GTX - Silver Ring Value Partners - Garrett Motion: Why Own The Stock At All?
2023-11-03 11:15:00 ET
Summary
- Garrett Motion's fundamentals are in line with expectations, but the conversion of preferred stock to common equity reduced the position size.
- The company is the top producer of turbochargers for internal combustion engine cars, but faces challenges from the increasing penetration of electric vehicles.
- The stock price is currently low, but there is uncertainty about the company's future in the EV market and the risk of mismanagement or customer demands.
The following segment was excerpted from this fund letter.
Garrett Motion ( GTX )
The fundamentals at the company are tracking in-line with my base case expectations. What made me reduce the position size from a medium one to a small one was that our preferred stock was converted into common equity.
When we owned the preferred stock, we had a particularly asymmetric risk/reward given the contractual downside protection offered by the preferred. After the conversion into common stock, that extra protection is gone, making the investment less attractive.
Why own the stock at all?
Garrett Motion is the #1 maker of turbochargers for cars that use an internal combustion engine ((ICE)). The business is typically very predictable, with design wins mapped out years in advance, and the industry is a concentrated oligopoly. The positive force driving growth has been the increasing penetration of turbochargers. The new negative force is that electric vehicles (EVs) are taking share and they don’t need a turbocharger.
At reasonable EV penetration rates the company will see its revenue growth flip from positive to negative, most likely 3 to 5 years from now. Whereas management is trying to invest organically in EV-related technology to address this large market, their success here is highly uncertain and material revenues won’t appear for at least 5 years.
Most investors stop there, call this business a melting ICE-cube (pun intended) and pass. The twist is that at the current stock price the likely Free Cash Flow ((FCF)) over the next 5 years is roughly equal to the market capitalization of the company. So this is an example of high uncertainty (about what happens to the business after year 5), but low risk of permanently losing capital.
While the risk is low, it’s not zero. Management could waste its FCF on EV-related acquisitions.
That’s mitigated somewhat by strong value investors on the Board, but it can still happen. Furthermore, there is always the risk that large powerful customers extract economics from the company in unexpected ways. The automotive value chain isn’t known for attractive returns for suppliers.
With the stock at around 60% of my Base Case value that does not include success in the EV market and a moderate downside to the Worst Case, a small position is warranted but a larger one is not.
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Silver Ring Value Partners - Garrett Motion: Why Own The Stock At All?