Automodular is a sequencer and subassembler of modules for large manufacturers. This work has traditionally been for auto manufacturers within North America. Currently, their only go forward business is with the Ford assembly plant in Oakville Ontario. They provide just-in-time assembling and sequencing of modules, and use their location within a few miles of the Ford plant to provide this service.
In 2012 AM’s revenues and earnings were enhanced by a 1 year contract to provide subassembly and domestic content for Vestas in Ontario. This contract has expired, and I do not anticipate similar business based on changes to the FIT (Feed in Tariff) program in Ontario. There is potential upside to the business if management finds other subassembly work.
The valuation here is undemanding, with 25 million in cash, other current assets (mostly payables) exceeding total liabilities by a factor of 1.6, no long term debt, and 29.5 million of EBITDA last year against a market cap of 62 million. This valuation is caused by market concerns that it is an undifferentiated business with unsustainably high margins, excessive customer concentration, and contract renewal risk. (The Ford contract expires June 2014).
I believe the Ford contract will be renewed, although AM may have to take slightly lower prices/margins. Their facility is located in extremely close proximity to the Ford plant, and they have a long history of service to this plant. Ford has had high demand at this plant recently, causing Automodular's 2012 revenues from Ford to increase to 86 million from 80 million in 2011. In addition, Ford has added a third shift to the Oakville plant to begin production in Q1 2013. The high level of integration of AM’s operations into the plant’s production process means switching suppliers would be disruptive, and not likely in a high demand period for the vehicles produced there. I expect contract renewal sometime in the summer of 2013. Three valuation cases are presented below, and probability weighted for a price target.
Automodular also has a $25 million breach of contract lawsuit outstanding against GM for the early termination of their contract at a GM plant. The MD&A indicates that GM expressly waived its termination rights, but litigation is unpredictable. I have not included any value from the lawsuit, but assigned it to the “margin of safety” bucket.
Base Case: Ford renewal and margin compression
Assuming Ford renewal at slightly lower margins and no new business makes 2011 an excellent comparable. In 2011 diluted EPS was $0.61, capitalize that at an undemanding P/E of 7, and add the $1.23 of cash on the balance sheet for a valuation of $5.50. This is the most likely case, assigned 70% probability.
Downside Case: Ford non-renewal and business windup
In the case of a Ford non-renewal, I believe the business would be wound up and cash distributed to shareholders, as management has proven to be shareholder friendly in the recent past (significant special dividends the last two years). In this scenario valuation is based on the 25 million of cash, and 18 months of cash generation, estimated at 27 million. (18 million yearly run rate from 2011 calculated as earnings plus depreciation). The excess of other current assets over liabilities, and the provision for operations windup should be sufficient to pay for windup. This case has a per share value of $2.55, 20% probability.
Bull Case: Ford renewal at current terms, new business to replace Vestas
This case values the business based on 2012 earnings, assuming new business equally profitable to the lost Vestas account is found. 2012 diluted EPS of $0.82 at 8x is $6.56, and adding the $1.23 of cash gets you to $7.79. 10% probability assigned to this case.
Valuation:
The weighted valuation works out to $5.13, with significant upside skew. Because the business is trading at an undemanding valuation, it’s a heads I win, tails I don’t lose much situation, where heads is dramatically more likely than tails.
Risk Factors:
-Wage differential
Wages were nearly half of the companies expenses this year, logical for a company whose business is essentially outsourced manufacturing. This percentage will be higher next year without the windmill contract, as Ford supplies the materials for its contract. Lower all-in wages for OEM employees increases the cost pressure on AM, as labour differential is one of its strongest advantages. Its workers are CAW represented with a current contract. If Ford's all in costs become low enough that it internalizes this work, AM would enter the bear case detailed above.
Disclosure: No position at time of post.
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