LNR.TO - Linamar Corporation

[mikazo]

"Linamar Corporation is a Canada-based diversified manufacturing company of engineered products powering vehicles, motion, work and lives. The Company operates through two segments: the Powertrain/Driveline segment and the Industrial segment. The segments are further divided into three operating groups: Machining & Assembly, Forging, and Skyjack. The Company's Machining & Assembly and Forging operating groups focus on precision metallic components, modules and systems for engine, transmission and driveline systems designed for vehicle and industrial markets. The Company's Skyjack operating group is noted for its mobile industrial equipment, notably its aerial work platforms and tele handlers."

 

I've been considering initiating a position in Linamar for a couple months now. Since I started looking into it, the stock price has fallen ~27%.

 

Here are the reasons for my interest in Linamar:

 

• Consistent growth in revenue/net income/retained earnings/free cash flow over the past several years
  
• Lots of growth in gross profit margin over the past several years
  
• Consistent reduction in SG&A expenses over the past several years
  
• Growing Return on Assets, 11% in 2014
  
• Growing Return on Equity, 19% in 2014
  
• Consistent reduction in debt-to-equity ratio over the past several years
  
• Strong and growing market share for SkyJack scissor lifts - (saw this myself on some construction sites near me)
  
• Strong insider ownership by CEO and her family, they consider it a family business
  
• Auto industry regulations are pushing for better fuel economy, which can be driven by lighter-weight aluminum parts manufactured by Linamar
  
• Recently acquired an aluminum foundry in France (Montupet) http://www.montupet.fr/english/about-us/
  
• More construction/infrastructure work to be announced with the new Liberal government in Canada, could drive more sales of SkyJack equipment - not a strong reason, but it's a factor
  
• P/E of ~9 as of this writing
  

 

I don't know much about the auto industry or its supply chain, so I would really appreciate any additional thoughts. I'm also not 100% sure why it's this cheap.

[kab60]

I've also been checking this Company out lately. It seems to have been hammered along with the rest of the auto industry, but it does seem like a much nicer business as it actually generates quiet alot of cash. I suppose fear of auto sales being at a peak might explain some of the weakness, and I think it's worth investigating the margins as well. Operating margin averaged around 6 pct. back in 2006-2012 (we did have a recession, and it actually did okay), but it's almost twice as high today. I think it's necessary to figure out what's driving that. Any idea (maybe lower energy/commodity prices?)

[kab60]

Surprised there is no more interest. + 20% ROE, seems to take marketshare, run like a family business (very high inside ownership), low turnover among staff, P/E 7, growth, lots of FCF considering it's a growing industrial company. Decent amount of debt so focused management/deleverage. Could gain from infrastruture boom if politicians decide to go that route instead of QE. Margins/ROE a fair bit above historical levels, I suppose that's the tricky part to figure out.

[Spekulatius]

I've also been checking this Company out lately. It seems to have been hammered along with the rest of the auto industry, but it does seem like a much nicer business as it actually generates quiet alot of cash. I suppose fear of auto sales being at a peak might explain some of the weakness, and I think it's worth investigating the margins as well. Operating margin averaged around 6 pct. back in 2006-2012 (we did have a recession, and it actually did okay), but it's almost twice as high today. I think it's necessary to figure out what's driving that. Any idea (maybe lower energy/commodity prices?)

 

I think the lower CAD may help with the margins, but I am not sure. THis company looks pretty good and cheap too, considering the numbers that they are generating. Car suppliers are highly cyclical, so that is definitely a concern. I need to understand their competitive edge better to make an informed decision about the stock.

[kab60]

I bought a large chunk last night. It's trading at a P/E of some 6,5, below book value while it's growing nicely and sporting a ROE above 20. I find management very impressive. They seem to have both a short, medium as well as long term vision for the Company.

 

They recently bought MacDon, that makes equipment for the agriculture industry and even though it has pushed leverage up somewhat, this Company spits out quiet a bit of cash, so they expect to delever quickly. The acquisition makes the Company less dependent on the auto cycle, and even though the price does seem fair, I believe it will turn out quiet nicely. MacDon was family run, and it seems like they picked Linamar (over say PE) due to their history of operating with a long term vision and more as a family/founder-led than public Company.

 

For anyone interested I recommend the annual shareholders letters (even though the constant use of exclamation marks annoys me!): http://www.linamar.com/sites/default/files/reports/2017%20Annual%20Report%20-%20FINAL.pdf

 

Tariffs on auto car parts could be a big slap in the face (since they apparently cross the border some 7 times) and so could a major slowdown in SAAR, but there's quiet a bit of lead time for their parts, and they've already booked revenue of some $8.5 - $9 b in 2021 (versus $6,5b in 2017).

 

Needless to say, I think the risks are more than priced in, and the industrial segment - while cyclical (agriculture and scissor lifts) - gives some diversification (and should demand a bigger multiple).

 

If one is afraid of EV's I think the shareholder letters give a bit of comfort - they're already taking more than their fair share of orders.

 

I'd love any input, because I think the setup looks almost too good to be true. My main concerns are weak capital allocation and empire building, but history seems very solid (Scyjack, bought 15 years ago, is something like a 20-30 bagger probably, and I like the reasoning behind both Montupet and MacDon as well). I also hate that it's listed in Canada, so share buybacks are a PITY compared to the US.

 

 

[topofeaturellc]

Seriously? It's marginal auto production capacity at the top of the cycle? That's why it seems too good to be true.  You might eventually get paid but it'll either be because you gutted out a cycle or Saar takes forever to roll and you get multiple expansion before then.  It's not an easy story.

[kab60]

Half of their operating earnings in Q2 had nothing to do with auto, and they're trading cheaper than their US peers. Even with falling auto volumes in NA their revenue is growing nicely due to increased content per car. As I wrote, they already have some 8,5-9B of business booked for 2021. Not sure one needs multiple expansion. 18 months and they'll have delevered from the MacDon acquisition and they're on the way to earn 9/share this year vs expected 10 and 11 in 19/20. Two smart 1b acquisitions in two years without issuing a share. I think I understand the risk, and I think it seems very much priced in.

[topofeaturellc]

You said it was an easy set up. I'm just telling you it's not.  SAAR can roll before it delevers, those backlogs can disappear real fast, and long term there is a pretty viable existential issue for the parts business given they are marginal capacity in components whose demand is structurally impaired by EVs.  And Management's arguments on that last topic are a little tough to buy, especially if you think about their customers own economics and desire for economies of scale.

[kab60]

Thanks for the input. Sorry if I seemed dismissive, I really appreciate the pushback. Can't say I have a good handle on how they'll fare in a big downturn, but they managed to handle the GFC nicely while car makers got creamed. Next time they'll be more diversified so that's a plus, but Montupet might have increased fixed costs. Management might be BS'ing, but according to them the future has never looked brighter. Wouldn't give it any consideration if they didn't own 20 pct.

[topofeaturellc]

They benefited a lot in the last downturn from being the best capitalized in the parts space.  They don’t have that advantage this time around.  Still well run company, all that.  Just don’t quite get the appeal of parts at the top of the cycle

[kab60]

Is this the top? I don't know. Economy seems to chuck a long nicely. I agree we're probably (very?) late cycle, but in 18 months they might've earned 1/4 of their market cap and gotten leverage down to 1xebitda. Even if we have a recession tomorrow and they lose money - and have a couple of years with margins cut in half - I still don't think it looks expensive. Obviously they need to survive, but again, they don't rely exclusively on auto.

 

Again, thanks a bunch for the pushback.

 

What nags me a bit is having read Capital Returns where one message - that makes sense intuitively - is to buy cyclicals when they look expensive - not when they look cheap. But it seems like a lot of people have abandoned the space already in anticipation of a major crash.

[topofeaturellc]

I think that’s totally fair if not the decision I would make.  I think if you want to buy something over-earning you need to be comfortable with what a stress scenario does to the cap structure and be really honest with yourself about what likely scenarios will shake you out from doubling down if real pain does hit.

 

I love the classic marathon capital cycle stuff but I think it’s important to remember it’s not just buy cyclicals in pain, it’s buy them when capital is exiting the sector, ie D>capex

[rb]

Linamar is indeed a fine company. I don't own any because I have to hold a large position in Magna, so auto parts manufacturers out of scope. But after taking a quick look today I may actually buy some.

 

Basically if you mention anything to with autos, someone will scream cycle, cyclicals, top of the cycle or something to that effect. But nobody seems to be talking about valuation for some reason.  ???

 

So basically with Linamar you have a company that is well run. A large shareholder who's interests are aligned with the plebs and hasn't been making mistakes. Supposing we're at the top of a cycle, earnings growth peak-to-peak has been 17.5% per year and ROE (though to peak) over the cycle has been 15%. This company is trading at 6x PE and basically book value. Most businesses are cyclical and they're not trading anywhere close to 6 PE. plus we don't actually know if we're at a cycle peak or if the cycle is over.

 

Let's talk a bit about the cycle. The US vehicle flee is about 268 million and the average age is 11.7 years. In 2017 there were about 17.25 million vehicles sold in the US. That implies an average vehicle replacement age of 15.5 years. I know that vehicles have been getting better, but 15.5 is a quite a lot and well in excess of the average age of the fleet. So at 17 million units a year it doesn't seem like we're in a crazy, frothy part of the cycle and we're about to fall off a cliff.

 

But for the sake of the argument let's assume that 17 million is a peak? What should be a normal run rate for autos? 15 million units for an average replacement age of 17.9 years? At that point what would be the valuation for Linamar?  9 or 10x PE? What's really wrong with 9 or 10 PE?

[UK]

Re buybacks and capital allocation: they are not buying back shares, but so far LNR has succeeded to reinvest in business/acquisitions and to keep ROE constant/growing, while also diversifying, at least somewhat, from the auto disruption threats. Also LNR bought back ~5 M shares for ~65 M CAD in 2008 and Hasenfratzs between them (mostly by current CEO) increased their ownership by ~4.6 M shares (from ~25 to 33 per cent of the company) in that year. In my wildest dream for this company, in their next acquisition, they just have to go after the aerospace field:)))

 

 

[kab60]

This one has taken a bit of a beating which I think is interesting considering the guidance for 2019. They expect to increase sales, margins and lower capex as well as getting to 1xdebt/ebitda in 2019. That means they expect more than 600m FCF on a market cap of 3b as well as ROIC trending higher. EV/Ebitda should approach something like 3,5x for a high quality business where management has significant skin in the game and think there's potential to quadruble the size of Macdon.

 

Not sure what effect the GM closures will have, but I'm buying more.

[mjm]

not to say that i am near as knowledgeable  as the many fine posters here, but would PCP at brk look at this business?  as i can see they are somewhat in same field and do not appear to have any overlap in business. know couple years ago meryl witmer thumbed up LNR on barron's and she is on BRK bod.

 

also believe GM shut down caused some of drop last few days, but know part of shutdown involved transmission plant, which to me may be a positive as GM may consider outsourcing that work. believe that is one of  main thesis here as F, GM, etc may consider outsourcing. would appreciate any input.

[kab60]

not to say that i am near as knowledgeable  as the many fine posters here, but would PCP at brk look at this business?  as i can see they are somewhat in same field and do not appear to have any overlap in business. know couple years ago meryl witmer thumbed up LNR on barron's and she is on BRK bod.

 

also believe GM shut down caused some of drop last few days, but know part of shutdown involved transmission plant, which to me may be a positive as GM may consider outsourcing that work. believe that is one of  main thesis here as F, GM, etc may consider outsourcing. would appreciate any input.

I think the whole business would be attractive to BRK, but I think a deal is highly unlikely. They are quiet bullish on their prospects and think the equity is way undervalued (hopefully they'll act on it post 2019).

 

GM closures might hit them short term, but longer term I think it's a positive. It might mean more outsourcing (which is a tailwind already), but it'll also lower GM's fixed costs so it should hold up better in a downturn and thus lessen Linamars' risk. GM and Chryslers issues were a problem in the last downturn - this time they look in better shape.

 

Seeing where they've taken Skyjack, I really like the acquisition of MacDon. They paid a fair price but eventually it might turn out to be a steal. I think that's a free option here.

[Spekulatius]

One thing to consider is that most of their powertrain business is going away or at least change with automobile electrification. I know that Linanar puts a positive spin on this, claiming it will increase their addressable market, but it does increase risk, imo.

 

Power train appears to be the vast majority of their business.

[kab60]

One thing to consider is that most of their powertrain business is going away or at least change with automobile electrification. I know that Linanar puts a positive spin on this, claiming it will increase their addressable market, but it does increase risk, imo.

 

Power train appears to be the vast majority of their business.

I think you're right, but I also expect electrification to take a long time to play out which means decent management should have a decent shot at mitigating that risk or turn it into an opportunity. They still guide 8,5-10,5b revenue in 2022 (8,5 booked so far) versus 7,7b in 2018, so midterm looks fine absent a major recession.

[kab60]

I think I'll get the book, but this article has some intesting bits on Linamars management and founder: https://www.guelphmercury.com/news-story/2788699-linamar-s-founding-family-is-guelph-firm-s-largest-largest-investor/ (among others, they really took advantage of the last downturn. Antifragile isn't the right word, but it's interesting nonetheless)

 

Another point, which is hard to quantify and not part of any thesis, but they seem to have a lot of political goodwill in Canada (recently got a fairly big R&R grant I believe). Say they do get in financial distress, I think their Canadian lenders would go a long way to help them out. Obviously don't expect that to be necessary, but would probably be trickier if their debt was bonds with lots of different investors.

[kab60]

CEO has bought shares recently and now they announced a decent sized buyback. I'm happy they take advantage of the low share price and didn't wait till leverage was down to 1xdebt/ebitda. I've made it a very large position and buybacks (or lack off) was an annoyance so glad they act.

 

"We are initiating this NCIB in recognition of what we believe is a

significant level of under valuation of Linamar stock. We do not feel that the

value of our business is being adequately reflected in our current share

price" said Linamar CEO Linda Hasenfratz.

 

Under the Bid, the Company may repurchase on the open market (or as otherwise

permitted), at its discretion during the period commencing on January 29, 2019

and ending on the earlier of January 28, 2020 and the completion of purchases

under the Bid, up to 4,506,324 common shares of the Corporation (the "Common

Shares"), representing approximately 10% of the "public float" of the Common

Shares (within the meaning of the rules of the TSX), subject to the normal

terms and limitations of such a bid."

[RadMan24]

Interesting. I was wondering if and when that was going to happen. Thanks for sharing.

[compounding]

Is there a way to track share repurchases on the Toronto Stock Exchange or do we have to wait for the quarterly report for updates?

[Spos]

Is there a way to track share repurchases on the Toronto Stock Exchange or do we have to wait for the quarterly report for updates?

 

You can track share repurchase activity on sedi.ca.  I am not sure of the exact reporting requirements, but companies either report shortly after transactions are made or monthly.

[longlake95]

you can see transactions here too:

 

https://www.canadianinsider.com/node/7?menu_tickersearch=LNR+%7C+Linamar