank Securities Inc.
Imported cars in Brazil are taxed with a 35% import tax, a 25% IPI
(Industrialized Product Tax) and recently an additional 30% levy, which in
conjunction offer a very protective environment for the OEMs. In fact, the
quality of light vehicles in Brazil is still significantly below European and U.S.
ones – they lack turbo technologies and safety features that are mandatory in
developed countries and are considered unsafe for global standards.
The “Inovar Auto” and other subsidies
In an effort to address such issues,, the Brazilian federal government in 2011
and 2012 announced tax exemptions to local manufacturers (IPI, payroll and
VAT), subsidized funding to capital goods participants (the PSI-4 FINAME
program), mandatory reduction in electricity costs (~20% cut in R$ per MWh)
and launched a new automotive policy to stimulate the local auto industry. It
raised taxes on imported cars (an additional 30% IPI levy), exempting those
automakers that accomplish innovation, energy efficiency (lower fuel
consumption), and use more local autoparts (the “Inovar Auto” regime). As in
U.S., the automotive market in Brazil is further protected by a long-standing
prohibition on importing second-hand vehicles, which is allowed in Mexico.
So far, all these governmental measures have not helped the industry – recent
data from Sindipecas (Brazilian Autoparts Manufacturers Association) show
that imports continue soaring while exports are declining. The trade deficit in
autoparts in the January-June 2013 period increased to a record high
US$4.7bn from US$2.9bn reported in the same period of 2012. According to
Sindipecas, nearly 65% of all imports were made by OEMs. Japanese and
Korean ones, for instance, are not only importing more engine and gear
components (i.e., powertrain) from their suppliers in Asia but are also bringing
them to Brazil while the aftermarket increases imports of Chinese parts. The
higher technology content of passenger cars in Brazil prompted local OEMs to
expand global sourcing and contract with specialized international suppliers.
Industry participants expect the Inovar Auto to benefit local manufacturers by
2014 after some implementation issues, particularly the tracking of
components’ origin (the incentive for local content to protect the industry was
not working).
Figure 7: Brazilian Output of Vehicles and Autoparts, Index
0
50
100
150
200
250
0
50
100
150
200
250
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Vehicle unit production (2002 =100) Autoparts unit production (2002 = 100)
Source: ANFAVEA, Denatran, IBGE, MDIC and Sindipecas
The “Inovar Auto” program
has not taken off as expected
- benefits should be noticed in
2014-2015
9. 4 September 2013
Capital Goods
Latam Autoparts
Deutsche Bank Securities Inc. Page 7
Autometal and Mahle should benefit the most from such subsidies
According to industry consultants, these subsidies should mostly benefit
suppliers that use simple technologies in their production lines and imported
products with inexpensive and simple logistics (fast and riskless packing,
loading and unloading). Accordingly, local suppliers of plastics, forged, and
stamped products should experience a strong import substitution effect and
increase sales to OEMs in 2014-2015, and we highlight Autometal as the main
beneficiary in our coverage universe. Mahle operates on the edge of the
automotive technology to increase engine power, reduce energy losses, and
therefore lower fuel consumption. The company’s role in developing innovative
solutions for environmentally friendly vehicles bodes well for higher sales in
Brazil over the coming years. The reduction in export and payroll taxes and
BNDES subsidized funding for customers help both companies while also
favoring Iochpe-Maxion, Randon and Marcopolo.
Investment Methodology
Largest Brazilian auto parts are unique and have listed stocks
Iochpe-Maxion, Autometal, Mahle Metal Leve, and Randon are some of the
largest Brazilian suppliers, producing a wide variety of products for different
clients and market niches. While Iochpe is well known for its leadership in
wheels and structured components, Mahle is highly specialized in engine
components, Randon in truck trailers, suspension and brake systems, and
Autometal largely diversified. Sales volumes measured in units are accordingly
not comparable. One could say that Autometal (AUTM3) has only two listed
comparables in Brazil, Mahle (LEVE3) and Iochpe (MYPK3). Even so, they do
not compete with each other and are in different growth stages – Mahle is a
low growth, cash cow, high tech company with limited competition in Brazil,
while Iochpe is a global enterprise, highly leveraged, and focused in few
products (mainly wheels). Marcopolo is a different company – it is focused in
bus bodies and complete small buses to attend bus operators worldwide.
Five investment criteria, 17 tenets
We tried to answer 17 tenets grouped in five main investment criteria:
Qualitative (earnings visibility, low volatility in business, competitive
advantages, and corporate governance); quantitative (free cash flow, solid
track record of results, and dividends/share buybacks); growth (insulation from
macroeconomics, structural demand/new markets, and consolidation
opportunities); momentum (news flow, ST results, and “out of favor” status);
and valuation (DCF method, implied IRR, FCF multiples, and M&A implied
valuation).
Qualitative Analysis: Are the business and the company’s model simple
and reliable? What is our confidence level in estimating the company’s
future? Is the industry steady over time or unstable? What are the
company’s competitive advantages and how do they compare to peers? Is
there bargaining power with customers, suppliers, and industry barriers of
entry? Are the company’s products and services highly demanded and
does it have pricing power? Does it have market leadership, valuable and
rare assets, modern facilities, superior logistics, a large and faithful
distribution network, strong brands, and high switching costs for
customers? What are its main economic moats? What do competitors and
industry consultants say about the company and the industry? We also
look for signs of strong corporate governance, such as owner’s culture,
10. 4 September 2013
Capital Goods
Latam Autoparts
Page 8 Deutsche Bank Securities Inc.
sound management execution and reputation, honest and determined
controlling shareholders and high respect to minority shareholders (Board
of Directors details, independent committees, no related party
transactions, etc).
Quantitative Analysis: How were the company’s results over the past ten
years? Have they been firm or volatile? Were operating margins and
profitability ratios solid or unstable? Has it generated strong free cash? Is it
a cash cow operation? How did capex, particularly maintenance capex,
compare to EBITDA over time? Is the CCC (cash conversion cycle) short or
does EBITDA vanish on high working capital use? Is CROIC (cash ROIC)
consistently above the company’s weighted average cost of capital?
What’s the balance sheet situation vs. its free cash flow? Are the reported
financials accurately audited and comparable over time? Are there off-
balance sheet items? What story is the Cash Flow Statement telling? Is the
story already proven, with a long track record? Has it returned value to
shareholders in the form of dividends and share buybacks followed by
share cancelations?
Growth: Our growth analysis investigates if the company has increased
operating earnings accompanied by sound free cash flow, i.e., high quality
growth. We are interested in uncovering if it can grow organically,
independently from macroeconomics influence, or at least with reasonable
insulation. Does it have rising economies of scale? Is there pent-up
demand for the company’s services and products or is the market largely
penetrated? Are new markets untapped and emerging? Are there tailwinds
such as favorable demographics trends or global industry changes? Does it
operate in a fragmented market with consolidation potential? Are mergers
and acquisitions normally straightforward or do they embed integration
difficulties and many corporate culture differences? Can we analyze
reported growth or is the horizontal analysis impaired with lots of
acquisitions and accounting adjustments?
Momentum: As the famous adages say, “great companies are normally
bad stocks” and “the best time to buy is when there is blood on the
streets”. We look for signs of popularity driving the stocks ahead of their
fundamentals and adopt a “contrarian” philosophy – the market tends to
perpetuate the status quo and fall into behavior finance traps. Is the stock
out of favor and the company facing temporary problems, such as poor
short-term earnings prospects? Is the news flow weak? What is the street
saying about the company? Has it suffered downward earnings revision
recently? What is the stock price now in historical terms? Is there too
much hype about the stock and irrational action?
Valuation: What is the margin of safety to purchase the stock as shown by
a conservative, short, and simple DCF model? What is the fair value
sensitivity to various discount and perpetuity growth rates? Does the
implied IRR (internal rate of return) of purchasing the stock today compare
well to the current risk free rate (the opportunity cost of staying in cash
deposits)? Is the forecasting process starting from a normal set of financial
results or is it a historical bottom/peak? Is it possible to accurately mark to
market the company’s net PP&E? Are there hidden assets in the balance
sheet and potential liabilities that make the NAV significantly different from
the accounting shareholders equity? What are the company’s earnings
power, recurrent free cash flow, and maintenance capex in relation to the
stock’s market capitalization? What are the free cash flow multiples (FCF
yield or P/FCF)? We also apply transaction multiples based on a historical
“References to EBITDA make
us shudder — does
management think the tooth
fairy pays for capital
expenditures? We're very
suspicious of accounting
methodology that is vague or
unclear, since too often that
means management wishes
to hide something” (Warren
Buffett)
“One of the most
counterintuitive points in all of
finance: Good companies are
generally bad stocks, and bad
companies are generally good
stocks” (William Bernstein)
11. 4 September 2013
Capital Goods
Latam Autoparts
Deutsche Bank Securities Inc. Page 9
sample of deals to verify what would be the fair value of the stock in a
potential M&A deal and if minority shareholders would capture any control
premium (i.e., implied M&A fair value).
Figure 8: Operating and Financial Comps (2011-2013E, average)
R$ m Net
Revenues
Operating
profit
Operating
margin
ROE ROIC* CCC** Capex/EBITDA 5 yr
FCF***
Autometal 1,757 249 14% 17% 9% 22 0.4 238
Iochpe 4,898 351 7% 16% 3% 45 1.2 (1,446)
Marcopolo 3,666 413 11% 27% 19% 107 0.5 511
Mahle Metal Leve 2,263 269 12% 14% 8% 84 0.3 832
Randon 3,925 351 9% 13% 1% 96 0.7 (267)
Average 3,302 327 11% 17% 8% 71 0.6 (26)
Source: Deutsche Bank *ROIC or CROIC = (EBIT – taxes – WK change)/(total Assets – cash) **Cash Conversion Cycle in days (Receivable
days + Inventory days - Payables days - Taxes days) ***accumulated free cash flow to equity 2009-2013E
Figure 9: Latam Autoparts – General Assessment
AUTM3 RAPT4 POMO4 MYPK3 LEVE3
Qualitative Neutral Neutral Positive Positive Positive
Quantitative Neutral Negative Positive Negative Neutral
Growth Positive Neutral Neutral Neutral Neutral
Momentum Neutral Hype Neutral Neutral Hype
Valuation Buy Sell Sell Hold Hold
Source: Deutsche Bank
Target Prices and Trading Multiples
Figure 10: Latam Autoparts Trading Comps (share prices as of September, 03)
Upside %
EV Market Cap EV/EBITDA P/E
FCF Yield
(%)
Implied
IRR*Ticker Rating Price 12M TP (USD $ m) (USD $ m) 13E 14E 13E 14E 13E 14E
Autometal AUTM3.SA Buy 18.61 26.00 39.7 948 994 6.2 5.3 13.2 11.8 2.8 6.1 19%
Randon RAPT4.SA Sell 11.55 9.50 (17.7) 1,756 1,251 7.4 6.8 13.5 12.9 (8.7) 3.9 4%
Marcopolo POMO4.SA Sell 6.55 5.50 (16.0) 4,836 4,703 13.5 10.3 18.4 13.4 0.4 3.6 3%
Iochpe-Maxion MYPK3.SA Hold 28.65 28.50 (0.5) 2,305 1,153 8.6 7.1 20.8 14.8 1.5 3.6 6%
Mahle Metal Leve LEVE3.SA Hold 26.99 30.00 11.2 1,553 1,442 8.3 8.0 15.9 14.5 5.2 5.5 7%
Total/Average 9,543 16.2 8.6 25.1 13.5 0.3 4.2 6%
Source: Deutsche Bank estimates and Bloomberg Finance LP *implied annual return of buying the stock today and holding indefinitely, nominal local currency terms
Our top pick is Autometal;
Randon has weak financials
and is overvalued; Iochpe is
too leveraged and fairly
valued, as well as Mahle, a
cash cow operation;
Marcopolo is priced to
perfection
13. 4 September 2013
Capital Goods
Latam Autoparts
Deutsche Bank Securities Inc. Page 11
Autometal
Investment Thesis: Buy
Fair company with moderate financials, steady growth, but undervalued;
initiating with a Buy
Based on our five investment criteria (Qualitative, Quantitative, Growth,
Momentum and Valuation) we concluded Autometal has strong competitive
advantages but limited earnings visibility and fair corporate governance.
Although it has moderate financial ratios and a short track record, free cash
generation is solid and growth prospects are encouraging on rising economies
of scale with OEM expansion plans in Latam, Mahindra’s acquisition, and the
“Inovar Auto” program in Brazil. Although the stock does not seem out of
favor as per our momentum analysis it seems undervalued as shown by our
valuation assessment, offering a considerable margin of safety. Therefore, we
are initiating coverage on Autometal with a Buy rating and R$26 target price
per share, implying ~40% total return potential (including dividends). Free cash
flow yield of 6% in 2014E (not including Mahindra’s earnings contribution) is
the highest in our coverage universe, supporting our recommendation.
Figure 12: Autometal: Case Summary
Criteria Summary Score
Qualitative
Various technologies, different markets, currencies, acquisitions and green fields limit earnings
visibility; OEMs investments in emerging markets mitigates the impact of economic turmoil; Some solid
competitive advantages; Lean corporate structure oriented to results but some related party
transactions affect corporate governance.
Neutral
Quantitative
Short track record of audited financial statements, good capex to EBITDA ratio and short CCC; Strong
balance sheet but moderate FCF generation and soft return ratios (low ROIC to WACC ratio); it is a
good dividend payer.
Neutral
Growth
Vast growth opportunities, organic and through M&A; Brazil increasing share in the global auto
industry, Mexico absorbing production previously based in U.S. and Mahindra’s acquisition is
transformational; Autometal should be the most benefited with the “Inovar Auto” regime; Larger
companies are consolidating the market.
Positive
Momentum
Newsflow is mixed on related party transactions and the deceleration in the production of vehicles in
Brazil (but we anticipate strong ST results from the international operations). Lowering dependence on
Brazil is a plus but the stock has already rallied since the bottom reached last June. Very low stock daily
turnover (US$2m/day).
Neutral
Valuation
High margin of safety to fair value and high upside potential to DCF-based price target; high FCF yield
and compelling IRR relative to fixed income returns; M&A valuation comps also support a Buy rating.
Buy
Source: Deutsche Bank
14. 4 September 2013
Capital Goods
Latam Autoparts
Page 12 Deutsche Bank Securities Inc.
Model updated:26 August 2013
Running the numbers
Latin America
Brazil
Capital Goods
Autometal
Reuters: AUTM3.SA Bloomberg: AUTM3 BS
Buy
Price (3 Sep 13) BRL 18.61
Target Price BRL 26.00
52 Week range BRL 15.00 - 21.60
Market Cap (m) BRLm 2,343
USDm 994
Company Profile
Autometal is an industrial group headquartered in Brazil
that specializes in components for the auto parts industry.
Controlled by the Spanish group CIE Automotive, it
operates in Brazil, Mexico, the U.S. and China. In 2012
Brazilian operations represented approximately 60% of
consolidated revenues, followed by Mexican at 35% (90%
of Mexican output is exported to the NAFTA market).
Price Performance
8
12
16
20
24
Sep 11 Mar 12 Sep 12 Mar 13
Autometal BOVESPA (Rebased)
Margin Trends
12
14
15
17
18
20
10 11 12 13E 14E 15E
EBITDA Margin EBIT Margin
Growth & Profitability
0
5
10
15
20
25
30
-5
0
5
10
15
20
25
30
35
10 11 12 13E 14E 15E
Sales growth (LHS) ROE (RHS)
Solvency
0
5
10
15
20
25
30
-40
-20
0
20
40
60
10 11 12 13E 14E 15E
Net debt/equity (LHS) Net interest cover (RHS)
Bernardo Carneiro, CFA
+55 11 2113-5685 bernardo.carneiro@db.com
Fiscal year end 31-Dec 2010 2011 2012 2013E 2014E 2015E
Financial Summary
DB EPS (BRL) 1.45 1.46 1.25 1.41 1.57 1.88
Reported EPS (BRL) 1.45 1.46 1.25 1.41 1.57 1.88
DPS (BRL) 0.50 0.73 0.63 0.71 0.79 0.94
BVPS (BRL) 5.99 8.96 9.05 9.76 10.54 11.49
Valuation Metrics
Price/Sales (x) nm 1.1 1.2 1.1 1.0 0.8
P/E (DB) (x) na 9.1 12.4 13.2 11.8 9.9
P/E (Reported) (x) na 9.1 12.4 13.2 11.8 9.9
P/BV (x) 0.0 1.4 2.3 1.9 1.8 1.6
FCF yield (%) na 6.4 nm 2.8 6.1 7.4
Dividend yield (%) na 5.5 4.0 3.8 4.2 5.1
EV/Sales nm 0.9 1.1 1.1 0.9 0.8
EV/EBITDA nm 4.6 6.5 6.2 5.3 4.6
EV/EBIT nm 5.6 8.5 7.7 6.5 5.5
Income Statement (BRLm)
Sales 1,572 1,563 1,613 2,096 2,446 2,792
EBITDA 301 291 280 363 411 469
EBIT 247 240 214 292 335 388
Pre-tax profit 198 247 206 258 296 354
Net income 137 184 157 178 198 237
Cash Flow (BRLm)
Cash flow from operations 131 207 145 192 243 288
Net Capex -126 -99 -184 -126 -100 -114
Free cash flow 5 108 -39 66 143 174
Equity raised/(bought back) 0 419 0 0 0 0
Dividends paid -53 -6 -109 -89 -99 -119
Net inc/(dec) in borrowings 14 146 76 0 0 0
Other investing/financing cash flows 12 69 -29 26 35 42
Net cash flow -22 735 -101 3 80 98
Change in working capital -60 -29 -78 -56 -31 -30
Balance Sheet (BRLm)
Cash and cash equivalents 193 929 828 831 911 1,009
Property, plant & equipment 558 626 732 787 811 844
Goodwill 0 0 0 0 0 0
Other assets 763 757 1,029 1,098 1,187 1,274
Total assets 1,514 2,313 2,589 2,716 2,908 3,127
Debt 450 670 746 746 746 746
Other liabilities 453 461 580 593 650 708
Total liabilities 903 1,131 1,326 1,339 1,397 1,455
Total shareholders' equity 611 1,181 1,262 1,377 1,512 1,673
Net debt 257 -258 -82 -85 -165 -263
Key Company Metrics
Sales growth (%) 23.4 -0.6 3.2 29.9 16.7 14.1
DB EPS growth (%) -11.5 0.5 -14.4 13.1 11.2 19.8
Payout ratio (%) 34.2 50.0 50.0 50.0 50.0 50.0
EBITDA Margin (%) 19.1 18.7 17.4 17.3 16.8 16.8
EBIT Margin (%) 15.7 15.3 13.3 13.9 13.7 13.9
ROE (%) 25.7 21.7 13.9 15.0 15.5 17.1
Net debt/equity (%) 42.1 -21.9 -6.5 -6.1 -10.9 -15.7
Net interest cover (x) 5.0 nm 25.9 8.7 8.5 11.5
DuPont Analysis
EBIT margin (%) 15.7 15.3 13.3 13.9 13.7 13.9
x Asset turnover (x) 1.1 0.8 0.7 0.8 0.9 0.9
x Financial cost ratio (x) 0.8 1.0 1.0 0.9 0.9 0.9
x Tax and other effects (x) 0.7 0.7 0.8 0.7 0.7 0.7
= ROA (post tax) (%) 9.4 9.6 6.4 6.7 7.0 7.9
x Financial leverage (x) 2.7 2.3 2.2 2.2 2.2 2.2
= ROE (%) 25.7 21.7 13.9 15.0 15.5 17.1
annual growth (%) 17.3 -15.6 -36.1 8.3 3.0 10.4
x NTA/share (avg) (x) 5.7 6.7 9.0 9.4 10.2 11.0
= Reported EPS 1.45 1.46 1.25 1.41 1.57 1.88
annual growth (%) -11.5 0.5 -14.4 13.1 11.2 19.8
Source: Company data, Deutsche Bank estimates
15. 4 September 2013
Capital Goods
Latam Autoparts
Deutsche Bank Securities Inc. Page 13
Qualitative Analysis: Natural
Company description
Autometal is a holding company operating 17 plants in Brazil and Mexico,
most of which originated from acquisitions in the 2000 decade (six of which
concluded in 2006-2007), one plant in the U.S. and one recently formed JV in
China. Its origin dates back to 1964 in the state of Sao Paulo, Brazil and in
2010 a major shareholder restructuring took place: the controlling shareholder
CIE Automotive (CIE SM, Spain, not covered) exchanged direct ownerships at
each unit for a larger stake (a 75% interest) in a consolidation vehicle,
Autometal. The company specialized in grouping various steps of the auto
parts chain in order to outsource the least possible and adapting production
lines to various raw materials and technologies. It defines itself as a tier 1.5
manufacturer (tier 1 players sell straight to OEMs while tier 2 sells to tier 1
players). In 2012, Brazilian operations represented approximately 60% of
consolidated revenues, followed by Mexican operations with 35% (90% of the
Mexican output is exported to the NAFTA market). The stock is listed at the
Novo Mercado with roughly R$2.3bn of market cap, offering 100% tag-along
rights and trading an average of R$4.0m/day.
CIE Automotive originated in Spain, Bilbao, in 1939, and is controlled by five
investment companies, representing Spanish wealthy families and Corporación
Gestamp (Spain’s largest steelmaker), which holds 26% of CIE.
Figure 13: Autometal: Corporate Structure
Source: Company reports
Economic moats: diversification of products, technology and inputs flexibility
Autometal is a multi product manufacturer for a wide array of vehicles,
benefiting from technology advantages of being part of a large group (CIE
Automotive provides technology transferring) and operating two R&D centers –
AUTM3 has the lowest daily
turnover in our coverage
universe, USD2m per day
16. 4 September 2013
Capital Goods
Latam Autoparts
Page 14 Deutsche Bank Securities Inc.
one in Brazil and one in Mexico. By using different raw materials and operating
flexible assembly lines (switching between raw materials) Autometal managed
to increase market-share over time, gain scale and lower costs vs. competitors,
most of which are small, inefficient and having poor balance sheets. At plant
level the company has expertise in four major processes: plastics, metals,
painting and die stamping.
Competition is more intense in the Tier 2 segment as the industry is very
fragmented, each player operating a single manufacturing process. Its largest
client is Volkswagen, accounting for ~20% of consolidated revenues and
together with GM and Ford the three automakers account for nearly 50% of
that.
Approximately 90% of its consolidated output is destined for the passenger car
segment while 10% goes to trucks and buses. The main product lines are
powertrain (motor and transmission), chassis & steering, and decoration.
Autometal is a reliable strategic partner of local based OEMs, which gives it
some bargaining power: automakers need fast delivery to comply with just-in-
time and Kanban logistics and high quality standards, rarely met among
Brazilian players. Contracts with customers usually last between three to five
years, exactly the car model lifetime in the consumer market. In addition,
Autometal’s engineers work jointly with OEMs in the design and improvement
of components and that enhances customer relationships over time, enabling
the company to increase business upon new model launches. In addition, it
has dozens of patents and trademarks filed with the Brazilian agency of
industrial protection (INPI). Autometal’s facilities have decades of track record
in manufacturing thousands of different components and therefore has
accomplished important learning curves. The company’s relationship with
unions is solid, with no record of strikes, demonstrations or stoppages for
many years.
Resilient market position in Mexico and Brazil, but difficult visibility abroad
The company manufactures components for over 100 different models at a
given time (the largest revenue contributor is VW Gol responding for ~6% of
total revenues). Approximately 72% of revenues come from contracts with
OEMs, 23% from Tier 1 manufactures and 5% from the retail market (spare
parts, replacement). The significant investments announced recently by OEMs
in Mexico and Brazil attracted by lower costs and fast growing consumer
markets mitigate the influence of macroeconomic downturns in 2013-2014
(low GDP growth and higher interest rates) and the cyclical nature of the auto
industry. Raw material accounts for 67% of total costs, of which steel, iron and
aluminum account for ~64% of that. While raw material suppliers are few and
large, its global sourcing gives the company some economies of scale when
negotiating for steel and plastics inputs. All of the costs run by Brazilian
facilities are linked to the BRL while in Mexico approximately 70% of costs are
dollar denominated, 30% in Mexican Peso.
Rising imports of autoparts remain a threat to Brazilian based manufacturers,
particularly after the trade balance results in the first semester of 2013. The
company’s expansion into Asia and Eastern Europe should mitigate the issue.
Considering Autometal’s exposure to different markets such as Brazil, Mexico
(indirect exposure to U.S.), China, India, and the various technologies, we have
limited visibility in forecasting earnings in the long run.
17. 4 September 2013
Capital Goods
Latam Autoparts
Deutsche Bank Securities Inc. Page 15
Lean corporate structure oriented to results, some related party transactions
We welcome Autometal’s incentive compensation schemes at the units: each
facility has a separate P&L, earnings goals, and ROIC calculation in every
technology division (plastics, metal, painting, and die stamping), led by a
senior manager whose annual bonus is linked to EBITDA and cost-cutting
targets. However, we think the company is growing too fast in different
regions with a too-small team in the top management (only four executive
directors). The recent acquisitions in India and China (potentially CIE’s targets
and not Autometal’s) raised concerns on changes in strategy – the initial plans
were to expand only in Brazil and Nafta – but we think the decision was correct
in terms of capital allocation. Also, the management team in Autometal turned
the company more profitable and promising than other CIE units, turning it the
most important asset of CIE. Though, by maintaining stakes in various holdings
and having three listed stocks (CIE, Autometal and Mahindra) we think the
controlling shareholder may put at risk its supervision focus.
The company pays roughly ~0.8% of net revenues to the controlling
shareholder as part of a technology transfer agreement and trademarks rights
in Brazil and Mexico on the “CIE Automotive brand”. CIE entered into a
financial arrangement with BEI, an European bank, which obliged Autometal to
comply with annual dividend payments of at least 50% of consolidated profits
up to 2016 (the company’s bylaws defined a minimum dividend pay-out ratio
of 25%).
Figure 14: Autometal: Business Diversification
Source: Company reports
Board of Directors and management: some signs of a solid corporate
governance
The company’s Board comprises seven members and only two of them are
independent from the controlling shareholder and the management. The
chairman, Mr. Jesús María Herrera Barandíarán, is the CEO of the company
and also Chief Operating Officer of the controlling company CIE Automotive.
18. 4 September 2013
Capital Goods
Latam Autoparts
Page 16 Deutsche Bank Securities Inc.
Autometal does not have a live Fiscal Board, does not have a particular
management & Board performance evaluation program and does not have
separate committees to oversee management (such as Audit, Risk or
Compensation committees). The Board of Directors usually meets four times a
year, as set by the company’s by-laws.
We highlight that management is very experienced in auto parts – two
executive directors have been working at Autometal for more than 35 years.
Their bonus and profit sharing are linked to the achievement of goals and the
level of consolidated results. However, variable compensation measured as a
percentage of operating earnings soared from 0.2% in 2010 to 1.3% in 2012.
Interestingly, and different from other companies in this report, the Board of
Directors had no compensation at all in 2011 and 2012 – a form of avoiding
conflicts of interest as some members also work for the controlling
shareholders. Autometal has a stock option program for the top management
and members of the Board and it set a maximum potential dilution of 2.75% in
outstanding shares, among other candid terms. As of June 2013, the Board
and management held no shares in the company.
Autometal scores moderately on qualitative criteria.
Quantitative Analysis: Neutral
Short track record, solid margins, low capex to EBITDA ratio and short CCC
Autometal is a relatively new company, created to organize and consolidate
several existing units spread between Brazil and Mexico. Therefore, audited
financial statements date back to a few years and IFRS accounting
improvements continue an ongoing process in Brazil. We can only have an
accurate and reliable assessment of the company’s track record back to 2010
(previous financials are “combined” statements). In addition, most of the
company’s earnings growth has been through acquisitions and underlying
earnings have increased mildly over the years (influenced by currency
fluctuations, labor costs pressure, and government stimulus to the auto
sector). So far, Autometal has been a reasonable free cash generator, reporting
above average operating margins (13-14% range) and fairly stable over time,
helped by its large scale, raw material flexibility and strict cost control at its
facilities. Maintenance capex is low and the cash conversion cycle is short,
less than 30 days. Most R&D expenses are accounted when incurred, the small
difference is reported as intangibles (R$13m as of December 2012, or just 1%
of total assets).
Figure 15: Autometal: Main Financials
R$m 2009 2010 2011 2012 2013E 2014E 2015E
Operating Income 160 247 240 214 292 335 388
operating margin 12.6% 15.7% 15.3% 13.3% 13.9% 13.7% 13.9%
FCFF 72 62 110 (29) 126 218 251
Capex/EBITDA ratio 0.8 0.4 0.3 0.7 0.3 0.2 0.2
CCC (days) 21 19 12 25 29 29 29
Dividends paid 207 53 6 109 89 99 119
ROE 19% 26% 22% 14% 15% 15% 17%
ROIC 17% 10% 11% 5% 10% 12% 13%
Source: Deutsche Bank and company reports *ROIC or CROIC = (EBIT – taxes – WK change)/(total Assets – cash)
In the 2008-2012 period
Autometal reported R$1.3bn
in EBITDA but R$212m in free
cash flow, which is a
moderate outcome
19. 4 September 2013
Capital Goods
Latam Autoparts
Deutsche Bank Securities Inc. Page 17
Solid balance sheet, good dividend payer, but low ROIC vs. WACC
Despite a solid financial situation – important for a high fixed cost business –
and naturally hedged to the FX volatility vs. the BRL (roughly 50% of revenues
and 55% of costs are exposed to foreign currencies) the company has been
reporting modest returns on invested capital. Our ROIC calculation adjusts
EBIT for the working capital spending reported in its cash flow statement as
Autometal is in a capital intensive business (we prefer ROIC and ROA to ROE in
order to adjust for leverage effects). Over the past five years, ROIC has been
below the company’s weighted average cost of capital, ranging between 9 to
11% in nominal terms (2009 was one-off). We think that the recent
acquisitions in U.S., China (both incorporated in October 2012), and the deal
with Mahindra should improve ROIC over the next two years as the cash raised
in its February 2011 IPO was finally appropriately deployed. In addition,
Autometal is currently developing four green field units, which should take a
while to generate returns – we expect that profitability and return ratios should
improve by 2015.
Over the past five years, the company reported R$1.3bn in accumulated
EBITDA but R$212m in free cash flow, which is a moderate outcome. The
company has been a good dividend payer, distributing on average 50% of net
earnings, and has just announced its first share buyback program – though
very small (0.3% of outstanding shares to fund stock options).
Autometal scores moderately on quantitative criteria.
Growth Outlook: Positive
While worsening macroeconomics are headwinds for top-line growth, the
structural characteristics of the Brazilian market (low car penetration per
capita, poor public transport systems, strong public appeal for cars, and a
large and growing vehicle financing market) should provide Brazilian suppliers
solid organic growth. Moreover, as the auto industry evolves in scale, OEMs
will probably search for more efficiency (i.e., just-in-time production, fast and
reliable logistics) and accordingly generate more contracts with larger,
efficient, and trustworthy companies (including Autometal), in detriment to
small suppliers. We are less concerned with imports following the recent BRL
depreciation, but acknowledge that the arrival of Asian suppliers in Brazil
should hurt primarily the hundreds of small players, which have weak balance
sheets and lack technology.
Brazil increasing share in the global auto industry, Mexico crucial for U.S.
Over 90% of all planned investments announced by OEMs in Brazil, totaling
R$35bn up to 2015, comprise expansion projects of Autometal’s existing
clients. The Mexican automobile industry has been growing rapidly since it
bottomed in the aftermath of the 2008 crisis: U.S. based OEMs have been
increasingly shifting production facilities to Mexico in search of lower costs
and tax breaks inserted on the NAFTA agreement. According to CMS
Worldwide, a leading research institute, light vehicle production CAGR in Brazil
should average 6% between 2013 and 2016, while in Mexico it should average
10% over the same period.
Latam suppliers are going global and consolidating
Autometal is somewhat experienced in making acquisitions and turning
around targets. In some cases, it managed to double operating profits in a few
20. 4 September 2013
Capital Goods
Latam Autoparts
Page 18 Deutsche Bank Securities Inc.
years by adding new contracts, improving efficiency, and canceling
unprofitable product lines. In others, it also launched new products and
entered new market niches (i.e., painting or stamping or vice-versa). The
autoparts market in Brazil is still very fragmented with approximately 500
companies, mostly mom-and–pop operations. According to Autometal, 60% of
them consist of local family businesses lacking basic management skills, and
50% of them are in bad financial shape with extremely high funding costs.
However, and based on the company’s recent track record target opportunities
are scarce in Brazil: 1) companies have lots of labor and tax contingencies out
of their balance sheets; 2) contracts with customers have weird clauses to
inflate ST earnings; and 3) family owners usually mix their private accounts
with their companies’ financials, which further complicates due diligence
efforts.
Figure 16: Autometal: Expansion History
Source: Company reports
Acquisitive companies should be looked at with care, but India’s deal is
transformational
Actual earnings growth in the underlying business is unclear as Autometal
originated from dozens of acquisitions and incorporations over the past ten
years, and audited financial results do not show the organic performance of
the existing businesses separately. We are skeptical with acquisitions in capital
intensive business and history shows that 1) actual synergies are frequently
lower than anticipated; 2) integration and efficiency gains take much more
time than initially planned; and 3) acquisition targets have logistics, inventory
management, and systems that usually don’t match the buyer’s standards,
leading to substantial write-offs and extra charges. Nonetheless, Autometal
has been expanding in other emerging markets to increase presence in lower
cost regions, add aluminum and forgings technologies, and exposure to truck
parts. This is happening at a time when the Brazilian economy is slowing down
amid higher labor costs and macroeconomics turbulence, which we welcome.
21. 4 September 2013
Capital Goods
Latam Autoparts
Deutsche Bank Securities Inc. Page 19
In India, Autometal is concluding the acquisition of the automation
components manufacturer Mahindra Systech, a subsidiary of the Mahindra &
Mahindra Group (“M&M”), which specializes in forging, foundry, stamping,
and magnetic products with facilities in India, Germany, UK, and Italy, for a
total consideration of US$157m. Autometal was attracted by the country’s low
production costs, high growth markets, and leadership in heavy vehicles
components, particularly forgings. Autometal plans to merge Mahindra
Systech with the forging units of its controlling shareholder (CIE Automotive)
located in Europe in order to consolidate CIE’s forging operations and maintain
a listed stock on the Bombay Stock Exchange (Mahindra Forgings, MFOL IB,
not covered), renaming it Mahindra CIE Automotive Ltda. Autometal will have
a 37% interest in the new company (but for its controlling role it will fully
consolidate Mahindra CIE in its financial statements) and will become an EM
global company – Latin America’s exposure should drop to 55% of sales by
2017 vs. 95% today. Indian Bharat Forge Limited (BFL) of the Khalyani Group is
the largest forging company in the world and Autometal’s major competitor in
Europe.
Our earnings estimates combine expansion plans, industry trends, 1H13 results
and Mahindra
We consider in our earnings model Autometal’s ongoing green field projects in
Mexico, Brazil, and China, a stronger USD benefiting Mexican (100% dollar
denominated), China’s and U.S. operations, and forecasts from leading auto
consulting firms on cars and trucks production in Latin America. On the cost
side we acknowledge that visibility is limited given the company’s 1) ability to
shift between raw materials to reduce costs, 2) economies of scale in global
purchases, 3) unpredictable revisions in the ramp-up of the green fields under
construction and associated occupancy rates at the facilities, and 4) low
visibility on labor costs in Brazil and Mexico offset by increasing automation
efforts. We highlight that the company’s low income tax payments (~21%
effective tax rate) should continue into the future as the Mexican subsidiaries
were incorporated by PIA-1, a Spanish based holding company so Autometal
could benefit from tax savings agreements. Since the incorporation of
Mahindra’s financials includes many steps scheduled for the second half of
2013, we opted to run a separate and simple earnings model for it, supported
by management’s guidance.
Autometal should benefit with the “Inovar Auto” regime
According to industry consultants, the Brazilian government’s subsidies to
increase the local content in the autoparts should mostly benefit suppliers that
use simple technologies in their production lines and which imported products
have inexpensive and simple logistics (fast and riskless packing, loading and
unloading). Accordingly, local suppliers of plastics, forged, and stamped
products should experience a strong import substitution effect and increase
sales to OEMs in 2014-2015, and we highlight Autometal as the main
beneficiary in our coverage universe.
Autometal scores highly on growth prospects.
Momentum Analysis: Neutral
Autometal can be considered a slightly unpopular stock, with low daily
turnover despite the coverage of more than ten brokers. News flow is mixed as
it is properly lowering exposure to business in Brazil, which is now
22. 4 September 2013
Capital Goods
Latam Autoparts
Page 20 Deutsche Bank Securities Inc.
experiencing an economic slowdown, logistics issues, and political
uncertainty; there seems to be a general perception of related party
transactions, corporate governance concerns and integration challenges in
recent acquired assets. We anticipate strong ST results over the next quarters
on the back of the strong performance of the NAFTA vehicle market
(Mexican’s exports to U.S. are booming) partly offset by the current
deceleration in the Brazilian automotive industry.
AUTM3 has recovered since it reached the bottom June 2013 (R$15 per share).
The analysis of consensus earnings forecasts for 2014 are somewhat distorted
– relevant acquisitions in the past twelve months prompted market participants
to update and raise their earnings estimates to incorporate the acquired
targets. Changes in analysts’ ratings, shown by upgrades and downgrades, are
more accurate in our view and imply the stock is not out favor. On a contrarian
and bargain hunting standpoint, we cannot affirm the stock is a hidden gem
for investors.
Figure 17: Autometal: Bloomberg Finance LP Consensus History
R$m 12m 6m 3m Current
Buy ratings* 50% 64% 58% 58%
EBIT 14E 277 276 308 304
EPS 14E 1.74 1.65 1.77 1.77
ROE 14E 18% 16% 17% 17%
Source: Bloomberg Finance LP * percentage of Buy ratings compiled by Bloomberg Finance LP
Autometal is not out of favor nor popular on momentum analysis.
Valuation Analysis: Buy
Price target calculation and main assumptions, FCF yield multiple
Our price target of R$26 is the midpoint of our DCF valuation model, which
results in a fair value range of R$22 – 24, plus R$3.4 per share in value
contribution from Mahindra. Considering the company’s moderate scores in
our qualitative and quantitative criteria we require a substantial margin of
safety to recommend the stock, which it satisfies. The upside potential of 40%
(including 4% dividend yield) is well above Deutsche Bank’s 10% threshold
required return and is paramount for our rating, supported by the 6-7% FCF
yields anticipated for 2014-15E (the highest in our coverage universe not even
including Mahindra’s earnings). Accordingly, we are initiating coverage on
Autometal with a Buy rating. Our DCF valuation is based on a WACC of 14.2%
(nominal local currency) as the discount rate for the FCFFs (free cash flows to
firm), a risk-free rate of 9.4% (average of the CDI rate 2013-2014E), an equity
risk premium of 6%, and a cost of debt of 11.4% (CDI + 2%).
We use a 6% nominal perpetuity growth rate, which we think is reasonable as
it results in a 12x exit multiple in the perpetuity value calculation: 1/(WACC – g)
= 1/(14.2%-6%) = 12x. The low confidence in our long-run FCF estimates (short
track record and acquisition risks) justifies a low exit multiple vs. the normal
15-20x range. We consider a multiple of 1.0x P/BV as fair value for the minority
shares in the company and subtract that from the fair value calculation of
AUTM3 to be consistent – all of our DCF inputs (i.e. operating earnings, taxes,
capex, etc) are fully consolidated numbers.
23. 4 September 2013
Capital Goods
Latam Autoparts
Deutsche Bank Securities Inc. Page 21
Figure 18: Autometal: DCF Valuation Summary (ex-Mahindra)
R$m 2013E 2014E 2015E 2016E 2017E
EBIT 292 335 388 428 476
EBIT x (1-t) 219 251 291 321 357
(+) Non-Cash Expenses 71 76 81 87 92
(-) Capital Expenditures (126) (100) (114) (125) (91)
(-) Change in Working Capital (56) (31) (30) (24) (27)
Free Cash Flow to Firm 107 196 228 259 330
NPV of FCF 2,569
(-) Net Debt plus minorities 64
Equity Value 2,505
Shares Outstanding (Mn) 126
Price Target (R$) 22.7
Source: Deutsche Bank estimates
Figure 19: Autometal: Target Price Sensitivity (ex-Mahindra)
g
5.0% 5.0% 6.0% 7.0% 8.0%
13.2% 18 23 25 29 33
13.7% 18 22 24 27 30
WACC 14.2% 17 21 22.7 25 28
14.7% 17 20 22 24 26
15.2% 16 19 21 22 25
Source: Deutsche Bank
Figure 20: Mahindra CIE Automotive, DDM model (R$m)
2013 2014 2015 2016 2017
Net Revenues 550 2,618 2,880 3,168 3,485
YOY % - nm 0 0 0
EBITDA 33 288 317 348 418
(-) Depreciation & Amort 22 105 115 127 139
EBIT 11 183 202 222 279
net debt 341 737 654 664 672
Financial Expenses 10 44 39 40 40
Pretax earnings 1 139 162 182 238
(-) income taxes (0) (33) (39) (44) (57)
Net income 1 106 123 138 181
pay-out ratio 50% 50% 100% 100% 100%
Dividends 0 53 123 138 181
PV of Dividends 0 46 95 93 107
Perpetuity Value - - - - 1,601
Total Equity Value - - - - 1,942
Autometal's stake @ 37% - - - - 718
(-) acquisition price - - - - (345)
(=) Autometal's Interest - - - - 373
# shares - - - - 126
(=) incremental PT - - - - R$ 3.4
Source: Deutsche Bank and company data
We are also presenting separate estimates and NPV calculation for Mahindra
Systech, as we think this was one of the most important transactions in the
recent past and needs some special attention. CIE and Autometal are building
Our separate Mahindra CIE’s
earnings model adds R$3.4
per share to Autometal’s
consolidated PT of
R$26/share
24. 4 September 2013
Capital Goods
Latam Autoparts
Page 22 Deutsche Bank Securities Inc.
one of the largest forgings players in the world on the edge of technology –
forged crankshafts – and allowing Autometal, as the acquisitive party, to run
the show with a 37% indirect stake. Since the incorporation of Mahindra’s
financials includes many steps scheduled for the second half of 2013 and
management provided a rough estimate of the new company, we chose to
leave Mahindra out of Autometal’s consolidated estimates for a while. The
table below shows our earnings forecast and a simple DDM (Dividend
Discount Model) for the company, which adds R$3.4 per share to Autometal’s
fair value.
Implied nominal IRR of 19% justifies our Buy rating
Considering our free cash flow estimates, perpetuity growth assumptions and
the company’s current enterprise value (market cap plus current net debt and
minority liabilities), the stock is pricing in a nominal annual return of 19%
(~14% real). This return compares very well to the interest rates in Brazil of
~9%, risk free, the opportunity cost of staying in cash deposits. This fact
increases our confidence in a Buy rating on AUTM3.
M&A implied valuations as a sanity check and preferred to trading comps
Based on a broad availability of corporate transactions in the autoparts
industry, we believe that M&A implied valuations are useful for a sanity check
comparison to valuation methods based on earnings estimates (naturally very
uncertain). Autometal has been very active in corporate transactions over time,
which also supports our valuation exercise.
Figure 21: Autometal: Implied Fair Value on M&A Multiples (LTM multiples)
Date Acquirer Target US$m P/E P/BV EV/EBITDA
Jul-08 INA-Holding Schaeffler Continental AG 8,132 12.7x 2.8x 5.0x
May-11 Volkswagen AG MAN SE 7,418 2.3x 13.9x
Jul-08 Icahn Enterprises LP Federal-Mogul Corp 2,953 22.1x 2.2x 7.4x
Oct-11 Iochpe-Maxion SA Hayes Lemmerz International 1,317 5.9x
Jul-11 Toyota Motor Corp Toyota Auto Body Co Ltd 960 5.9x
Oct-10 Carlisle Cos Hawk Corp 406 7.0x
Sep-12 Titan International
Titan Europe
PLC/Worcestershire
367 4.3x
Feb-12 Mitsui-Soko Co Mitsui-Soko Logistics Co Ltd 293 5.0x
Oct-11 Iochpe-Maxion SA Galaz 225 9.0x 6.0x
Feb-10 Fiat SpA Sollers OJSC 205 4.1x 1.9x 4.6x
Mar-13 Shareholders Cooper-Standard Holding 200 8.4x 1.3x 4.3x
Apr-13 Randon Part. Suspensys 195 16.0x 9.3x
Feb-11 Gentherm WET Automotive Systems AG 171 11.4x 2.3x 4.9x
May-12 Andritz AG Schuler AG 163 13.5x 2.7x 4.2x
Jun-13 Autometal Mahindra Systech 157 10.0x
Jan-12 Nexen Corp Nexen Tire Corp 143 13.9x 2.5x 10.5x
Median 259 12.7x 2.3x 5.9x
Average 1,457 12.3x 2.2x 6.8x
EBITDA R$m Implied EV Fair value/share
Autometal 2013E 363 2,453 19.0
Mahindra 2014E 288 721 3.0
(=) Total 22.0
Upside potential 18%
Source: Bloomberg Finance LP and Deutsche Bank
25. 4 September 2013
Capital Goods
Latam Autoparts
Deutsche Bank Securities Inc. Page 23
The company can be considered a great acquisition target for foreign players
willing to establish a local footprint in emerging markets as they would rapidly
benefit from its track record with local OEMs, proven logistics, and formal
labor relations and economies of scale. Considering the average of 6.8x LTM
EBITDA of the following transactions over the past three years and that
minority shareholders could potentially benefit from tag-along rights on top of
any acquisition price premium, the implied valuation of AUTM3 would be
roughly R$22 per share.
We believe that historical transaction multiples among global peers offer a
better valuation assessment than trading multiples. First, they offer a concrete
estimate of fair value per share insulated from the current market’s condition
(i.e., euphoria or panic levels distort trading comps); second, a broad database
of transactions over time reduces the weight of outliers in times of ample
liquidity and high confidence (high valuations in M&A) and lower liquidity and
global markets turmoil (low valuations); finally, transaction multiples are based
on actual earnings reported by the acquired targets and not forecasts, which
are naturally imperfect and unstable. We highlight that minority investors
benefit, through their tag-along rights, from the unhidden value unlocked by
acquisitive firms and entrepreneurs, particularly if the stocks they hold include
strategic assets with competitive advantages (synergies potential = higher
M&A valuations).
Based on a broad valuation analysis AUTM3 is a Buy.
Risks to Investment Thesis
Downside risks to our investment recommendation are: as follows.
Worsening competitive environment: Imports of autoparts from Asian
manufacturers are increasing quickly in Brazil while exports have been
declining. High production costs and logistics issues, as well as a strong
currency, are behind such phenomenon. New OEMs coming into Brazil
such as Chinese automakers may bring their Asian suppliers in long-term
contracts, which could intensify competition for market-share and hurt
Autometal’s profitability.
Client concentration: The automotive global industry is cyclical and some
of the leading automakers in the world have entered into Chapter 11 or
suffered severe financial distress. In Latin America, automakers have also
experienced booms and bursts over the past twenty years with negative
consequences to the industry’s supply chain, including labor layoffs and
cost cutting. Ford, GM, and VW account for nearly half of Autometal’s
total revenues and such client concentration may hurt its operating
performance in case one or more of them gets into financial trouble.
Auto industry downturn: Potential increases in interest rates, availability of
consumer credit and/or GDP contraction, either in Brazil or U.S., could
affect the demand for cars and trucks and reduce automaker activity. If the
Brazilian and U.S. economies slow, followed by lower consumer
confidence, then demand for autoparts from OEMs would drop, as already
happened in U.S. during 2007-2009.
Overpayment in acquisitions: Since its IPO in 2011, the company
celebrated three agreements to purchase foreign operations, which we
could not appropriately value and suggested a shift in the company’s initial
strategy to grow in Latin America. We are concerned with management’s
acquisition frenzy, potentially leading to overpayment, delays in
integration, extra charges, and value destruction.
28. 4 September 2013
Capital Goods
Latam Autoparts
Page 26 Deutsche Bank Securities Inc.
Randon
Investment Thesis: Sell
Solid competitive advantages but weak financials, unclear growth and
overpriced; initiating with a Sell
Based on our five investment criteria (Qualitative, Quantitative, Growth,
Momentum and Valuation), Randon has solid competitive advantages but
unclear earnings visibility and questionable corporate governance. It is a
company of moderate financial ratios (low margins and low ROIC), volatile
track record, and poor free cash generation. Moreover, growth is complicated
by fierce competition, intense cost pressures, government support, and
frequently high capex. Also, the stock is very popular (positive newsflow and
strong results) based on our momentum analysis and it seems overvalued as
shown by our valuation assessment, offering no margin of safety for a long
position. Therefore, we are initiating coverage on Randon with a Sell rating and
R$9.5 target price per share, implying 18% loss potential (including dividends).
Free cash flow yield of 4% in 2014E seems a fair valuation but our forecasts
carry downside risks.
Figure 25: Randon: Case Summary
Criteria Summary Score
Qualitative
Solid competitive advantages: brand, quality reputation and reliable autoparts business through
international JV's; six plants are integrated in the same site meaning high economies of scale and lower
costs; low earnings visibility and capex uncertainty; family owned company with weak corporate
governance.
Neutral
Quantitative
Poor cash generation, unstable operating margins (9-14% range), moderate capex to EBITDA ratio and
long CCC; It has a regular balance sheet, has been a poor dividend payer and has a low ROIC vs.
WACC.
Negative
Growth
Fleet renovation and poor storage capacity in agribusiness imply solid demand for trailers regardless of
GDP; Credit stimulus, government subsidies through competitive funding, tax exemptions and
technology changes (i.e., Euro 5) make earnings growth volatile; The acquisition mode in autoparts
seems accretive.
Neutral
Momentum
Increased admiration to the stock, covered by lots of brokers, enjoying positive newsflow from
government's support and the boom in truck production; Latest results were strong and outlook is
positive for the 2H13; the stock is not far from its recent high; Latest consensus forecasts were revised
upwards.
Hype
Valuation
No margin of safety to fair value, downside potential to DCF-based price target and very low implied
IRR vs. fixed income securities; M&A valuation comps suggest the stock is overvalued; Moderate FCF
yield multiples carry downside risks; a special DDM valuation showed the stock is expensive.
Sell
Source: Deutsche Bank
29. 4 September 2013
Capital Goods
Latam Autoparts
Deutsche Bank Securities Inc. Page 27
Model updated:26 August 2013
Running the numbers
Latin America
Brazil
Capital Goods
Randon
Reuters: RAPT4.SA Bloomberg: RAPT4 BZ
Sell
Price (3 Sep 13) BRL 11.55
Target Price BRL 9.50
52 Week range BRL 10.46 - 13.60
Market Cap (m) BRLm 2,816
USDm 1,194
Company Profile
Randon is fifth largest global manufacturer of towed
vehicles and one of the largest autoparts manufacturers in
Latin America with a strong bias to truck components. The
company has annual revenues of BRL4.0bn and operates
in three segments: (i) towed vehicles, railcars and specialty
vehicles (50% of net sales); (ii) auto parts and automotive
systems (47% of net sales); and (iii) financial services and
others (3% of net sales). Randon produces through units
located in Brazil, Argentina, USA and China.
Price Performance
8
9
11
12
14
15
Sep 11 Mar 12 Sep 12 Mar 13
Randon BOVESPA (Rebased)
Margin Trends
4
8
12
16
10 11 12 13E 14E 15E
EBITDA Margin EBIT Margin
Growth & Profitability
0
5
10
15
20
25
-20
0
20
40
60
10 11 12 13E 14E 15E
Sales growth (LHS) ROE (RHS)
Solvency
0
5
10
15
20
25
0
10
20
30
40
50
60
10 11 12 13E 14E 15E
Net debt/equity (LHS) Net interest cover (RHS)
Bernardo Carneiro, CFA
+55 11 2113-5685 bernardo.carneiro@db.com
Fiscal year end 31-Dec 2010 2011 2012 2013E 2014E 2015E
Financial Summary
DB EPS (BRL) 1.02 1.10 0.17 0.90 0.90 1.00
Reported EPS (BRL) 1.02 1.10 0.17 0.90 0.90 1.00
DPS (BRL) 0.35 0.34 0.29 0.29 0.29 0.32
BVPS (BRL) 4.81 5.56 5.62 6.23 6.84 7.52
Valuation Metrics
Price/Sales (x) 0.7 0.6 0.7 0.7 0.6 0.6
P/E (DB) (x) 10.2 9.6 58.8 12.9 12.9 11.6
P/E (Reported) (x) 10.2 9.6 58.8 12.9 12.9 11.6
P/BV (x) 2.4 1.5 2.3 1.9 1.7 1.5
FCF yield (%) 1.7 nm nm nm 3.9 4.4
Dividend yield (%) 3.4 3.3 2.8 2.5 2.5 2.8
EV/Sales 0.8 0.8 1.0 1.0 0.9 0.9
EV/EBITDA 5.5 5.9 12.3 7.2 6.8 6.3
EV/EBIT 6.7 7.3 21.6 9.4 8.9 8.3
Income Statement (BRLm)
Sales 3,719 4,156 3,502 4,117 4,336 4,600
EBITDA 551 572 295 556 585 621
EBIT 450 460 168 425 446 471
Pre-tax profit 464 520 132 404 371 412
Net income 249 269 43 218 219 243
Cash Flow (BRLm)
Cash flow from operations 230 -38 -63 272 261 325
Net Capex -186 -248 -235 -530 -150 -200
Free cash flow 44 -287 -298 -258 111 125
Equity raised/(bought back) 0 0 0 0 0 0
Dividends paid -43 -86 -84 -70 -70 -78
Net inc/(dec) in borrowings 478 102 367 0 0 0
Other investing/financing cash flows 110 102 11 85 59 66
Net cash flow 588 -169 -5 -243 100 113
Change in working capital -121 -420 -133 -77 -97 -69
Balance Sheet (BRLm)
Cash and cash equivalents 1,274 1,104 1,099 857 957 1,070
Property, plant & equipment 1,094 1,183 1,352 1,351 1,361 1,411
Goodwill 0 0 0 0 0 0
Other assets 1,274 1,732 1,870 2,281 2,407 2,507
Total assets 3,641 4,020 4,321 4,488 4,725 4,987
Debt 1,410 1,512 1,878 1,878 1,878 1,878
Other liabilities 614 647 585 647 676 707
Total liabilities 2,023 2,158 2,464 2,525 2,554 2,585
Total shareholders' equity 1,618 1,861 1,858 1,963 2,171 2,402
Net debt 136 407 779 1,022 921 808
Key Company Metrics
Sales growth (%) 50.6 11.8 -15.7 17.6 5.3 6.1
DB EPS growth (%) 21.7 7.9 -84.2 412.8 0.2 11.2
Payout ratio (%) 34.6 31.2 164.1 32.0 32.0 32.0
EBITDA Margin (%) 14.8 13.8 8.4 13.5 13.5 13.5
EBIT Margin (%) 12.1 11.1 4.8 10.3 10.3 10.2
ROE (%) 23.0 21.3 3.1 15.1 13.7 13.9
Net debt/equity (%) 8.4 21.9 41.9 52.0 42.4 33.7
Net interest cover (x) nm nm 4.7 20.8 5.9 8.0
DuPont Analysis
EBIT margin (%) 12.1 11.1 4.8 10.3 10.3 10.2
x Asset turnover (x) 1.2 1.1 0.8 0.9 0.9 0.9
x Financial cost ratio (x) 1.0 1.1 0.8 1.0 0.8 0.9
x Tax and other effects (x) 0.5 0.5 0.3 0.5 0.6 0.6
= ROA (post tax) (%) 7.8 7.0 1.0 5.0 4.7 5.0
x Financial leverage (x) 3.0 3.0 3.1 3.1 2.9 2.8
= ROE (%) 23.0 21.3 3.1 15.1 13.7 13.9
annual growth (%) 70.1 -7.2 -85.3 383.7 -9.1 1.2
x NTA/share (avg) (x) 4.5 5.2 5.6 5.9 6.5 7.2
= Reported EPS 1.02 1.10 0.17 0.90 0.90 1.00
annual growth (%) 21.7 7.9 -84.2 412.8 0.2 11.2
Source: Company data, Deutsche Bank estimates
30. 4 September 2013
Capital Goods
Latam Autoparts
Page 28 Deutsche Bank Securities Inc.
Qualitative Analysis: Neutral
Company description
Randon is fifth largest global manufacturer of towed vehicles and one of the
largest autoparts manufacturers in Latin America with a strong bias to truck
components. Founded in 1949 by the Randon family in the state of Rio Grande
do Sul, south Brazil, it controls thirteen units. Six of them are integrated in the
same site, in the industrial city of Caxias do Sul, and account for ~70% of the
total trailers capacity (~120 units per day). Production starts in rough mode –
cutting, folding, and stamping steel plates through high pressure and extreme
temperatures. Exports and foreign operations (i.e., hard currency) represent
~13% of consolidated revenues, split between facilities in Argentina (semi-
trailers), China and U.S. (autoparts). The IPO was carried in 1971 at the
Bovespa and the stock has two classes of shares, PN (non-voting) and ON
(voting) – all having 80% tag-along rights. RAPT4 has been trading an average
of R$11m/day.
Figure 26: Randon: Corporate Structure
RandonS.A.Implementos e
Participações
DRAMD
Participações
40.6%
Randon
Brantech
Randon
Implementos
Randon
Argentina
FRAS-LE
Suspensys Master
JOST
CASTERTECH
Randon
Investimentos
BancoRandon
Consórcio
Randon
100%
100% 100% 100% 100% 100%
45.2%
100% 51%
51%
Vehicles and Trailers Auto parts Financial Services
100%
Source: Deutsche Bank and company reports
Economic moats: revenue diversification, brand equity, integrated facilities,
and technical support
Randon has a diversified revenue line and a broad portfolio of products,
including small components of brakes (through subsidiary’s Fras-Le),
suspension systems, and coupling parts for commercial vehicles as well as
final products such as towed vehicles for various industries. These, mainly
trailers, semi-trailers, and off-roads (tractors and backhoes) represent fifty
percent of total revenues and are sold to a vast variety of clients such as
freight companies, beverage producers, fuel distributors, and large
agribusiness companies (ethanol, grain, and sugar trailers represent one-third
of total revenues). Imports competition is very limited on high freight costs,
lack of technical assistance network, and lack of knowledge of Brazilian truck
specifications by regulators.
The remainder of sales comprises autoparts demanded mostly by OEMs (35%
of revenues) and the retail market (10% of total revenues) and face some
imports threats. Randon is also the largest producer in Brazil of off-road trucks
in the 30 ton category for the mining and construction industries. In 2003,
management took a smart decision to start producing railcars to benefit from
31. 4 September 2013
Capital Goods
Latam Autoparts
Deutsche Bank Securities Inc. Page 29
its know-how in trailers for the agriculture sector, raw material and production
similarity, and some idle capacity in the assembly line (railcars are
manufactured in the same production lines of trailers/semi-trailers). In a few
years, Randon conquered 30% of the railcar market in Brazil and is now the
second largest player in the country.
The company enjoys a solid reputation not only for the quality of its products
(customer design, durability and higher than average residual value) but also
for its ample technical assistance and distribution network, the largest among
competitors. The towed vehicle unit uses the sales structure of the autoparts
units and vice-versa in over ninety distribution facilities in Brazil and sixty-five
abroad. Randon’s own credit agency accounts for 3% of revenues and its
bank, Banco Randon, was created in 2010 to support its credit agency. In
2006, the company started its own foundry unit, Castertech, with the capacity
to produce 30,000 tons/year of foundry ironed parts.
Figure 27: Randon: Towed Vehicle Segment
Source: Company reports
Truck trailers: increasingly difficult business on competition, high fixed costs
and low returns
There are dozens of small players in the trailer market that have their place in
the industry and compete on price, not on product differentiation. While the
market leaders produce 30 to 120 vehicles per day, these make one to five per
month. Most of their customers are independent truck drivers or small service
providers that cannot afford a Randon product and pay for its brand, quality,
and technical assistance (i.e., Randon trailers are considered premium
products). For instance, the resale price in Brazil of a second-hand Randon
trailer has a 15-17% premium to competitors. The barrier of entry is low – lots
of steel shops are able to manufacture a trailer by purchasing the parts in the
market and hiring a couple of temporary workers. Indeed, Randon sells auto
parts to competitors in order to create barriers against imports and foreign
manufacturers willing to establish a footprint in Brazil, but we think it is a risky
strategy.
32. 4 September 2013
Capital Goods
Latam Autoparts
Page 30 Deutsche Bank Securities Inc.
Figure 28: Randon: Brazilian Truck Trailer Market
19% 20% 24% 25% 26% 26% 28% 28% 27% 28%
10% 8%
7% 6% 6% 7% 7% 7% 10% 10%
2% 3% 2% 3% 4% 5% 7% 9% 10% 10%19% 18% 15% 15%
16% 15%
15% 11%
13% 12%
17% 14% 14% 13%
14% 11%
11% 12%
10% 12%
34% 36% 38% 37% 33% 35% 32% 33% 31% 29%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2004 2005 2006 2007 2008 2009 2010 2011 2012 1Q13
Others NOMA LIBRELATO GUERRA FACHINNI RANDON
Source: Company reports
Randon lost market-share in the past five years as it refused to enter a price
war with competitors and that worked well as it lost unprofitable sales. Also, it
opted to focus on value added products (i.e., refrigerated trailers), which have
fewer orders. In 2007 the company reported a 37% market share in the truck
trailer segment, which dropped to 29% in 2013. Noma and Librelato gained
market share in the period, and according to our research they offer very
competitive products (quality, design and robustness) as well as attractive
financing conditions and technical support (after sales services).
Sales volume in the towed vehicles segment comprises small orders,
frequently tailor-made trailers, and a lot handicraft – all of which limit
economies of scale and productivity gains. The company schedules its
production according to the orders placed by the customers, i.e., it does not
build inventories of final products such as in the autoparts segment. Therefore,
occupancy rates are out of the company’s control and fixed cost dilution is
more difficult to achieve.
Autoparts: JV’s with global suppliers, technology, and scale support market
leadership
The company’s competitive advantages are more evident in the autoparts
division. Randon has signed strategic partnerships in the past to build
autoparts facilities in Brazil, helped by technology transfer agreements in order
to meet OEMs requirements of quality and trust. Jost Werke, a German based
supplier and Meritor, a U.S. leader in brake systems both formed joint-ventures
with Randon a few decades ago. Today, these units hold significant market-
share in their niches: in 2012 Jost detained nearly 88% of all “fifth wheels”
sold in Brazil, Suspensys 58% share of axles and suspension systems, and
Master roughly 66% of air brakes sold. Fras-Le, a listed company (FRAS4 BZ,
not covered) was acquired by Randon in 1996 and today is the largest world
exporter of brake linings for trucks and holds 50% of market-share in the local
market. Sales volume in the autoparts division is more regular, production
schedule more predictable, and accordingly, economies of scale are larger.
Jost and Suspensys have higher returns on equity and higher margins
compared to the truck trailers unit (ROEs in the 20-30% range vs. ~10%,
respectively).
We think Randon’s autoparts
division is by far a better
business than the
manufacturing of truck
trailers
33. 4 September 2013
Capital Goods
Latam Autoparts
Deutsche Bank Securities Inc. Page 31
Figure 29: Randon: Autoparts Segment
Source: Company reports
In the autoparts segment, most of Randon’s competitors are local units of
European and U.S. companies. We mention Knorr and Wabco (brakes),
Hendrickson, BPW, and SAF Holland (axles and suspensions), Fontaine and
Amsted Maxion (articulation systems), and Bendix, Cobreq, and Duroline
(friction materials), among others.
Low visibility on frequent ups and downs and capex uncertainty
Although the company discloses unit sales per business segment we highlight
that data is very volatile: there are frequent changes in client orders, sales mix
(due to a vast array of product categories), and seasonality effects (such as
grain trailers purchases in advance for the crop season). Moreover, the
company has dozens of prices per product line and therefore changes in the
sales mix make a large effect on revenues in a given period. Lastly, effects of
governmental stimulus on funding, tax exemptions, and environmental
regulation (such as the buoyant movement in 2011 ahead of Euro 5 motor
change) contribute to reduce earnings visibility.
Aside from top-line uncertainty we emphasize there are frequent changes in
capex budgets, particularly reflecting economic conditions, customer order
pipeline, and necessary improvements in the facilities (remove of bottlenecks,
internal logistics, etc). We looked at analysts forecasts over many years vs.
actual figures and noticed that actual capital expenditures normally exceeded
original estimates. Raw material responds for 80% of total costs and metal
components (steel and others alleys) around 50% of that part. There is a
committee to oversee joint purchases of raw materials and negotiate better
terms with suppliers.
Board of Directors and management: still a family owned company on a soft
mode
Management is very experienced in auto parts and the truck trailer industry.
There are nine executive directors in top management, sometimes with
34. 4 September 2013
Capital Goods
Latam Autoparts
Page 32 Deutsche Bank Securities Inc.
duplicated functions, and nine other MDs responsible for the operating units.
Despite efforts to make the company more professional and independent,
Randon is still a family company. The founder and chairman, Mr. Raul Randon,
83 years, has three children working at the company: two are executive
directors and another is Fras-Le’s CEO. The family is the sole controlling
shareholder (the parents hold 2.1% of the controlling vehicle DRAMD Part.
while each of their five children holds roughly a 19.6% stake).
Mr. Randon has been preparing a succession plan in the daily activities for
many years, and supported by tax deferrals provided by the government, he
founded in 1979 a fruit and cheese processing company (Rasip, RSIP3 BZ, not
covered). However, he only left the CEO role at Randon in 2009 succeeded by
his son, Mr. David Randon. The company’s Board is composed of five
members and two of them are independent from the controlling shareholder
and the management, elected by minority shareholders. The Board of Directors
usually meets four times a year, as set by the company’s by-laws.
Randon does not pay bonuses for its management, only profit sharing, which
is strictly dependent on the achievement of a net earnings target on a
consolidated basis. Profit sharing measured as a percentage of operating
earnings increased from 1.1% in 2010 to 1.7% in 2012. It is worth noting that
from 2010 to 2012, the Board of Directors made approximately 65% of
management’s total compensation, which we think is excessive. Mr. Raul
Randon, the chairman, was the main beneficiary. As of June 2013, the
independent members of the management held 0.8% of the total capital.
Randon has a live Fiscal Board and minority shareholders are represented by a
well known long-only investment fund in Brazil. The company does not have a
particular management & Board performance evaluation program and does not
have separate subcommittees to oversee management (such as Audit, Risk or
Compensation committees). Considering the dual class share and a soft history
of dividend distribution we think that Randon’s corporate governance needs to
improve.
Randon scores moderately on qualitative criteria.
Quantitative Analysis: Negative
Unstable margins, moderate capex to EBITDA ratio and long CCC
By all means Randon has not been a free cash flow business: 1) capital
expenditures are high and frequently above expectations; 2) its inventory
turnover is low and receivables are large; and 3) profitability has been very
volatile over the past ten years. Randon has been reporting volatile operating
margins (9-14% range), explained by ups and downs in sales, raw material and
logistics issues and difficult cost control. Also, maintenance capex ranges
between R$120m-R$150m, which limits free cash flow to shareholders,
negatively affected by a long cash conversion cycle of roughly 90 days (2012
was one-off). All R&D expenses are accounted when incurred with no effect on
the balance sheet (R$46m R&D expenses in 2012 represented 1.3% of
consolidated net revenues).
The company incurs the burden of the high efficiency just-in-time operations of
local OEMs: it builds excess inventories of auto parts to protect its B2B
operations and avoid shortages or logistics interruption. Based on
conversations with management we think this reflects its conservative
In the 2008-2012 period,
Randon reported R$2.2bn in
EBITDA but burned R$50m in
free cash flow, the weakest
result in our coverage
universe
35. 4 September 2013
Capital Goods
Latam Autoparts
Deutsche Bank Securities Inc. Page 33
approach to business – it also buys more raw material than needed to
safeguard it from potential shortages.
Regular balance sheet, poor dividend payer and low ROIC vs. WACC
Randon’s financial situation is moderate, with a net debt/EBITDA ratio around
3.0x (potentially deleveraging to 2.4x by 2014E according to our estimates). If
we exclude the debt associated to Banco Randon from the consolidated
balance sheet (~R$140m) the leverage ratio drops to 2.6x. As the EBITDA
calculation includes the results associated with minority interests, we added to
the net debt the liabilities portion related to minorities. Return ratios are low,
reflecting the company’s very intensive capital structure, working capital
weakness, and low margins: ROIC has been very volatile, topping 10% in
strong years like 2008 (on high margins) and 2009 (on strong inventory
reductions and shorter receivables). Over the past five years, Randon reported
R$2.2bn in accumulated EBITDA but burned R$50m in free cash flow.
Therefore, the company has been for a long time reporting poor results and
returns have been below its weighted average cost of capital.
Its FX exposure in the balance sheet is immaterial - according to its June
quarter fillings, the company has a net currency exposure of only US$4m
(including dollar denominated debt, foreign based assets, and derivative
contracts, net). In addition, it has US$280m of annual exports (nearly all costs
and expenses denominated in BRL) and US$120m of imports resulting in a net
operating exposure of US$160m. So, a weaker BRL would positively impact
both the operating and bottom lines. Intercompany sales have been around
17% of total revenues and are eliminated in the consolidated audited
financials. Last but not least, the company has been a timid dividend payer,
distributing on average 33% of net earnings and has only repurchased shares
in 2006-2007, when it spent R$28m (shares are still in the company’s treasury).
Figure 30: Randon: Main Financials
R$m 2009 2010 2011 2012 2013E 2014E 2015E
Operating Income 219 450 460 168 425 446 471
operating margin 8.9% 12.1% 11.1% 4.8% 10.3% 10.3% 10.2%
FCFF 186 132 (235) (105) (153) 245 249
Capex/EBITDA ratio 0.4 0.3 0.4 0.8 1.0 0.3 0.3
CCC (days) 77 59 83 107 98 101 101
Dividends paid 76 43 86 84 70 70 78
ROE 15.1% 23.0% 21.3% 3.1% 15.1% 13.7% 13.9%
ROIC 10% 9% -3% 0% 7% 7% 8%
Source: Deutsche Bank estimates and company reports *ROIC or CROIC = (EBIT – taxes – WK change)/(total Assets – cash)
Randon scores poorly on quantitative criteria.
Growth Outlook: Neutral
Fleet renovation and poor storage capacity in agribusiness imply solid demand
regardless of GDP
Brazil is now one of the largest markets for autoparts for heavy vehicles – a
total circulating fleet of 2.0m trucks with an average age of 15 years according
to ANTT data (vs. 6 to 7 years in U.S.). This makes for a solid demand for spare
parts for replacement purposes, particularly on the back of poor and unsafe
highways – 60% of all cargo is transported through highways compared to 20
to 30% in developed countries. Moreover, a large part of the circulating fleet is
