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RF Capital Bets On Garrett Motion, Trims Position in Joint Corp

Faizan Farooque

RF Capital Management released its 2019 Q3 investor letter – you can download a copy here.

The investment management company reported a 6.98% decline in its quarterly returns. On the other hand, the S&P 500 index returned 1.7%, bringing its year-to-date return to 20.6%.

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In detailing its quarterly results, RF Capital revealed it initiated a position in several stocks, including Garrett Motion Inc (NYSE: GTX).

GTX is an American company primarily involved in engineering, development, and manufacturing of turbochargers and related forced induction systems for ground vehicles from small passenger cars to large trucks and industrial equipment and construction machinery.

Our calculations showed that GTX isn’t among the 30 most popular stocks among hedge funds. GTX was in 23 hedge funds’ portfolios at the end of the second quarter of 2019. There were 19 hedge funds in our database with GTX holdings at the end of the previous quarter.

The firm had the following to say on the stock in its investor letter:

Garrett Motion is an automotive supplier that makes turbochargers, electric boosting technology, and automotive software. Long-term customer relationships include Ford, Volkswagen, Daimler, BMW, Hyundai, Renault, and Caterpillar. Currently, the turbocharger market is growing faster than vehicle production due to tougher CO2 regulations. IHS and industry sources project 6% CAGR over the 2018-2022 period versus 1%-2% CAGR for vehicle production. The only other major global player that competes with GTX is BorgWarner. Other competitors are either medium-sized global players or local firms.

GTX is a great business that generates returns on capital north of 100%. The business has low working capital needs with >20x turns and a highly variable cost structure of 80%. Furthermore, CapEx is only 3%-3.5% of net sales. There is also revenue visibility out to 2023. The most recent September 2019 outlook reveals awarded contracts of 100% for 2019E, 93% for 2021E, and 71% for 2023E. Long-term financial targets for 2018-2022 include 4%-6% CAGR for revenue, CapEx of 3%-3.5% of net sales, adjusted EBITDA margin of 18-20%, and net leverage of 2x consolidated EBITDA around EOY 2020.

Shares of GTX are currently cheap because it is a small-cap spinoff in the auto supplier industry. GTX was spun out of Honeywell in 2018. Spinoff dynamics led to a lot of selling, especially since GTX is too small for many institutions to own. GTX currently has a market cap of $710 million whereas Honeywell, a multinational conglomerate, has a market cap of $120.7 billion.

Auto supplier stocks have also been depressed due to the US-China trade war. Furthermore, there are fears of a possible recession. However, GTX is not your typical auto supplier. GTX essentially operates as a duopoly in the turbocharger market with BorgWarner. GTX is also at the top of the auto supplier chain with an 80% variable cost structure. In the event of a downturn, we believe GTX will perform better than other suppliers. The contracts that have already been awarded provide downside protection as well.

Investors are probably concerned about GTX’s debt load and asbestos liabilities as well. However, GTX should be able to de-lever considerably given its FCF stream. Additionally, there are no debt maturities until 2023 and 2025. The asbestos liability payments are also capped at $175 million every year. In fact, future payments are likely to be lower based on the recent trend of cases.

We made GTX a 5% position at an average cost of $9.97 per share. We believe shares are worth at least $20 per share based on recent transactions in the auto supplier industry and GTX’s low EV/EBITDA and P/E multiples. The only concern at the moment is the departure of Alessandro Gili, the company’s CFO. Gili’s departure is a potential red flag in regards to management’s ability to execute and deliver on its financial targets. We originally liked how Gili previously worked at Ferrari and Fiat under the late Sergio Marchionne. His experience will certainly be missed. However, we will continue to monitor the management team and possibly increase our position size. We initially wanted to make GTX a 10% position, but the departure of the CFO put a hold on additional purchases.

Automobile Association

In addition, the firm also commented on Joint Corp (NASDAQ: JYNT), a former top 5 position but which has been subsequently trimmed. Commenting on the matter, the firm had the following to say in the investment letter regarding the stock:

The Joint Corp. (JYNT) – The Joint used to be a Top 5 position for us. However, we have trimmed our position considerably. While we still like the business, we believe fundamentals have gotten ahead of the valuation. The stock currently trades at 154.65x P/E and 71.55x EV/EBITDA, which are multiples any value investor would be uncomfortable with. Despite reducing our position size, we will continue to hold onto our remaining shares until a better investment alternative comes along. Meanwhile, we will ride the positive momentum. We invested in JYNT at $4.95 per share. Shares have since gone up 4X.

JYNT has experienced an increase in hedge fund sentiment recently. JYNT was in 10 hedge funds’ portfolios at the end of June. There were 9 hedge funds in our database with JYNT positions at the end of the previous quarter. Our calculations also showed that JYNT isn’t among the 30 most popular stocks among hedge funds.