These are not easy times to be in the business of supplying parts and components for the passenger vehicle or commercial vehicle markets. Although U.S. auto sales have been quite good of late, business has slowed in Europe and many emerging markets, while numbers and management guidance from a host of truck, agriculture and mining OEMs has pointed to slowing trends as well.
Against that backdrop, I still think it is worthwhile for investors to take a closer look at Dana Holdings (NYSE:DAN). Numbers have come down a bit, and there are definitely risks in end-user demand for 2013, but this company's diversification across geographies, end markets, technologies and customers makes it a differentiated parts and components company. Coupled with a valuation that does not seem demanding, the stock is likewise interesting at these levels.
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Addressing Numerous Sizable Markets
Many parts and components companies will serve both the passenger and commercial vehicle markets (including both Honeywell (NYSE:HON) and Cummins (NYSE:CMI)), but rarely to the extent that Dana does.
While light vehicles make up the largest part of revenue and EBITDA, in both cases it is less than 40% of the total. Commercial vehicles and off-highway are both roughly one-quarter of the business, while power technologies (a category that cuts across passenger and commercial vehicles) makes up the remainder. That gives Dana solid exposures to virtually all of the major global land vehicle categories - passenger vehicles, trucks, mining equipment, agriculture, construction and so on.
Dana also offers relatively broad geographic and customer diversification. Ford (NYSE:F) is roughly 20% of sales (and more than 40% of light vehicle sales), but the exposures drop significantly from there, as General Motors (NYSE:GM), Toyota (NYSE:TM), Caterpillar (NYSE:CAT) and PACCAR (Nasdaq:PCAR) all end up as less than 10% of the company's business. With geography, North America is the largest contributor (roughly 40%), but emerging markets like South America and China have grown to be quite significant as well.
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Will Outsourcing and Technology Create More Opportunity?
Certainly, Dana does have competition for its drivetrain, cooling and sealing products. American Axle (NYSE:AXL) is a player in passenger vehicles, with its significant position as a supplier to GM. Likewise, companies like Meritor (Nasdaq:MTOR), Magna (NYSE:MGA), GKN and Behr do show up as rivals in the same vehicle markets.
It seems to me, though, that the biggest opportunity for Dana may not come so much from bludgeoning its rivals and taking the business as they have as from convincing OEMs to outsource more of their business. Ford, for instance, keeps its F-150 axles in-house and most off-highway OEMs likewise source internally. There's always a give-and-take with outsourcing (including sacrificing margins in some cases), but if Dana can make the case that they can do these tasks better, it could be a significant source of growth potential.
Likewise, ongoing initiatives for better fuel efficiency and other technological advances should allow Dana to sell more expensive (and profitable) products in the future. Dana is a leader, for instance, in battery cooling - a potentially significant market opportunity if hybrids, electrics and cars with stop-start technology really take off.
Be Realistic on the Risks
There's a lot to like about Dana, from its diversified business exposures to a CEO that hails from a well-run parts supplier (BorgWarner (NYSE:BWA)) to what is, by vehicle components company standards, a pretty clean balance sheet.
However, that shouldn't lull investors into a false sense of complacency. The parts/components industry as a dreadful record when it comes to long-term returns on capital and free cash flow generation. What's more, the volatility and cyclicality of commercial vehicle demand is both unpredictable and likely permanent. Last and not least, there are no guarantees that companies won't reverse course and in-source more of the drivetrain and other component needs.
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The Bottom Line
After many years of negative free cash flow production (and a trip through bankruptcy), Dana has at last been producing some free cash flow these past few years. Now one of the biggest questions is whether the company can lift that margin into the mid-single digits. If Europe can stabilize, and if the global commercial vehicle market comes back in 2013, 3 to 4% compound revenue growth through 2017 and steady improvement in free cash flow generation would make Dana a compelling stock.
I do believe that BorgWarner and Cummins are better (or at least more proven) companies in the parts/components space, but they carry the sort of multiples that show Wall Street believes in them. An investment in Dana does arguably carry more risk, but investors confident in the long-term health of the passenger and commercial vehicle markets, and confident in the ongoing improvements that management has made here, could do well with this stock.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.