Note to Reader: All New Or Revised Material Since Last Report Is Highlighted
Note to Reader: All new or revised material since last report is highlighted.
Reason for Report:Pre-earnings update Previous Ed: January 25, 2005
Overview
Ohio-based Dana Corporation (DCN or the Company) is an independent supplier of modules, systems and components for light, commercial and off-highway vehicles for original equipment manufacturers (OEM) globally as well as for related OEM service customers. Products are used in passenger cars and vans; sport-utility vehicles (SUVs); light, medium and heavy trucks; recreational vehicles and motor homes, and off-highway vehicles. The Company's operations are organized into two principal business units: the Automotive Systems Group (ASG), and the Heavy Vehicle Technologies and Systems Group (HVTSG). Dana is also a provider of lease financing services in selected markets through its wholly-owned subsidiary, Dana Credit Corporation. Spicer, Victor Reinz, Clevite, Glacier and Vandervell are the Company's primary trademarks.
Further information on the Company can be found at:
Investors in DCN should make an investment decision based on their assessment of the following issues:
Key Positive Arguments / Key Negative ArgumentsRestructuring efforts – Analysts believe that restructuring efforts will bring some relief to the stock through cost control in the long term. / High exposure to big three automakers – DCN is heavily exposed to the big three automakers (General Motors, Ford, and DaimlerChrysler).
Value Appeal – Automotive and auto supplier stocks are nearing trough valuations and could begin to appeal to value investors, according to a number of analysts. / Rising Interest rates – Rising interest rates are a major concern owing to deteriorating Company credit profile.
Weak Balance Sheet – DCN’s balance sheet is weak because of increase in short-term debt and excessive free cash flow spending.
Challenging North American market – DCN continues to face a tough and competitive operating environment in both its light and heavy truck segments.
Of the 15 analysts covering the Company, 6 have given a neutral rating and 5 have given a negative rating on the stock. None of the analysts gave a positive rating on the stock. One analyst (Merrill) has not provided any rating on the stock.3 analysts’ (B. of America, MorganStanley,R W. Baird) updates were not available.
NOTE: The Company’s fiscal year ends on December 31; all fiscal references coincide with the calendar year end.
Revenue
In 3Q05, sales were up 13.3% yearoveryear to $2,396M as compared to $2,114M during the same period in FY04.
Sales in the Automotive Systems Group (ASG) were up 13.8% year over year in 3Q05 to $1,745Mversus $1,534M reported in 3Q04.
Sales in the Heavy Vehicle Technology and Systems group (HVTSG) rose 14.8% year over year to $642M, as compared to $559M reported in 3Q04.
DCN’s FY06-FY08 backlog of net new business stands at $900M, down from $1.3B recorded in FY05-FY07 primarily affected by divestitures. According to one analyst (Wachovia),DCN booked approximately $160M of new business for FY06 and FY07; and the current FY08 backlog of $95M is discouraging. However, management believes that it has substantial opportunity to increase the current balance in next 12-18 months.
Provided below is a summary of revenue as compiled by Zacks Digest:
Total Revenue ($MM)FY ends December / FY 2004A / 1Q05A / 2Q05A / 3Q05A / 4Q05E / FY 2005E / FY 2006E / FY 2007E
Digest High / $9,048.0 / $2,484.0 / $2,625.0 / $2,396.0 / $2,450.0 / $10,033.0 / $10,423.0 / $10,471.0
Digest low / $9,048.0 / $2,484.0 / $2,625.0 / $2,396.0 / $2,164.0 / $9,570.5 / $8,786.0 / $10,259.0
Digest Average / $9,048.0 / $2,484.0 / $2,625.0 / $2,396.0 / $2,346.5↑ / $9,857.2 ↑ / $9,781.0 / $10,365.0
Digest YoY growth / 7.5% / 12.7% / 13.3% / 2.3% / 8.9% / -0.8% / 6.0%
Digest sequential growth / 8.3% / 5.7% / -8.7% / -2.1%
Zacks Consensus / $10,352.0 / $10,518.0
For 4Q05, analysts’ total revenue projections range from $2,164.0M (Wachovia) to $2,450.0M (Wall Street Strategies), with an average of $2,346.5M (compared to previous estimate of $2,338.3M). For FY05, the range is $9,570.5M (Smith Barney) to $10,033.0M (UnionBankSwitz.), with an average of $9,857.2M (compared to previous estimate of $9,852.5M). For FY06, the range is $8,786M (Bernstein) to $10,423.0M (UnionBankSwitz.), with an average of $9,781.0M (compared to previous estimate of $9,715.7M). For FY07, the range is $10,259M (Goldman) to $10,471M (Zacks Investment Research), with an average of $10,365.0M (compared to previous estimate of $10,294.0M).
Two analysts (Goldman, Wachovia) project a 4% increase in revenues for FY06. According to one analyst (Goldman),a $375M FY06 backlog will be primarily attributable for this improvement.
Margins
In 3Q05,a comparison of quarterly operating income yearoveryear was impacted significantly by taxes according to analysts. 3Q04 results included a significant tax benefit compared to 3Q05 results which reflected tax expense on income of foreign operations, despite the fact that there was a consolidated loss before tax. This is due to the fact that the Company no longer provides deferred tax benefits against U.S. losses. On an EBIT basis the Heavy Vehicle Technologies and Systems Group earned $16M in 3Q05, compared to $41M during the same period in FY04 reflecting substantially higher steel costs and production inefficiencies within the commercial vehicle business. Additionally, the off-highway business experienced higher costs associated with the ongoing realignment of its manufacturing facilities. Similarly on an EBIT basis, Automotive Systems Group earnings declined to $41M in 3Q05 from $65M during the same period last year. Interest expense was $11M lower in 3Q05 than in 3Q04 owing to lower average debt levels.
Most of the analysts believe that inefficient internal cost control initiatives and rising steel price are the major factors affecting DCN margins. One analyst (Goldman) believes that rising energy costs will negatively affect EBIT in FY06 by approximately $15M. One analyst (Wachovia) expects modest increases in operating margin will be more than offset by lower revenues and higher interest expense in FY06. The analyst expects interest expense to increase by $23M in FY06 owing to the Company’s deteriorating credit profile, which will raise borrowing costs. The analyst expects operating margin to increase 20 bps year over year to 2.5%.
Provided below is a summary of margins as compiled by Zacks Digest:
Margins / FY 2004A / 1Q05A / 2Q05A / 3Q05A / 4Q05E / FY 2005E / FY 2006E / FY 2007EEBITDA / 6.7% / 4.8% / 5.5% / 3.8% / 3.6% / 4.3% / 4.2%
Pre Tax / -2.0% / 0.0% / 0.8% / -14.6% / -2.4% / -1.8% / -0.6% / 0.0%
Net / 0.7% / 0.5% / 1.1% / -53.2% / -1.7% / -12.6% / 0.3% / 0.0%
Note: 4Q05 EBITDA margins were not available, as the analysts didn’t provide EBITDA figures.
Earnings per Share
In 3Q05, diluted earnings per share (EPS) from continuing operations, excluding unusual items, were a loss of $0.42, while GAAP EPS came in at($8.50) as compared to $0.28 per share reported in 3Q04.
In 3Q05, DCN posted a net loss of $1,272M versus net income of $42M. This included $918M reduction in net income toward valuation allowances against restated net U.S. deferred tax assets during 3Q05. In addition, this also included $13M for a similar allowance against the Company's U.K. tax assets. Additionally, an impairment charge of $275M after tax was recorded in 3Q05 related to the Company’s divestment of its non-core engine hard parts, fluid products, and pumpproducts businesses.
Forward and quarterly EPS estimates for DCN are as follows:
EPSFY ends December / FY 2004A / 1Q05A / 2Q05A / 3Q05A / 4Q05E / FY 2005E / FY 2006E / FY 2007E
Company Guidance
Zacks Consensus / $0.01 / $0.31 / $0.31
Digest Avg. / $0.44 / $0.08 / $0.20 / ($0.42) / ($0.14)↓ / ($0.13)↓ / ($0.02)↑ / $0.27 ↓
Digest High / $0.44 / $0.08 / $0.20 / ($0.42) / $0.12 / $0.46 / $0.78 / $0.80
Digest Low / $0.44 / $0.08 / $0.20 / ($0.42) / ($0.45) / ($0.58) / ($0.70) / ($0.42)
Digest YoY growth / 0.0% / -75.8% / -51.2% / -216.7% / 78.8% / -128.8% / 84.2% / 1462.5%
Digest sequential growth / 112.1% / 150.0% / -310.0% / 66.7%
Highlights from the above chart are as follows:
• 2005 forecasts (Total 12) range from ($0.58) to $0.46; the average is ($0.13).
• 2006 forecasts (Total 12) range from ($0.70) to $0.78; the average is ($0.02).
• 2007 forecasts (Total2) range from ($0.42) to $0.80; the average is $0.27.
Target Price/Valuation
The average Zacks Digest target price is $4.78 (↓ from $4.81 published in the last update). The price target ranges from $2.50 to $7.00 with a median of $4.50. Most of the analysts have used an EBITDA and/or EPS based methodology to arrive at a target price.
The analyst with the lowest target priceforecast (Deutsche Bank) uses probability weights based on a 60% cumulative probability of default in the next 5 years and a 40% probability of a $6 stock price, while the analyst with the highest target price forecast (Bernstein) uses 1.0x DCN’s book value of $7.00 per share. Valuation targets by individual analysts vary significantly due to differences in valuation techniques and underlying model assumptions; please refer to the accompanying spreadsheet for further details
Metrics detailing current Management Effectiveness are negative due to negative net income.
Metric(TTM) / Company / Industry / S&P 500Return on Assets(TTM) / N/A / 4.94% / 7.98%
Return on Investment (TTM) / N/A / 6.68% / 11.98%
Return on Equity(TTM) / N/A / 10.28% / 19.99%
Rating Distribution
Positive / 0.0%
Neutral / 54.5%
Negative / 45.5%
High / $7.00
Low / $2.50
Median / $4.50
Avg. Target Price / $4.78 ↓
No. of Analysts with Target Price/Total / 9/15
Capital Structure/Solvency/Cash Flow/Governance/Other
On January 11, 2006 Fitch Ratings cut Dana Corp.'s debt ratings deeper into junk status, citing the auto and truck parts maker's deteriorating operating results, accounting and financial control issues, and sustained higher debt levels. The rating agency cut Dana's senior unsecured debt and issuer default ratings to "B," five notches below junk status, from "BB-minus." Fitch has indicated the ratings may be cut again.
On January 11, 2006 DCN and GETRAG GmbH & Cie KG announced they expanded their strategic alliance to jointly develop electronically controlled limitedslip differentials and electronic torque couplings. Under terms of the agreement, engineers from Dana and GETRAG will be working in the United States and Europe to develop advanced torque transfer products. The electronically activated devices will be used in both Dana and GETRAG axles, transaxles, and powertransfer units, which in turn will be applied in both lighttruck and passengercar platforms.
On December 30, 2005 DCN filed amended 10Q and 10K restating figures from FY2000 to FY2004 and 3QFY05. Restatements reduced results for FY03 through 2QFY05 by $44M to $2.9B. The primary items in the restatements impacting the reduction in aggregate net income were inappropriate recognition of certain customer pricing increases and supplier reimbursement costs in the Company's commercial vehicle business, which prompted internal investigations. As announced on Dec. 23, the reduction was also affected by a correction to the prior calculation of the Company's 2004 LIFO inventory reserves with respect to steel surcharges.
DCN’s restructuring efforts continue at a slow but steady pace according to analysts. Management anticipates $40M in cost savings starting FY06 owing to workforce reduction and an additional $20M in FY07 on operational improvements. DCN plans to divest the engine hard parts, fluid products, and pump products business lines in FY06 and should report these areas as discontinued operations in 4Q05. One analyst (Smith Barney) expects these divestitures to reduce revenue by $1.3B. Further in 1Q06,DCN plans to assume 100% ownership of the Spicer axle and driveshaft manufacturing facilities. The Company currently holds a 49% interest indirectly. In return, DESC will get DCN’s 49% share of the joint venture’s transmission and aftermarket gasket operations. Moreover, DCN will close facilities in Danville, IN, Sheffield, PA and Burlington, Ontario. Production will be shifted to its St.Clair, MI and Cambridge, Ontario plants. The Company will also eliminate 800 jobs at a Canadian plant and three Australian plants owing to supply contract roll-offs in its frame and axle businesses.
Long-Term Growth
The estimated long-term EPS growth rate expected by analysts ranges from 4% (Smith Barney) to 10% (Zacks Investment Research) with the Digest average being 7.3%.
DCN’s business is affected by the cyclical nature of the OE markets, according to analysts. Financial performance also depends, in large part, on the varying conditions in the global automotive, commercial vehicle and off-highway OE markets that it serves. Demand in these markets fluctuates in response to overall economic conditions, and is particularly sensitive to changes in interest rate levels and, in the vehicular markets, changes in fuel costs.
DCN is also faced with increasing commodity costs that it may be unable to fully recover from. Increasing steel and other raw material costs had a significant impact on results and those of others in the industry in 2004. DCN could be adversely affected if it experiences shortages of components from suppliers and is faced with continued price reduction pressure from customers. One analyst (Smith Barney) believes that DCN’s financial and business fundamentals should improve in the long term based on management’s restructuring plan, leverage to a recovery in the heavy-duty sector, and potential for meaningful debt reduction.
The global auto industry is highly cyclical, vulnerable to sudden shifts in consumer sentiment, employment, interest rates, and general economic activity. Growth in the auto industry is likely to be stagnant because of weak demand and pricing. There is continuing price pressure from OEMs to reduce costs. Generally, if a supplier is unable to generate sufficient cost savings in the future to offset customer cost reductions, margins could be adversely impacted. Exposure to SUVs and trucks has another side asthe sectors have begun to suffer due to higher oil prices that are stifling demand for large, less fuel-efficient vehicles. Option packages that include safety features have also led to pricing power. One analyst (Wall Street Strategies) thinks that the auto parts industry outlook through FY06 is very unclear as massive bankruptcies and bailouts have made profits scarce; and both suppliers and producers face overcapacity and margin pressures.
Individual Analyst Opinions
POSITIVE RATINGS
None at this time.
NEUTRAL RATINGS
Wall Street Strategies – Hold ($5.80 – target price): 1/17/06 - The analyst downgraded DCN from Buy to Hold based on a poor outlook and believes that further downgrades are possible owing to insufficient restructuring and persisting operating problems.
Bernstein – Market Perform ($7.00- target price): 1/18/06- The analyst has maintained a Market Perform rating and reduced the 12-month price objective from $8 to $7. The analyst remains cautious on the stock based on a deteriorating balance sheet and elusive profitability in the US market. The analyst also believes that lack of guidance and accounting restatements hamper visibility.
Goldman – In-Line: 1/18/06 – The analyst is cautious on the stock based on a challenging operating environment in North America,low confidence in management’s ability to execute, and unsuccessful restructuring effort.
J.P. Morgan – Underweight: 1/18/06 –The analyst remains concerned with the heavy truck division margins, and reduced FY06 estimates reflecting lower operating assumptions at both the heavy and light vehicle divisions.
Smith Barney – Hold (2) ($6.00 – target price): 1/17/06 –The analyst remains cautious based on the belief that DCN lacks earnings visibility, higher operating leverage, a lackluster backlog of net new business, and higher steel prices.
UnionBankSwitz. – Neutral 2 ($6.00 – target price): 1/18/06 -
Wachovia – Market Perform ($4.50 –average target price): 1/17/06- The analyst maintained a Market Perform rating, and set a 12-month price objective range of $4 - $5. The analyst believes that DCN will continue to struggle owing to declining truck production at Ford and its inability to control its cost structure.
NEGATIVE RATINGS
Zacks Investment Research – Sell ($4.25- target price): 1/31/06- The analyst rated the stock Sell and set a 12-month price objective of $4.25 andbelieves that a weak light vehicle market and soaring raw material costs areadversely affecting earnings.Theanalyst expressed concern over lowered earnings guidance for 2005 and subsequent downgrading of debt ratings by leading credit rating agencies.
Deutsche Bank - Sell ($2.50- target price): 1/17/06- The analyst has maintained Sell rating and reduced the12-month price objectivefrom $4.50 to $2.50.Despite expecting DCN’s results to improve slightly in FY06, the analyst does not believe management’s restructuring plan is sufficient to restore the Company’s profitability.
Lehman –Underweight ($3.00 - target price): 1/20/05- The analyst downgraded the stock from Equal weight to Underweight, and reducedthe target price from $9.00 to $3.00, reflecting the Company’s weak fundamentals, stretched balance sheet, and worsening cash burn outlook. The analyst believes that DCN’s price concessions to OEM customers,coupled with adverse volume/mix will have a negative effect on internal cost reduction initiatives.
Prudential – Underweight ($4.00- target price): 1/17/06- The analyst downgraded the stock from Neutral Weight to Underweight, and reduced the target price from $7 to $4, reflecting DCN’s high cash burn rate, poor earnings visibility, and possibly weak cash position.
NOT RATED
Merrill – 1/30/06 – The analyst believes that DCN’s light vehicle business has been hit by rising raw material costs, pricing pressure and lower than expected NA production. However, the analyst believes that restructuring actions will provide support to the stock.
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