Switzerland-based Garrett Motion (GTX 1.23%) sells turbochargers to the automotive industry. Its turbochargers go in electric hybrid cars, gasoline-powered cars, and light commercial vehicles. In addition to its turbocharger business, Garrett is investing in software and powertrain for all-electric cars.
In the midst of a global auto chip shortage and a weakening euro, the company provided investors with rosy numbers and an even rosier outlook. Even so, the stock is down about 14% since the end of June while the broader market has rallied. Is this the right time to consider Garrett Motion?
Turbocharged earnings
Last week Garrett Motion reported solid earnings. Revenue was flat after accounting for the weak euro. That may not sound all that encouraging, but the quarterly revenue number was 600 basis points (that is, 6 percentage points) higher than estimated global light vehicle production.
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Garrett Motion operates in a duopoly with BorgWarner's turbocharger segment, which affords both of them significant pricing power. Thus, price increases during the quarter offset cost inflation for the company. Volumes for the quarter were down from the first quarter, but demand started to come back after the books closed in the first quarter.
That corresponds to Garrett's customer Ford, which reported a 50% increase in second-quarter revenue based on volume improvements. For the full year 2022, Ford estimates its wholesale revenue to improve by 10% to 15%. Ford management also believes the chip shortage will continue to ease in the year's second half. Those are encouraging signs for Garrett.
In the second quarter, Garrett also fully redeemed its Series B preferred stock held by former parent company Honeywell, putting its recent bankruptcy firmly in its rearview mirror. Garrett was spun off from Honeywell in 2017 along with a nagging asbestos liability that was completely unrelated to Garrett. In November 2020, the company voluntarily filed for bankruptcy to alleviate itself from the liability. During the bankruptcy, Honeywell agreed to accept redeemable Series B preferred stock in exchange for the liability.
Since its emergence from bankruptcy in April of 2021, Garrett's ample free cash flow has allowed it to improve its net debt-to-EBITDA multiple from 2.33 times to 1.87 times.
Is the stock a buy?
The future looks bright for Garrett. The company sees a massive growth opportunity in its light vehicle business. About 44% of gas and electric hybrid engines used turbochargers in 2021. As electric hybrid cars continue to sell, Garrett believes that the percentage of electric hybrids using turbochargers will increase to 52% by 2024. In another sign of Garrett's market dominance, it has already contracted more than 94% of its 2023 and 2024 revenue.
The bugaboo with Garrett is that fully electric vehicles do not use turbochargers. Though aftermarket turbochargers and electric hybrid usage should continue to provide growth for the company, Garrett is diving into the EV market. The company is devoting over 50% of its research and development budget to its EV business, which includes EV software, electric powertrain boosting, and air compressors for hydrogen fuel cells.
In its second-quarter report, management increased full-year guidance. Garrett now sees constant currency net sales growth of 5% to 10%, up from its previous forecast of 1% to 6%. On top of that, net income guidance was increased from $250 million-$295 million to $290 million-$335 million.
Garrett also plans to start buying back shares. Its board of directors has authorized a massive $100 million share repurchase program. The repurchases will be split 4-to-1 between its Series A convertible preferred shares and common shares.
Garrett is a smaller company with a market cap of only $430 million. Based on management's net income guidance and adjusting for conversion of its Series A preferred shares, the stock trades at a forward P/E of about 6.5 times at recent prices. That's an attractive valuation for a high-quality company like Garrett Motion.
