Superior Industries (SUP) has been on my “to research” pile for over a year. I never got around to spending some time on the company until the last 2 weeks. There are a few others that have opinions on SUP, so check them out.
I though I should share my thoughts to timestamp my research and potentially get a discussion going around the name.
From their website:
Superior Industries International, Inc. is engaged in the designing and manufacturing of aluminum road wheels for sale to original equipment manufacturers (OEMs). The Company is a supplier of cast aluminum wheels to the automobile and light truck manufacturers, with wheel manufacturing operations in the United States and Mexico. The Company operates five manufacturing facilities in the United States and Mexico. Products made in its North American facilities are delivered to automotive assembly operations in North America, both for domestic and internationally branded customers. Its OEM aluminum road wheels are sold for factory installation, as either optional or standard equipment, on many vehicle models manufactured by Ford, General Motors (GM), Chrysler Group LLC (Chrysler), BMW, Mitsubishi, Nissan, Subaru, Toyota and Volkswagen.
Here is a quick summary of how the business has performed over the last 10 years.
You can see a tough time before the Great Recession and a decent recovery. Now lets take a look at the income statement.
The previous 2 charts are further evidence of a rough time during the recession and hint at the nature of how tied the business is to the new auto market.
Once you get a glimpse of the company over a business cycle, you can see how little they control their fate if there the ultimate end user stops purchasing products. Having said that, the purchase of new autos can really only be delayed as eventually cars and trucks wear out and need to be replaced.
Another chart will give some additional context to the business. This is from their latest conference call presentation.
You can see that the company shipments of wheels tracked the NA vehicle production closely until the end of 2011. The main reason for this is that they have hit their peak capacity from their current PPE while the NA production continued to grow. They even operated above capacity for a few quarters, but that is unsustainable.
Remember those negative gross margins in the last downturn? That is the price you pay to keep capacity idle during a downturn. If you read Frank Voisin’s post, it mentions how they shut down some plants due to lack of demand from end users. Though the idea likely seemed good at the time, I wonder if given the hindsight of today they would have made the same decision.
Currently, the company is building a new facility in Mexico that will give them an additional 20% capacity jump when finished.
Some of the characteristics mentioned and some not mentioned:
- limited top line by PPE capacity
- for the most part a price taker
- historically has had a tough time earning excess returns on invested capital
Given these factors, I would think the valuation of choice would be some sort of earnings power value (EPV). Buying at a discount to EPV or buying at a replacement value and selling at EPV (if the gap is large enough to provide a margin of safety) makes sense to me for a company where the dynamics of their business does not change dramatically over 10 years.
Earning Power Value (EPV)
Before I get to my interpretation of EPV for Superior, I should make note of capex. For a business with a large portion of assets being fixed, capital expenditures are important to analyze. Here is a quick summary.
Nailing down maintenance capex is important to properly understand EPV and a distributable cash flow or owner earnings. We know what revenue took a dive during the recession, so one could assume that only the most basic expenditures were being made. But maybe there were under-investing in the PPE and would eventually pay the price for it. Either way I assumed 3% of rev or 20% of average net PPE must be spent on maintenance. Here is what those numbers look like relative to Depreciation. The conference calls and annual reports I researched didn’t give a hard number for maintenance capex, so I have to take an educated guess.
You can see how close they have tracked each other over the last 5 years. So I took the average of the 2 and used that as maintenance capex.
Here is what I get for EPV.
You can see a strong recovery in EPV after the recession. But is struggles to eclipse NAV (which I have kept as tangible book value). This coincides with ROIC being little more than their likely cost of capital outside the really low interest rate environment.
I ended up passing on SUP. Even with some cheap(ish) valuations based on EV/EBITDA and P/TB. I see 3 reasons why I want more margin of safety:
- Tangible book and EPV haven’t moved much over the last 10 years for a business that doesn’t pay a huge dividend. Meaning that they won’t grow additional margin of safety for me.
- Very low gross margins will lead to operating leverage that cuts both ways.
- My history with large capacity expansions has not been positive. There can be something that goes wrong that spooks the market and presents opportunity.
Some Potential Positives I haven’t Mentioned
I mentioned that they are building a new plant in Mexico. There is some additional scale in the fixed SG&A costs that may bring up EBIT margins.
There is also a large cash balance on the books that can give them additional flexibility if needed.
I have taken a rough stab at what the income statement could be like with the successful integration of the new plant and eventual scale from lower SG&A spread out over the entire business. This is based on a jump in revenue, 11% gross margins, and 3% of revenue spent on SG&A. The business could see a run up to 82 million in operating earnings. That’s dramatically higher than the current 36 million. But with a more normalized 9% gross margins we get 62 million in operating earnings. If a person put a 10x EV/EBIT on these numbers you would get around $36 and $28 as a rough estimate of where the share price could move to. At around $20 today, I would like a little more room for error given that we are likely 18-24 months away from full operation of the new platn.
I would look at SUP again in the mid teens. It may never get there, so do your own research if you like the name.