2023-05-15 15:45:37 ET
Summary
- DAN's 1Q23 results exceeded expectations, with significant revenue and EBITDA figures.
- The company's strong performance suggests underlying momentum and improved operational efficiency.
- Investments in EV infrastructure pose cost pressures and profitability challenges.
Overview
Dana Incorporated ( DAN ) designs and produces parts and systems for use in automobiles, large trucks, off-road vehicles, internal combustion engines, and other industrial applications around the world. I have written about Lear Corporation ( LEA ) previously which I saw had a positive secular uptrend (content per vehicle increase) that DAN is exposed to as well. DAN also stands to benefit from the increasing electrification of commercial vehicles, which could present a large revenue opportunity over conventional ICE commercial vehicles. In addition, I believe that the non-light vehicle market, where DAN is relatively more exposed, will continue to expand at a healthy rate over the next few years which makes it slightly more attractive than LEA in this aspect. Altogether, I am recommending a buy rating for DAN.
On track to meet guidance
DAN reported a very strong 1Q23 result that suggest underlying momentum is strong. Strong demand in all of the company's target markets and some recovery of commodity costs led to 1Q23 revenue of $2.64 billion, which was significantly higher than the consensus estimate of $2.59 billion. The company's EBITDA of $204 million was also significantly above the $173 million expected by consensus. I believe this is a key indicator of the improved state of the operating environment, the increased efficiency of operations (which was an issue previously), and DAN's electrification investments. Importantly, management has restated their guidance for FY23, which includes a revenue estimate of $10.35–$10.85 billion and an adjusted EBITDA range of $750–850 million, for a margin of just 7.2%–7.8%. Given the strong momentum in 1Q23, I was actually expecting DAN to raise its FY23 guidance, but it seems like a conservative decision given the minor headwinds that might impact results.
For instance, net cost inflation which is expected to be a $50 million headwind this year could blow up to be more than expected. Also, while commodities recovery is a positive, the guide is now a positive contribution of $70 million instead of the $85 million previously mentioned. All these individual line items might not be huge by themselves, but altogether, they can impact quarterly results by quite a bit. That said, I do see a path for DAN to beat guidance instead. A key aspect of my belief was that management expressed improved conversion rates on their traditional organic business, with approximately $420 million in sales roll-on and a conversion rate of around 19% (which is 600bps higher than the previously mentioned). I see this as a positive development because it results from a combination of factors, including a more advantageous product mix, better operational performance in the face of inefficiencies, and higher prices for new programs. If we look at the upcoming launches, FY23 is a year of many launches (about 120 launches). Notably, The Wrangler and Super Duty will be the two single largest programs annualized at well excess of $1 billion in revenue. As such, I am positive on DAN being able to hit its top line. Especially now that supply chain constraints have eased, inflation might start to come down, and importantly, there is clearly an improvement in execution (1Q23 strong result is a testament of this) which should improve margins as well.
Margin
Regarding margins, I am optimistic about management's confidence in the improving operational environment and internal execution. However, I believe that investments in EV infrastructure will continue to exert cost pressure on margins and profitability in the coming 2 years as the company works towards introducing new EV programs to the market. Over the past few earnings, management has repeatedly mentioned the need for investment in EVs – which is fair as they need to spend for base infrastructure as well as program-specific management. To put things into context, management estimates a $35 million investment headwind, or 40 basis points of margin, as increased spending on commercialization and research and development cancels out the positive impact of higher sales. I expect to continue seeing this EV investment as a headwind for the rest of the year, and this could be one of the line items that cause DAN to not beat guidance, in my opinion. Management has also put out their expectations for profitability timeline in the EV business – breakeven in 2025 (at least 2025). I believe this message has put a cap on how much margin can expand, and also investors expectation on margin expansion.
Long-term tailwind
As I have written before in my LEA post, I reiterate my points for DAN as well. If we look back the evolution of cars, the number of electrification and programming content installed have increased significantly. I believe this will continue to increase for ICE vehicles as we continue to get more use to a digital world – this would be consumer demand driven. The long-term growth driver to more content per vehicle would be the rise of Electric Vehicles. According to the IEA , more than 10 million electric cars were on the road in 2020, and 18 of the 20 largest OEM have committed to increase their offer and sales of EVs. Relative to ICE vehicles, the electric and programming content is much higher, which bodes well for DAN.
Conclusion
I believe the company is well-positioned to benefit from the growing electrification of commercial vehicles and the growth of the non-light vehicle market. The strong 1Q23 results, surpassing expectations in revenue and EBITDA, indicate a positive operating environment and improved efficiency. Importantly, management's restated guidance for FY23, despite minor headwinds, demonstrates confidence in DAN's momentum.
For further details see:
Dana Incorporated: Strong Q1 Results Suggest Strong Underlying Momentum