Dana Stock: Serious Margin Challenges Too Spicy For The Street (NYSE: DAN)

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connecting the propeller shaft assy

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I pushed my luck.

Writing about Dana (DAN) in March of last year, I was encouraged by the strong performance of this light truck and commercial vehicle supplier during the pandemic, as well as its underrated leverage to electrification. Unfortunately, input costs and issues tied to OEM production schedules hammered the business, especially in the second half of 2021, and sent the shares down about 30%, worse than the 20% to 25% declines for most commercial vehicle suppliers like American Axle (AXL), Cummins (NYSE: CMI), CVG (CVGI), Meritor (MTOR) (pre-deal), and so on.

The margin weakness is disappointing to be sure, but I do not believe it necessarily reveals any fundamental weakness in the business or its management, as I believe the circumstances of the last six to 12 months are far from typical. Moreover, I still see a meaningful electrification opportunity here and a pretty compelling valuation that can drive double-digit future annualized returns.

The Spicer Story Is Well-Seasoned And Ready To Cook

I do not expect the debate over the electrification of light trucks, commercial, and off-road vehicles to end any time soon, and I fully expect people to continue claiming it’ll never happen while electrified trucks are passing by outside their windows. I do continue to believe, though, that Dana is well-placed for this evolution, and not only is not all that vulnerable to electrification cannibalizing its business, but positioned to leverage content growth from evolution.

Dana has developed a range of electrification products under its core Spicer brand, including e-Direct Drives (e-motors, inverters, battery packs, and software), e-transmissions, and e-axles (which include motors, an axle, a gearbox, an inverter, and software), as well as thermal products used to cool and monitor batteries. All told, management increased their estimate of net content growth opportunities to 3x that of current vehicles, versus 2x in the past, while also noting that many EV configurations will still require axles and prop shafts (where the company is already strongly positioned).


Dana Inc (investor day presentation)

Management has also argued (including the September Investor Day and in sell-side presentations) that OEM insourcing is not the threat that some bears believe. I’ve argued this for some time, but whereas my position has been that many OEMs will try to insource and ultimately outsource when they appreciate the scale of the task, Dana management argues that they do not see much evidence of OEMs insourcing components that they do not already insource. I suspect this difference may be one of perspective, given Dana’s focus on trucks, vans, and commercial vehicles as opposed to sedan cars.

I also believe there could be some upside to management’s targets. I’m including the slides from that Investor Day, where you can see their estimates of electrification within various markets by 2025 and 2030. While I think the heavy-duty truck penetration number for 2030 could be a bit high, I think the mining and ag numbers could well prove meaningfully low.

EV adoption 2025

Dana Inc (investor day presentation)

EV adoption 2030

Dana Inc (investor day presentation)

Waiting For Normalization

There’s no question that 2021 was a tough, disappointing year for Dana and that guidance for 2022 suggests more of the same. I previously thought that Dana would get to double-digit EBITDA margin in 2022, possibly even as high as 12%, but management’s guide to start the year was 9.6% at the midpoint and 12% may still be a stretch for 2024.

Dana has seen the same input cost pressure as everybody else, and there’s not much they can do about it. As I mentioned in a recent article on CVG, OEMs often have brutal contract terms with suppliers, including mandatory cost-downs irrespective of what’s happening in the broader market. When steel, logistics, and other costs go up, particularly when they go up a lot and do so quickly, there’s not much companies can do to offset the pressure.

Worse still, the erratic production schedules of OEMs make it harder to operate efficiently. With OEMs scrambling to get the components they need to finish units (semiconductors, in particular), there’s been a lot more “stop, restart, rush, stop again, start again” behavior in production, and it’s hard to run a manufacturing operation efficiently under those conditions.

I expect chip availability will be an issue for the bulk of the year, leading to more production push-outs into 2023. I do not think conditions will get much worse (famous last words, I know…), but it likely won ‘ t be until 2023 at best where Dana seems more normal behavior, and even then I would expect to see OEMs pushing hard to catch up on their backlogs / order books.

The Outlook

Dana has long enjoyed strong share in its core businesses, and the current EV project win list is a who’s who of quality names in pickups, medium / heavy-duty trucks, mining and so on, including Ford (F), General Motors (GM), Komatsu (OTCPK: KMTUY), and PACCAR (PCAR), as well as newcomers like Rivian (RIVN).

EV component development will still weigh a bit on results, but the company is already seeing significant launches in 2022 and this should be a growth driver across the next decade given the content opportunity and the opportunity to pick up business in under-penetrated markets like mining where Dana has historically seen more insourcing but where OEMs need expertise they do not have, particularly in high-torque, high-payload applications where Dana has a lot of knowledge and where electrification challenges can be even more acute.

I’m expecting long-term normalized revenue growth of a little more than 3%, and that could prove conservative if the company really delivers on content growth and can use electrification to drive increased penetration in areas like mining and high-HP agricultural equipment.

My near-term margin assumptions are obviously lower now, but I do think 12% to 13% EBITDA margins are possible ahead of the big EV push, and I think long-term FCF margins can climb toward the mid-single-digits over time . This may be the most bullish part of my modeling, as Dana has historically generated FCF margins around 2%; I believe content growth will create margin leverage opportunities, but OEMs may succeed in limiting their margin leverage. If there is no historical FCF margin leverage relative to past experience, the shares would be fairly valued today.

With the modeling assumptions I’m using, though, these shares look quite undervalued, with a double-digit annualized total return potential even with a double-digit discount rate. The shares likewise look undervalued on a margin basis even with the hit to near-term expectations; a 9.5% EBITDA margin can support a 0.6x forward revenue multiple or a fair value of around $ 26. Even with a more bearish multiple of 0.5x (the low end of the historical range relative to Dana’s expected margins), there would still be upside to around $ 20.

The Bottom Line

I do not think there’s anything fundamentally broken with Dana, though the cost / margin issues are significant in the short term and have taken all the momentum away. As seen with the recent Cummins deal for Meritor, though, there’s value in commercial vehicle electrification, and I think Dana still has credible underrated leverage there. It may take a little while for these shares to move again given limited prospects for substantial near-term operating leverage, but I think patient investors will be rewarded.

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