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Morningstar | Adient's Fiscal 2Q Shows Progress in Metals Turnaround but There's a Long Way to Go. See Updated Analyst Note from 07 May 2019

Adient's fiscal second-quarter results had flat adjusted diluted EPS sequentially of $0.31 but still missed consensus of $0.39. Adient also disclosed that it may soon write off a material portion of its deferred tax assets due to reevaluating its intercompany financing structure following its May 6 debt refinancing. This may result in shifts of interest income and expense between geographies so we think management will write off a lot of its deferred tax assets in fiscal third quarter. The net deferred tax asset balance at fiscal year-end was $347 million. This charge will be noncash but means higher taxes going forward so we are raising our tax rate assumption through fiscal 2023 to 25% from 15%, which along with more minority interest modeled causes a fair value estimate reduction to $53 from $60.

We've long said Adient's turnaround story is for the patient investor, and we continue to believe that. In the slide deck, management outlined a timeline that doesn't have significant improvement to free cash flow until the fiscal 2020-22 period and closing the profit margin gap with Lear until fiscal 2023 and beyond. That is a long time to wait, but there are some positives for fiscal 2019. Management calls this year a stabilization year, which we agree with, and still guides for second-half results to be better than the first half. Also encouraging is the Adient Aerospace joint venture with Boeing secured its first customer, business class seating on Hawaiian Airlines 787-9 entering service in 2021.

For the quarter, execution problems around North American and European launches and currency pressures, mostly from the euro, weighed on results. Adjusted EBIT fell 53% year over year but grew 11.4% sequentially from the fiscal first quarter. The metals business improved sequentially with adjusted EBITDA up $22 million to negative $51 million. Free cash flow got help from working capital and was $60 million compared with negative $146 million in the prior-year quarter.

Adient finally disclosed all its maturity dates around the new debt obtained on May 6 as first discussed in our April 15 note. New 7% $800 million senior secured notes due May 2026 (but callable earlier by Adient) and an $800 million term loan B due in May 2024 have paid off the $1.2 billion term loan A due in July 2021. Adient also secured a new $1.25 billion credit facility available until May 2024. Adient's debt maturities now give the firm time to withstand a recession in the near future should one occur and time to execute its turnaround plan. Most encouraging is the new debt appears to have eliminated restrictive debt covenants such as the net secured leverage Adient's old debt had.

We are still concerned about Adient's debt load, but the maturities are far enough out in time that we are not uncomfortable about the balance in 2019, though actions will be needed to refinance and also hopefully reduce debt by 2024 and 2026. The first debt due is a $186 million European Investment Bank loan in fiscal 2022. Then the big maturities are in fiscal 2024 and fiscal 2026. Fiscal 2024 has EUR 1 billion 3.5% unsecured bonds and the $800 million term loan B. Fiscal 2026 has the new 7% $800 million bonds plus $900 million of 4.875% unsecured bonds issued in conjunction with Adient's 2016 spin-off from Johnson Controls. We expect once Adient's turnaround is showing meaningful free cash flow in a few years that it will seek to refinance the fiscal 2024 and fiscal 2026 maturities. We also expect the company to redeem some of the 7% notes early if its cash flow story improves because this debt is expensive relative to its other bonds. Net debt at March 31 factoring in the May refinancing is about $2.9 billion.