This week, Durig Capital takes a look at an industrial designer, manufacturer and marketer of aftermarket parts for light vehicles, commercial trucks and other industrial uses. Tenneco Inc. recently posted a fantastic fourth quarter and full year results in large part due to its recent acquisition of Federal-Mogul. Highlights include:
- A 79% increase in fourth quarter revenue.
- Record revenues for 2018 of $11.8 billion.
- A 21% increase in 2018 adjusted EBITDA.
- 2018 interest coverage of 2.3x.
Later this year, Tenneco will create two separate, market leading companies from its acquisition of Federal-Mogul. Federal-Mogul brings strong brands, products and capabilities that are complementary to Tenneco’s portfolio. Creating two new product focused companies with stronger product portfolios will allow each of them to move faster in executing on their specific growth priorities. Tenneco has already realized value-added revenue from the acquisition of Federal-Mogul of $3.6 billion in the fourth quarter alone. This looks to be a smart play on Tenneco’s part. The company’s short-term bonds, maturing in December 2024, are currently trading at a discount giving them a competitive yield-to-maturity of about 6.75%. These bonds provide an excellent diversification opportunity in adding exposure in the automotive / industrial industries, and as such they make an excellent addition to Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, the aggregated performance of which is shown below.
Fourth Quarter and Full Year 2018 Results
Tenneco posted fantastic fourth quarter results, in part due to the completion of the acquisition of Federal-Mogul in October. This also contributed to the company’s excellent full-year results as well. However, even without the increases related to the acquisition, the company still posted healthy organic growth in its revenues for both the fourth quarter and full-year, exceeding the growth (or declines) in the corresponding industries. Here are some highlights from the company’s fourth quarter and full year results.
- Fourth quarter revenue totaled $4.3 billion reflecting a 79% increase, mainly due to the acquisition of Federal-Mogul. When excluding the effects of the revenues from Federal-Mogul, revenues still increased year-over-year by 4% (organic growth). This organic growth outpaced light vehicle industry production by 10 percentage points.
- For the full year 2018, Tenneco produced record high revenues of $11.8 billion, including the revenue from Federal-Mogul. However, even without the revenues from the acquisition, Tenneco still had organic revenue growth of 6% year-over-year. This organic growth outpaced industry production by 7 percentage points.
- Adjusted EBITDA for the full year increased 21% over 2017 to $1,046 million.
- Cash generated by operations for the full year 2018 was $439 million.
Brian Kessler, Tenneco co-CEO commented on the company’s fourth quarter and full year results, including recent and in-process acquisitions. “We closed the Federal-Mogul transaction, accelerating the transformation of the combined businesses into two purpose-built, industry leading companies, and our acquisition of Öhlins will fuel the growth of advanced suspension technology and enhance our portfolio in broader mobility markets.”
Tenneco completed the acquisition of Federal-Mogul in October 2018. With this acquisition, Tenneco has already realized value-added revenue of $3.6 billion for the fourth quarter 2018. Tenneco also recently completed the acquisition of Öhlins Racing, a Swedish technology company that develops premium suspension systems and components for the automotive and motorsport industries. Both of these acquisitions will contribute to the spin off of one company into two market leading companies with complementary product lines.
About the Issuer
Headquartered in Lake Forest, Illinois, Tenneco is one of the world’s leading designers, manufacturers and marketers of Aftermarket, Ride Performance, Clean Air and Powertrain products and technology solutions for diversified markets, including light vehicle, commercial truck, off-highway, industrial and the aftermarket, with 2018 revenues of $11.8 billion and approximately 81,000 employees worldwide. On October 1, 2018, Tenneco completed the acquisition of Federal-Mogul, a leading global supplier to original equipment manufacturers and the aftermarket. Additionally, the company expects to separate its businesses into two new, independent companies, an Aftermarket and Ride Performance company as well as a new Powertrain Technology company in the second half of 2019.
One Company Transforms into Two Companies
When Tenneco acquired Federal-Mogul, it did so with the intent to spin off two separate entities to create two market leading companies. The acquisition brought together two companies that have complementary business lines. Post-spin, the aftermarket and ride performance company will include Tenneco Ride Performance and Federal-Mogul Motorparts, and the powertrain technology company will include Tenneco Clean Air and Federal-Mogul Powertrain. Post-split, the breakout will look something like this (see below).
In February, Tenneco announced the name of the new Aftermarket and Ride Performance Company – the new company is called DRiV. Following the separation, DRiV will be one of the largest global multi-line, multi-brand aftermarket companies, and one of the largest global OE ride performance and braking companies. DRiV’s principal product brands will feature Monroe®, Öhlins® Walker®, Clevite®Elastomers, MOOG®, Fel-Pro®, Wagner®, Ferodo®, Champion® and others. DRiV would have the new Tenneco as one of the world’s largest pure-play powertrain companies serving OE markets worldwide with engineered solutions addressing fuel economy, power output, and criteria pollution requirements for gasoline, diesel and electrified powertrains.
Current Cost Synergies
Since its acquisition of Federal-Mogul, Tenneco has been working hard to realize cost synergies between the two companies and is making good progress towards achieving their targeted goals. Tenneco has targeted $200 million in earnings synergies in the areas of engineering, general and administrative (G&A) costs, and supply chain and sales force costs. By the end of Q4, Tenneco had achieved a synergy run rate of approximately $100 million and the company is well on its way to meet its goal of $150 million by its third quarter 2019. Also, Tenneco has targeted $250 million for its one-time working capital synergies from inventory reductions and adjustments to accounts payable terms. The company has already reached 50% of that target and expects to achieve the remainder by Q3 2020.
Interest Coverage and Liquidity
For bondholders, interest coverage conveys the ability of the bond issuer to cover and service its existing debt load. For 2018, Tenneco had operating income of $306 million and interest expense of $132 million for an interest coverage of 2.3x. In terms of liquidity, as of December 31, 2018, Tenneco had cash and cash equivalents of $697 million.
The risk for bondholders is whether Tenneco can successfully spin the one company into two while maintaining profitability and cost containment. Tenneco has masterfully combined two companies (itself and Federal-Mogul) with complementary business lines and is in the process of redistributing these product lines to form two leading companies in the industries which they serve. For 2019, Tenneco provided guidance that estimates, on a pro forma basis, constant dollar revenue growth in the range of 4% to 5%. The company also expects that in 2019, its revenue growth will outpace global industry production. With the anticipated solid growth in revenues against a backdrop of forecasted light vehicle production declines, the yield-to-maturity of roughly 6.75% on Tenneco’s 2024 bonds does appear to outweigh the risks identified.
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
Tenneco has shrewdly combined its market leading product lines with those of Federal-Mogul, also a market leader in its space. Combining and then redistributing these product lines to complement each other in two separate and distinct companies creates two focused, purpose-built, industry leaders in their respective markets with greater scale, with both strategic and financial flexibility. The company’s short-term maturity bonds maturing in 67 months, couponed at 5.375% are currently trading at a discount, giving them a yield-to maturity of about 6.75%. In light of the company’s excellent fourth quarter and full year 2018 results, as well as the promising prospects for the two new companies being created later this year, these competitive yielding notes make an ideal addition to Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, shown above.
Issuer: Tenneco Inc.
Ratings: B2 / BB-
Price: ~ 93.0
Yield to Maturity: ~6.75%
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Durig Capital provides investors with a specialized, transparent fiduciary service at a very low cost. Our FX2 (Discretionary Management) Portfolio over time has greatly outperformed our FX1 (Non-discretionary) Portfolio, giving significantly higher (at times double) the returns of FX1. Our professional service enables access to a broad spectrum of bond, high yields, and lower price points that are often found in less efficient markets, but not evidenced in many bond services. Most of our client accounts are custodied in their own name at TD Ameritrade Institutional, a large discount service provider that is SPIC insured, or at Interactive Brokers. We have now started offering our highly successful FX2 service to clients of other Registered Investment Advisors through segregated accounts at TD Ameritrade. Please ask us to learn how this might work for you and your current advisor.
Disclosure: Durig Capital and certain clients may hold positions in Tenneco’s December 2024 bonds.
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