Up another 25% from my last write-up on the company, I still believe Dana (DAN) has more upside from here. Not only is Dana leveraged to recoveries in autos, trucks, and other commercial vehicles, but the company’s surprisingly strong decremental margins so far lends a lot of credibility to management’s past comments about the resilience of its margin and cash flow structure. Further down the road, Dana has a portfolio of electrification technologies that should enable it to preserve its business as manufacturers and customers shift to electric powertrains.

Low single-digit revenue growth and low-to-mid single-digit FCF margins can support a fair value in the high teens, though the near-term margin-driven EV/revenue fair value is more in the mid-teens. Either way, I think these shares offer appealing potential here even with the risk of a protracted downturn in the company’s major markets.

Better Decrementals The Main Highlight Of Q1

Looking back at first quarter results, Dana managed to outperform reasonably well on the top line (around 5%), but significantly on the EBITDA line (about 25% better than expected). Of course, this outperformance has to be viewed in the context of lowered expectations going into the quarter, but I believe the margin outperformance is a significant takeaway and one that reduces some of the risks at this still-early point in the downturn.

Revenue declined about 14% in organic terms, with the auto business doing considerably better than the commercial vehicle business. Light vehicle driveline revenue declined about 9%, outperforming underlying production by about 1,400bp, while the Power Technologies business declined 6%, outperforming by about 1,700bp on platform/program launches.

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On the commercial side, Off-Highway declined about 22%, while Commercial Vehicle declined about 20%. Good data on underlying production volumes are hard to find, but looking at the results from companies like Commercial Vehicle (CVGI), Cummins (CMI), and Tenneco (TEN) suggest to me that Dana’s results were basically in line.

Gross margin declined about three points, and EBITDA declined 20%, with margin down about 130bp, but the decremental margins in the low 20%s were meaningfully better than expected. Margins declined in all segments, but three of the four units maintained double-digit margins (Commercial being the exception). This quarter’s results underling a lot of what management has been saying about its flexible cost structure, and management sounds as though they will be prudent about what costs they add back as the end-markets recover.

Time Will Tell How The Recovery Shapes Up

I’m still expecting a pretty healthy recovery in passenger volumes in 2021, helped by what I expect will be government-led stimulus programs in multiple markets. On top of that, Dana stands to benefit from ongoing outperformance of trucks relative to cars and additional upcoming platform launches. Backlog conversion was a positive driver in the first quarter, and I don’t think that is completely tapped out yet.

I’d also note that Dana’s commercial markets (particularly heavy and medium-duty trucks) were already going into cyclical decline before COVID-19. Clearly, this cycle has already been different, with factories forced to close and many customers slashing capex to bare minimums, but I don’t yet see any reason to believe that the total “area under the curve” will be substantially different in this downturn versus past truck downturns.

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The rest of the commercial business is a tougher call; I think construction equipment demand could be pressured for a few years without an infrastructure stimulus bill, and I’m likewise not as bullish on agriculture or mining equipment.

The biggest risk I see to Dana, and parts supplier valuations, is an extended or double-dip decline. If there were another wave of COVID-19 infections sufficient to lead to another round of shutdowns, whether later in 2020 or in 2021, the recoveries across Dana’s markets would definitely be delayed, and the company would be looking at another year of weak margin leverage. On the other hand, I don’t see that changing the overall magnitude of the eventual recovery; the relationships between vehicle/fleet ages and volumes tend to be pretty consistent, and older vehicles would still need to be replaced.

The Outlook

Dana management believes that the company is FCF breakeven at around $6B billion in revenue or a 30% decline from the prior year. Based on past results and the margin/cash flow resilience seen this quarter, I believe that’s credible guidance, and I don’t see revenue breaking that threshold.

I’m still looking for long-term revenue growth in the low single-digits (or low-to-mid single-digits on an adjusted basis). Although Dana doesn’t have the same leverage to electrification as BorgWarner (BWA) or Valeo (OTCPK:VLEEY), it’s better-positioned than companies like Allison (ALSN) and Cummins, and I believe Dana will be much more of a participant in electrification than a victim. I’m not expecting significant long-term margin leverage versus past cycles, and it remains to be seen whether parts/components companies can attain the same level of margins with electrical components as they have with internal combustion components. In any case, I’m expecting FCFs margins to bounce off a low in 2020 and average out in the low-to-mid single-digits.

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The Bottom Line

Between discounted cash flow and margin-driven EV/revenue, I believe the fair value for Dana is in the mid-to-high teens. Dana has more debt than you’d like to see, but I believe Dana will still be FCF positive, and I’m not concerned about the company’s liquidity or solvency situation. While some of the easy money has been made with Dana up significantly off the March panic lows, I still see meaningful upside from here and this remains one of my preferred names in the parts sector.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.