Description

Cooper-Standard (CPS) was last written up in 2016 by HighLine09 and that report provides some good background information on the company. Since that time the stock reached a peak of $145 in 2018 and fell to as low as $8 in March of 2010. The stock today trades at $37 for a market cap of $630m. They have $440m of cash and $1.1bn of debt for a total enterprise value of $1.35bn. A lot has gone wrong for the company the past two years - their exposure to Europe, the new Ford Explorer rollout, and lastly COVID and industry shutdowns last year. I believe we are at an inflection point where earnings will accelerate given the company’s right-sizing of operations and industry tailwinds.

Cooper-Standard is an automotive supplier with leading positions in sealing systems ($1.5bn annual revenue, 51% of total company revenues and #1 share globally), Fuel and Brake delivery systems ($600m annual revenue, 25% of company revenues and #2 globally) and fluid transfer systems ($400m annual revenue, 20% of company revenues and #3 globally). Their largest customers are Ford ~25%, GM ~22% and FCA ~11%. Revenues are split 51% North America, 26% Europe, 20% Asia Pacific and 3% Latam. It is important to note that their content is weighted towards light trucks, SUVs and CUVs (~73% of global revenues and 88% of North American revenues) and the top 10 platforms, including the Ford F-150, Explorer, Chevy Equinox account for 45-50% of 2021 revenue.

What went wrong?

In 2017 CPS reported adjusted EBITDA of $461m, up from $414m the prior year and had initially been guiding to growth in 2018. However, they got hit by several one time factors that snowballed into a massive headwind.

The first was Europe where they had exposure to several luxury German OEM manufacturers who got shut out from the China market. As the Chinese market fell (SAAR in China went from ~25mm+ vehicles in 2017 to under 20mm in 2019) CPS customers who were exporting their sedans were forced to retrench. CPS European revenues declined from $1bn to $600m and earnings I estimate declined by ~$100m-$150mm from operating deleveraging. In 2020 CPS sold a significant part of their European operations and today have a much more nimble and flexible operating base.

The second major headwind was their exposure to the new Ford Explorer. This is their second most important vehicle (they provide the sealing, hose, fuel and brake lines) and in 2018 Ford built a new factory in Chicago to produce this vehicle. The new factory was a disaster (see here: https://www.bloomberg.com/news/articles/2019-10-21/ford-botches-explorer-launch-putting-ceo-back-on-the-hot-seat). Production was shut for months, vehicles were piled in remote locations and the factory operated at inconsistent production levels. CPS' exposure to this vehicle wasanother major headwind. The issue has been resolved but I estimate this was $50mm+ headwind to 2019 earnings.

Finally, COVID was a major headwind as 2Q auto production fell to nearly zero which for a high fixed cost business like CPS was a disaster. EBITDA guidance which had been $150-200m in February of 2020 came in for the full year at just $36m. Taken together, I estimate the decline from 2017 EBITDA of $461m to $36m was as follows - $150m from Europe, $200m from COVID and $50m from the Explorer. 

Outlook:

I believe the worst is behind for CPS and that the stock has largely been forgotten which is the opportunity. We have gone from 7 analysts to 1 covering the company. CPS made significant cost cuts in 2019/2020 through closing 5 plants globally and divesting 11 in India/Europe, reducing headcount and limiting discretionary spend. This has resulted in a cost base that is $80m below where it was in 2019. In spite of the cuts they have continued to operate well for their customers. The company has a 98% on-time performance rating for new launches. North American SAAR is rebounding strongly and that is CPS’ strongest market.

The company has provided the following guidance relative to 2020. They believe they can achieve a 10% sales CAGR through to 2023, achieve adjusted EBITDA margins of >10% with capital expenditures of less than 5% and achieve returns on capital >10%. If they hit those targets, which I believe will likely prove conservative given the operating leverage in the business and the fact that North America has shown the ability to earn mid-teens EBITDA margins this is what the business will look like:

The company should be able to earn ~$6.00 of fully taxed EPS in 2023 which assumes they use cash generation in the interim to pay down their high cost debt. I also present an upside case that shows what the company can earn based on their current footprint and should they get back to the profitability they had in 2017. Note that in 2016/2017 the company had a 20% pretax return on tangible capital and margins were 12-12.5% with expectations of getting to 15%.

I am not arguing that CPS is a compounder nor is it an asset light business that deserves a large multiple. I do, however, believe it is a much better business than its recent history would suggest and that management is focused on the right things – fixing the cost structure, focusing on the profitable areas of growth and improving returns on capital. I think $6 of EPS is reasonable in two years and that number should grow from there. At 10x that would be a $60 price target representing 60% upside.

Optionality:

Applied Materials Science: CPS has developed a unique material called Fortrex which is a new class of lightweight elastomers which can be used in everything from automotive seals, cable seals, footwear, piping, etc. It can reduce weight by up to 30% compared to traditional EPDM rubber and the cost to produce is much less (though it is priced at a premium). In 2018 it won the automotive PACE Award and management has been signing contracts (6 so far) with industry producers to license and commercialize the product. Revenue has not been meaningful and for several years management has been slowly developing the market through signed contracts and testing (Polyone/Avient is a major customer). Having seen this product and understanding its capabilities I believe it can become a major profitability driver in time. I don’t think the company at the current share price gets any benefit for this product.

You can find a good summary here: https://www.cooperstandard.com/products/material-compounding-licensing/fortrex

Electric Vehicles: CPS is currently a supplier on 16 of the top 25 best selling EV platforms and was awarded $100m in new EV business in 2020. The company expects revenue to grow at a 50% CAGR over the next five years and the content per vehicle for CPS in an EV relative to an ICE is 20% greater. Specifically, while there is no change in the sealing content (though given the weight of an EV they prefer using Fortrex seals rather than EPDM), fluid transfer content actually increases given the need to cool the battery. 

Catalyst

2020 Earnings were a trough and 2021 SAAR combined with cost cuts should provide earnings inflection.