LNR.TO - Linamar Corporation

[kab60]

Company has regularly updated the market during Covid19. Obvious difficult conditions but still expect to be profitable and free cash flow positive for the year - and not break any covenants. Some insider buying as well. Surprised by their frequent communication - a lot of Companies could learn from them. They came thundering after the GFC when weaker suppliers got killed and they picked up business. Wouldn't expect anything less this time around, and perhaps their transition to making medtech equipment will accelerate. Still think it is an absolute steal for a diversified industrial with disciplined and longterm oriented management operating in cyclical businesses but with structural tailwinds. Company will be much bigger and much more valuable in 10 years.

[kab60]

For anyone interested in the Company history but also how they operate in a decentralized manner (each plant with its own P&L), their return hurdles, margin targets etc I can highly recommend the book Driven to Succeed even though it is too promotional at times.

[kab60]

Q1 results out. Looks fine considering the backdrop:

Free cash flow1 for Q1 2020 increased 572% to $147.1 million compared to $21.9 million in the first quarter of 2019 ("Q1 2019");
Liquidity, measured as cash and cash equivalents and available credit at March 31, 2020, improved to $1.2 billion;

Q2 will be ugly, but still expects to be profitable and FCF positive for the year and comply with covenants

Anyway, highlight is this part:

"The current global environment and economy is certainly a challenge but it is one that the Linamar team is 100% able to handle. Linamar is a strong, responsive, agile team with a culture perfectly suited to handle crisis. We are laser focused on cost reduction, cash generation, finding new business opportunities and supporting our global team and communities and delivering on every one of these counts. Tough times don't last but tough teams do and we are one tough team," said Linamar CEO Linda Hasenfratz.

[kab60]

I know nobody cares for a boring industrial company which actually has to invest in PP&E (despite double digit ROE and double digit growth), but Q2 results came out yesterday and were quiet fine I'd say - considering the backdrop. They dialed back capex massively, generated 170m FCF (net debt reduced 600m in a year) and had a minor loss despite revenues getting cut in half. I thought they would've been hit a lot harder by operating leverage, so I think it's quiet a testament to managements' abilities and their ability to respond extremely quickly. Oh yeah, they also keep taking share. I think they'll come charging back.

[kab60]

Seems like Christmas comes early this year for boring, cashflowing businesses. Just announced a pretty massive Q3 with earnings up y/o/y, generated plus 700m of FCF ytd (this was at a 1,5b market cap earlier this year) and issued ten year notes at 1,37%. Dividend back to normal levels.

[jfan]

Nice to see such positive results. Net debt to ebitda at 1.1 and no debt due until 2023. Cpv was also up in north America and Asia. Financial leverage risk levels much improved.

[kab60]

Yep, just went through the CC, very impressive. Expect 7-9 pct net margins next year despite still expected soft volumes. Things starting to look better at MacDon and Skyjack as well. Possibly even looking at taking over weak competitors. They've shown before they don't let a crisis go to waste.

[jfan]

Few interesting comments from the CC:

"Linamar's utilization of flexible, programmable equipment is the key factor in allowing us flexibility in times of market softness to continue to tool up new business without requiring significant CapEx. This is a massive advantage Linamar has in comparison with competitors, who may invest in more dedicated equipment, which, although cheaper and often require less labor, is not easy to reallocate to new programs or to scale the line to match actual capacity needs."

- This was an interesting comment that reduces the risk of owning fixed assets. Not a major competitive advantage but interesting to see how they think about managing their assets over time.

"I think it's also critically important to point out that the type of equipment utilized in machine parts for electrified vehicles is literally identical to the equipment using machine part for internal combustion engine vehicles. Electric vehicles use gears, shafts, structural parts and a variety of housing, just like internal combustion engine vehicles. A gear grinder or shaper used to make a gear for an internal combustion engine vehicle is the very same equipment we will use to make a gear for an electric vehicle. I highlight this point as it means we will not have significant levels of [ stranded ] assets to deal with as the world transitions into electric vehicles."

- This is useful in their transition to a new powertrain business

" I think that both dividends and share buybacks are effective means by which to return cash to shareholders. We had cut the dividend, so we thought it was a prudent first step to restore that to our shareholders. And of course, we will continue to assess dividend levels and buyback potential in the context of ongoing cash needs and leverage levels. So I think it's prudent to be conservative right now, just given there are some uncertainties in the road ahead and the current wave of the pandemic effect. So we're going to be cautious."

- It seems that maintaining a conservative debt level is more important than stock price returns

" It is charting actual booked content. So this is based on booked business. We are not putting anything in here that is speculative that we haven't won yet. So we're taking actual booked sales for programs that we've been awarded, by internal combustion, battery electric and hybrid. And then we're just dividing them by the current forecast for number of vehicles to be produced in those years for each of those propulsion types. "

- Can't attach the presentation chart but its on page 31. If we assume 1/3 hybrid, 1/3 ICE, and 1/3 BEV (I know this is not fully accurate) but for the sake of brevity in a post, they go from $100 CPV across all propulsion types to $170 CPV in 2024.

[kab60]

Yes, lots of interesting nuggets on the call. It's a secular growth story with lots of option value in MacDon and it's been trading somewhat like a cyclical cigarbutt. Their TAM is huge, and electric vehicles seem like a very interesting growth driver as OEM's will likely increase the amount of outsourced components. It's obviously cyclical, and thus lumpy once in a while, but this downturn has demonstrated just how impressive operators they are and how they can release working capital in a downturn. I expect them to emerge even leaner and meaner than pre-crisis. That's what they did in the GFC, that's what they'll probably do this time. It's still trading below book value, which is obviously not the best proxy of value, but considering they target 20 pct. ROE on their investments, it should take off if they get close to that again.

They could be more aggressive on share buybacks, but I think it's hard to fault them. They actually have a 100 year plan (yeah, sounds dumb) and considering most of their family wealth is tied up I expect them to continue running it conservatively and diversify even further.

It's funny with these cyclical industrials that are now trading above where they were in January. The outlook back then was better, and while everyone feared an downturn there wasn't really anything on the horizon. Then China flu out of nowhere, and now it seems like investors think the risk of another major downturn is unlikely since we've just gone through one. Not sure that's how it works but whatever.

[kab60]

New update out, vehicles sales better than expected and agriculture and industrials trending positively: https://www.linamar.com/sites/default/files/reports/Q4%202020%20Market%20Update.pdf

They're doing well, but it's still funny how the stock is almost a double since the fall of 2019. Can't say I quiet understand the pessimism back then nor the optimism right now. It's not expensive by any means, and I think it'll be worth a lot more ten years down the line, but it's crazy how fast narratives change. It was trading at 2xfree cashflow in March. Haven't sold a thing, but I liked it better in March.