Methode Electronics: 60% Upside After Overdone Sell-Off

Summary

MEI trades at only 6x LTM EBITDA after just posting a record year for revenues and profitability.

In the past 3 years, the company has achieved revenue and EBITDA CAGRs of 24% and 75%, respectively.

While the long-term growth story remains intact, MEI is now trading at a 40% discount to its 3-month high because of a weak FY 2016 guidance.

We expect the company to rebound in FY 2017 with another record year as several promising contracts are slated to commence.

With its strong backlog, exciting product pipeline, and the potential for share repurchases or a buyout, we believe MEI offers compelling asymmetric upside at current prices.

Methode Electronics (NYSE:MEI) manufactures highly-engineered electronic component devices for original equipment manufacturers (OEMs) in various industries. Within its largest segment, Automotive, MEI's products include the integrated center stack (center console screen), transmission frames, sensors, and various ergonomic and hidden switches. Within the Interface segment, products include solid-state touch interfaces for consumer appliances (washers, dryers, ovens), radio remote control systems for industrial applications (concrete pumps, cranes, locomotives, work platforms, etc.), as well as transceivers, fiber optic and copper cable assemblies for data centers. Finally, through its Power segment, MEI produces electric vehicle bus bar assemblies (Nissan Leaf and Tesla S) and power rail products for big data customers.

(click to enlarge)Source: SEC filings

(click to enlarge)Source: SEC filings

Company Background

Headquartered in Chicago, Methode was founded in the 1940s and primarily provided circuit boards to television and other consumer electronics manufacturers in its early years. In the 1970s, the company began to expand into the automotive and aerospace markets, but most of its products were highly commoditized. In 2007, the management team started executing a plan to transform MEI from a component vendor of undifferentiated, commodity-like products into a company that offers innovative, patented, and highly-engineered product solutions with world-class manufacturing expertise. In the late 2000s, Methode was awarded a significant contract to provide the center stacks for several Ford/Lincoln models (Edge, Explorer, Flex, Taurus, MKS, MKT, MKX). In 2010, the company announced another massive victory - it had won an even bigger contract to provide the center stacks for multiple GM/Chevy models (Tahoe, Yukon, Silverado, Sierra, Suburban, Canyon, Colorado). As MEI successfully shifted its focus toward higher value-add products, its financial performance reached new highs:

(click to enlarge)Source: SEC filings

Today, Methode is truly a global player with manufacturing, design and testing facilities in China, Egypt, Germany, India, Italy, Lebanon, Malta, Mexico, Singapore, Switzerland, the U.K. and the U.S. Through its transformation, the company has built an impressive roster of clients:

(click to enlarge)Source: SEC filings, MEI press releases, earnings calls, and investor presentations

Poised to Benefit from the Secular Shift toward Smarter Cars

It's no secret that more electronic components and modern technologies are being applied in the automotive industry. As the capabilities of our smartphones have increased exponentially, consumers are demanding better user interfaces and functionality in our automobiles. As a result, OEMs have been investing more in the center stacks of new cars. This trend is expected to continue for at least the next decade.

• Based on our research, 10 years ago, electronic components comprised ~25% of the parts value in the average car. Today, it's estimated that electronic components make up approximately 40%.
• Last year, roughly a quarter of new cars shipped had some kind of infotainment system in the center console. Industry experts estimate that in 10 years, the majority of new cars will have an infotainment screen.
• According to IMS Research, 5.8 million automotive touchscreens were sold globally in 2011; they predict that sales volume will rise six-fold to 35.7 million in 2019.

Methode is well-positioned to capitalize on this massive secular trend. We estimate that center stack sales accounted for 35-40% of the company's revenue in FY 2015. MEI is considered one of the top Tier 1 suppliers to the OEM marketplace due to its innovative product lines, global manufacturing capabilities, reliability, and its seasoned launch and design teams. Across GM/Chevy and Ford/Lincoln, Methode has successfully launched and executed center stack programs for 15 different car models (sedans, trucks, and SUVs).

While there are several competitors in the center stack space, our research indicates that MEI possesses a strong reputation within the industry for its quality and reliability.

• MEI has the best technological solution for minimizing heat. Since the OEMs are intensely focused on reliability, and heat is the enemy of all electronics, we believe this is a strong competitive advantage.
• Methode ranks amongst the best when it comes to energy efficiency.
• MEI's center stacks have better touch sensitivity than most of its competitors.
• Since MEI has far fewer automotive product lines compared to competitors like Alpine or Delphi, its engineering resources are more focused. As a result, Methode's engineering talent is highly-regarded due to their specialization. Rather than being a jack of all trades, master of none, MEI is really good at designing and manufacturing a few auto products (center stack, transmission frames, switches, and sensors).

Why Does the Opportunity Exist?

(click to enlarge)Source: Bloomberg