DAN - Dana Incorporated: Another Chance To Buy The Stock

2023-11-27 17:55:09 ET

Summary

• I re-recommend a buy rating as the stock price is attractive at this level.
• Despite concerns over slowing EV adoption, Dana's fundamentals remain strong and its EBITDA margin performance is expected to expand.
• The end of the UAW strike removes uncertainty and Dana is expected to meet its guidance, indicating potential for a stronger year in FY24.

Investment action

I recommended a buy rating for Dana Incorporated ( DAN ) when I wrote about it t he last time in May, as I expected the business to benefit from the positive secular uptrend that I had identified, such as the increasing electrification of commercial vehicles. Based on my current outlook and analysis, I recommend a buy rating. I believe the current stock price has provided another opportunity for investors to buy the stock. DAN fundamentals remain strong, especially its EBITDA margin performance, which I believe can continue to expand back to the historical level of 10+%.

Review

After my post in mid-May earlier this year, the stock skyrocketed to a high of ~$20 in August, an almost 50% gain from the time of the previous post. Since August the stock has dropped back down below $13. To those who managed to exit at the top, congratulations. For those who missed out on that ride, I think the current valuation presents another buy opportunity. While the share price has tracked downward since August, I believe the fundamentals remain very solid, especially after reviewing the latest results. DAN reported overall revenue of $2.669 billion, driven by Light Vehicle Driveline revenue of $1.084 billion, Commercial Vehicle Driveline revenue of $535 million, Off-Highway Driveline revenue of $739 million, and Power Technologies revenue of $311 million. I believe one of the reasons why DAN’s stock price continues to see pressure is because of the slowing EV adoption concern, which indirectly impacts DAN as the narrative of “vehicle electrification." Especially with several negative headlines (by Forbes , Reuters , S&P , etc.) floating around, this would have certainly caused some investors to panic if they were not following the company deeply. However, I believe the impact is not as big as it seems. Thanks to postponing EV spend and incremental efficiencies in ramping for EVs, DAN managed to reduce investment drag for EVs (electric vehicles) to less than $20 million. It is also worth mentioning that DAN's EV-exposed backlog for Light Vehicles is relatively small, considering it was the last segment to electrify, and that the EV backlog for LVs typically falls outside of its current three-year backlog. This also means that EV is not going to significantly change the growth outlook for the next 2 to 3 years.

Another point to note on growth is that while EV adoption seems to be slowing, this does not mean that EV adoption is coming to a halt. I still believe EV adoption is in its early stages. The key problem is affordability , and with all the brilliant minds working on driving costs down, especially with better battery technology appearing every now and then, I am inclined to believe the cost of an EV will be similar to that of an ICE vehicle in the future. Suppose EV adoption recovers in the near term. DAN is also well positioned to take advantage of this growth. Note that DAN’s equipment capacity is modular and it has sufficient human capacity; therefore, DAN will be able to scale up as the customer's demand pulls through and invest more reactively to better align with demand.

Margins

DAN reported EBITDA of $242 million, implying a margin of 9.1%, which is well above the consensus estimate of $205 million at a 7.6% margin. Importantly, the strong margin improvement proved that DAN could further expand its margin back to double digits (it was at low teens pre-covid). Dissecting the margin expansion shows that DAN generated traditional organic EBITDA growth of $35 million on $20 million in traditional organic sales growth. Assuming a 20% incremental margin (management did not reject this 20% assumption during the call), traditional organic growth contributed ~$4 million in organic EBITDA. This suggests that $31 million of the organic EBITDA growth was contributed by improved operating performance. This is a strong message, in my opinion, as it indicates that Dan is operating at a much more efficient level. Hence, on a like-for-like basis (vs. pre-covid), DAN should be able to achieve a higher margin.

“the biggest single chunk of that is really operational, right? To be very honest, right?” 3Q23 call

Meeting guidance is not an issue

In the earnings report, management updated their 2023 guidance to account for two possible outcomes from a strike: one where the strike ends in October (the higher end of this scenario guidance is the middle point of the previous guidance), and another where the strike continues all the way through the end of the year (the lower end of the new guidance). Now that the UAW strike has ended, this has certainly removed any uncertainty that the market might have regarding DAN meeting the high end of its guidance. However, what was notable is that even with the strike, DAN's full-year guidance suggests that it can still meet the midpoint of its prior guidance, which is very impressive. This also indicates that FY24 might be a stronger year on a y/y basis, as FY23 is an easy comp. In terms of numbers, DAN guided an adjusted EBITDA range of $760–$850 million on lower-than-expected sales of $10.2–10.7 billion, indicating a margin of 7.5% to 8%.

Valuation

With the UAW strike ended, I believe DAN will be able to meet the high end of its FY23 guidance with no issues. I modeled the same 5% growth for FY24 and FY25, as I remain conservative on the recovery of EV adoption. However, I expect margin to expand back to DAN historical lows as the business seems to be operating much more efficiently and on a larger scale. To value DAN, I looked across all the global auto parts manufacturing players and compared their growth and EBITDA profile against DAN’s. On average, DAN has a similar growth profile, and with my outlook for DAN EBITDA margin to expand to ~10%, I think DAN deserves to trade at a similar level to peers (~4.7x forward EBITDA).

Risk and final thoughts

As DAN invests in the necessary infrastructure to launch new EV programmes, I have concerns that EV investments could put pressure on FY24 margins. If this electric vehicle investment takes off at a faster rate than I anticipate, it may take more time than anticipated to achieve a margin of 10% or more.

Overall, I think the current stock price for DAN is an attractive buying opportunity. While concerns over slowing EV adoption have affected market sentiment, DAN's ability to efficiently manage EV-related costs and its limited exposure in the short-term backlog diminishes the impact on its growth trajectory. The company's modular capacity and proactive scaling strategies position it favorably for future demand surges, including potential EV market recoveries.

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