American Axle Stock: Getting Electrified (NYSE:AXL)

It has been a long time since I covered American Axle & Manufacturing (NYSE:AXL). In fact, it was back in 2016 when the company acquired Metaldyne, adding quite a bit of leverage at a good point in the cycle. The company announced a huge deal, effectively a merger, with high promises at the time, but the results of the deal have not played out fully amidst secular headwinds. This includes a tough automotive market and secular headwinds from the electrification of cars and trucks.

Amidst these headwinds, American Axle has been unable to create value for its investors, but as the share of electrification picks up and headwinds might dissipate a bit, it is a low (equity) valuation which might be compelling, but some real execution would be required for that to happen.

Former Take

When American Axle announced to acquire MPG in a $3.3 billion deal in 2016, that was a huge deal. After all, American Axle itself generated $3.9 billion in sales in 2015 on which it posted EBITDA of $571 million with the company awarded a $2.3 billion enterprise valuation, although a substantial part of that valuation included net debt.

The $3.3 billion purchase of MPG was huge, giving the company strong engineering expertise in powertrain components, as the combination is set to provide integrated manufacturing capabilities across powertrain, drivetrain and driveline. Another benefit, the reliance of American Axle on General Motors (GM) was set to fall from 66% to still a high 41%.

MPG was set to add $3.05 billion in revenues and $528 million in EBITDA, with both metrics just a bit smaller than American Axle, as another $100 million in costs synergies was projected. The pro forma business was set to generate $7 billion in sales, just over a billion in EBITDA and trade around 3-4 times leverage ratios.

Shares of American Axle fell in a big manner upon the announcement of the deal, down $3 to $14 per share on the back of the premium paid for the business, as investors arguably were fearful about the added leverage despite the potential for earnings to come in close to $3 per share. This resulted in very non-demanding multiples, as was typically applied to automotive suppliers.

With so much debt appearing on the balance sheet, I believed that shares more represented a call option rather than a serious investment, leaving both huge risks to the downside but also the upside.

Caution Saved The Day

Fast-forwarding more than 5 years in time, shares of American Axle have showed serious underperformance, and now have fallen to $7 per share, marking a huge 50% value destruction in five years’ time, a huge disappointment. So what happened?

Years of underperformance have put a major dent into the revenue base of the business as sales fell back to $5.2 billion in 2021, yet despite a small recovery from 2020 (for obvious reasons), sales are down substantially from 2016. This is driven by a tough automotive market, but most of the problems are self-inflicted with exposure to electrification being underrepresented, as many of its core products are under pressure amidst this rapidly increasing transformation by the industry at large, as well as the chip shortages.

The company continues to be solidly profitable, at least if we focus on EBITDA. Adjusted EBITDA came in at $833 million, for margins in excess of 16%. In fact, the company believed that lost sales and associated EBITDA hurt the bottom line results by $188 million, as otherwise EBITDA should top the billion mark in 2021. The EBITDA mark is quite misleading here as the D&A component is quite heavy with the company posting adjusted earnings of $0.93 per share and GAAP earnings of just $0.05 per share.

After all, the adjusted earnings numbers of nearly a dollar are just a fraction of the combined 2016 earnings power of around $3 per share, as charges to arrive at GAAP earnings are plentiful, quite recurring and often involve cash outflows as well. Net debt has been cut to $2.5 billion, yet with EBITDA coming in below the billion mark, leverage ratios themselves remain quite elevated. With just 114 million shares outstanding, the $7 per share price works down to just an $800 million price tag for the equity of the firm.

The 2022 outlook is relatively modest. Sales this year are seen between $5.6 and $5.9 billion, including up to $200 million in metal market pass-through pricing. Adjusted EBITDA is seen at $800-$875 million which is in line with the 2021 performance, despite the comment by management that the 2021 results were impacted by nearly two hundred million by chip shortages, undoubtedly expected to continue (in some way) for most of the year.

Adding Some Electrification

In April, American Axle announced an EUR 125 million purchase of German-based Tekfor Group in a deal adding automotive fasteners and metal formed components for driveline, powertrain and e-mobility applications. The acquired activities are set to add EUR 285 million in revenues, suggesting a mere 0.4 times sales multiple has been paid, actually a lower sales multiple at which American Axle itself is trading, despite the current depressed valuation.

The added electrification is part of a trend which is rapidly turning into real results. Right now about a third of the backlog comes from electrification, with as much as two-thirds of current quotes focusing on electrification, indicating a real and rapid transition to that area, albeit that not all the businesses can likely be converted, but nonetheless, it is a comforting sign.

On the other hand, the degree of the disappointment is huge, after all, earnings are down two-thirds from the projected run rate some 5 years ago, as this reduced earnings power and still substantial leverage are a real cause of concern, certainly amidst challenging economic (upcoming) conditions including higher inflation and likely a reduction in consumer spending.

Hence, I have learned that investing in the long run focuses on strong businesses and the truth is that American Axle is not a strong business, despite a reasonable outlook for 2022 and what appears to be a nice German bolt-on deal. Hence, I am happy to follow the story this year, as cash flows appear solid, but structural valuation creation here (still) seems hard to find.