Description

Adient has been written up several times over the years, on both the long and short sides – so I’m going to forego the 10-k book report. Suffice it to say that Adient is the largest supplier of automotive seating in the world, with ~1/3 market share and typical output on the order of 25mm seats annually.

Perhaps the one thing I’ll note on Adient’s background is that it was another ill-fated spin out of JCI who, whether intentionally or not, saddled ADNT with a number of commercial and operational issues that had a long-lasting impact on profitability due to the long-lived nature of automotive contracts. In automotive seating, a commercial decision today will have an impact on years of production—and problems don’t immediately surface—so auto platforms need to be underwritten judiciously. This is most evident in its dramatic margin and ROIC underperformance vs its competitors, and can’t all be ascribed to structural differences. Furthermore, the company’s capital allocation policy has been littered with about-faces, impairments/write-downs, and ongoing restructuring costs.

I say all of this, because Doug Del Grosso, who joined as CEO in FY2019 is known quantity as a great operator with a real engineering background and a high degree of credibility within the automotive industry. To the extent that a portion of Adient’s underperformance was self-inflicted or cultural, the regime change marked an important turning point for the company. The issues related to COVID and the destruction it’s wrought to the supply chain absolutely postponed any hopes for a quick turnaround, but the management change will eventually yield results.

Recent Results

After weakening modestly in 2019, global automotive production sharply fell in Q2-Q3 2020 as many manufacturing plants were taken offline due to COVID restrictions. In FY2021, Adient along with the broader automotive industry experienced a considerable rebound in demand, but supply chain bottlenecks constrained production volumes and raw material inflation pressured margins across the value chain.

Notably, Adient was forced to absorb an outsized amount of this impact due to Adient’s mix of fixed-price contracts and OEM’s ability to flex orders up or down. (Note: Irrespective of the company’s marketing materials, Adient’s strong global market share and oligopolistic industry structure are not enough to shield the company from the reality that it is a below-average, capital-inefficient widget maker who will take price and eat costs on behalf of its partners.)

Some of these headwinds appeared to have stabilized slightly into 2022, until the perfect storm of commodity volatility, supply chain challenges, COVID lockdowns, and geopolitical chaos have pushed hopes for recovery further to the right. As a result, March quarter EBITDA of $159mm represented a further leg down (-45% y/y on a fully adjusted PF basis), and LTM adjusted EBITDA of $541mm marks a new post-GFC nadir against Adient’s high water mark of $1.6bn. Furthermore, the timing of a full recovery remains highly uncertain while these tensions persist.

Thesis

Notwithstanding this volatile operating environment, Adient has had success in deleveraging through non-core asset sales and swaps, contract renegotiations, and scaling back the capital intensity of its former SS&M segment.

Furthermore, normalization of auto production is a matter of “when” and not “if”. Looking ahead, the profound supply-demand imbalance for light vehicles globally provides a strong backdrop against which Adient can continue to drive volume growth, streamline its cost structure, and ultimately continue to delever toward its 1.5-2x target range.

The same factors that make Adient a mediocre company while it’s overearning, make it an interesting recovery play at the troughs. The equity implies a valuation of at 8.5x EV/LTM EBITDA, but sub-3x my FY26E EBITDA.

Just for illustrative purposes, if Adient were to hit management’s long-term profitability targets for the problematic SS&M segment, and Adient’s core business were to achieve 2017 levels of profitability (they were overearning, to be clear), this would imply a 2.5x enterprise multiple and a 40-50% levered FCF yield. Again, my base case doesn’t sniff these levels.

I don’t have a particularly positive view on the company through the cycle—I don’t think Adient will achieve margin or capital efficiency parity with Lear, for instance—but I do believe the present valuation is overly punitive for a business with a decent balance sheet, a much improved management team, and nearing the tail-end of a horrific down cycle.

As for timing of a cyclical rebound, I have little intelligent to say beyond noting that the backdrop can’t get much worse than it is today. I’m modeling -$56mm of FCF for FY22—easily digestible with $1.1bn in cash—after which I expect gradual improvements in fiscal years 2023 and 2024. I penciled in ~$970mm of EBITDA for FY23, with a little bit of benefit from burning off peak working capital—which gets me to ~$500mm of FCF. In total, I’d expect Adient to average in excess of $500mm of FCF from FY24-26, which would allow the company to achieve its target leverage and evaluate buybacks. Last thing I’d advocate for is reinvestment back in this business—which I guess underscores my views on the idea outside of valuation and likelihood of cyclical overearnings.

Catalyst

Unprofitable contracts finish burning off, streamlining and restructuring efforts bear fruit, core earnings return back to mid-cycle (or better) levels

Meanwhile, the auto supply chain gradually eases (basic material cos and other suppliers are indicating some green shoots today), and volumes return to pre-covid levels