2023-11-01 04:15:33 ET
Summary
- Revenues have increased significantly in recent years, but are expected to moderate in the foreseeable future.
- Profit margins improved significantly in the third quarter of 2023, but high volatility remains a concern.
- The balance sheet is very strong as cash and equivalents and inventories are significantly higher than long-term debt.
- Long-term debt is starting to decline after two acquisitions carried out in 2022.
- This represents a good opportunity for investors with enough patience.
Investment thesis
Gentherm (THRM) is recovering from some weak quarters strongly impacted by the current macroeconomic context, especially in terms of profit margins. Material and wage inflation, supply chain issues, and increased freight costs have negatively impacted profit margins since 2021. Still, decreasing freight costs have allowed a significant recovery in profit margins in the third quarter of 2023. To this, we must add that sales have expanded by 14.57% in 2021 and by 15.15% in 2022 as the company continues making acquisitions. The balance sheet is very robust as cash and equivalents and inventories are, together, much higher than long-term debt, so despite more modest revenue growth forecasts, the company can still continue to expand through more acquisitions, and positive cash from operations should, at the same time, allow more share repurchases to be carried out in order to reward shareholders while reducing long-term debt. Also, investors should not forget that current headwinds are likely of a temporary nature due to their direct link with the macroeconomic context, so these should eventually disappear.
For these reasons, and despite growing concerns of a potential recession due to recent interest rate hikes carried out to contain high inflation rates, I consider that the recent 58% drop in the share price from all-time highs represents a good opportunity for investors with enough patience to wait for prospects to improve again as the company is prepared to navigate current headwinds for a very long time thanks to its strong balance sheet.
A brief overview of the company
Gentherm is a leading global manufacturer of thermal management and pneumatic comfort technologies for the automotive industry, but the company also has some space in the medical patient temperature management systems market. The company, which was founded in 1991, supplies leading automotive players and enjoys a $1.34 billion market cap as it employs over 14,000 workers worldwide.
Gentherm operates under two business segments, Automotive , which provided 96% of the company's total revenues in 2022, and Medical , which provided the rest, which means most of the company's operations take place in the automotive industry, and even though sales have expanded significantly in recent years, more modest expected growth rates and a recent contraction in profit margins have caused a significant drop in the share price.
Currently, shares are trading at $41.34, which represents a 58.24% decline from all-time highs of $99.00 reached on January 14, 2022. This essentially reflects the growing pessimism among investors despite significant growth experienced in recent years boosted by acquisitions as profit margins are currently depressed.
Recent acquisitions and divestitures
In order to expand its operations, the company has carried out some acquisitions in recent years, which have taken place without compromising the balance sheet thanks to relatively high profit margins that allow for reliable cash from operations.
In November 2017, the company acquired Etratech , a manufacturer of advanced electronic controls and control systems for the automotive, RV and marine, security, medical, and other industries, for ~$64 million.
Later, in February 2019, the company divested its Cincinnati Sub-Zero Industrial Test Chamber business for $47.5 million after acquiring it in April 2016, and in April of the same year, it acquired Stihler Electronic, a manufacturer of patient and blood temperature management systems, for $15.5 million.
More recently, in July 2022, the company acquired Jiangmen Dacheng Medical Equipment , a medical materials and medical equipment manufacturer focused on temperature management solutions, for $38 million, and a month later, it also acquired Alfmeier Präzision , a global manufacturer of lumbar and massage comfort solutions and a leading provider of advanced valve systems technology, integrated electronics, and software, for €177.5 million.
Revenues keep increasing, but growth is moderating
Boosted by the acquisitions carried out in recent years, the company has managed to grow its revenues at very acceptable rates and, despite a 7.33% decline in 2019 and a further 6.03% decline in 2020, they increased by 14.57% in 2021 and a further 15.15% in 2022. Furthermore, revenue growth continued through 2023 boosted by acquisitions.
Gentherm revenue (Seeking Alpha)
In this regard, revenues increased by 35.85% year over year during the first quarter of 2023, by 42.81% year over year during the second quarter, and by 9.98% year over year during the third quarter (but declined by 1.64% compared to the second quarter). Revenues are expected to increase by 21.67% in 2023 and by a further 8.90% in 2024 to $1.59 billion as the company's goal is to surpass the $2 billion mark by 2026, which suggests more acquisitions are on the horizon.
Using 2022 as a reference, 39% of the company's total revenues are generated in the United States, whereas 15% are provided by operations in China, 8% in South Korea, 6% in Germany, 5% in Japan, and 27% in the rest of the world, and despite significant revenue growth, the recent share price decline has caused a sharp decline in the P/S ratio to 0.953, which means the company generates annual revenues of $1.05 for each dollar held in shares by investors.
This ratio is 45.23% lower than the average of the past 10 years and represents a 69.83% decline from 10-year highs of 3.159 reached in 2022, which is explained not only by the moderation of growth rates but also by the contraction of margins that the company has suffered in 2021 and 2022, which is gradually recovering in 2023, albeit at a slow pace.
Margins remain depressed as the company continues restructuring its operations
Overall, the company has achieved gross profit margins that hover around 30% and EBITDA margins that have remained in the 10% to 20% range in recent years, and the company consolidated all its North American electronics manufacturing to Mexico in 2019. Still, these profit margins have suffered a series of headwinds since 2021, including inflationary pressures, supply chain issues, and increasing freight costs, as the trailing twelve months' gross profit margin currently stands at 22.49%, and the EBITDA margin at 6.62%.
Nevertheless, the gross profit margin improved to 23.54% in the third quarter of 2023, and the EBITDA margin to 10.18%, boosted by ongoing productivity initiatives and lower freight costs, and the company plans to keep expanding margins by making investments in Morocco and Mexico. Still, there is still some way to go to recover profit margins as inflationary pressures continue to negatively impact operations, so profit margins are expected to continue improving as inflationary pressures subside, although it may not occur linearly.
Easing inflationary pressures should ultimately allow the company to continue strengthening its balance sheet as it has already begun to reduce its long-term debt thanks to the fact that cash from operations is higher than interest expenses and capital expenditures. Still, investors should be patient as it is uncertain when this will occur. Luckily, the company is prepared to withstand current headwinds and even a potential recession for a long period of time.
The balance sheet is very robust as long-term debt is very low
Overall, the company has historically maintained a robust balance sheet thanks to very limited debt exposure. In this regard, long-term debt currently stands at $208 million while cash from operations is very close at $154 million.
Additionally, the company currently holds higher-than-usual inventories of $206 million, which should allow it to continue generating strong cash from operations in the foreseeable future. This greatly reduces the risk that long-term debt poses for the company and represents a very valuable safety net against current headwinds and even a potential recession in the short and medium term.
Regarding cash generation, trailing twelve months' cash from operations currently stands at $82.03 million as inventories decreased by $28 million and accounts receivable by $18.6 million in the same period while accounts payable increased by $5.6 million, which reflects the recent difficulties caused by margin contraction. Despite this, the trailing twelve months' net income remains positive at $18.1 million while the trailing twelve months' cash from operations is starting to improve boosted by recent margin expansion. Furthermore, accounts receivable of $277.5 million are significantly higher than accounts payable of $213.9 million.
Still, trailing twelve months' total interest expenses currently stand at $12.45 million, and capital expenditures at $41.27 million as the company keeps expanding its product offerings, so despite the fact that the company still generates enough cash from operations to cover them, the difference is very tight and it will be necessary for profit margins to remain at levels similar to those of the third quarter of 2023, or even slightly improve, in the foreseeable future in order to avoid headwinds to have a negative impact on the balance sheet.
Furthermore, the company reported total interest expenses of $3.37 million in the third quarter of 2023, which means it is expected to pay around $13.50 million per year at current debt levels and interest rates. Besides, net debt increased by $5 million in the third quarter of 2023 due to share buybacks and higher capital expenditures, but long-term debt decreased by $10 million.
Despite this, a robust balance sheet should allow the company to continue paying its long-term debt in the coming quarters, so total interest expenses are expected to be reduced in the long run, which should free up some cash and decrease the company's risk profile.
Share buybacks remain in force
The company began reducing the total number of shares outstanding in 2018 through share repurchases. In this regard, the total number of shares outstanding decreased by 5.46% in the past 10 years as the company increased the share repurchase authorization to $300 million in June 2018, but the decrease has been almost 11% since the share repurchases began.
This means that each share now represents a larger portion of the company, and this represents a way of returning cash to shareholders as it allows for an increase in per-share metrics. In the foreseeable future, the company has enough resources to keep carrying out share buybacks as it has done in the past quarter, but if profit margins do not improve soon, share buybacks could be paused in order to preserve as much cash as possible until the situation improves.
Risks worth mentioning
Before investing in Gentherm Incorporated, there are certain risks that I would like to highlight, especially for the short and medium term.
- Recent interest rate hikes could cause a global recession, which would likely have a direct impact on the company's operations not only in terms of declining revenues but also in terms of profit margins due to lower volumes.
- Profit margins could take much longer than would be expected to recover if the macroeconomic landscape continues to be disrupted and inflationary pressures don't relax anytime soon.
- The company could have difficulty converting its inventories into actual cash if demand weakens. This is especially true in the event of a potential recession materializing.
- Due to the high volatility that characterizes the markets today, the share price could continue to decline even further if profit margins do not show a significant improvement in the coming quarters or if the macroeconomic outlook worsens, so those investors with a more conservative risk profile could opt for averaging down in order to reduce the average share purchase price in case prices continues to fall.
- The company may not find optimal candidates to continue with its M&A activity, which would make it difficult to keep up with growth rates in the medium and long term.
- Share repurchases could cease if profit margins do not recover soon as the company could decide to preserve as much cash as possible if cash from operations remains weak or suffers another contraction.
Conclusion
The recent 58% share price decline represents a good opportunity for those investors with enough patience to wait for the company's prospects to improve. Profit margins, although still depressed, are allowing the company to continue reporting positive net income, and a robust balance sheet is allowing it to start reducing the debt incurred in 2022 to make the acquisitions of Alfmeier and Jiangmen Dacheng Medical Equipment. Additionally, the company should eventually be able to make a new acquisition as cash and equivalents is currently very high at $154 million, thus breaking the current moderation trend. Furthermore, high inventories should allow for relatively high cash from operations.
Despite this, investors should not forget that the current macroeconomic landscape is marked by high volatility, and therefore, those investors with lower risk appetites might consider saving some bullets in order to buy more shares at lower prices and thus reduce the average purchase price in case they keep falling. After all, a potential recession is not out of the equation, and margin volatility still remains a concern.
For further details see:
Gentherm: Short-Term Pain, Long-Term Gain