By conventional valuation measure shares in roofing, insulation, and composite materials manufacturer Owens Corning (OC 0.58%), axle and drivetrain technology company Dana (DAN 2.46%) and automation and power transmission technology company Altra Industrial (AIMC) are cheap stocks. Although all three face headwinds in 2020, their valuations appear to have Armageddon scenarios built in, and merely avoiding worst-case outcomes could lead to strong price rises. Let's take a closer look at all three.
It hasn't been a perfect year for the company. Slowing industrial production growth negatively affected its composites segment and lower volumes and production curtailments in the North American residential fiberglass market led to lower profits at insulation. Meanwhile, management expects U.S. industry shingle shipments to be flat in 2019. On the bright side, Owens Corning's roofing sales are expected to rise due to taking market share -- partly down to more favorable geographic exposure.
Looking ahead, management is taking action to produce annual cost savings of some $25 million by 2021 in insulation. Hopefully, a pick-up in industrial production in the second half of 2020 will also aid its composite segment.
Roofing demand is always a function of a combination of underlying conditions in the housing market and the effects of weather and major storms. Around 70% of demand comes from repair and remodeling and new construction. Clearly, there's scope for volatility in roofing revenue due to the weather, but underlying conditions in housing remain positive.
House prices continue to rise, new housing permits are growing again, and the U.S. months supply of new single houses has dropped to levels indicating a need for housing expansion.
All told, Owens Corning looks capable of getting back on track in 2020. What's more, its stock is trading on a forward PE ratio of less than 13 times earnings and 15 times current free cash flow (FCF). It looks like a good value stock.
These two companies have three things in common:
- Heavy exposure to the truck production market, which is expected to drop significantly in 2020, but then stabilize and start growing again in the 2021 time-frame.
- They trade on very attractive valuations -- see chart above.
- They are set to generate bundles of cash flow in the coming years, and this should offset concerns about their elevated debt levels.
Starting with Dana, it's no secret that the light vehicle market (Ford, Jeep, and Nissan are key customers and Dana generates around 40% of its revenue from the market) and the heavy truck market -- (Daimler, Navistar (NAV) and PACCAR are key customers and Dana gets 29% of its sales from the market) are set for a difficult 2020. Meanwhile, its off-highway sales -- 21% of revenue -- could also be challenged if the dim outlook given recently by another customer, Deere, is correct.
Indeed, here's a look at the recent industry estimates given by Navistar on its recent earnings report.
It's not going to be a great year for an axle, power technology, and driveshaft manufacturer like Dana, and just as Navistar dampened down expectations recently, there could be more negative news to come.
But here's the thing. Dana's valuation is so cheap that you can't help thinking there is a huge margin of safety baked in. For example, the company's current market cap is $2.6 billion; add in net debt and it gives an enterprise value of $5.2 billion.
Digging into the details, on the investor day presentation in March 2019, management outlined expectations to generate $2 billion in free cash flow from 2019-2023 with free cash flow jumping from $243 million in 2018 to $465 million in 2020. Obviously, expectations have been reduced in the near term due to the slowdown in the economy, but Dana is still expected to produce around $230 million in 2019 leading to $409 million in 2020 -- equivalent to around 15% of its current market cap. https://danaincorporated.gcs-web.com/static-files/3dd7d370-0992-4b4c-a1df-5c614f8a1247
Frankly, the light vehicle and truck market is going to have to enter a sustained downturn before Dana doesn't look like a good value.
Altra Industrial Motion
Around a quarter of this company's sales go to the transportation market, and Altra also has significant exposure to other markets, such as factory automation (15% of sales) and a bunch of other heavy industries such as energy (7%), metals and mining (7%), and materials handling (6%).
It all adds up to a difficult 2020, and analysts have sales dropping 3.4% in 2020 only to grow again by a similar amount in 2021. It's a sobering outlook, and just as with Dana, don't be surprised if there are some negative revisions to expectations along the way. Such things happen when end markets are trending downwards.
That said, management expects $1 billion in free cash flow over the next five years. Given that Altra only trades on a market cap of $2.3 billion and an enterprise value of $3.8 billion, there appears to be a significant amount of leeway built into the current valuation so as to deal with anything other than a severe downgrade to expectations.
Stocks to buy?
If you can ignore some potentially bad news and possible downward revisions to earnings expectations in the coming months, then these stocks might work for you. They all look cheap on a free cash flow basis, and provided the economy doesn't enter a severe contraction, they are likely to look like a very good value at the end of the year.