There aren't too many auto or commercial vehicle component manufacturers doing very well in the market right now, as even popular names like BorgWarner (NYSE:BWA) and Cummins (NYSE:CMI) are getting sold on fears about waning global demand. That leaves Modine Manufacturing (NYSE:MOD) in a precarious position - the company serves both passenger and commercial vehicle manufacturers, it has a sizable exposure to Europe and it's trying to execute a restructuring of some of its operations.

Although there's definitely a risk that Modine's restructuring efforts will fail, as well as industry-wide risks regarding demand and sustainable free cash flow generation, the potential payoffs of success make this a name worth watching.

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

Running Hot and Cold
I don't suppose that Modine is a household name with most investors, so a little background might be helpful. Modine specializes in heating and cooling systems for vehicle (passenger and commercial) OEMs, as well as providing some commercial heating and cooling products. Said differently, Modine sells radiators, heat transfer components and a variety of cooling products, such as engine oil coolers and EGR coolers - in fact, the company's history goes back to supplying the standard radiator on every Ford (NYSE:F) Model-T.

Modine has built itself into a globally diverse player with a long customer list of well-known names. While 10 customers accounted for about 60% of revenue in fiscal 2012, none of them were 10% or more of revenue (though BMW (OTC:BAMXY) often has been). The customer list is largely a "who's who" of quality OEMs - BMW, Daimler (OTC:DDAIF), Caterpillar (NYSE:CAT), Volkswagen (OTC:VLKAY) and Deere (NYSE:DE).

That said, North American passenger vehicles make up a relatively small portion of sales; for better or worse, this is company built largely around commercial vehicles and European passenger vehicles. And that's part of the problem today - companies like Caterpillar and Deere have been dialing back global construction, mining and agricultural equipment sales expectations, while a variety of European OEMs have likewise been projecting lower commercial vehicle and passenger vehicle sales.

SEE: Understanding The Income Statement

European Restructuring Carries Risks, but Makes Long-Term Sense
Like many other industrial/manufacturing companies, it seems like Modine has been in a state of near-perpetual restructuring. In addition to closing several plants around the world since 2006, the company is currently in the midst of restructuring its European operations.

These moves have included exiting non-strategic businesses and shifting more of the focus to commercial vehicles. That latter point, the shift to more CV, makes considerable sense given the differing margin structures of light vehicle versus commercial vehicle components, but it's not without risks. There is often less visibility and more volatility in commercial vehicle order trends, and Modine will still be a relatively small and specialized company (which may mean that margin improvement is more limited).

Likewise, the company's expansion efforts into markets like Brazil and China have yet to really pay off. I don't think anybody argues with the long-term necessity of having a strong presence in these markets, but the short-term effect is one of greater quarter-to-quarter volatility and less visibility (particularly as the construction market in China struggles).

The Bottom Line
Investors who are unwilling to take on a lot of risk would probably do better with BorgWarner, Cummins or Honeywell (NYSE:HON) (one of Modine's competitors in commercial vehicles), or skipping the vehicle sector altogether. After all, while a few well-run companies have managed to produce reliably solid free cash flow, it's more the exception than the norm.

When it comes to Modine, that industry-wide legacy of iffy cash flow production is one of my biggest worries. It's been more than seven years since the company has delivered what I'd consider good free cash flow, and even if the company's restructuring and growth initiatives work, there's probably always going to be cyclicality to the financial performance.

Nevertheless, Modine is relatively unusual in that its debt load doesn't obliterate its long-term discounted cash flow value. If Modine can continue to build share in commercial vehicles and improve its cost structure enough to deliver consistent free cash flow in the 2 to 3% of revenue range (and up closer to 5% towards the end of the next decade), these shares should trade in the double-digits, but that's a very big "if." Therefore, investors have to balance the rewards of a much better Modine with the risk that the company will continue to muddle along, struggling to deliver cash flow or value.

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

Related Articles
  1. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  2. Charts & Patterns

    Understand How Square Works before the IPO

    Square is reported to have filed for an IPO. For interested investors wondering how the company makes money, Investopedia takes a look at its business.
  3. Markets

    Why Gluten Free Is Now Big Business

    Is it essential to preserving your health, or just another diet fad? Either way, gluten-free foods have become big business.
  4. Technical Indicators

    4 Ways to Find a Penny Stock Worth Millions

    Thinking of trading in risky penny stocks? Use this checklist to find bargains, not scams.
  5. Professionals

    Chinese Slowdown Affects Iron Ore Market

    The Chinese economy's ongoing slowdown is having a major impact on iron ore demand.
  6. Investing Basics

    Why do Debt to Equity Ratios Vary From Industry to Industry?

    Obtain a better understanding of the debt/equity ratio, and learn why this fundamental financial metric varies significantly between industries.
  7. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  8. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  9. Mutual Funds & ETFs

    ETF Analysis: iShares Morningstar Small-Cap Value

    Find out about the Shares Morningstar Small-Cap Value ETF, and learn detailed information about this exchange-traded fund that focuses on small-cap equities.
  10. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  4. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  5. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  6. Net Present Value - NPV

    The difference between the present values of cash inflows and ...
RELATED FAQS
  1. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  4. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  5. What is the difference between the return on total assets and an interest rate?

    Return on total assets (ROTA) represents one of the profitability metrics. It is calculated by taking a company's earnings ... Read Full Answer >>
  6. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!