American Axle: Growing Vehicle Production Volume Offset By Low Margins (NYSE:AXL)

Synopsis

American Axle & Manufacturing (NYSE:AXL) specializes in the design and manufacture of drive line and metal forming technology for the automotive industry. Over the last three years, AXL has shown robust net sales growth. On the other hand, its profit margins have been showing signs of stress. In its latest 1Q24, it continues to report strong top line growth and profit margins have expanded year-over-year, bringing in some signs of relief. Looking ahead, LV production volume is anticipated to continue growing, and its new business wins in the quarter are expected to support its net sales. However, when compared to peers, AXL underperformed them. Although there is improvement seen in 1Q24, I would like to wait for the next few quarters’ results and see improvements in them as well. Therefore, I am recommending a hold rating for AXL.

Historical Financial Analysis

AXL’s past three years have demonstrated strong top-line growth. For 2022, it reported net sales of $5.802 billion, up from 2021’s $5.156 billion. 2022’s growth was driven by the acquisition of Tekfor. Tekfor was acquired in the second quarter of 2022. Additionally, the growth was also driven by the increase in vehicle production volumes that AXL supports. In 2023, net sales continued to grow and reached $6.079 billion. The acquisition of Tekfor in 2022 and the continued increase in vehicle production volumes that AXL supports in 2023 contributed to the growth.

Moving onto profitability margins, AXL has shown clear signals of margin compression across the board over the last three years. For 2023, its gross profit margin contracted to 10.27% vs. 2022’s 12.15%. The drivers behind the compression were the acquisition of Tekfor, which increased the cost of goods sold [COGS] by around $196 million. Additionally, the impact of increased manufacturing costs, such as labor costs and production inefficiencies due to labor shortages, also resulted in a compression of the gross profit margin.

For 2023, the adjusted EBITDA margin decreased to 11.40% vs. 2022’s 16.16%. The reason behind the compression was the contraction in its gross profit margin, increased selling, general and administrative [SG&A] expenses, and interest expense. As a result, it also affected AXL’s 2023 net income margin, which decreased to negative 0.55% vs. 2022’s 1.11%. 2023’s adjusted EPS reported was negative $0.09 vs. 2022’s $0.60.

First Quarter 2024 Earnings Analysis

On May 3, 2024, AXL released its 1Q24 earnings results. For the quarter, net sales grew 7.6% year-over-year to $1.606 billion, up from the previous period’s $1.493 billion. The strong top-line growth was driven by the increased vehicle production volumes that AXL supports. AXL’s net sales are segmented into Driveline and Metal Forming. For the quarter, both segments increased year-over-year. The driveline segment increased to $1.106 billion from the previous period’s $1.013 billion. Its metal forming segment grew to $644 million from 1Q23’s $619 million.

Moving down AXL’s P&L, I will be analyzing its profitability margins, which include gross profit margin, adjusted EBITDA margin, and adjusted net income margin. Across the board, all three profitability margins expanded year-over-year. Its gross profit margin expanded to 12.35% from 1Q23’s 10.75%. Additionally, AXL’s adjusted EBITDA margin grew to 12.79% from the previous period’s 11.74%. The adjusted EBITDA margin expansion was driven by favorable volume and mix, efficiency benefits due to lower production volatilities, and operational efficiencies achieved through improvement initiatives.

For 1Q24, selling, general, and administrative [SG&A] expenses as a percentage of net sales were 6.1% vs. 1Q23’s 6.6%. As a result of its gross profit margin expansion and lower SG&A expenses, it bolstered AXL’s bottom line for 1Q24. AXL’s adjusted net income improved to 1.36% from 1Q23’s negative 0.08%. AXL’s 1Q24 reported adjusted EPS was $0.18, which is a significant improvement when compared to 1Q23’s negative $0.01 per share.

Growing Vehicle Production Volumes

AXL’s results, financial performance, and cash flow are dependent on light vehicle production volumes in North America. The reason is because its business is most significantly affected by volume fluctuations in this region. Looking at the FY2023 sales chart, AXL’s net sales are segmented into four areas: North America [NA], Asia [AS], Europe [EU], and South America [SA]. NA forms the largest segment, as it accounts for 75% of total net sales. Coming in second place is Asia with 12%, third is Europe with 11%, and last is SA with 2% of total net sales.

Moving onto NA production volume, in 2023, it reported a total of 15.6 million units vs. 2022’s 14.3 million units. This represented a year-over-year growth rate of 9.1%. The driver behind this growth was a recovery in supply chain constraints. For 2024, AXL forecasted NA production volume to continue growing and reach ~15.8 million units. For the other three remaining regions, production volume is anticipated to be flat to slightly increase. Overall, AXL’s demand outlook on a global level is expected to remain robust, and this positive outlook is expected to further support AXL’s top line.

New Business Wins Supporting Growth Outlook

The first business win AXL achieved was with XPeng DiDi. AXL announced that it is working hand in hand with Inovance to supply XPeng DiDi three-in-one electric drive units. For context, AXL and Inovance signed a technology development agreement back in 2021. This agreement will focus on the development and sales of a next-generation three-in-one electric drive system. This electric drive system is planned to be scalable and to be sold on the global market. As for the sales of the three-in-one electric drive units to XPeng DiDi, production of the units is expected to start in the later part of this year.

Thus far, AXL electric drive units’ total shipment to China has reached ~500 thousand units. Apart from the strong sales to China, AXL has also managed to secure contracts with a few luxury European original equipment manufacturers [OEMs]. This contract will supply these OEMs with electric vehicle components. Overall, AXL’s strong business wins are a clear testament to the strength of its electric drive systems’ market demand, and this strong demand is driven by its technology. When we combine AXL’s strong internal combustion engine [ICE] and hybrid business with its robust electrification business diversification strategy, this strategy is expected to continue to bolster AXL’s growth outlook.

EV Enthusiasm is Diminishing

Recently, multiple major carmakers, such as Ford and Volkswagen, to name a few, have scaled back their electric vehicle [EVs] plans. Although sales of EVs are anticipated to grow in the years ahead, demand and sales are not up to expectations. Instead, the automotive industry is expected to return to a more varied selection of vehicles, such as ICE, hybrids, and full EVs. Looking at the above chart, it is clear that in the US, hybrid sales have been outpacing EVs sales since 2017.

As a result, OEMs are reformulating their powertrain strategies as a response to consumers’ EV rates, particularly in North America. This implies that ICE platform vehicles will continue to operate for longer than anticipated. Additionally, we can expect to see future generations of ICE vehicles, particularly with hybrid applications.

Due to AXL’s strong ICE and hybrid businesses, this market trend is still beneficial for AXL. Although AXL is developing its electric business, management did not go all in on it given the current market dynamics. Instead, what AXL is trying to achieve is to position them well when market dynamics change again. AXL aims to be flexible, adaptable, and ready for changes in propulsion system technologies.

Relative Valuation Model

AXL operates in the automotive parts and equipment industry. Based on its 10K report, management listed down its competitor peer group, which are those that are listed in my valuation model. I will be comparing AXL with its peer group in terms of growth outlook and profitability margins.

In terms of growth outlook, AXL underperformed its peers. AXL’s forward revenue growth rate is 2.47%, significantly lower than its peers’ median of 5.23% and less than half of its peers’ median. In terms of profitability margins, I will be comparing EBITDA margin TTM and net income margin TTM. Although AXL has a higher EBITDA margin TTM of 11.15% vs. peers’ median of 8.07%, its net income margin TTM of negative 0.13% is significantly lower than its peers’ median of positive 2.32%.

Currently, AXL has a forward P/E ratio of 21.93x, which is way higher than its peers’ median of 11.07x. Given its underperformance in terms of growth outlook and net income margin TTM, I argue that its P/E should not be trading at such a high premium. Therefore, I will adjust my target 2025 P/E for AXL downwards towards the peers’ median of 11.07x. Given the margin expansion seen in AXL’s 1Q24, this P/E is fair. In addition, AXL’s five-year average forward P/E was 11.62x.

The 2024 market revenue estimate for AXL is $6.23 billion, while the 2024 EPS is $0.36 per share. For 2025, the revenue estimate is $6.25 billion, while the 2025 EPS is $0.56 per share. For its 1Q24 earnings release, management did provide their 2024 outlook. Net sales are guided to be between $6.05 billion and $6.35 billion, while adjusted EBITDA is guided to be between $685 million and $750 million. For a recap, AXL’s 2023 adjusted EBITDA was $693.3 million. Additionally, given my forward-looking analysis as discussed above combined with management’s guidance, the market’s estimates are justified.

By applying my target P/E of 11.07x to its 2025 EPS estimate, my 2025 target share price is $6.20. Although it is below its last traded share price, I recommend a hold rating for now. The reason behind that is the margin expansion seen in its 1Q24 earnings, higher net sales, and adjusted EBITDA guided by management.

Risk

The risk associated with AXL is regarding its margin expansion and top-line growth potential. For 1Q24, all three profitability margins expanded year-over-year when compared against 1Q23. Furthermore, its net sales for the quarter also grew strongly, driven by the increased vehicle production volumes that AXL supports. Looking ahead, management also forecasted LV volume production to increase, and they also guided to a higher 2024 net sales and adjusted EBITDA margin. If AXL is able to report results in line with these expectations, the market might hold on to its current valuation of AXL.

Conclusion

AXL’s historical financial performance has demonstrated strong top-line growth over the past three years. However, its profitability margins have been contracting annually. For its latest 1Q24, net sales continued to grow. On a brighter note, its 1Q24 profit margins have expanded when compared to the previous period.

For FY2024, LV production volume is expected to continue growing, which will bolster its FY2024 net sales. Additionally, its new business win with XPeng DiDi is also anticipated to support its net sales. Therefore, for FY2024, management guided net sales to be within the range of $6.05 billion to $6.35 billion and adjusted EBITDA to be between $685 million and $750 million.

Although I see improvements in its 1Q24 earnings results, it is still too early to jump to conclusions. It is safer to wait for the next few quarters’ results and see the trajectory of AXL’s performance. On that note, I am recommending a hold rating for AXL.