[Valuation Analysis] Honeywell's new spin-off may present a great buying opportunity

Since I read the book, You Can Be a Stock Market Genius, written by Joel Greenblatt, which suggests that spin-offs often present great investment opportunities (you can read the reasons here), I have been kept eye on new spin-offs to try the strategy in real life. After about a year of search, I finally came across an attractive opportunity: Honeywell (HON: NYSE)’s spin-off of its Transportation Systems (Garrett Motions Inc., will be listed as GTX: NYSE).

o   Company Overview

Garrett Motions Inc. (“Garrett”) is a company that is about to spin-off from Honeywell (HON: NYSE) on October 1, 2018. Garrett develops, manufactures and sells turbochargers, electronic boostings and automotive software. The company’s business exposures are mainly as follows:

o   The Spin-Off

In October 2017, Honeywell announced that it would spin-off its transportation systems business (Garrett) as the result of portfolio review. After almost a year, in September 2018, Honeywell announced that it would distribute the shares of Garrett to existing Honeywell’s shareholders on October 1, 2018. Honeywell’s shareholders will receive 1 Garrett share for every 10 Honeywell shares. The shares will be traded on NYSE with the ticker GTX.  

o   Competition

Garrett has over 1,400 patents issued and pending today, providing the competitive edge and leadership in the industry.

o   Valuation Analysis

Based on the information provided by Honeywell and my own assumptions, I decided to come with a valuation before the Garrett shares are listed on October 1, 2018.

 Projections on Garrett’s P/L, B/S and other items, created by the author.

Projections on Garrett’s P/L, B/S and other items, created by the author.

 Main assumptions used for the projections.

Main assumptions used for the projections.

For reference. (Excerpt from: Garrett Investor Conference, Sep 6, 2018.)

Although the Garrett will be loaded with substantial amount of debt (long-term debt: $1.6 billion) and other liabilities (asbestos related: $1.6 billion, the projected payment is already incorporated in the “other expenses” in the P/L sheet), I believe the company will generate enough cash flow to compensate it.

The beauty of spin-off is that it gives management more accountability. The CEO of the company will be awarded $4.3Mil worth of Garrett’s restricted stocks, half of which can be vested in 3 years and the rest in 4 years. Such substantial amount of stock compensation should align CEO’s motivation with the shareholder’s best interest. I believe he will try everything he can to meet the 4% annual revenue growth through FY2022 and generate free cash flow.

 WACC Estimate

WACC Estimate

Valuation.png

Since the valuation varies greatly based on WACC and terminal growth assumption, I created a table with a wide range of combination of the assumptions. Although the valuation changes based on the assumptions, my main target is terminal growth of 0% to be conservative and WACC of 14% based on the estimate above.

o   Conclusion

Based on my valuation, the Garrett’s shares (GTX: NYSE) could be a buy if the shares end up being traded below $14. Although Garrett will be loaded with a substantial amount of debt and purchasing its shares will be somewhat risky, I believe the company will generate sufficient cash flow to repay the debt and reward the shareholders well in the long-term. As spin-off stocks tend to face a sell-off in short-term, I would recommend buying the shares only if you are willing to hold them for over 2 years to see how it plays out.

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I currently do not own any Honeywell stocks (HON: NYSE). I may purchase Garrett Motions Inc. (GYX: NYSE) in near future, depending on the pricing actions and availability of my own capital.