Summary
- NN is ahead of schedule with respect to original strategic plan; proforma full year consolidated revenue is $680 million compared with 2018 revenue target of $800 million.
- Dominant market leadership in metal bearing components markets with growth drivers in the form of adjacent market expansion and favorable industry trends.
- Being among the top three global autocam precision components manufacturer will allow NN to benefit from the increased adoption of fuel efficient technologies requiring high precision metal components.
- Strengthening the balance sheet and returning excess capital to shareholders are part of NN’s capital allocation priorities, apart from re-investment in growth.
- Potential catalyst is the completion and release of the updated strategic plan with more aggressive targets.
Elevator Pitch
NN Inc (NASDAQ:NNBR) announced its strategic plan in January 2014, which targeted to more than double its revenue of $373 million in 2013 to $800 million by 2018. The original strategic plan involved incremental revenue contributions of $260 million, $145 million and $20 million from acquisitions, organic and adjacent market growth, and European recovery respectively. However, NN met the target for acquisitions three years ahead of schedule, having completed four acquisitions totaling $280 million in revenue by September 2014. With an estimated proforma full year consolidated revenue of $680 million, all eyes are on NN’s updated strategic plan, which management mentioned that they are in the process of updating. NN’s market leadership in two high-precision industrial segments will enable it to capitalize on the growing emphasis on automotive fuel efficiency. Its capital allocation policy is balanced between growth, return of capital and capital structure optimization. The DCF-derived target price of $23.57 represents an upside of 21%, based on its share price of $19.51 as of December 23, 2014.
Company Description
Founded in 1980 and listed in 1994, NN is a diversified global manufacturer and supplier of high-performance precision components. It boasts a footprint of 25 manufacturing facilities across 10 countries and supplies its products to blue chip customers in more than 30 countries. In September 2014, NN completed the acquisition of Autocam Corporation to become one of the top three global manufacturers of metal bearing and precision metal components. NN’s three platforms: metal bearing components, autocam precision components, plastics and rubber components account for approximately 43%, 51% and 6% of its revenue respectively. I will only be focusing on the metal bearing components and autocam precision components segments in my analysis below, as these two segments account for a substantial percentage (94%) of its top line.
Metal Bearing Components Segment
NN is among the top three manufacturers of precision balls and the market leader in tapered rollers. NN is the third largest manufacturer of precision balls with 24.2% global market share, after Tsubaki-Hoover (27.6% market share) and AK Steel Holding Co. (NYSE:AKS) (26.0% market share). In contrast, the other players are much smaller, with none of them having market share over 10%, and most of them lack the global footprint and product quality to compete with companies like NN. In the outsourced tapered roller market, NN’s market share is as high as 80%. Both the precision balls and tapered rollers markets boast characteristics of a low number of dominant competitors with significant market share, which suggest high barriers to entry. This is also validated by the fact that NN’s metal bearing components business has the highest operating margins of the three segments.
The downside of NN’s dominance in attractive markets with stable market shares like precision balls and tapered rollers is that it is also difficult for NN to grab market share from competitors. Instead, NN’s growth in metal bearing components segment will come from leveraging on favorable industry trends and adjacent market expansion. Given the increased emphasis on fuel efficiency for automotive, there is a corresponding increase in demand for fuel efficient bearing applications and their precision components. In addition, NN is developing new products such as spherical rollers to penetrate adjacent markets within the broader metal bearing components space.
Autocam Precision Components Segment
Following the acquisition of Autocam Corporation in September 2014, NN joined German companies Haering and A. Berger as the world’s three biggest manufacturers of autocam precision components; and it also benefits from relative economies of scale being more than twice the size of its next largest competitor. Similar to metal bearing components, automotive fuel efficiency is a key driver for autocam precision components as well. NN has currently identified several fuel saving technologies that it assessed that will have a long growth runaway, and is manufacturing high precision metal products required for these technologies. One example is the Gasoline Direct Injection technology which boasts a 15%-20% improvement in miles per gallon and whose market is expected to grow at a 17% CAGR going forward, based on estimates by IHS Automotive.
Capital Allocation
NN has been free cash flow positive in nine of the past 10 years and management is guiding for free cash flow of between $25 million and $35 million in 2015. As a result, NN’s capital allocation policy with respect to its free cash flow becomes critical with respect to shareholder value creation.
Apart from investing in capex and M&A to drive growth, NN is also wisely using its cash flow to return excess capital to shareholders and strengthen its balance sheet. NN paid out quarterly dividends consistently between 1995 and 2008, but stopped dividend payments from 2009 to 2012. In 2013, NN re-initiated the distribution of dividends and its current dividend policy is the payment of stable common dividends to shareholders under 20% free cash flow. NN currently sports a forward dividend yield of 1.5%. Another capital allocation priority is debt repayment. Given its current debt of $370.92 million and management’s EBITDA guidance of $110-$120 million in 2015, NN’s debt-to-EBITDA is approximately 3.4 times. NN plans to pay down debt to achieve its target leverage ratio of 2-3 times.
Potential Catalyst
Management is currently guiding for 2015 revenue of $690-$710 million, after meeting its planned acquisitions target ahead of schedule. NN completed four acquisitions totaling $280 million in revenue by the third quarter of 2014, exceeding its target of $260 million in acquired revenue by 2018. As a result, NN’s proforma full year consolidated revenue is currently already $680 million, suggesting that it could likely hit a top line of $800 million before 2018, as per outlined in its strategic plan announced in January 2014. Management recognizes this and mentioned that it is in the process of updating its strategic plan. A potential catalyst for NN will be the release of its new strategic plan with more aggressive revenue and earnings targets.
Target Price
I arrive at a target price of $23.57 for NN, drawing on assumptions of a free cash flow per share of $1.58 based on the mid-point of management guidance, five-year future EPS growth of 15%, terminal growth rate of 5% and a 12% discount rate. Based on NN’s share price of $19.51 as of December 23, 2014, the target price suggests an upside of 21%. The five-year future EPS growth is calculated based on consensus analyst forecasts for NN, while NN’s 10-year EPS growth rate is used as a proxy for the terminal growth rate.
Variant View
The deadly combination of business cyclicality and financial leverage continues to be the greatest risk for NN. NN’s business is inherently cyclical and heavily dependent on macro-economic conditions and industrial and automotive production. In 2009, NN’s revenue fell by close to 40%, following a significant reduction in customer orders driven by weak end market demand. In late 2011 and 2012, the European recession resulted its revenue declining by 13%. In addition to the cyclical nature of NN’s revenue streams, its weak balance sheet with a high gross debt-to-equity ratio of 205% poses further risks to its business.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. (More…)
NN Inc.: Unveiling Of Updated Strategic Plan Will Be Catalyst For Stock (NNBR) - Seeking Alpha
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