The interview includes the G&D standard ‘how did you get into the industry’, ‘describe your approach’ and ‘advice for students’. [Tangentially, while there are certainly some notable exceptions, it seems the more interviews I read, the more the answers all sound the same.] In this interview though, managing partners Michael Blitzer and Guy Shanon went deep into the fund’s largest position, Adient plc (ADNT), something many interviewees seem to avoid. The fund actually owns over 2.5% of the company’s shares and is one of the largest non-ETF owners.
For those who don’t remember or who haven’t been reading our site (shame!), Johnson Controls (JCI) spun off its seating business, Adient, last October. The transaction came about a month after the company completed a merger/inversion deal with Tyco and as a result, the spinoff was actually taxable for shareholders. The company argued that shareholders will benefit over the long term due to the lower overseas tax rate (debatable now), but interestingly, the lower rate isn’t really what is driving Kingstown’s interest in the name:
From an initial search process, it’s an example of something that struck our interest given the structure and nature of the spin off. It was a much smaller subsidiary, it was in a different industry, and it was an underinvested business of the parent. It’s also a very misunderstood business. Like many of its auto part competitors, it’s viewed as a very low quality and cyclical business and thus not favored by JCI investors. This bias along with a lot of forced selling, because it is no longer part of the S&P 500, pushed valuation to approximately 4x to 5x earnings late in 2016. But, if you look at the company, there are many competitive barriers to entry in an industry dominated by two main players and the business is actually more of a high-return just-in-time logistics provider and supplier than an old-line manufacturing company. The prior Vice Chairman of JCI is the new CEO of ADNT. He has a very significant compensation package that he converted from JCI that we think aligns well with future growth opportunities.
Furthermore, Kingstown thinks Adient will benefit if the trend towards autonomous cars pick up since the interior will become more of a focus of the car. The managers acknowledge that one of the big risks to the name is the ‘cycle’ and whether or not we are currently sitting at the peak. Read the entire interview for a more complete understanding, but in conclusion:
We think ADNT is going to generate $9 in earnings this year. Their margins are a lot lower than Lear’s despite the fact that ADNT is significantly bigger and there are real benefits of scale in this business which favors large global platforms supplying very large customers. These lower margins just relate to underinvestment in the business while controlled by the prior parent. Management has a plan over the next couple of years to at least match Lear’s margins, which at current volumes would take them from $9 to $12 or $13 a share or more. This was a stock that got as low as $45 in November and is still only $60 today. I think it’s a unique example of being able to purchase something with a pretty attractive growth opportunity at a mid-single digit earnings multiple.
Adient’s stock has performed quite well since the spinoff and it is certainly a popular name for many value investors. Just check out the writeups on Value Investors Club. Barron’s also recently published a piece recommending the name and essentially made the same arguments in favor of the company – underinvestment, potential margin expansion, cheapness etc. – that Kingstown pointed out. The article leans heavily on a recommendation from RBC’c Joseph Spak who put an $85 price target on the name, representing quite a bit of upside from today’s prices.
We have been watching Adient for a a bit now and the arguments in its favor are compelling. The shift to autonomy could be a wash. While the interior will be more of a focus, production and ownership levels could drop dramatically leading to fewer seats overall. The real concern is the ‘cycle’, although there are some also uneasy with giving such weight to its Chinese JV. What do you guys think?
Disclosure: Author currently holds no position in any stock mentioned.
KT loved $OCN in $30s and $40s and sold quite a bit in the $2s… I’ll take my chances elsewhere, thank you …