Value Library

The following is an excerpt from the ABC Perspective - January 2012 - Pg. 4-5

ABC Fund Value Favourites

Martinrea International Inc.

Martinrea International is a global supplier of automotive parts, including assemblies, modules and fluid management systems. The company has more than 10,000 employees in 37 plants located in Canada, the United States, Mexico, Brazil and Europe.

In our view, MRE represents an extremely attractive investment opportunity. Under the leadership of Executive Chairman Rob Wildeboer, MRE’s strategy focuses on long-term growth both organically and through strategic acquisitions. In connection with its Q3 2011 results, management provided a favourable outlook for its North American business, which accounts for the majority of MRE’s sales. In particular, the company expects 2012 North American vehicle volumes to remain steady or to increase. This is supported by the availability of financing, the present automobile scrap rate, which exceeds the sales rate, and the average age of vehicles, which at 10.2 years is significantly higher than in recent history.

On July 29th 2011, MRE acquired out of bankruptcy a  55% interest in Honsel AG, a German-based manufacturer of automotive parts. The remaining 45% of the company was purchased by Anchorage Capital Group LLC. Total consideration for the purchase (100%) was approximately $129 million, and MRE and Anchorage have each invested an additional $66 million of equity into Honsel to fund working capital and anticipated capital expenditures.

We believe the Honsel acquisition provides numerous strategic benefits to MRE. In addition to expanding its European business, where the company did not have a significant presence, Honsel was immediately accretive to MRE’s third quarter earnings by $0.06 per share despite only two months of contribution. Management expects that revenue and EBITDA from Honsel over the next twelve months could exceed $680 million and $41 million, respectively. Interestingly, the $129 million consideration for the Honsel assets equates to approximately 18.1% of the purchase price paid by Ripplewood Partners to acquire the company from The Carlyle Group in 2004. 

From a financial perspective, MRE’s recently reported Q3 2011 results were impressive on all accounts.  Sales increased 21% to $572 million, which included $147 million in revenue from the Honsel acquisition. Honsel also positively impacted the company’s consolidated Q3 2011 gross margin, which increased by 1.3% to 10.9%. Excluding Honsel, the company’s gross margin would have been 9.5%. This resulted in significantly improved Q3 EPS to $0.20 compared to $0.14 in Q3 2010 – a 43% increase. The company also provided 2012 earnings guidance of $1.05-$1.25 per share, exceeding most analysts’ expectations.

From a valuation standpoint, we believe Martinrea is extraordinarily inexpensive. In January 2011, the company’s shares peaked at $10.79, which we believe reflected investor optimism regarding the outlook for the automotive sector and MRE’s anticipated roll-out of new products. However, the uncertain global macroeconomic outlook, combined with volatile equity markets, has resulted in an approximate 30% pullback in MRE’s share price over the past twelve months. 

We believe the retreat of MRE’s share price is entirely unwarranted. Regardless of one’s view of the global economy and automotive sector on the whole, at current levels, we believe MRE’s deep discounted valuation should provide downside protection. To put this into context, MRE shares are presently trading at approximately 4.0x 2012 EV/EBITDA, which is at the low end of its historical trading range of 4-8x. In other words, the current stock price is effectively implying a trough valuation – which is typical during a recession and/or contracting business activity.

Considering management’s optimism with respect to MRE’s outlook, and the company’s inexpensive share price, we were not surprised to see that on November 14th, 2011, Martinrea initiated a normal course issuer bid to repurchase up to 4,161,317 common shares of the company, which equates to 5% of its outstanding shares. In the preceding twelve month period, MRE repurchased 778,000 common shares at an average price of $7.28 per share. The company remains well capitalized with $56 million in cash and $280 million of long-term debt.

WestJet Airlines

WestJet Airlines is a leading Canadian airline company that provides scheduled service to 71 destinations in Canada, the United States, Mexico and the Caribbean.  The company has more than 8,000 employees, and is the nation’s second largest carrier. WestJet also offers travel packages through its WestJet Vacations subsidiary, which has partnered with a wide range of hotels and activity partners.

In our view, WestJet is a true gem amongst its peers, consistently achieving financial performance in the top tier of North American airline companies. A cornerstone of the company’s business plan is its single fleet operation, which minimizes training, staffing and maintenance. The current fleet consists of 96 Boeing Next-Generation 737 series aircraft, and Westjet has firm commitments to take delivery of an additional 39 aircraft over the next six years. With certain aircraft leases set to expire, the company has the flexibility to end 2018 with a fleet size between 102 and 135 aircraft. At present, WestJet operates one of North American’s more modern fleets, with an average age of 5.6 years.

As we have seen time and again, the airline industry is an inherently difficult business to operate. In recent history, several North American airlines, including Delta Airlines, US Airways and AMR Corporation, as well as Air Canada, have filed for bankruptcy protection. Faced with a challenging economy, complex scheduling, price-sensitive consumers, rising fuel costs, and union issues, many airlines have faced financial distress over the past few years. Conversely, WestJet’s Q3 2011 financial results represented the 26th consecutive quarter of profitability for the company, which demonstrates its ability to sustain consistent earnings through all economic cycles.

WestJet’s growth strategy includes new scheduled flight routes, airline partnerships, and its WestJet vacations business. Consistent with this objective, on November 23rd, 2011, the company announced it had been the successful bidder for eight slot pairs at New York’s LaGuardia airport. We believe this is a significant announcement for WestJet, as it provides the company with a regular daily service route to New York, and to compete head-to-head with Air Canada in a very lucrative market.

WestJet is continuing to execute on its strategy of establishing partnerships with airlines around the world. At mid-December, the company had established interline relationships with 17 airline carriers globally and code sharing agreements with four airlines, including Cathay Pacific, American Airlines, KLM, and Japan Airlines.

A key point of differentiation between WestJet and other airline carriers is the company’s exceptionally strong balance sheet. At Q3 2011, WestJet had $1.3 billion in cash and $894 million in debt. The company’s strong financial position allowed it to initiate a $0.05/share quarterly dividend in Q2 2010 and to actively repurchase shares in 2011.  Although WestJet has not recently been active on its normal course issuer bid, given its current discounted valuation, we would not be surprised if the company reconsiders the repurchase of its stock.

With respect to financials, although WestJet’s Q3 2011 revenue increased by approximately 13%, the  impact of rising fuel prices, which increased 27% year-over-year, had a negative impact on the company’s operating margin.  The reduced margin contributed to a year-over-year decline in Q3 2011 EPS to $0.28 compared to $0.30 last year. However, it is worth nothing that in 2010, WestJet generated an EBT (earnings before tax) margin of 7.8%, ranking it one of the most profitable carriers in the industry. 

At its current share price of $11.75, we believe WestJet’s valuation is compelling. At present levels, the stock is trading at a 2012 P/E multiple of only 10.0x. Applying the 5-year industry average P/E multiple of approximately 15x suggests the stock could trade considerably higher in better market conditions.

In summation, we have a significant amount of confidence in WestJet’s business prospects and management team, and continue to believe the stock is undervalued at current levels.

Irwin A. Michael, CFA