January 08, 2015 Meritor, Inc. Current Recommendation Prior Recommendation Neutral Date of Last Change 01/08/2015 Current Price (01/07/15) $15.10 Target Price $18.00 SUMMARY DATA OUTPERFORM 52-Week High $15.39 52-Week Low $9.41 One-Year Return (%) 44.22 Beta 2.64 Average Daily Volume (sh) 1,224,022 Shares Outstanding (mil) 98 Market Capitalization ($mil) $1,480 Short Interest Ratio (days) 5.10 Institutional Ownership (%) 89 Insider Ownership (%) 2 Annual Cash Dividend $0.00 Dividend Yield (%) 0.00 5-Yr. Historical Growth Rates Sales (%) -4.5 Earnings Per Share (%) 27.1 Dividend (%) N/A using TTM EPS 14.8 using 2015 Estimate 11.1 using 2016 Estimate 9.3 Zacks Rank *: Short Term 1 3 months outlook 1 - Strong Buy * Definition / Disclosure on last page (MTOR-NYSE) SUMMARY We are upgrading Meritor to Outperform from Neutral based on strong fourth-quarter and fiscal 2014 earnings, along with an impressive guidance for fiscal 2015 and favorable long-term agreements. Moreover, the company is expected to benefit from its new business collaborations and success of the M2016 plan. Meritor reported adjusted income of $0.35 per share in the fourth quarter of fiscal 2014, which surpassed the Zacks Consensus Estimate of $0.16. Revenues increased 3.4% year over year to $933 million, beating the Zacks Consensus Estimate of $918 million. The year-over-year increase was due to higher sales in North America, partially offset by lower revenues in Europe, Defense and South America. Risk Level * Average, Type of Stock N/A Industry Auto/Truck-Orig Zacks Industry Rank * 93 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Dec) (Mar) (Jun) (Sep) (Sep) 2013 884 A 900 A 986 A 902 A 3,672 A 2014 900 A 954 A 979 A 933 A 3,766 A 2015 911 E 989 E 989 E 921 E 3,810 E 2016 4,033 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Dec) (Mar) (Jun) (Sep) (Sep) 2013 -$0.11 A $0.06 A $0.34 A $0.13 A $0.42 A 2014 $0.12 A $0.22 A $0.28 A $0.35 A $1.02 A 2015 $0.30 E $0.38 E $0.34 E $0.34 E $1.36 E 2016 $1.63 E *Note: EPS in 2014 do not add up to annual figure due to the impact of divestments. Projected EPS Growth - Next 5 Years % N/A 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
OVERVIEW Meritor, Inc. (MTOR), headquartered in Troy, MI, is a global automotive parts manufacturer and supplier. The company supplies a broad range of integrated systems, modules and components for commercial and specialty vehicles worldwide with leading positions in most of its markets. Meritor serves a broad range of original equipment manufacturers (OEMs) worldwide, including commercial truck, trailer, military, bus and coach, other industrial OEMs and certain aftermarkets in more than 70 countries. The company now operates in two main segments after divesting its light vehicle systems business: Commercial Truck & Industrial (79.1% of revenues in fiscal 2014): The Commercial Truck business supplies drivetrain systems and components, including axles, drivelines and braking and suspension systems, primarily for medium- and heavy-duty trucks in North America, South America and Europe. The Industrial business supplies drivetrain systems including axles, brakes, drivelines and suspension for off-highway, military, construction, bus and coach, fire and emergency and other industrial applications. This segment also includes the company s businesses in Asia Pacific, including all on- and off-highway activities. Aftermarket & Trailer (24.4%): This segment supplies axle, brakes, drivelines, suspension parts and other replacement and remanufactured parts, including transmissions to commercial vehicle aftermarket customers. This segment also supplies a wide variety of undercarriage products and systems for trailer applications. Note: The percentage share of segment revenues in total revenue includes inter-segment sales. REASONS TO BUY Meritor remains committed to its three-year plan, M2016, which aims at achieving margin, debt reduction and revenue growth through operational efficiency, enhancing customer value and reducing product costs. With this, the company aims to achieve 10% adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) margin for full-year 2016 and produce incremental run-rate booked revenues of $500 million per annum from the beginning of fiscal year 2013 to the end of fiscal year 2016. The target of reducing net debt (including retirement benefit liabilities) by $400 million to less than $1.5 billion has already been achieved by the company. The plan will improve operational excellence and customer value, and reduce product costs. Meritor s joint venture with ZF Friedrichshafen AG ZF Meritor LLC and Meritor Transmission Corporation received $400 million from Eaton Corp. in settlement of anti-trust litigations. Of this, Meritor received $210 million ($209 million after-tax) due to its ownership interest in ZF Meritor. Meritor used the proceeds to pre-fund its pension plans in the U.S. and UK, which significantly reduced its net debt. The financial flexibility provided by the settlement proceeds also allowed Meritor to authorize the repurchase of up to $210 million of equity or equity-linked securities. The company will complete the repurchase by the end of fiscal 2016. For fiscal 2015, Meritor expects adjusted earnings from continuing operations between $1.20 and $1.30 per share, significantly higher than $1.02 per share in fiscal 2014. The company s revenues are expected to be in line with the fiscal 2014 level of $3.8 billion. Adjusted EBITDA margin is likely to range from 8.8% to 9%, rising from 8.3% in fiscal 2014. Interest expense is projected to be in the range of $80 $90 million, down from $130 million in fiscal 2014. Equity Research MTOR Page 2
Meritor regularly gains new businesses, which will benefit the company in the long run. In Oct 2014, the company signed a long-term agreement to supply axles to Volvo in Europe and South America till Dec 31, 2021 and in Australia till May 31, 2019. In addition, Meritor agreed to extend its current agreement to supply axles and drivelines in North America till May 31, 2019. In the third quarter of fiscal 2014, Meritor also signed agreements to supply fully-dressed tandem axles to Kamaz Motor in India, and axles and brakes to Japan-based Hino. In the second quarter of fiscal 2014, the company signed a four-year contract with Daimler Truck North America for air drum brakes and drivelines supply. In the same quarter, it also won a new business deal with Daimler India to supply its MS-145 axle for Daimler s BharatBenz rigid truck. In Dec 2013, it was selected to supply the ELSA225H range of air disc brakes for Scania's trucks and buses. It also supplies EX+ air disc brakes for Volvo and Mack trucks. In addition, Meritor is strengthening its business relation with Ford, Mercedes, Paccar, Volvo, Navistar, MAN, DAF and Mahindra. RISKS Meritor has a high customer concentration. The company s 10 largest customers contributed 76% of its sales in fiscal 2014. Moreover, the three largest customers AB Volvo, Daimler AG and Navistar International Corporation represented approximately 27%, 18% and 12% of total sales, respectively, in fiscal 2014. This could hurt the company significantly in view of buyer power. Moreover, the loss of any of these customers could significantly affect Meritor s sales. The uncertain global economic condition has materially affected the automotive industry. Apart from North America and India, production in most key end markets of Meritor is expected to fall in fiscal 2015. The South American economy is recovering but is not on par with the expected level. Meritor expects weak demand in the region in the near to mid term. The economic weakness in Brazil is expected to continue. The European economy has also witnessed very slow recovery. Meritor expects production of medium- and heavy-duty trucks in the continent to fall 3% year over year in fiscal 2015 that will affect the company s sales. Meritor completed the sale of 50% ownership in Suspensys Sistemas Automotivos Ltd. to its joint venture partner, Randon S.A, in 2013. The company contributed earnings of around $4 million per annum. Due to the divestiture, the earnings of the Aftermarket & Trailer segment are being adversely affected. In Sep 2014, Meritor also sold its Mascot operations in Canada and the U.S. at a loss. The business contributed $29 million in revenues in fiscal 2014. Thus, the divestiture should affect the revenues going ahead. RECENT NEWS Meritor Q4 Earnings Beat Estimates on Higher Sales Nov 12, 2014 Meritor reported adjusted income of $0.35 per share in the fourth quarter of fiscal 2014 (ended Sep 30, 2014) that surpassed the Zacks Consensus Estimate of $0.16. Earnings increased significantly from $0.13 in the year-ago quarter. Adjusted net income jumped to $35 million in the reported quarter from $13 million in the fourth quarter of fiscal 2013. On a reported basis, Meritor posted net income from continuing operations of $29 million or $0.29 per share in the fourth quarter of fiscal 2014, compared with $40 million or $0.41 per share in the corresponding quarter last year. Equity Research MTOR Page 3
Revenues increased 3.4% year over year to $933 million, beating the Zacks Consensus Estimate of $918 million. The year-over-year increase was attributable to higher sales in North America, partially offset by lower revenues in Europe, Defense and South America. Adjusted EBITDA of Meritor increased to $80 million from $73 million in the fourth quarter of fiscal 2013. Meanwhile, adjusted EBITDA margin stood at 8.6%, compared with 8.1% in the year-ago quarter. The increase was led by improvements in material costs, operating performance and higher revenues, partially offset by the unfavorable mix impact. Fiscal 2014 Performance Meritor s adjusted earnings per share increased significantly to $1.02 for fiscal 2014 from $0.42 recorded in fiscal 2013, beating the Zacks Consensus Estimate of $0.70 per share. Revenues for fiscal 2014 increased 2.5% to roughly $3.8 billion from $3.7 billion in fiscal 2013, in line with the Zacks Consensus Estimate. The year-over-year increase was driven by higher sales in North America, partially offset by lower revenues in Defense and South America. Segment Results Revenues from the Commercial Truck & Industrial segment went up 2.8% to $729 million in the reported quarter. The improvement was driven by higher revenues in North America, partially offset by lower sales in Europe, Defense and South America. Segment EBITDA dropped 1.9% to $53 million from $54 million in the year-ago quarter. EBITDA margin decreased to 7.3% from 7.6% in the prior-year quarter due to unfavorable mix impact of lower sales in South America and Defense, and higher variable incentive compensation, partially offset by favorable impact of material and operating performance, and higher sales in North America. Revenues from the Aftermarket & Trailer segment increased 5.7% to $240 million. Segment EBITDA improved 25.9% to $34 million from $27 million in the year-ago quarter. EBITDA margin was 14.2% compared with 11.9% in the fourth quarter of fiscal 2013. Financial Position Meritor s cash and cash equivalents were $247 million as of Sep 30, 2014 versus $318 million as of Sep 30, 2013. Total debt amounted to $972 million as of Sep 30, 2014, compared with $1.14 billion as of Sep 30, 2013. In fiscal 2014, Meritor s cash flow from operating activities was $215 million, compared with cash outflow of $96 million in fiscal 2013. Capital expenditures were $77 million, compared with $54 million in fiscal 2013. Free cash flow stood at $138 million in fiscal 2014, compared with cash outflow of $150 million in fiscal 2013. Outlook For fiscal 2015, Meritor expects its revenues to be $3.8 billion. Adjusted EBITDA margin is likely to be in the range of 8.8% to 9% while adjusted earnings from continuing operations are expected between $1.20 and $1.30 per share. In addition, Meritor expects capital expenditures in the range of $80 $90 million for the fiscal year. Interest expense is projected to be in the range of $80 $90 million. Further, Meritor expects free cash flow to be $100 million. Equity Research MTOR Page 4
Meritor is focused on its three-year plan, M2016, which aims at achieving margin, debt reduction and revenue growth through operational efficiency, enhancing customer value and reducing product costs. With this, the company plans to achieve 10% adjusted EBITDA margin for full-year 2016 and reduce net debt by $400 million to $1.5 billion. The company expects to record revenue increases of $500 million per year, driven by new products and new customers. VALUATION Currently, Meritor s shares are trading at 11.1x our fiscal 2015 EPS estimate of $1.36. The company s current trailing 12-month earnings multiple is 14.8x, compared with the 16.5x average for the peer group and 18.4x for the S&P 500. Over the last five years, Meritor s shares have traded in a range of 3.5x to 104.1x trailing 12-month earnings. The stock is trading at a discount to the peer group and S&P 500, based on forward earnings estimates. The current is at a 19.6% discount to the peer group for fiscal 2015. Our long-term Outperform recommendation on the stock indicates that it will perform better than the broader market. Our target price of $18.00, which is based on 13.2x our 2015 EPS estimate, reflects this view. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Meritor Inc. (MTOR) 11.1 9.3 N/A 8.7 14.8 104.1 3.5 Industry Average 13.8 19.9 13.4 10.2 16.5 122.9 12.4 S&P 500 16.0 14.9 10.7 15.9 18.4 19.4 12.0 Dana Holding Corporation (DAN) 9.9 8.2 7.7 4.9 10.6 53.9 6.9 Oshkosh Corporation (OSK) 11.2 10.1 13.3 8.9 12.6 20.6 3.0 American Axle & Manufacturing Holdings Inc. (AXL) 8.7 8.6 13.7 5.4 9.1 31.4 3.7 Cooper-Standard Holdings Inc. (CPS) 8.9 7.0 N/A 4.6 31.0 34.7 13.5 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Meritor Inc. (MTOR) 0.3 N/A N/A 65.6-1.6 0.0 4.3 Industry Average 2.6 2.6 2.6 19.9 0.9 0.6 10.2 S&P 500 5.1 9.8 3.2 24.8 N/A 2.0 N/A Equity Research MTOR Page 5
Earnings Surprise and Estimate Revision History Equity Research MTOR Page 6
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of MTOR. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1110 companies covered: Outperform - 17.1%, Neutral - 77.0%, Underperform 5.1%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research MTOR Page 7