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Morningstar | Adient Placed on the Best Ideas List

Spun off from Johnson Controls in October 2016, narrow-moat Adient is the number-one automotive seating supplier. Its stock fell from $86.42 in September 2017 to the low $12 range in early 2019 as it kept disclosing manufacturing problems. These issues focused on botched launches and led to the removal of CEO Bruce McDonald and a dozen more legacy Johnson Controls executives and the suspension of Adient’s dividend. McDonald held a finance background, so we liked Adient’s board hiring operations expert Doug DelGrosso in fall 2018. DelGrosso spent 20 years at number-two seatmaker Lear, rising to COO and president, but also spent time at TRW and as CEO of two smaller auto suppliers.

We had been waiting for an asset sale or a balance sheet remake to give the company more time to fix its execution issues. The major debt maturity concerning us was a $1.2 billion term loan A due in July 2021. Adient announced in April that it intends to refinance this debt on May 6 with $800 million of new senior secured bonds due in 2026 and an $800 million term loan B. The company has not disclosed term loan B's maturity date. Adient also had an undrawn $1.5 billion credit line expiring in July 2021 that will be replaced with a $1.25 billion credit line. An expiration date on the new credit line is unknown, but we expect Adient to only use it in an emergency. We like this news because total debt only increases by about $400 million while giving Adient several years of additional time to fix itself. We don't think DelGrosso needs that much time, but a 2021 maturity made us nervous about Adient not being able to correct things before a recession hit. We are now less concerned about bankruptcy risk and comfortable with the story to add the stock to the Best Ideas list. We think the stock should move up considerably from early 2019 levels but feel Adient’s turnaround story is still in its early stages and the stock is only appropriate for clients with a very long time horizon.

We also like the balance sheet restructuring because we think it is now less probable that Adient either dilutes shareholders or is forced to sell off part of its Chinese joint ventures, which includes a 30% stake in the world’s largest automotive interiors firm Yanfeng. Adient is the number-one seating firm in China, with 45% market share there, and its more than 20 joint ventures are accounted for via the equity method, with about 70% of the JVs’ net income coming back to Adient as cash dividends annually. Equity income is generally $300 million-$400 million a year, so at a conservative 8 times multiple to those aftertax earnings of, say, $350 million, Adient’s market capitalization would be $2.8 billion. If the JVs alone are worth at least $2.8 billion, then investors buying the stock now are getting the consolidated business, the largest seating firm in the world, for free. Other upside option value exists from autonomous vehicles leading to more high-tech seats and thus more dollar content, as well as from a recently established business class airplane seat joint venture with Boeing that helps Adient leverage its ownership of Recaro. For more detail on Adient, please see our June 2018 report, “Narrow-Moat Adient Is Trading as if It Will Never Get Better.”