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Morningstar | Tenneco FY2018 Results and 2019 Guidance Disappoints Market; Maintaining $73 Fair Value Estimate

Narrow moat-rated Tenneco, which supplies emissions control, suspension, and powertrain components and modules to the global automotive industry and aftermarket parts, reported full-year 2018 diluted earnings per share before special items, or EPS, of $6.28, missing the $6.53 EPS consensus estimate by $0.25 and down $0.43 versus the year ago $6.71 EPS. The results were negatively affected by the lower volume of higher margin products in the Chinese market, aftermarket part manufacturing inefficiencies, tariffs, and higher steel costs. Including the Federal-Mogul acquisition completed in the fourth quarter, revenue jumped 27% to $11.8 billion, compared with $9.3 billion reported last year. Excluding the acquisition of Federal-Mogul and negative currency translation, organic revenue increased 6%, despite a 1% decline in the global production of light vehicles .

While 2019 revenue guidance ($18.2 billion to $18.4 billion) is in line with our $18.24 billion expectations, management expects value-added (excludes pass-through catalytic converters from revenue) adjusted EBITDA margin (excludes special items) to remain flat year over the year at 11.3%. We had forecast 11.1% 2019 value-added EBITDA margin in our previous model, but the market had expected margin expansion. After disappointing results and guidance, the stock sold-off $5 or 15%. While the stock may be volatile in the near-term as the market tries to make sense of the Federal-Mogul acquisition, we view this as an opportunity for long-term investors  to own Tenneco shares. The 5-star rated stock trades at a compelling 62% discount to our $73 fair value estimate.

We expect Tenneco organic revenue to grow 4 to 6 percentage points greater than our long-term global light vehicle demand growth rate forecast of 1% to 3%. The company benefits from tightening clean air standards for vehicle emissions and increasing demand for electronically controlled suspension. The growth of advanced driver assist systems, or ADAS, and the digitization of the passenger vehicle, provides an opportunity for Tenneco’s ride control group. Capitalizing on the need for suspension systems to interact electronically with ADAS, the company aims to continue launching intelligent suspension systems this year. As governments encourage the use of more ADAS systems through NCAP safety ratings, we expect automakers’ demand for Tenneco intelligent suspension products to outpace global vehicle production growth.