Long Equity: Delphi (DFG) Update
We have owned Delphi since purchasing its DIP loan facility in June of 2009. Delphi has been a core position of 2‐5% throughout the past three years as distressed debt, post‐reorg equity, post‐IPO locked up equity and since March, as unrestricted common stock trading on the NYSE. Accordingly, Delphi is a good example of a long term investment across the arc of the distressed cycle. Despite negative Q2 stock performance, Delphi is +33% in 2012, and has been the best performing Auto Supplier (or OEM) in a group where ~50% of companies are down for the year. Yet we are often asked why we "still" own Delphi. In our view, Delphi is a best‐in‐class supplier which still trades at the valuation of more commoditized and disadvantaged comparable companies. Delphi has premium business lines, an excellent geographic customer base, no need for further deleveraging, virtually no North American unionized labor, and significantly smaller pension liabilities than almost all of its peers. Using multiples closer to the upper quartile of suppliers – where we feel Delphi belongs and is headed – Delphi's stock should be worth between $35‐$40 per share, or a 30‐40% upside from current levels. We expect Delphi to expedite its multiple expansion by returning a significant portion of its free cash flow – about 25% of the current market cap by year end 2013 – to shareholders through continued share repurchases and the initiation of a quarterly dividend. We believe a $1 per share dividend puts them squarely in line with peer average payouts, is a level which can easily be grown, and should be initiated by the end of 2012 barring macroeconomic calamity or significant changes to tax policy.
Delphi also has limited downside, assuming no significant slowdown in global growth, which we hedge against and monitor across our portfolio. Given Delphi's low cost structure, strong amounts of booked revenue, and a recent acquisition which is margin accretive, we believe the company would still be close to free cash flow break even at trough production levels seen in 2009. This margin of safety makes us comfortable holding Delphi in its current size.
Probably the biggest concern for Delphi holders is the ownership base, which remains heavily skewed toward hedge funds. The exit of some of these investors during the first half of 2012 was positive, even if it temporarily depressed overall P & L on a mark to market basis as these players took long‐term profits and de‐risked their overall portfolios in May and June. We expect Delphi will diversify its concentrated shareholder base over the next few quarters, particularly once a dividend is initiated, and this development will reduce some of the volatility in the stock as it moves higher.