$ADNT: A Spin-Off that is Selling for only Seven Times Forward Earnings

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Main Topic: ADNT, the spinoff selling at only seven times forward earnings

Spin-offs are a reach pond for value investors to fish in. For an excellent description of the reason spin-offs can make value investors a ton of money, check out the book “You Can Be Stock Market Genius” by Joel Greenblatt.

The gist of the strategy is that spin-offs are subject to being dumped into the market by institutional holders of the parent stock, who either don’t want to, or are not allowed to hold on to the spun-off entity. Combined with earnings that are suppressed by often out-sized cost of the spin-off, and possible a heavy debt load, and you have a recipe for a dramatic sell off and fall in the stock price of the new entity.

Johnson Controls International and Tyco International (NYSE:TYC), merged in 2016 and Adient PLC ($ADNT) was separated from parent company Johnson Controls in a late 2016 spinoff event.

The company is the former automotive seating and interiors business component of the parent. Adient operates as the world’s largest independent supplier of automotive seating and a major supplier of interiors. Adient has operations in 33 countries, so it’s a major organization.

Adient operates in virtually every area of automotive seating including: seating systems, frames, mechanisms, foam, head restraints, armrests, trim covers and fabrics. Adient also produces instrument panels, floor consoles, door panels, overhead consoles, cockpit systems, decorative trim and other automotive products.

Certainly, there is nothing super sexy in the business of car interiors. This business is fairly easy to understand and its success will rise and fall with the destiny of the automotive industry.

But my thesis for this idea is not based on the future of the car industry, or even the present. My thesis is fairly simple and the core components are:

  • ADNT will generate adjusted earnings per share of $9 per share by the end of fiscal 2017 (September 30)
  • The market will apply a 12x multiple to the earnings to give the stock a valuation of $108 per share
  • Buying ADNT at the current price of $65 provides a margin of safety of 40%

ADNT earnings will rise dramatically from the absence of separation costs

ADNT earnings for the past twelve months have included the one-time cost of the spin-off and restructuring of the company and higher than normal interest costs

ADNT-separation-costs

The table above clearly shows that ADNT had $245 million in separation costs ($2.60 per share) in the twelve months ended March 31, 2017 and  subsequently had two quarters with zero costs in this category.

The company is forecasting adjusted net income of between $875mm and $900mm.


ADNT will earn (on an adjusted basis) between $9 and $9.58 per share in 2017

  • Shares outstanding of 93.9 million before buybacks
  • Estimated adjusted net income of $875-$900 million
  • $875mm adjusted net income / 93.9 million shares outstanding = $9.32 adjusted earnings per share.
  • $900mm adjusted net income / 93.9 shares outstanding = $9.58 adjusted earnings per share

Evidence of the company's real earnings power is evident in their breakdown of the most recently report quarter adjusted diluted earnings per share:

ADNT-2017-Forecast
ADNT-Adjusted-Earnings-per-share

Removing the separation cost sand restructuring costs, ADNT actually earned $2.52 per share in the three month period ended June 30, 2017.

At $9.00 per share in adjusted earnings, ADNT is selling at a low forward / normalized price to earnings ratio

· At current prices of around $65, ADNT is selling for:

  • A forward P/E ratio of only 7x times ($65 cost / EPS of $9)
  • An adjusted earnings yield of 14% ($9 EPS / $65 cost)
  • An owners earnings yield of 21%
    • ($1,612 EBITDA minus $330mm normalized capex = $1,282 owners earnings
    • $1,282 owners earnings divided by 93.9mm shares outstanding = $13.65 owners earnings per share
    • $13.65 owners earnings per share divided by $65 cost = 21%

·Once the market realizes that normalized earnings are more than nine dollars per share, I believe the earnings multiple will be revalued to at least 12x EPS for an equity capitalization of $108 per share.

·The price of $65 we are paying now gives us a margin of safety of 41%.

  • ​$108 estimated intrinsic value less $65 cost equals $43 profit per share divided by $108 intrinsic value gives a margin of safety of 40%

· The return possible under this scenario will be ~15.7% over a twelve month holding period.

  1. Earnings yield of 14% plus
  2. Dividend of 1.7% (we get paid to wait)

If the stock hits my target price of $108, the buyer at $65 cost will experience appreciation of 66%

  • Target price of $108 minus $65 cost divided by  $65 cost = $66%

Stock repurchases and margin protection initiatives will offset any weakness in the auto industry in the near term

  • Bought back $40mm worth in Q3 FY2017

With highly diversified products and customers, the relatively low leverage (1.7x net leverage) is an acceptable risk for a company with such tremendous cash generating capability

Conclusion:

ADNT is a spin-off that is trading at an unusually low price to earnings for a company with its underlying intrinsic value. A purchase of ADNT at around the current $65 price could lead to a first year value capture of more than 15%. If ADNT trades to twelve times adjusted forward earnings, the holder at a cost of $65 would have an unrealized gain of 66%.

Disclosure: I / we are long ADNT

Ask JB: Can a CEO manipulate company stock?

Ask JB: Can a CEO declare 'imminent chaos', wait for the share price to fall sharply, and then engage in aggressive share buybacks and dividend payouts or would this be illegal? (self.investing)

submitted by moomin100

Jo Bloggs is a shareholder CEO at FireworksCorp, which has a large cash position. She warns investors of 'imminent chaos' without giving further details. The share price plummets. The firm then buys back a large number of shares and declares a large special dividend. Jo Bloggs does not sell her shares but collects her special dividend and steps down as CEO.

'Imminent chaos' was certainly truthful. Share buybacks in undervalued firms is sound action, and paying a large special dividend is clearly the right course of action to maximise shareholder value in this case. Jo Bloggs steps down from FireworksCorp, buys a big boat and sails out into the Mediterranean.

Has she broken the law and if so, at which stage?

JB Says: First, I’m not an attorney so this just my opinion. It’s not illegal for a company to “talk it’s stock down.” One question would be if the “imminent chaos” had anything behind it. If not, it could be considered stock manipulation. As for the rest of this hypothetical, but stock buybacks and dividends would require the Board of Directors to approve them. The CEO can’t just act unilaterally. The Board has rights too.

When researching firearms law a while back, I found that due to the manufacturing restriction on automatic weapons the number of them is limited and people started buying them as investments rather than just for the typical purpose of a gun. Does anyone have experience using automatic or any other kind of firearms as an investment?

JB Says: Scarcity is not the only requirement for a good speculation. Even with firearms, you are betting on the greater fool theory. What if A law could be passed that bans the transfer of an automatic weapon to another party - this is another thing that could crash the value of your "investment." A similar law was just passed in California for semi-automatic weapons with a bullet button so it's an entirely plausible scenario.

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About the Author

Jeremy Scott Bailey is an investor, author, entrepreneur and host of the "What Works In Investing?" podcast now available on iTunes. He is founder and Chief Investment Officer of Burgeón Group, Inc. an investment advisory firm that provides portfolio management services to families and individuals.

Leave a Reply 2 comments

Nicholas Reply

Hi JB,

Why do you think 12x PE is a fair PE for ADNT. Is this valuation based against its peers or industry average or something else. Thanks.

Nicholas

    jbadmin Reply

    Hi Nicholas, great question! When estimating what a company could sell for in the market, I use 12x P/E as a rule-of-thumb proxy for a decently run company with modest growth potential and reasonable leverage. If I would get my required return if ADNT sells for that multiple, that is one hurdle passed. You can compare to competitors like Lear Corp (10x P/E) but overall industry multiples may be depressed at any given time, so I use a proxy for what I think an ADNT-type company should sell for in a normalized market / industry.

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