EUR 850.00 For Business Accounts Only

Morningstar | Adient Starts Fiscal 2019 With A Weak Quarter; Turnaround Requires a Lot of Investor Patience

Although Adient's fiscal 2019 first-quarter free cash burn of $272 million beat January guidance of about a negative $300 million, adjusted diluted EPS of $0.31 badly missed consensus of $0.56 and adjusted EBIT fell 35% year over year to $105 million, sending the stock down over 20% early Feb. 7. We are lowering our fair value estimate to $60 for several reasons. Fiscal 2019 revenue guidance introduced Feb. 7 of $16.5 billion-$16.7 billion is below our $17.1 billion expectation. We also lowered our equity income over our five-year forecast by nearly 12% to account for softness in the Chinese auto industry in fiscal 2019. These changes result in a higher credit risk rating in our model, which raised our weighted average cost of capital to 9.5% from 9.3%. Despite the lower fair value, we still think Adient's stock offers excellent upside for patient investors willing to wait beyond 2019 for new CEO Doug DelGrosso to turn the company around.

Fiscal 2019 guidance is more vague than in prior years because management is still not ready to talk about the precise timing of a recovery, but they do plan to update investors later this year. For now, CFO Jeff Stafeil is only saying full-year fiscal 2019 adjusted EBITDA, which includes equity income, will be worse than 2018's $1.2 billion and second-half fiscal 2019 adjusted EBITDA will be better than first-half. Headwinds include about $500 million of foreign currency hurting revenue, one-time selling, general, and administrative benefits not repeating in fiscal 2019, more spending on the Adient aerospace seating joint venture with Boeing, and the big issue is continued execution and launch problems in some North America and European plants. DelGrosso continues to feel Adient's problems are fixable and there is no reason Adient's EBITDA margins cannot equal peer firms. We agree but stress this turnaround will take a lot of time. We think Adient's stock is very cheap but it will remain cheap probably at least into fiscal 2020.

The quarter saw revenue down 1.1% year over year to $4.2 billion, but we calculate 1.1% growth excluding a $94 million currency headwind. Europe sales fell 8%, while North America and Asia rose 10% and 3%, respectively. SS&M, the metals group, improved its EBITDA $10 million to negative $72 million as reduced expedited freight costs and less scrappage waste gave a tailwind. DelGrosso lamented on the call that SS&M needs to price better and has not been selective enough on picking customers, causing cash drain for far too long. SS&M is investing in common seat architectures, which is expensive now but should help scale over time. The seating segment saw adjusted EBITDA fall 26% to $261 million but a $10 million exchange and commodity headwind along with $70 million of negative variance from operating issues and expedited freight pounded results. Seating has a bright future, though, as demand remains in good shape and Adient announced wins for complete seating work on the new generation Ford F-150 pickup due in 2020 and the BMW 7-Series, both high-profile wins.

Adient's Chinese joint ventures have over $1 billion in net cash, which management keeps saying it is looking to monetize, so that is one balance sheet action to look for perhaps later in fiscal 2019. Management is also looking to extend the credit facility maturity beyond July 2021. On Feb. 7, Adient filed an 8-K detailing a material amendment to its debt covenant. The net leverage ratio calculation is now a net secured leverage covenant and the cash deduction to calculate net secured debt is limited to $250 million from no limit previously. This change matters because Adient has about $2.1 billion in unsecured debt now excluded from its covenant calculation in the form of two bonds due in 2024 and 2026. Secured debt is the $1.2 billion Term Loan A due in July 2021, as well as about $330 million for a European Investment Bank loan and other European debt. If Adient could extend the term loan maturity beyond 2021 in the next few months, then we could see the stock reacting favorably to that news.