The auto-parts business, in its various forms, has been enjoying a very consistent period of growth and profitability. But returns have varied depending on what part of the auto-parts chain you occupy. Those businesses that were deeply levered to U.S. original equipment manufacturers (OEMs) were hurt when the auto industry took a nosedive. Auto-parts retailers, on the other hand, have been investment home runs over one-, three-, five- and 10-year holding periods.
Federal-Mogul Corp. (FDML) is a global auto-parts company that supplies both OEMs and the aftermarket industry. It manufactures and distributes parts, components, modules and systems to customers in the automotive, small engine, heavy-duty, marine, railroad, aerospace and industrial markets worldwide. In its current form, the company is the brainchild of activist investor Carl Icahn. He scooped up FDML bonds before the company filed for bankruptcy protection in 2001. In early 2008, FDML emerged from bankruptcy and Icahn swapped his debt for equity. He currently owns 76% of the company's shares.
This is an incredibly attractive business with several catalysts of value creation. At the current price of about $18, the shares trade for less than 9x 2011 earnings estimates, a wide discount to industry peers. Annual net sales of $7 billion dwarf the company's market cap of $1.7 billion. Net debt of $1.6 billion is quite reasonable given annual operating income that exceeds $700 million and free cash flow that averages more than $300 million a year. More than 60% of sales come from outside the U.S. and no single customer accounts for more than 5% of global revenue. Since the economic downturn, the company has reduced its cost structure by more than $400 million.
Federal-Mogul serves hundreds of customers on the original-equipment side. Whether it's major automakers like GM (GM) or Toyota (TM), an industrial titan like Deere & Co. (DE), or lifestyle names like Harley-Davidson (HOG) and Porsche, FDML is a supplier. In most of its products, the company holds a No. 1 or No. 2 market share. Nearly 40% of sales come from the aftermarket segment and, again, Federal-Mogul supplies everyone from AutoZone (AZO) and Pep Boys (PBY) to Wal-Mart (WMT).
Besides the attractiveness of the valuation, another catalyst is at work: Icahn himself. Earlier this year, he announced his intention to sell FDML, and likely would have at around $24 to $28 a share. But when the market started selling off, deal appetite was suppressed. Then, as shares declined, Icahn started to buy more around $15 a share. Granted, his purchases were insignificant in light of his 76% stake. Nonetheless, with shares trading at about $18, the business is cheap, trading at less than 11x enterprise value/free cash flow. In morning trading, FDML was down $0.61, or 3.4%, to $17.39.
At current prices, Icahn's actions clearly indicate that FDML shares are undervalued. Moreover, he has publicly made it his intention to sell the company at a valuation that is 30% to 50% higher than today's stock price. With current market sentiment shifting for the better, I expect interested buyers to emerge.