American Axle and Manufacturing Bonds, Short Term, High Yield, Fixed Income Investment, Yielding 6.7% YTM

  • Adjusted free cash flow increased by 19% year-over-year.
  • Net cash from operations was $217.1 million
  • Adjusted EBITDA increased $20 million from the first quarter 2019 and adjusted EBITDA margins increased by 130 basis points.
  • Interest coverage in the second quarter was 2.1x.

This week, Durig looks at the auto industry to focus on a manufacturer who supplies components to many of the industry’s leader auto makers. American Axle & Manufacturing (NYSE:AXL), a leading supplier of driveline technology, recently released its second quarter results.  The company registered solid free cash flow, net cash from operations and improving EBITDA and EBITDA margins (see bullets above).

Although the U.S. has experienced a slowdown in auto sales since mid-year,  American Axle & Manufacturing (AAM) is forecasting increased profitability in the second half of 2019. The company’s 2025 bonds, couponed at 6.250%, are trading at a discount, giving them a very competitive yield-to-maturity of about 6.7%. This yield is in stark contrast to the less than 2% current yield on the 5-year U.S. treasury. The opportunity for diversification into the auto industry along with the excellent yield on these relatively short-term bonds, makes them an ideal candidate for addition to Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, the aggregated performance of which is shown below.

Second Quarter 2019 Results

AAM’s recently released its second quarter results (for the three months ending June 30, 2019). Although the company began to see a slowdown in auto sales during the month of June, there were still some verifiable wins to celebrate.

  • Adjusted free cash flow for Q2 was $119.3 million as compared to $100.3 million a year ago.
  • Net cash from operations for the second quarter totaled $217.1 million.
  • On a sequential basis, the company saw a $20 million improvement on adjusted EBITDA as compared to the first quarter, along with a 130 basis point improvement on EBITDA margins as compared to the prior quarter. This improvement came even despite lower sales this quarter.

On its most recent earnings call, AAM management indicated that it anticipates the company will increase it profitability in the second half of the year. This is due to several factors including sales volume / product mix, cost synergies, productivity and reduced launch costs.

(Source: Second Quarter 2019 Earnings Call Presentation)
David C. Dauch is Chief Executive Officer of AAM, a position he has held since September 2012. Mr. Dauch was appointed Chairman of the Board in August 2013. From September 2012 through August 2015, Mr. Dauch served as AAM’s President & CEO. Prior to that, Mr. Dauch served as President & Chief Operating Officer (2008 – 2012) and held several other positions of increasing responsibility from the time he joined AAM in 1995.

AAM’s Chairman and Chief Executive Officer, commented on the company’s performance in the second quarter. “In the second quarter of 2019, AAM continued to improve its operational performance with sequential quarterly margin increases and strong free cash flow generation. As we look towards the second half of 2019, we are focused on efficiently operating our business and adapting to the changing market demand.”

About the Issuer

American Axle & Manufacturing  (AAM) is a leading global tier 1 automotive supplier. AAM designs, engineers and manufactures driveline, metal forming and casting technologies that are making the next generation of vehicles smarter, lighter, safer and more efficient. Headquartered in Detroit, AAM has over 25,000 associates operating at nearly 90 facilities in 17 countries to support its customers on global and regional platforms with a focus on quality, operational excellence and technology leadership. Another issuer we reviewed last month that provides materials to the automotive industry is AK Steel.

Going Electric

Much of the buzz today in the auto industry surrounds the growing number of electric car options. And while current electric car usage is mostly for the wealthy, the industry is betting that will start to change, as most of the major automakers either already have an all-electric vehicle or are in the process of producing one. In order to answer this growing demand from carmakers for electric components, AAM is investing in electric technology and has already produced and sold one of its electric driveline systems to a major auto manufacturer.

 

(Source: Investor Presentation – September 2019)

 U.S. and Global Automotive Industry Outlook

With the third quarter of 2019 drawing to a close, many predictions for the domestic and global auto industry for 2019 have been borne out. Global consulting firm Alix Partners and auto data firm Edmunds have both forecast for the U.S. auto industry to decrease in 2019, with Edmunds saying it anticipates U.S vehicle sales to drop to 16.9 million for the year, down from 17.3 million in 2018. Alix Partners also predicts that those numbers will drop further to 16.3 million in 2020 and 15.1 million in 2021. Globally, auto sales are also predicted to fall in 2019, and in the years following, according to a forecast from Germany’s Center for Automotive Research (CAR). The report from CAR projects 2019 auto sales to be down by 4 million units in 2019 to 79.5 million from 83.7 million in 2018. Furthermore, CAR’s report projects that sales won’t recover to that level until 2022 when sales are projected to be 84 million units.

A slowing automotive market affects companies like AAM, whose revenues depend, albeit indirectly, on the health and vitality of the automobile industry. AAM has witnessed these slowdowns this year and is prepared to address decreasing market demand as indicated by the company’s recent investor presentation.

 

(Source: Investor Presentation – September 2019)

Interest Coverage and Liquidity

Interest coverage is an important metric for bondholders as it is an indication of an issuer’s ability to service its existing level of debt. For its most recent quarter, AAM had operating income of $119.9 million with interest expense of $56.2 million, for an interest coverage ratio of 2.1x. In terms of liquidity, as of June 30, 2019, AAM had a total liquidity of $1.2 billion.

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Risks

The risk for bondholders is tied to whether AAM can react to changes in market demand in an appropriate and timely manner. Like many industries, auto sales are cyclical and many predictions point to a domestic and global slowdown in the amount of cars sold both this year and in the next few years. During the most recent earnings call from AAM, company management seemed prepared to face whatever adjustments may be necessary to address changes in market demand. Also from a bondholder perspective, the company doesn’t have any major bond maturities until 2022 and much can transpire in 3 years’ time.

Much of AAM’s revenues are generated from one customer. In 2018, 41% of the company’s net consolidated sales were to GM. Changes to supplier agreements as well as decreasing auto / truck sales for GM could have a pronounced effect on AAM’s revenues due to its high concentration of business with this one manufacturer.

Generally, there is reduced risk for investors who invest in Durig’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio due to its diversification across many bond issuers and industries, as compared to the purchase of individual bonds.  Historically, the FX2 Portfolio has significantly outperformed when compared to portfolios where investors have chosen bonds individually. Durig Capital currently holds this bond in its FX2 Portfolio.

In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments.  Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.

Summary and Conclusion

Automobiles are a part of everyday life in most parts of the world. Companies like AAM help to supply automakers with essential components for their vehicles. Although auto sales are predicted to slow this year, and possibly for the next few years, AAM, by its own admission, feels prepared to weather any type of adjustment to market demand. The company has predicted a strong second half of 2019 and is still looking forward, investing in new technologies with its electric driveline systems. The company’s 2025 bonds are trading at a slight discount, which translates to a very competitive yield-to-maturity of about 6.7%. In light of the falling yield on U.S. Treasuries (1.66% for the 5-year treasury at the writing of this article),  AAM’s 2025 bonds are an ideal addition to Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio.

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Issuer: American Axle & Manufacturing
Symbol: (NYSE: AXL)
Bond Coupon: 6.250%
Maturity: 04/01/2025
Rating: B2 / B
Pays: Semi-annually
Price: ~ 97.93
Yield to Maturity: ~ 6.70%

Disclosure: Durig Capital and certain clients may hold positions in American Axle & Manufacturing’s April 2025 bonds.

Disclaimer: Please note that all yield and price indications are shown from the time of our research.  Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. The high yield strategies presented in this review by Durig Capital may not be suitable for all investors.  This is not investment advice from Durig Capital, nor a specific recommendation to buy or sell securities. If you have any questions or concerns about its suitability for your personal investment, you should seek specific investment advice from a registered professional before making an investment decision.

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