Elevator Pitch
I continue to rate Adient plc (NYSE:ADNT) shares as a Buy.
My prior update for ADNT written on November 8, 2022, discussed about Adient’s financial performance for Q4 FY 2022 (YE September) and the company’s initiation of a new share repurchase plan.
My attention turns to the review of Adient’s recently announced Q2 FY 2023 results in this latest write-up. ADNT’s second quarter performance wasn’t as bad as what the earnings miss appeared to imply, and the company’s value enhancement drivers for the long run are still intact. As such, I maintain a Buy rating for Adient.
Adient’s Q2 FY 2023 Earnings Failed To Meet The Market’s Expectations
ADNT’s share price fell by -7.6% to $34.32 as of May 3, 2023, after the company’s Q2 FY 2023 financials released on the same day before trading hours surprised the market in a negative manner.
The non-GAAP adjusted earnings per share or EPS for Adient decreased -5.9% QoQ from $0.34 in the first quarter of fiscal 2023 to $0.32 for the most recent quarter. ADNT’s actual Q2 FY 2023 normalized EPS turned out to be -25.6% lower than the Wall Street analysts’ consensus bottom line projection of $0.43 per share.
But Adient’s revenue expanded strongly by +11.3% YoY from $3,506 million for Q2 FY 2022 to $3,912 million in Q2 FY 2023, which represented an acceleration from the +6.3% top line growth that ADNT registered in Q1 FY 2023. ADNT’s second quarter sales also beat the market’s consensus top line forecast of $3.78 billion by +3.5%. In other words, higher than expected expenses were what led to Adient’s earnings miss for Q2 FY 2023.
At its Q2 FY 2023 earnings briefing, Adient revealed that a key factor that drove below-expectations earnings was a “net $39 million headwind from commodity (costs).” However, ADNT explained that while “significant spikes in inflationary pressures on commodities” might hurt the company’s bottom line in any specific quarter, the company stressed that “we fully expect over time we recover that.” This implies that Adient’s lower-than-expected second quarter bottom line was negatively impacted by the timing of cost recoveries from clients, rather than any structural factors.
It is also noteworthy that ADNT kept its full-year FY 2023 EBITDA guidance of $850 million unchanged, and even increased its FY 2023 free cash flow guidance by +7.5% to $215 million as indicated in its Q2 earnings presentation slides. This implies that Adient’s full-year profitability outlook hasn’t changed despite the company’s EPS miss, which supports the view that ADNT’s Q2 results were impacted by one-off factors.
Moving beyond Adient’s most recent quarterly financial performance, ADNT has opportunities to create value for shareholders in the mid to long term in areas such as profitability improvement and capital allocation.
ADNT Has The Potential To Achieve Higher Margins
Adient’s EBITDA margin improved from 4.5% in Q2 FY 2022 to 5.5% for Q3 FY 2023, but there is still room for ADNT’s operating profitability to improve to levels comparable with that of its peers. As an example, the most recent quarterly EBIT margin for Lear Corporation’s (LEA) seating business was 6.7%, so LEA’s EBITDA margin for its seating segment will be even higher than 6.7% adding back depreciation & amortization expenses.
In the company’s second quarter results presentation, Adient noted that there are expectations of “improved profitability” as “balance in / balance out progress continues” and “increasing levels of vertical integration.”
ADNT’s “balance in / balance out” refers to the ongoing optimization of the company’s program mix, prioritizing profitable programs over less profitable or even loss making ones. Separately, there are positive signs indicating that Adient is increasing its degree of vertical integration for new programs. ADNT disclosed at Bank of America’s (BAC) Global Auto Summit on April 4, 2023 that “85% of our wins last year (2022) had more than one component (e.g., foam, metals, trim etc.) of the value chain in it,” so the company is moving away from just doing assembly.
These are the two key factors should allow Adient to generate higher operating margins that are more in line with its peers in the intermediate to long term.
Adient’s Capital Allocation Initiatives
Adient continues to pay down the company’s debt and buy back its own shares, and I am of the view that ADNT has enhanced shareholder value with these capital allocation initiatives.
Gross debt for ADNT decreased from $2,909 million as of December 31, 2022 to $2,533 million as of March 31, 2023, while Adient’s net debt was lowered from $2,008 million to $1,707 million during the same period. The company’s deleveraging is expected to translate into a reduction in financing expenses and lower refinancing risk. Adient expects its cash interest cost to go down from $192 million in FY 2022 to $145 million for FY 2023 as mentioned in its earnings presentation. Separately, ADNT indicated in its Q2 FY 2023 results call that its weighted average debt maturity has been extended from 3.5 years to 5.0 years.
Previously, I discussed about Adient’s new $600 million share buyback plan in my earlier November 8, 2022 article. It is encouraging to see ADNT starting to repurchase its own shares, as the company spent $30 million (or close to 1% of its current market capitalization) on share repurchases in Q2 FY 2023. At the early-April BAC Auto Summit, Adient had emphasized that it will “be disciplined and opportunistic” when it comes to share buybacks, considering “where the share price is at.” The market is currently valuing Adient at attractive forward FY 2024 and FY 2025 EV/EBITDA multiples of 4.5 times and 3.8 times (source: S&P Capital IQ), respectively. As such, I believe that Adient is trading at sufficiently appealing valuation levels where the company has the opportunity to execute on value-accretive buybacks.
Closing Thoughts
Adient plc’s low-to-mid single digit forward EV/EBITDA valuations are undemanding, and there are medium-to-long term drivers in the areas of capital allocation and profitability improvement for ADNT to create value for its shareholders.
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