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Why You Should Retain Meritor (MTOR) in Your Portfolio Now

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Meritor Inc.’s (MTOR - Free Report) shares have rallied around 43% on a year-to-date basis, outperforming the industry. While the company’s M2022 goals, Axle buyout and soaring free cash flow bode well, Meritor is likely to feel the heat from industry headwinds and lower truck sales, especially in the markets of Europe, China and India. Let’s dig deeper to analyze the overall picture of the company.

Growth Drivers in Place

While Meritor has successfully executed the three-year M2019 program, itis on track to achieve M2022 goals that focus on new business opportunities, margin expansion and cost-containment efforts. Per the M2022 goals, the firm is expected to attain 75% free cash flow conversion and remain committed to return money to its shareholders.

Meritor’s buyout of AxleTech has enhanced its growth. The buyout led to the introduction of a complementary product portfolio, providing the company with a full line of independent suspensions, material handling axles, new braking solutions and drivetrain components. It also diversified Meritor’s exposure in adjacent end markets served, which will support its target of realizing more than $15 million in annual cost synergies by fiscal 2020.

The company regularly introduces products that position it as a market leader in electric drivetrains. Theseproduct introductions have enabled it to clinch contracts from MAN, Mercedes Benz and Iveco. The expanding product portfolio will enable the company to meet the changing needs of customers. In addition, it announced 22 electrification programs with global OEMs that are expected to put nearly 130 fully-electric medium and heavy-duty commercial trucks on road through 2020.The company is likely to gain from higher marginstied to OEM adoption of advanced products such as eAxle, air disc brakes and precision gearing.

The firm’s free cash flow, a key metric to gauge the financial health, has been increasing over the past two years. The metric came in at $147 and $163 million in fiscal 2018 and 2019, reflecting a year-over-year increase of 4% and 81.4%, respectively. The company’s investor-friendly moves boost its shareholders’ confidence. In fiscal 2019, Meritor repurchased 5.3 million shares of common stock for $95 million. The company also approved an increase in the share repurchase authorization from $250 million to $325 million during the fiscal year.

Headwinds

Trade tensions and slowdown in global economic growth are playing spoilsports for truck makers. Amid sluggish freight volumes, truck makers are logging lower orders.Reportedly, truck giants in North America like PCCAR Inc. (PCAR), Navistar International Corporation (NAV), Volvo Trucks USA and Daimler Trucks North America — a subsidiary of Daimler AG (DDAIF) — have been witnessing a sharp decline in year-over-year orders for heavy-duty models in 2019. Amid macroeconomic headwinds, the truck manufactures are not expecting market conditions and sales to improve in the near term as well.

Softening heavy-duty truck markets in the United States and declining demand for Class 8 trucks are likely to weigh on commercial truck and industrial parts makers like Meritor. In the North America Class 8 market, Meritor projects fiscal 2020 production within 240,000-250,000 units. Production levels in the markets of Europe and India are expected to decline 6% and 17%, respectively, in fiscal 2020. Significant economic slowdown in China is likely to lower the firm’s revenues from the region. In fact, the firm’s initial guidance for fiscal 2020 sales is projected in the band of $3.7-$3.8 billion, indicating 14% decline from the midpoint of the forecast.

Meritor’s high debt is a spoilsport. The long-term debt of the company was $902 million in fiscal 2019 (ended on Sep 30), reflecting a year-over-year increase of 23.5%. The firm’s elevated leverage of 68.4% restricts its financial freedom to tap onto growth opportunities.

Bottom Line

While we certainly believe that macroeconomic headwinds will hamper Meritor’s revenues in the near term, the Zacks Rank #3 (Hold) company should be able to counter this limitation in the long term, courtesy of product expansion initiatives, cost-cut efforts and synergy benefits of acquisitions. As such, it is advised to retain the stock in your portfolio at the moment.

Looking For Auto Stocks? Check These

Some better-ranked stocks in the Auto-Tires-Trucks sector are Spartan Motors, Inc. (SPAR - Free Report) , SPX Corporation (SPXC - Free Report) and BRP Inc. (DOOO - Free Report) , each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Spartan Motors has an estimated earnings growth rate of 85.4% for the current year. The company’s shares have surged 127.4% in a year’s time.

SPX has an expected earnings growth rate of 23.2% for 2019. The company’s shares have appreciated 61.2% in the past year.

BRP has a projected earnings growth rate of 18.5% for the current year. Its shares have gained around 47.7% over the past year.

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