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TRW AUTOMOTIVE HOLDINGS CORP  (TRW)

Last Updated: May 3, 2012


Research Note - May 3, 2012

There was nothing particularly unusual or noteworthy about TRW's Q1 results. Sales were up 2.5%, although taking out currency effects and divestitures, sales were up better than 5%. Operating margin improved to 7.5%, the best performance in many quarters, mainly due to lower legal costs as the anti-trust case against several automakers could possibly be winding down. TRW commented that auto sales in North America have been very strong, up 16% year-over-year, offsetting similarly weak performance in Europe, where low consumer confidence led to a 5% decrease. TRW's concentration in luxury brands helped soften the blow there. Emerging markets continued to be strong, with Brazil and China growing 15% and delivering about 15% of the company's revenues.

The outlook for 2012 continues to be about flat with 2011, but management re-iterated its belief that revenue growth would accelerate into the 2013-14 time period due to several ongoing investments into higher-margin opportunities. I'm raising the sell early price modestly to $65.

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Business Summary

TRW Automotive is one of the largest automotive parts and systems manufacturers in the world. The company's primary focus is on development of safety systems. Chassis systems (59% of sales) consists of steering, braking, and suspension systems. Occupant safety (24%) includes air bags, seat belts, steering wheels, vehicle security (such as locking), and safety electronic systems. Automotive components (11%) includes body controls, engine valves, and various fasteners and components. Finally, Electronics (5%) consists of a wide array of sensors, driver assist systems, and other control units. Some examples here would be keyless entry, crash sensors, and cruise control. TRW is considered a "Tier 1" supplier, with 85% of sales made directly to vehicle manufacturers. Europe accounts for about 49% of sales, North America 32%, and Asia 14%.

Growth Strategy

There is plenty of growth potential for TRW. Automobile sales in developed geographies such as North America and Europe are highly cyclical, and the industry continues to bounce off 30-year low volumes in the 2008-09 period. Consider that before the "Great Recession", U.S. auto sales averaged about 17 million a year, while 2011 barely exceed 13 million, and 2012 looks to be only around 14-15 million. The scrappage rate in the U.S. is nearly 15 million a year, indiciating plenty of room for continued domestic recovery. Meanwhile, China is expected to post 6-11% annual growth in vehicles, India 16-18%, and Brazil around 10% over the next several years. TRW in particular stands to benefit from increased government safety regulations that will require greater expenditures on the kind of products the company sells. The company has also made significant restructuring and debt reduction progress, improving operating margins and lowering interest burdens, which all flows to the bottom line earnings per share number.

Competitive Position

There is plenty of competition in the auto supply chain. TRW's most direct competitors are Autoliv (particularly in safety and electronics), Bosch, and Continental-Teves, although several others compete in individual product lines. TRW enjoys several competitive advantages. First, it is a geographically diverse company with 180 facilities in 26 countries around the world, providing parts near wherever automakers choose to build their vehicles. Second, the firm has long-standing relationships with automakers, and its systems are "sticky" - difficult for customers to switch out once designed in, and most vehicle platforms are developed on 5-7 year schedules. Lastly, TRW can boast of solid financial footing, often a problem in the auto parts industry, and making the firm more attractive to potential customers. Competitive advantages are quite good here.

Risks

TRW has to be considered an "aggressive" pick given the difficulty of the industry's dynamics alone. Vehicle sales are hugely dependent on the overall economic environment, and continuing high unemployment could crimp the ceiling for them. Labor strikes have plagued the industry since its beginning. Commodity costs, particularly steel, aluminium, copper, and energy, are unpredictable and difficult for TRW to pass through to customers (although this can work both ways). Tight credit markets, as we continue to experience, can limit the ability of many people to purchase new automobiles. TRW is reliant on just 4 customers - VW, Ford, Chrysler, and GM - for over 60% of sales. The loss of any one of these would be devastating. Finally, TRW's largest market is Europe, a region that is experiencing several sovereign debt crises and low consumer confidence, both of which are crimping automobile sales growth at present.

Management

John Plant is the chairman and CEO, holding the latter position effectively since 2001. Prior to that he was president of Lucas Varity Automotive prior to its acquisition by TRW in 1999. The CFO, COO, and most of the VPs have been in place since the early 2000's, giving TRW a seasoned management team. Blackstone (a private equity firm) owns about 16% of the company. Restructuring and debt reduction efforts over the last few years have been successful, and major share dilutions should be behind us after 2010's share secondary offering. This management team seems to have the company on the right track to continue delivering attractive returns to shareholders.

Financial Health

TRW, like many auto suppliers, has traditionally carried a less-than-stellar balance sheet, but this is changing. Currently the firm has $1 billion in cash vs. $1.5 billion in total long-term debt. The nearest major maturity of debt is in 2014, with about $770 million due. This is a concern that management is well aware of, and I expect early repayments to continue and the balance to likely be refinanced or paid off using the firm's undrawn $1 billion credit line. Interest coverage is fine at 10 times and rising. TRW is solidly cash-flow positive, with annual free cash flow coming in around $500-700 million. Returns on capital have dramatically improved to near 20% from under 8% even before the Great Recession. Simply put, TRW is in fine financial shape, even for a highly cyclical business.

MagicDiligence Opinion

It is no surprise that investors remain gun shy about the automotive sector after the debacle of 2008-09, when one auto firm after another went bankrupt or had to take to begging for government loans. But a lot of lessons were learned there, and TRW in particular is a much leaner and efficient firm than it was before. Even at lower vehicle volumes, TRW is generating record sales and profitability right now. It seems inevitable that at some point, U.S. and European auto sales will return to historical levels about 10-20% higher than current rates. Emerging economies are set to deliver double-digit auto sales growth for many years to come. Combine these with ever-increasing safety and sensor content on cars (think curtain air bags, electronic steering controls, lane assist sensors, etc.), and TRW's market opportunity looks enticing. It also gives our Top Buy portfolio some exposure into the auto sector where we had none before. The initial sell early price on TRW is $65.

Steve owns shares of TRW Automotive Holdings Corp

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