Excuse my previous post. I found some errors in it and decided to basically rewrite this.
Garrett Motion (GTX) is the leader in automotive turbochargers to make internal combustion engines (both gas and diesel) more efficient and better able to meet emissions targets. They control about a third of the global turbocharger market for light & commercial vehicles with 85% of sales outside North America.
It’s a 2018 spinout from Honeywell, where Honeywell loaded it with a bunch of debt and asbestos claims. They have just emerged from a very short bankruptcy in April. escaping those Asbestos claims thanks to Chapter 11, but still burdened with $1.2B in debt and nearly $2B in preferred, giving it negative shareholders equity of $700M, and an EV/EBITDA of 7 counting all that preferred. The opportunity is that if it continues to produce EBITDA consistent with it's historical performance, it should be able to pay down nearly all of that debt by the end of the decade and substantially increase it's owner earnings.
GTX got my attention when it reported $5.53 in Q2 earnings while trading slightly over $7 and with sales on pace to be nearly 30% higher than last year. Of course most of Q2 earnings are just an artifact of exiting bankruptcy, about 3/4s were a one time write-down of obligations to Honeywell.
To determine its worth we need to determine the future cash flow accruable to common shares, outside those debt and preferred obligations. We first want to determine how likely GTX will have cash flow to cover its interest payments, and then how much is likely to be left after preferred dividends and repayments. The good news is that EBITDA is still strong and easily adequate for $42M in annual interest payments. Using pre-COVID as a timeline from 2015 to 2019 it averaged $523M in EBITDA, trailing 12 months is $543M (COVID 2020 was brutal, only $364M). Note that you can just use operating earnings + depreciation/amortization here, as the pre Chapter 11 GTX reported large amounts of non-operating expenses due to the Asbestos claims.
There are two preferreds, Series A is the bankruptcy exit funding and Series B the remaining Honeywell obligations. Total preferred payment obligations start small, roughly $70M this year, $178M next year, and $243M every year until 2027 when GTX has the right to force conversion of Series A to common stock. After that obligations drop to $100M a year until last of Series B is retired in 2030. One negative here is that preferred dividends aren't tax deductible, but thats the price we pay for payment flexibility.
FORECAST
To model common earnings going forward I've taken the current revenues/EBITDA and assumed they remain flat for the next decade. I've used their average tax rate for their pre-bankruptcy era (2015-2019), which at 42% may be too high as it's skewed by foreign profit repatriation from the 2016 tax bill. Deducting taxes, interest and preferred interest from operating earnings, I estimate GAAP earnings starting at $1.78 per share in 2022, growing to $2.20 in 2027. Then assuming the Series A converts at $25/share I estimate earnings at $2.55 in 2028, reaching $2.90 per share in 2031 with a $16 tangible book value.
RISKS
The reason I modeled no growth is that GTX was only growing 3% a year before the pandemic, and I can’t tell if this year is just delayed demand from a bad year last year or genuine growth in demand. Forecasting future demand is the problem, though they have products for hybrids and electrical components, GTX is mostly a bet on internal combustion engine demand remaining near todays levels. Tthe risk is that EV growth causes the ICE automotive market to decline. So there is a real risk of declining revenues that given their debt and preferred loads, could easily snowball into substantial dilution for common.
POSSIBLE LEVERS
A strong period of inflation would benefit earnings since debt and preferred obligations are fixed.
Also their strong results this year should trigger B preferred right to repayment in Q4. Repayment would be accretive to common since GTX should be able to replace 7.25% after tax preferred with 3.7% tax deductible debt, increasing per share earnings roughly 50 cents per share next year. But I don’t expect that to happen, since 7.25% is probably a good rate for Honeywell to park money at in todays climate.
Lastly, GTX’s post 2027 earnings are highly dependent upon the stock price during the Series A conversion. Note that my 2027 forecast conversion price ($25) is only at 11x earnings, the higher the stock price is during the conversion the lower dilution is, and the higher the intrinsic value of the common will be. But that also works in reverse.