Waiting to Buy this Growth Stock when it Becomes a Value Stock

Here’s the first company I’m writing about from the Forbes Best Small Companies list from last year.

If you missed it, I went over the list and created a list of all 100 companies with stats for each one.

You can download the spreadsheet from the article.

The company in focus today is number 2 on the list, so it’s supposed to have a lot of growth and potential.

There are lots of companies I really like from this list. The catch is that a lot of them are growth stocks so it all comes down to price.

Remember what Howard Marks says as you go through this list.

“Value investing” – is supposed to be about buying based on the present value of assets, rather than conjecture about profit growth in the far-off future.

Gentherm (THRM)

Before you continue, you can download a PDF of numbers to follow along which I’ve exported from the OSV Analyzer.

Just click any of the buttons from the article to unlock the download link.

What Does the Company Do?

Gentherm is in the thermal comfort technology business with majority of the revenues coming from the automotive industry.

But their business is broken down into three segments.

  • Climate controlled equipment for the automotive industry. Things like heated seats and heated steering wheels where their customers are Hyundai, Ford, GM, Fiat, Toyota, Nissan and Tata Motors.
  • Advanced technology like air conditioning system for electric hybrid batteries.
  • and W.E.T which is a global manufacturer of automotive seat comfort systems. Although the products overlap with the Climate Controlled Seats,  it operates independently

Their products are mostly options for new car purchases. Some a standard on higher end cars, but heated arm rests and doors are options.

When my wife got her car, she wanted all the options and I remember wanting to choose specific upgrades because I didn’t need things like heated steering wheel, a backup camera or an auto dimming rear view mirror.

But car manufacturers are obviously smarter than me.

Instead of allowing me to choose and only upgrade the bare minimum, the only option was to choose between upgrade “packages”.

Not surprisingly, my wife loves her heated seats, heated steering wheel, back up camera and auto dimming mirror.

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What’s to Like

It’s dependent on the auto industry and downturns will obviously affect Gentherm. But because they are OEM’s and not aftermarket or branded products, car manufacturers still require a solid and proven supplier to provide those heated seats and temperature controlled cup holders.

With so many recalls of late in the auto industry, the last thing car manufacturers want to do is recall thousands of cars due to a faulty thermal electronic module that is a fire or safety hazard.

In fact, there’s quite a lot to like about the business.

Gentherm’s business and fundamentals actually boomed due to the acquisition of W.E.T in 2011. If you take a look at the financials, revenues increased by 230% in 2011 compared to 2010.

Growth has come rapidly as more people started to replace their cars as we eased out of the recession.

Wide Customer Base with Significant Customers

Their customer base is spread out so it’s not reliant on a single company.

Check out their list of customers.

The big names in the auto industry are all there.

5 manufacturers exceed 10% of revenues and although a customer making up more than 10% of revenues looks risky, you have to understand that in the auto industry, getting a part into a car takes a very long time.

A few years back, I used to monitor the testing of bluetooth audio systems for different car manufacturers.

One thing I learned is that the process to get the bluetooth system into a car took about 4 years.

Unlike the mobile phone industry where suppliers are replaced in a matter of months, the life cycle of a car is much longer. A design update takes about 4 years and until then, it’s highly unlikely that any significant change is released year over year.

So once you’ve won a contract, provide quality items at a competitive price and it’s unlikely that you’ll get replaced.

Patented Technology

The business has a patent for most of their products and despite the company manufacturing “boring” products, they spend a lot of  money into their technology and coming up with new things.

Instead of just being branded as a heated seat company, they work to break that mold by aiming higher with thermo electric products.

Here’s a look at how Gentherm has been spending money.

Consistent R&D as a % of Revenue | Enlarge

Compare Gentherm to peers like Johnson Controls (JCI) or Lear Corp (LEA) who don’t even have an R&D expense line on their income statement.

I don’t think it will be easy to win contracts when competing against Gentherm.

Global Supply Chain

With customers located all over the world, getting everything done in China isn’t going to be efficient.

Heated seats or thermoelectric units aren’t small electronics you can wrap in bubble wrap and ship to your customers. These are oversize products and there’s a limit to how much can fit inside a freight container.

They manufacture in Mexico, Ukraine and China.

This way, Gentherm can ship their stuff to the Americas, Europe and Asia efficiently.

Political issues with Russia is a real threat to the Ukraine location.

What’s to Dislike – Slowing Growth

Gentherm isn’t a perfect company though.

When the company was ranked number 2 on the list of Best Small Companies from Oct 2014, the growth rate from the data is 53%.

That’s clearly not sustainable and it’s showing up in the numbers now.

Wall Street loves growth, and if a stock with lots of growth expectations doesn’t deliver or it looks like the magic growth mushroom isn’t growing any further, it’s not surprising to see the stock get hammered.

Down about 25% from the peak compared to 0% for the SPY.

Here’s the slowing growth I’m talking about.

THRM Slowing Revenue | Enlarge

If you look at more quarters and compare between comparable quarters (Q1 to Q1, Q2 to Q2 etc) the growth rate comes out to an average of 21% over the past 8 quarters.

That’s high, but I don’t see it being that high for 5 years.

5 years is a number I like use as a measuring stick. It makes for objective valuation easier which I’ll get to below.

Auto Industry is Cyclical

Once the recession hit, the auto stores and parts businesses rocketed up because people were delaying the purchase of new cars.

Over the past few years, consumer confidence has grown and auto sales growth numbers have come a long way.

But for how long?

It’s safe to say that we are no longer in the bottom of the auto cycle but more like between the middle and the peak.

If car sales slow down, then Gentherm will also be affected.

Now I can’t time when the cycle will boom or bust, so the next best thing I can do is to buy on the cheap or when there’s value.

Is the Stock Cheap?

Not right now.

10 years of historical numbers aren’t very helpful because of the W.E.T acquisition.

The numbers from 2011 are the most useful and is what I’m basing my views on.

Here’s a look at the value ratios I focus on.

Gentherm Value Ratios
Gentherm Value Ratios

Certainly not the cheapest numbers for a company with ROIC and CROIC below 20%.

I’d say that an EV/EBIT of 15x is about right though.

A DCF isn’t the best because I want at least 5 solid years of FCF data.

And it’s easier to see whether market expectations are realistic by using the EBIT valuation model.

Analysts are expecting an EPS of $1.87. So when I plug the number into the OSV spreadsheet using a range of 12x ~ 17x for EV/EBIT, the value is still below the stock price.

EBIT Valuation Shows Price is Overpriced | Enlarge

As it stands, I’d like to see it fall to $30 before I get interested in buying.

There’s a lot of potential here, but I expect the opportunity will come when the auto industry starts to slow down.

An area I could be completely wrong is that more cars are offering heated seats and other products as standard options.

If this continues to be the trend and low oil prices help people to make car buying easier, then the demand could continue and I may never see Gentherm come down to my desired levels.

Don’t forget to download the stock analysis PDF if you haven’t.

(Click to Download the PDF Stock Analysis)


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