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ArvinMeritor’s Quarter So Bad They’re Changing Their Name

February 02, 2011 | About:
ArvinMeritor (ARM) was one of the biggest losers yesterday in an overall market that could only go up. After releasing disappointing earnings in the morning, they shed nearly 8%. As if to hide from angry investors, they also announced they were going to change their name. Henceforth, or rather, in late March, they’re dropping Arvin and sticking with Meritor. They’ll also get a new, as yet unannounced, ticker symbol.

This 101 year old auto parts supplier sells to OEMs, dealers, independent distributors and service garages. They currently operate in four segments. Commercial truck provides drivetrain systems for medium and heavy duty trucks. Industrial does the same for military, emergency vehicles, bus, construction and other off-highway vehicles. The aftermarket and trailer segment is focused on commercial vehicle aftermarket customers and products for trailers. Finally, the LVS segment supplies roof and door systems.

They reported disappointing earnings with a surprise adjusted loss of $0.07 per share compared to analyst expectations of a $0.01 gain. On the positive side, sales were up more than 20% YoY, although it was an easy comparison.

Is this a one-time drop or will it be a continuing problem? Management’s fiscal Q2 EPS guidance is for $0.05 to $0.15 on dramatically increased revenue. Analysts expect gains in 2011, but fiscal year Q1 was disappointing in this regard, which led to the big price drop. Now that they’ve sold they’re body systems business, which they’ve been working on for more than a year, they can move forward in a more focused way. This was the last part of the light truck segment they had owned and it was a drag on earnings.

The company is still heavily leveraged despite the segment sale and share dilution from earlier last year. They are working on fixing their balance sheet, and their debt covenants do not appear to be in jeopardy, but that doesn’t mean all is rosy on the balance sheet front.

In terms of valuation, there is just too much unpredictability associated with ArvinMeritor. Shares have doubled in the last year as the company has worked on getting its house in order. Even with the 8% drop, it still seems rich to me. 2011 could certainly be a good year if a number of things fall in place. If construction in the U.S. picks up, demand for ArvinMeritor’s products could dramatically increase. On the other hand, they could be squeezed as raw material costs go up and they’re not able to pass those costs along. Heavy competition may prevent them from being able to do that, and we could see further losses. Their international exposure is commendable and truck demand may increase overseas, but it remains to be seen when that will occur. At $20, the risk of hope is rich.

I’ll throw out one more potential boost to profits. They just recently announced a new segment that will offer logistics services for its customers. I don’t know the market well, and haven’t seen what it will add to the bottom line, but it appears they may be filling a niche which could prove to be profitable in the future. Near term, though, I don’t expect this new segment to have much of an affect on the stock price.

While uncertainty isn’t necessarily risk, I’m going to sit on the sidelines with ArvinMeritor as many of these changes begin to take shape. Their profitability could see wild, unexpected swings, and it’s just too difficult to effectively value the company until there is more clarity. Even with today’s big drop, the price is just not low enough for the risk involved. It’s no surprise that insiders have been nothing but sellers since May of last year. Perhaps the name change will change their fortunes.

Disclosure: No positions

About the author:

Steven Kiel
Steven Kiel is the president and chief investment officer for Arquitos Capital Management, a Virginia-based investment management firm. He is a graduate of George Mason School of Law and a captain in the Army Reserves. He manages two spoke funds, The Freedom Fund, a value-oriented portfolio, and The Hayek Fund, a portfolio dedicated to free market principles. He can be contacted at steven.kiel@arquitos.com or through the firm's website at www.arquitos.com.

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