Does American Axle Have The Horsepower To Outrun Its Balance Sheet?

By Stephen D. Simpson, CFA | September 18, 2012 AAA

There's no one right way to value a company, and that seems particularly relevant in the case of American Axle (NYSE:AXL). Investors who rely on discounted cash flow models are not likely to find much value here, as the company's huge debt load overshadows even optimistic projections for revenue and cash flow growth. On the other hand, the company is leveraged to potential demand growth in pickup trucks and looks potentially interesting on simpler valuation measures like P/E and EV/EBITDA.

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No Europe, No Problem?
Prior to this most recent downturn in growth for Europe and major emerging markets, investors liked stories like Cummins (NYSE:CMI) and Autoliv (NYSE:ALV) that had meaningful exposure to European and/or emerging markets and commercial vehicles. For most of the last six months, though, that trade has reversed and investors have tried to shed exposure to those slowing markets. For American Axle, that may not be such a bad thing. Europe is only about 3% of American Axle's sales base, while Brazil is about 5% and commercial vehicles about 6%. By way of comparison, the average auto parts company gets about one-third of its revenue from Europe. If American auto demand stays relatively strong and Europe continues to weaken, American Axle should be an outperformer.

Diversification Is Slow, but Real
While American Axle's heavy reliance on the United States and General Motors (NYSE:GM) are clearly risks if the U.S. slows and/or Europe starts to improve, American Axle is gradually becoming a more diverse player. The company isn't looking to go beyond its core driveline business (at least not through organic diversification efforts), but the company is looking to build its OUS business and possibly execute a significant deal.

Non-U.S. launch costs have been running higher than expected, but this could be worth it in the long run. American Axle has garnered some business from Daimler's Mercedes unit, for instance, on the basis of Mercedes not wanting to build additional capacity to serve China. American Axle had the capacity and capabilities, so Mercedes outsourced some work to the company.

As far as deals go, it was mentioned during the recent CEO transition that the company would consider a "transformational" deal if the right opportunity appeared. It's easy to play the mix-and-match guessing game (and most such guesses are wrong), but I could see a deal for a company like Meritor (NYSE:MTOR) being possible if American Axle really wanted to get aggressive about diversifying its business.

Plenty of Challenges and Questions Remain
None of this is to say that American Axle is a spot-free investment option. For starters, the company has a sizable debt load - over $14 per share in net debt, excluding pension liabilities. The company recently made moves to restructure the maturities of this debt (including pulling forward some pension funding requirements), but that's still a lot of debt. It's also worth noting that the company recently went through a CEO transition as now-former CEO Dick Dauch handed over the role to his son (and former COO) David Dauch. While this transition has long been anticipated, some investors may not like this family arrangement.

Last and not least, the company remains keenly dependent upon GM as a customer. GM makes up roughly three-quarters of the company's revenue, and American Axle is the supplier of choice for driveline components for a variety of GM light trucks, SUVs and cars. GM is looking ahead to a transition to K2XX and next-generation truck launches that could drive higher pick-up truck sales, but the reverse is also true - if the new launches don't go well, American Axle will feel it.

The Bottom Line
The worthiness of American Axle's stock really revolves around your preferred methodology. The company has been generally beating expectations, even if there was some recent margin turbulence. On the other hand, numbers have been heading lower for GM lately and there are some signs of softness in the U.S. car market. On a cash flow basis, it's hard to make this stock work. Even if American Axle can grow its revenue to nearly $4.5 billion by 2016 and boost free cash flow margins into the mid-single digits, the debt load decimates the fair value today. On the other hand, the company's P/E and EV/EBITDA ratios both look somewhat low relative to its potential growth over the next three to five years. Consequently, American Axle is not the highest-quality idea out there right now, but I could see this stock outperforming if the company gets a few breaks.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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