NYSE: TKR
THE TIMKEN COMPANY
Investment Thesis
The Timken Company is the largest tapered roller bearings
manufacturer in the world and one of the largest manufacturers of alloy
and specialized steel in the world. The company reports revenues in
three business segments: Steel (31% of 2005 revenue), Automotive
(32%), and Industrial (37%).
I feel that Timken is capable of delivering solid EPS and top-line
revenue growth over the next two years, driven largely by demand for
industrial bearings and steel products in key end-markets, including
aerospace & defense, energy, rail, mining, and construction. Timken’s
Industrial and Steel margins have been expanding since 2004, and with
strong demand for the company’s products and global capacity
constraints, I forecast margin expansion through 2008.
28 November 2006
Analyst: Constantine Elefter
Fisher College of Business
The Ohio State University
Columbus, Ohio
Contact: 330.806.6217
Email: Elefter.1@osu.edu
Fund: OSU SIM
Class: Bus-Fin 724
Manager: Royce West, CFA
Recommendation
Price Target
I have assigned Timken a one-year price target of US $42.00. This
price target is based on applying a 14.0x P/E multiple of my 2007E
EPS of $3.07. This P/E multiple was constructed using a weighted
Sector: Industrials
average comparables multiple of automotive, industrial, and bearings
Industry: Machine Tools & Accessories
companies (see Equity Valuation: Multiples section for discussion).
Timken is a strong BUY based on valuation, with a 38.2% upside to the
company’s 11/17/2006 stock price of $30.38.
Stock Data
Estimates
Price:
US $ 30.38
(US$)
2004A 2005A 2006E 2007E 2008E
Price Objective:
US $ 42.00
GAAP EPS
$1.50 $2.81 $2.81 $3.07 $3.69
52 Week High:
US $36.58
52 Week Low:
EPS Change YoY
87.3% 0.0% 9.3% 20.2%
US $26.57
Market Capitalization: US $2.74 B
Consensus EPS (First Call: October)
$2.70 $2.99 $3.60
Shares Outstanding:
High EPS
94.1 MM
$2.75 $3.20 $3.65
YTD Return:
-18%
Low EPS
$2.69 $2.70 $3.55
Beta:
1.09
40
TIMKEN COMPANY (TKR)
PRICE 30.38 DATE 11-17-2006
2006E Net Sales:
38
US $5,286 MM
StockVal®
2006E EPS:
US $2.81
BUY
34
34
32
200
50
32
30
30
28
28
26
2005 Revenue Breakdown by
Business Segment
26
SP5
0.98
24
24
22
Q4/04
22
Q1/05
Q2/05
Q3/05
Q4/05
Q1/06
Q2/06
Q3/06
Q4/06
60 Day Avg. Volume 801
3100
1700
1700
1000
1000
600
600
300
300
200
200
100
100
Volume in Thousands of Shares
Steel
31%
Automotive
32%
Industrial
37%
1
Table of Contents
Company Overview
3
Products
3
Tapered Roller Bearings
3
Precision Cylindrical and Ball Bearings
3
Spherical and Cylindrical Bearings
3
Needle Bearings
4
Bearing Reconditioning
4
Steel
4
Business Segments
4
Automotive Group
4
Restructuring: Automotive
6
Industrial Group
7
Steel Group
7
Macroeconomic Conditions
8
Gross Domestic Product
8
Industrial Production
8
Manufacturing and Equipment Orders
10
Pricing: Steel and Capital Equipment
11
Regulatory Framework (CDSOA “Byrd Amendment”)
12
Industry Analysis
13
Industrials Sector Valuation
14
Competitive Advantages: Growth Drivers
15
Engineering
15
Acquisition
15
Competitive Pressures
15
Project ONE
15
Sources of Growth
16
DuPont Analysis
17
Summary
18
Financial Statement Ratios Analysis
19
1
2
Equity Valuation: Multiples
20
Absolute Valuation
20
Automotive Comparables
20
Industrial Comparables
21
Bearings Comparables
22
Conclusion
22
Equity Valuation: Discounted Cash Flow
23
Revenue Forecast
23
Income Statement Assumptions
23
Balance Sheet Assumptions
24
Summary and Outputs
24
Conclusion: BUY
25
Risks and Concerns
26
Timken Bearings Snapshots
27
Endnotes
28
Valuation Appendices
Segment Revenue and Profitability
Income Statement and Drivers
Balance Sheet and Drivers
Cash Flow Statement and Analysis of FCF
DCF Valuation
2
3
Company Overview1
Founded in 1898 by Henry Timken and incorporated in 1904, The Timken Company (“Timken”
or “the company”), is headquartered in Canton, Ohio.
Timken is the largest manufacturer of tapered roller bearings and alloy seamless mechanical steel
tubing in the United States and a leading global manufacturer of highly-engineered bearings,
alloy and specialty steels, and a provider of related products and services. Timken is the largest
North American-based bearings manufacturer. The company has operations in 29 countries on
six continents. As of December 31, 2005, Timken employed approximately 27,000 people.
On February 18, 2003, Timken completed the acquisition of The Torrington Company
(Torrington), a manufacturer of needle bearings used in transmission and wheel applications.
Torrington is now integrated into the company, and has added tremendous scale to Timken’s
operations.
Products2
Timken manufactures two basic product lines: anti-friction bearings and steel products.
Differentiation within each product line exists as a function of the type or the application of the
bearings and steel products.
Tapered Roller Bearings
The tapered roller bearing is Timken’s best-known and signature product in the anti-friction
industry segment. Timken sells these bearings in a wide variety of configurations and sizes to
meet customer adaptations.
Precision Cylindrical and Ball Bearings
Timken’s aerospace and super precision facilities produce high-performance ball and cylindrical
bearings for high-accuracy applications in the aerospace, medical and dental, computer, and
other high-performance industries.
Spherical and Cylindrical Bearings
Timken produces spherical and cylindrical roller bearings for large gear drives, rolling mills, and
other process industry and infrastructure development applications. These products are sold
3
4
worldwide to original equipment manufacturers (OEMs) and industrial distributors serving major
industries, including metals and mining, pulp and paper production, and general industrial goods.
Needle Bearings
With the acquisition of Torrington, the company became a leading global manufacturer of highly
engineered needle roller bearings, serving automotive, construction, and agriculture industries.
Bearing Reconditioning
Bearing reconditioning is a service supporting industrial and railroad customers domestically and
internationally. Bearing reconditioning services accounted for less than 5% of the company’s net
sales in 2005.
Steel
Steel products include steels of low and intermediate alloy, vacuum-processed alloys, tool steel
and some carbon grade available in a wide range of solid and tubular sections. Customization is
also an important element of the company’s steel business.
Business Segments
Timken has three reportable business segments: Automotive Group, Industrial Group, and Steel
Group.
Automotive Group (Auto)
The Automotive Group includes sales of bearings and other products and services (other than
steel) to automotive original equipment manufacturers (OEMs). Automotive bearings and other
products service multiple front-end units, including heavy truck, axle, and wheel applications.
Beginning in 2003, the automotive aftermarket front-end was reorganized and is now part of the
reported Industrial Group. The Auto segment remains the main area of my concern due to
Timken’s inability to return the segment to profitability over the past two years in the face of
continuing challenges faced by the domestic automotive industry.
It is estimated that about 70% of Timken’s Auto output is directly or indirectly tied to the three
largest North America automotive manufacturers (Big 3)—General Motors (GM), Ford, and
Chrysler—with its largest exposure to GM. Over the past few months Ford, Chrysler, and GM
announced substantial production cuts for 2006 and 2007. The worsening state of the domestic
4
5
auto industry has severely impacted Timken’s Auto Group and has forced the company to
accelerate internal restructuring to shrink its Auto capacity in an effort to mitigate continual
losses from the business segment.
Timken’s top-line Auto revenue growth is highly correlated with North America production
growth by the Big 3. Actual annual North America production for the Big 3 has fallen
drastically since 2004. It is estimated year-over-year growth has decreased between -1.7% and 3
7.0% for North American production by the Big 3 from 2004 to 2007 (Table 1) . Chart 2 plots
Timken’s Auto sales percentage growth versus North America production growth for the Big 3.
Over the period 2001 to 2007E, there is a 97% regression correlation between the two factors.
TABLE 1
North America Production (units) Y/Y%
Growth
Annual Production
2004 2005 2006 2007
GM
-5.0%
-7.0%
-4.0%
-3.0%
Ford
-5.0%
-6.0%
-9.0%
-4.0%
Chrysler
5.0%
2.0%
-8.0%
-4.0%
TOTAL
------
------
------
------
-1.7%
-3.7%
-7.0%
-3.7%
CHART 2: Timken's Auto Revenue Growth vs. Big
3 North America Production Growth
20.0%
10.0%
0.0%
2001
2002
2003
2004
2005
2006
2007
-10.0%
-20.0%
Timken's Auto Sales % Growth
Big 3 North America Production
5
6
I feel that the market has already factored the Auto risk and exposure in Timken’s (TKR) stock
price. Timken is currently trading below the average multiple of automotive suppliers, despite
the fact that only 30% of its business relates to the auto industry. I feel this multiple is simply
not justified considering 70% of the company’s exposure is in faster growth steel and industrial
sectors (see Equity Valuation: Multiples section for discussion). Therefore, any meaningful
restructuring activity going forward should be viewed as a positive catalyst for the stock. It is
also important to view Auto independently of Timken’s other business segments, where outlook
is strong and margins projections are robust.
Restructuring in the Automotive Group: Positive
In an effort to offset Auto risk, Timken has begun to shift Auto capacity into the higher growth
Industrial segment. Lower proportion of unprofitable Auto and larger exposure to better return
and higher growth Industrial will greatly benefit Timken’s business portfolio in the long-run.
Although Auto restructuring will result in additional charges, negatively effecting earnings and
cash flow, I view it as a long-term positive. Currently, certain Timken facilities manufacture
products for both segments, so management’s decision to reallocate to Industrial seems
achievable, and necessary.
On September 29, 2006, Timken announced a workforce reduction of about 700 positions in its
Auto segment. The company has already discussed its ongoing plan of further position
eliminations in the segment by the end of 2007. Altogether, employee count should be down 8%
from 2005, which is in-line with production and employee decline at the Big 3 from 2005 to
2007.
In the end, Auto restructuring is the key element for Timken to emerge as a strong global player.
The company must walk away from its current business portfolio and model, with exposure to
Auto, in lieu of a new, central focus on the industrial growth and steel businesses. Timken does
not need to eliminate Auto exposure completely, especially if the Big 3 rebound in the shortterm, but must be willing to accept lower Auto returns from OEMs and continue to shift capacity
into Industrial.
6
7
Industrial Group (Industrial)
The Industrial Group includes sales of bearings and other products and services (other than steel)
to a diverse customer base. Industrial bearings and other products service seven front-end units:
aerospace & defense, automotive aftermarket, power transmission, off-highway, rail, consumer
& super precision, and heavy industry. Most of the end Industrial markets are expected to post
another couple years of growth which should result in continuing solid demand for bearings
products in 2007 and beyond. Industrial bearings are sold in various international regions as
well, and the fast growing Asian market—particularly China—is fueling future growth at high
levels.
Industrial capacity is currently working near its peak in the segment. The constraint should be
favorable to Timken’s pricing environment, adding top-line Industrial revenue increases as
pricing contracts come due and are increased. To address capacity constraints, in the first threequarters of 2006 Timken has had record capex as the company is actively investing in expanding
the capacity of Industrial bearings and reallocating existing Auto manufacturing facilities to
Industrial. I forecast solid profitability in the Industrial Group 4Q:06 and throughout 2007. The
only drain on positive momentum for Industrial margins will be shifting idle Auto capacity into
Industrial production.
Steel Group (Steel)
The Steel Group includes sales of low, intermediate, and high-end alloy steels available in a wide
range of solid and tubular sections. Timken also manufacturers custom-made steel products.
The major end markets of Steel are: automotive, bearing, industrial, tool steels, distribution,
aerospace, and energy. Approximately 10% of the company’s steel is consumed in its bearings
operations. The energy, industrial, and aerospace industries are expected to have several years of
strong growth.
I am forecasting expanding Steel margins, largely because of the acceleration in growth of the
aerospace and energy markets. Additionally, Timken’s pricing and surcharge system on its
existing contracts allows the company to effectively pass down rising scrap costs to its
customers, should steel scrap prices remain high. This should support the continued
7
8
maintenance of Steel margins over the next two years. I am very bullish on the sustainability of
robust demand for the company’s Steel products as well as healthy pricing in the segment in
2007.
Macroeconomic Conditions4
Key macroeconomic indicators relevant to Timken’s performance include: domestic economic
growth (GDP), industrial production (IP) in key international markets, equipment and durable
manufacturing orders, and prices of steel and capital equipment.
Gross Domestic Product (GDP)
Economic growth is potentially the largest driving macroeconomic factor impacting Timken’s
stock performance because GDP growth signals a strong economy and business investments in
capital – machinery and equipment that use Timken’s bearings and steel products. The 10-year
average GDP growth rate is 5.4%; however, the White House reports slower economic growth
this year and next, estimating 3.1% and 2.9% respectively. These figures do not bode well for
Timken, but demand has been strong in key end-markets offsetting GDP stagnation.
Industrial Production
Industrial production and the related capacity indexes and capacity utilization rates (not shown in
charts below) cover manufacturing, mining, and electric and gas utilities. The industrials sector,
together with construction, accounts for the bulk of the variation in national output over the
course of the business cycle. Industrial production is a measure that is provided by these indexes
and utilization rates, which tell a story about a particular country’s structural development. It is
this structural development and potential output growth that demands capital-intensive products
that use Timken’s bearings and steel products. Increasing amounts of Industrial Production in
key international markets (GDP is used to assess domestic investment, but chart below looks at
the US IP Index through January 2007), such as industrialized Western Europe and Asia, are
positive signs of potential demand growth for Timken production. Of particular note, and not
available on StockVal for pictorial representation, 2006 Chinese Industrial Production is
5
estimated to have 16.4% year-over-year growth . China’s structural and infrastructure building
remains key to Timken’s international growth efforts.
8
9
U.S. Industrial Production Index: Past Trend Present Value and Future Projection – Index
Value sets 1997 = 100
6
Industrial Production Index: Select Countries
StockVal®
1996
1997
1997
1998 1998
1999 19992000 2000 20012001 2002
2002
2003
2003
105
2004
2004
2005
2005
2006
2006
2007
2007
2008
HI 104.70
LO 97.30
ME 100.40
CU 99.00
GR
0.0%
102
99
11-30-1996
09-30-2006
96
INDUSTRIAL PRODUCTION INDEX-UK
120
HI 116.40
LO 80.60
ME 98.70
CU 115.70
GR
1.9%
110
100
90
11-30-1996
09-30-2006
80
INDUSTRIAL PRODUCTION INDEX-GERMANY
120
HI 114.50
LO 65.20
ME 100.10
CU 106.60
GR
1.7%
100
80
70
11-30-1996
09-30-2006
60
INDUSTRIAL PRODUCTION INDEX-FRANCE
108
HI 106.80
LO 87.70
ME 98.20
CU 106.10
GR
0.6%
102
96
90
11-30-1996
09-30-2006
84
INDUSTRIAL PRODUCTION INDEX-JAPAN
9
10
Manufacturing and Equipment Orders
Although the GDP outlook forecasts stagnant growth for 2006 and 2007, durable manufacturing
and plant & equipment orders are at all time highs. Commercial construction, mining, energy,
and aerospace markets continue to experience rapid growth, and these end-markets are driving
equipment orders to high levels.
Durable Manufacturing and Plant & Equipment Orders
StockVal®
1996
1997
1997
1998 1998
1999 19992000 2000 20012001 2002
2002
2003
2003
2004
2004
2005
2005
2006
2006
2007
2007
2008
260
240
HI
LO
ME
CU
GR
220
200
180
160
245.23
145.79
182.45
235.26
3.4%
11-30-1996
09-30-2006
140
NEW ORDERS-DURABLE-MFRS ($BIL)
1000
950
HI
LO
ME
CU
GR
900
850
800
750
989.80
725.44
855.05
976.41
2.3%
11-30-1996
09-30-2006
700
PLANT & EQUIPMENT ORDERS ($BIL)
72
HI
LO
ME
CU
GR
64
58
52
48
42
71.60
38.40
56.60
52.10
-0.9%
11-30-1996
10-31-2006
38
ISM NEW ORDERS INDEX
10
11
Pricing of Steel and Capital Equipment
With growing domestic and international Industrial Production and record high-levels of
manufacturing and equipment orders despite capacity constraints, it is quite understandable to
see inflated pricing power of steel and capital equipment products. I anticipate that as certain
long-term contracts come due in the next two years, Timken will be able to increase pricing.
Steel and Capital Equipment PPI
StockVal®
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
160
150
HI
LO
ME
CU
GR
140
130
120
110
155.50
100.30
115.95
152.10
2.0%
11-30-1996
10-31-2006
100
PPI-HOT ROLLED STEEL
148
HI
LO
ME
CU
GR
146
144
142
140
138
146.80
136.70
139.25
146.80
0.6%
11-30-1996
10-31-2006
136
PPI-CAPITAL EQUIPMENT
168
161
HI
LO
ME
CU
GR
154
147
140
133
162.10
130.10
139.70
158.40
1.8%
11-30-1996
10-31-2006
126
PPI-FINISHED GOODS
11
12
Regulatory Framework7
Timken is a beneficiary of the Continued Dumping and Subsidy Offset Act (CDSOA), known as
the Byrd Amendment, which provides the annual distribution of antidumping duties to domestic
producers in selected industries. The effect on the company’s free cash flow is neutral because
Timken continues to use these additional cash proceeds towards pension funding (Timken has
significant pension and postretirement liabilities: See Risks and Concerns to Investment Thesis
for further explanation). Any gains from the CDSOA receipts are accounted for as nonoperational.
The Byrd Amendment is currently in the process of being repealed, but the final decision has
been delayed until the end of 2007; hence, the company might still benefit from the
disbursements over the next two years. CDSOA could easily add over $100 MM to Timken’s
cash flows in the next two years.
12
13
Industry Analysis
The industrials sector of the S&P 500 is highly cyclical. As a component of the industrials
sector, Timken typically moves relative to the business cycle in the United States. Timken
flourishes when the economy is growing, yet faces downside risk to growth and earnings when
the economy slows as industrial and automotive companies cut back and industrial production
falters. In my view, the economy is in a current state of recovery and expansion; both,
rebounding and upward economic trends that bode well for industrials, and therefore Timken
(Graph 1). Timken stock’s beta is 1.09 which means that the stock performs almost in-line with
the market, which has a beta of 1.0.
GRAPH 1
8
Timken is a relatively mature company within a mature and stable industry. Timken pays a
steady stream of dividends. According to StockVal, Timken’s annual dividend yield is 2.11%.
Although I would not consider Timken as a growth company, it is currently revamping its
operations, strategic alignment, and information technology (IT) systems in order to facilitate
growth opportunities in the near future. As the leading technological roller bearings
manufacturer in the World, Timken is constantly engineering innovative ways to enhance the
performance of the company’s customers.
13
14
Industrials Sector Valuation
Currently, the industrials sector appears to be relatively cheap by most valuation methods. Price
to Forward Earnings is near historic lows, as is Price to EBITDA. Price to Sales metric is also
below its 10-year mean. Focusing on Price to Forward Earnings, which I feel is the most
accurate valuation measure for this sector (because Sales and EBITDA are more sensitive to
cyclical swings); there is one central explanation for the low valuation. Following the terrorist
attacks on September 11, 2001, the US stock market took a big hit and the US economy fell into
a recession that lasted, by conservative estimates, until January 2004. Earnings for industrial
suppliers were especially impacted as most major companies cut back CapEx and investment.
The economy is finally rebounding post 9/11, yet valuation measures have not caught up. This
suggests that going forward, valuation measures, especially Price to Forward Earnings, should
expand, reverting back to the 10-year mean.
S&P INDUSTRIALS SECTOR COMP ADJ (SP-20) Price 49.38
1996
1997
1997
1998 1998
1999 19992000 2000 20012001 2002
2002
2003
2003
2004
2004
2005
2005
StockVal®
2006
2006
2007
2007
2008
30
27
HI
LO
ME
CU
24
21
27.2
14.4
20.0
15.9
18
15
11-15-1996
11-17-2006
12
PRICE / YEAR-FORWARD EARNINGS
2.2
2.0
HI
LO
ME
CU
1.8
1.6
2.00
1.18
1.59
1.53
1.4
1.2
11-15-1996
11-17-2006
1.0
PRICE / SALES
12
11
HI
LO
ME
CU
10
9
11.6
6.9
9.2
8.3
8
7
11-15-1996
11-17-2006
6
PRICE / EBITDA
14
15
Competitive Advantages: Growth Drivers9
There are several drivers of growth that I feel are acting as positive catalysts for long-term
investment in Timken and give the company sustainable competitive advantages.
Engineering
Within the bearings and industrial manufacturing space, Timken is the leading engineer of highperformance, high-precision products. Timken is always on the cutting edge of technological
advancement, engineering, and product innovation. Timken’s competitors are constantly trying
to imitate the company’s engineering and innovation capabilities, but simply are not able to do
so. Currently, Timken is expanding its research and development (R&D) initiatives in the
United States and internationally to sustain this “innovative advantage”. As the preeminent
tapered roller bearings manufacture and a leader in innovation, Timken is consistently able to
engineer new products to meet its customer demands, which makes it a first choice for new and
repeatable business.
Acquisition
In 2003, Timken completed a successful acquisition of Torrington, a leading global manufacturer
of needle bearings used in transmission and wheel applications. The integration of Torrington
into Timken has been completed. The acquisition has expanded Timken’s product offerings and
increased economies of scale. As a past employee of Timken, I know firsthand the scale, global
opportunities, and edge Torrington’s operations has given Timken in the industry.
Competitive Pressures
Although Timken faces constant pressure from its competitors, the company’s diverse business
portfolio has added flexibility that its competitors lack. Additionally, the machine tools &
accessories industry has high barriers to entry, and with Timken’s dominance as a global leader,
economies of scale, and recognizable name, Timken faces a very limited threat from new
entrants in the future.
Information Technology/Supply Chain Improvements
In 2005, Timken launched the Project ONE initiative, a five-year program designed to improve
business processes and information systems capabilities. Project ONE should provide
integration and technology solutions that will better prepare Timken for future growth. A major
component of Project ONE is a thorough analysis of Timken’s distribution and supply chain
15
16
functions. As of August 2005, Project ONE has identified a major distribution and supply chain
route process that needs overhauled. The Project ONE executive team is currently reviewing
options relating to this overhaul, and it is transformations like this that will slim associated costs
while streamlining operations to enhance profitability.
Sources of Growth
Strong demand for Timken’s bearings and steel products (organic growth), growth through
acquisition (Torrington, 2003), margin expansion due to domestic and international demand in
key end-market and capacity constraints, and information technology and supply chain cost
reductions (Project ONE), all provide solid sources of earnings growth and economies of scale.
Chart of Timken’s 10-year stock performance history and related data:
TIMKEN COMPANY (TKR)
55
PRICE 30.38 DATE 11-17-2006
48
StockVal®
42
36
36
32
32
27
27
24
24
21
21
18
18
16
16
14
14
12
12
10
9
The Ohio State University 10
Fisher College of Business 9
1997
1998
1999
Price Change
%
Diff SP5
1-Day
-1.46
-1.56
1-Week
1.47
-0.00
4-Weeks
2.05
-0.33
QTD
2.01
-2.88
YTD
-5.12
-17.37
2005
23.06
20.06
2004
29.71
20.72
2003
5.03
-21.35
FYE Dec 2005 EPS 2.54
2000
2001
First Call Data
Mean Estimate
Change
High
Low
Total
# Up
# Down
House Estimate
PE Ratio
2002
2003
2004
2006
2.70 ↓
+6%
2.75
2.69
7
2
5
2007
2.99 ↓
+11%
3.20
2.70
7
1
6
11.2
10.2
2005
2008
3.60 ↓
+20%
3.65
3.55
2
0
2
8.4
2006
2007
2008
Data Page # 1
Revenues ($Mil)
Market Value ($Mil)
Shares Out (Mil)
Volume 60-Day Avg (Th)
Volume 60-Day Avg ($M)
Dividend Estimate
Payout Ratio
Retention Rate
Dividend Yield
5,289
2,860
94.1
801
24.3
0.64
24%
76%
2.11%
16
17
DuPont Ratios Analysis10
See chart below for complete DuPont analysis for five years of Timken’s financial statements.
The fiscal year 2003 numbers may not be comparable due to Timken’s acquisition of Torrington.
DuPont Ratios
Profit Margin % (EBIT/Sales)
Asset Turnover (Sales/Assets)
Return on Investment (ROI)
Leverage Multiplier (Assets/Equity)
Return on Equity Adjusted (ROE)
2001
0.27%
0.96x
0.26%
-4.66x
-0.15%
2002
4.59%
0.97x
4.45%
5.57x
7.43%
2003
2.88%
1.18x
3.40%
4.30x
7.48%
2004
5.55%
1.20x
6.66%
11.50x
10.37%
2005
8.55%
1.32x
11.29%
18.81x
16.98%
Profit Margin (EBIT/Sales) is a quick measure of operating management. When this ratio is
positive and rising over time, as is the case of Timken, it is a good sign that operating
management is going well. Timken’s management is producing sales and controlling costs such
that the bottom line is growing.
Asset Turnover (Sales/Assets) is a measure of asset management. When this ratio rises across
time, it is a good sign that asset management is going well. As in the case of Timken, a rising
ratio means that the firm is able to produce more and more sales from its assets. In other words,
Timken is steadily becoming more efficient in using its assets. Different industries have
different levels of total asset turnover that indicates efficient asset management. For example, in
certain industries a high level of asset turnover could mean that the firm is not adequately
replacing its assets and this would be a poor sign of asset management, despite a high ratio.
Most manufacturing firms strive for asset turnover ratios of 1x to 2x. Timken’s asset turnover
ratio falls between this “ideal” manufacturing parameter standard.
Return on Investment or ROI (Profit Margin*Asset Turnover) measures the profitability of assets
in use by the company. The same levels of ROI can be produced by either a high profit, low
turnover strategy or by a low profit, high turnover strategy. Profit on sales and asset turnover
can be thought of as a potential strategic tradeoff. Timken’s strategy probably falls in between
these ranges, in which some products yield a higher margin while others seek higher turnover.
17
18
Timken’s ROI has been increasing from 2001 to 2005, and more than doubled between 2004 and
2005.
Leverage Multiplier (Assets/Equity) is a representation of capital structure. This ratio typically
should not be rising over time because an increase means that more debt is being used to finance
the firm. Debt requires fixed payments of principle and interest and if these payments are not
met it could force the company into bankruptcy. High levels of debt and therefore a high
leverage (equity) multiplier represents poor capital structure management. Timken’s leverage
multiplier has risen dramatically recently, which is a negative sign of capital structure
management. However, I feel the acquisition of Torrington, in which Timken took on debt to
finance the transaction, skews our perspective of the multiplier quite a bit. Furthermore, my
analysis estimates that Timken’s end of period cash position should rise to $400MM by the end
of 2008, providing ample interest coverage for the company’s short and long-term debt
payments.
Return on Equity or ROE (ROI*Leverage Multiplier) is a measure of the profitability of funds
invested by the owners of the firm. All companies, no matter the industry, should attempt to
make ROE as high as possible over the long-term. Most of ROE should be produced by high
return on investment, profit margin, and asset turnover: not the leverage multiplier. As such, for
this analysis I used an adjusted ROE to smooth the multiplicity of Timken’s high leverage
multiplier in order to better understand how and if the company’s ROE is in fact growing.
DuPont Analysis: Summary
In my judgment, Timken is in a strong financial position – indicative of the company’s high and
growing ROE. I expect Timken’s leverage multiplier to return to normality (near 5.0x) by the
end of fiscal year 2008, in large part to its (anticipated) growing cash position. Timken’s
operating management, asset management, and ROI are especially strong, and coupled with an
expected decline in leverage, Timken should be viewed as a prudent and transparent investment,
capable of delivering solid and sustainable ROE over the long-term.
18
19
Financial Statement Ratios Analysis
See chart below for selected financial statement ratios over the last five years for Timken. The
fiscal year 2003 numbers may not be comparable due to Timken’s acquisition of Torrington.
Financial Statement Ratios
Days in Accounts Receivable
Days in Accounts Payable
Days in Inventory
Inventory Turnovers
Net Trade Cycle
2001
45.9
46.0
76.5
4.8x
76.6
2002
80.2
65.8
121.8
3.0x
92.1
2003
58.0
49.3
80.7
4.5x
89.5
2004
57.1
49.9
86.9
4.2x
94.2
2005
50.3
44.5
88.6
4.1x
94.6
Days in Accounts Receivable measures how many days it takes a company to collect its
receivables. Timken has gradually been more efficient in collecting money owed to the
company, which is a positive sign; the less amount of the receivable, the more money Timken
has received and has available to spend, therefore increasing cash flow.
Days in Accounts Payable measures the average number of days it takes a company to pay its
suppliers. Timken’s Days in Accounts Payable ratio has been steadily declining to about 45.
Timken has good relationships with the company’s suppliers, and this is huge positive.
Days in Inventory and Inventory Turnovers are both ratios assessing the inventory management
of Timken’s operations. Both ratios have remained steady since 2003. I would hope that in the
future the company becomes better able to push its inventory out its doors as saleable product.
Net Trade Cycle is calculated by taking receivables plus inventories minus payables, and is a
comprehensive look at the number days from cash to inventory to accounts receivable to cash.
In other words, Net Trade Cycle (Operating Cycle) reveals how long cash is tied up in
receivables and inventory. A long Net Trade Cycle means that less cash is available to meet
short-term obligations. Although Timken’s management has not been able to significantly
reduce its Net Trade Cycle, the ratio has not increased much either. Timken does portray
moderate health, yet there is room for managerial improvement.
19
20
Equity Valuation: Multiples11
There are several multiples valuation methods I used to assess the true intrinsic value of
Timken’s stock price; including, absolute valuation, comparable analysis of automotive
suppliers, comparable analysis of industrial companies, and a comparable analysis of bearings
companies. The best intrinsic value assessment for Timken comes from the blended P/E
multiple of automotive, industrial, and bearings companies outlined below.
Absolute Valuation
Timken is trading near the low end of its historical P/E multiple (Table 2). On an absolute basis,
Timken is currently trading at a 10.5x P/E multiple, whereas its ten year average P/E multiple is
15.0x. I do not think this is justified based on the company’s projected earnings growth over the
next two years and strong global demand for the company’s bearings and steel products.
TABLE 2
Absolute
Valuation
A.
P/Forward E
P/S
P/B
P/EBITDA
P/FCF
High
B.
N/A
1.01
2.60
10.20
10.80
Low
C.
8.80
0.29
0.80
2.40
3.40
Mean
D.
15.00
0.48
1.60
4.60
6.00
Current
Target
Multiple
E.
10.50
0.54
1.70
4.10
6.40
F.
14.00x*
0.60x
1.70x
5.00x
8.00x
Target
(E, S,
B, etc) /
Share
G.
$3.07
$56.60
$17.87
$7.10
$2.20
Target
Price
H.
$42.98
$33.96
$30.38
$35.50
$17.60
Comparables Analysis: Automotive
Based on a peer group of automotive suppliers American Axle, ArvinMeritor, and BorgWarner,
Timken is trading at a significant discount (Table 3). My comparable analysis of automotive
suppliers yields a 2007 automotive average P/E of 13.4x. Timken is trading below this average
comparison, at 10.3x.
20
21
TABLE 3
Comparable Analysis of Automotive Companies
Company
Stock Price
11/17/2006
P/E
2006E
2007E
American Axle (AXL)
ArvinMeritor (ARM)
BorgWarner (BWA)
Automotive Average
$19.04
$17.67
$60.13
12.6x
13.9x
13.5x
13.3x
12.8x
14.3x
13.2x
13.4x
Timken
$30.38
10.5x
10.3x
Comparables Analysis: Industrial
Based on a peer group of industrial suppliers Eaton, Ingersoll Rand, ITT Corp., and SPX Corp.,
Timken is trading at a significant discount (Table 4). My comparable analysis of industrial
suppliers yields a 2007 industrial average P/E of 14.2x. Timken is trading below this average
comparison, at 10.3x.
TABLE 4
Comparable Analysis of Industrial Companies
Company
Stock Price
11/17/2006
P/E
2006E
2007E
Eaton (ETN)
Ingersoll Rand (IR)
ITT Corp. (ITT)
SPX Corp. (SPW)
Industrial Average
$75.60
$38.40
$54.70
$61.21
11.8x
11.1x
16.6x
17.2x
14.2x
12.0x
10.9x
16.4x
17.5x
14.2x
Timken
$30.38
10.5x
10.3x
Comparables Analysis: Bearings
Based on a peer group of bearings companies Kaydon, NN Inc., and Regal Beloite, Timken is
trading at a significant discount (Table 5). My comparable analysis of bearings companies yields
a 2007 bearings average P/E of 14.5x. Timken is trading below this average comparison, at
10.3x.
21
22
TABLE 5
Comparable Analysis of Bearings Companies
Company
Stock Price
11/17/2006
P/E
2006E
2007E
Kaydon (KDN)
NN Inc. (NNBR)
Regal Beloite (RBC)
Bearings Average
$50.29
$10.74
$50.29
17.4x
11.9x
13.9x
14.4x
17.7x
11.6x
14.1x
14.5x
Timken
$30.38
10.5x
10.3x
Equity Valuation: Multiples, Conclusion
Timken’s operations are diversely spread between Auto, Industrial, and Steel businesses, with a
special global focus on tapered roller bearings manufacturing. As such, I believe the company
should be valued somewhere between an automotive supplier, industrial supplier, and bearings
company. The peer group of automotive suppliers that I identified in Table 3 trade at an average
P/E multiple of 13.4x, at what should be the low-end of Timken’s valuation range, whilst the
peer group of bearings companies in Table 5 trade at an average P/E multiple of 14.5x, at what
should be the high-end of Timken’s valuation range. The comparable analysis of industrial
suppliers yields an average industrial P/E multiple of 14.2x, right in the middle of Timken’s
range that I just specified.
Weighting the comparable analyses of industrial and automotive suppliers, and bearings
companies, I believe Timken should trade at a year-forward P/E multiple of 14.0x in 2007.
Timken (Blended 1/3)
$30.38
14.0x
14.0x
Timken is trading well below this average comparison at a year-forward P/E multiple of 10.3x in
2007. Just taking into consideration the peer automotive suppliers’ average of 13.4x in Table 3,
which should be the low-end of the company’s valuation range due to its business portfolio,
Timken is still trading at a heavy discount. Timken stock is trading below every major valuation
metric illustrated in this report. In my view, Timken’s current valuation is simply not warranted.
Timken’s deep discount on a year-forward P/E multiples basis presents a key buying
opportunity.
22
23
Equity Valuation: Discounted Cash Flow (DCF)
To ascertain the intrinsic value of Timken, a DCF model was derived to support the
aforementioned multiples valuation assessment. It concludes very similarly with the price target
established of $42.00. The DCF model generates an implied equity value per share of $41.81.
On a high level basis, I will explain the procedure and outline the assumptions made to the
model.
DCF Modeling Assumptions: Revenue Forecast
The Net Sales line of the Income Statement was built meticulously to capture historical
changes to each individual business segment: automotive, industrial, and steel sales.
Automotive revenue forecasted as a function of year-previous revenue multiplied times
revenue % growth.
Automotive revenue % growth imputed as -6% in 2006 due to the challenging
environment in the automotive industry. Margins improve to -2% in 2007 and 2% in
2008 as the automotive industry rebounds.
Industrial revenue forecasted as a function of year-previous revenue multiplied times
revenue % growth.
Industrial revenue growth has averaged roughly 10% over the past three year; I forecast
sustainable 8% revenue growth in 2006 and 2007, and 6% in 2008.
Steel revenue forecasted as a function of year-previous revenue multiplied times revenue
% growth.
A slowing US economy warrants steel revenue growth of 3% in 2006, 2% in 2007 and
1% in 2008.
For Timken as a whole, revenue will grow 2.3% in 2006, 3.2% in 2007, and 3.4% in
2008.
DCF Modeling Assumptions: Income Statement
Net Sales: Segment revenue model.
COGS: Set as a % of the gross margin.
SG&A: Set as a % of revenues.
Other Expenses: Set as a % of revenues.
23
24
Income Tax Expense: Assumed a 33% tax rate.
Other income statement line-items were modeled based on extrapolations from historical
levels.
DCF Modeling Assumptions: Balance Sheet
Cash and Cash Equivalents: Set as the end-of-period cash balance line-item from the
Statement of Cash Flows. Derived from beginning-of-period cash balance plus/minus net
changes in cash for that period. Reconciliation derivation.
Receivables: Set as a function of total Timken sales divided by (365/days receivable).
Inventories: COGS divided by inventory turns.
Deferred Income Taxes, other Assets: Set as a % of revenues.
PP&E: Calculated dynamically as net of prior year’s PP&E, D&A, CapEx, and
Divestitures and/or Acquisitions.
Goodwill: Directly imputed using historical levels.
Accounts Payable: Set as a function of COGS divided by (365/days payable).
Salaries: Set as a % of revenues.
Debt: A debt schedule was not built due to difficulties obtaining information regarding
large term debt revolvers and short-term debt instruments. Assumed constant debt level.
Accrued Pension Cost: Modeled as year-previous pension liability minus a set amount of
$150mm in 2006 and $50mm in 2007. Intuitively this makes sense because Timken has
been paying down pension liabilities with accrued CDSOA funds.
Other Long-Term Liabilities: Set as a % of revenues.
DCF Modeling Assumptions: Summary and Relative Outputs
Sustainable operating margins of 9.0% were used. This is reasonable, despite historical
suggestions, considering Timken’s internal restructuring to shift Auto capacity (with sub
0.0% margins) to Industrial production (with 12-13% margins) going forward.
Terminal discount rate of 10.5%.
Terminal FCF growth rate of 4.0%.
Implied terminal P/E multiple of 14.7x which is in-line with Timken’s historical P/E
multiple of 15.0x.
24
25
Conclusion: BUY
The Timken Company is the largest tapered roller bearings manufacturer in the world and one of
the largest manufacturers of alloy and specialized steel in the world. The company reports
revenues in three business segments: Steel (31% of 2005 revenue), Automotive (32%), and
Industrial (37%).
Currently, the domestic automobile industry is facing enduring challenges that threaten the fate
of automobile manufacturing in North America. Nearly one-third of Timken’s revenue is
directly or indirectly tied to the Big 3—GM, Ford, and Chrysler—domestic automakers.
Ongoing, Timken is adamantly restructuring the company’s Auto Group by shifting Auto
capacity into higher-margin and higher-return Industrial bearings production. This should be
viewed as a position catalyst for the stock.
In my view, the market is negatively overpricing Timken’s Auto exposure. Timken’s stock price
is down nearly 18% YTD, which I feel overestimates the company’s Auto risk, and presents a
buying opportunity. Currently, Timken is trading below its historic P/E multiple of 15.0x.
Additionally, the company is trading on a P/E basis below a peer group of automotive suppliers,
which is not warranted because 70% of Timken’s business is in higher valuation Industrial and
Steel segments.
I feel that Timken is capable of delivering solid EPS and top-line revenue growth over the next
two years, driven largely by demand for industrial bearings and steel products in key endmarkets, including aerospace & defense, energy, rail, mining, and construction. Timken’s
Industrial and Steel margins have been expanding since 2004, and with strong demand for the
company’s products and global capacity constraints, I forecast margin expansion through 2008.
I have assigned Timken a one-year price target of US $42.00. This price target is based on
applying a 14.0x P/E multiple of my 2007E EPS of $3.07. This P/E multiple was constructed
using a weighted average comparables multiple of automotive, industrial, and bearings
companies (see Equity Valuation: Multiples section for discussion). Timken is a strong BUY
based on valuation, with a 38.2% upside to the company’s 11/17/2006 stock price of $30.38.
25
26
Risks and Concerns to Investment Thesis12
Further deterioration of profitability in the Auto segment and uncertainty associated with
potential bankruptcy of major OEMs and suppliers in the US automotive industry
Impairment and restructuring charges related to the internal shift in Auto capacity to
Industrial could materially effect earnings (Timken has taken approximately $26.1
million in impairment and restructuring charges for the Automotive Group during 2005,
and expects to take additional charges in connection with this initiative)
The failure to achieve anticipated results of Auto restructuring
Competition and consolidation in the steel industry, together with global overcapacity,
could result in significant pricing pressure for Timken’s steel products and services
Operational risk and execution costs due to the implementation of global information
technology system Project ONE
The inability of Timken to pass along rising steel scrap prices to its customers, together
with rising input raw materials and energy costs
Timken is a benefactor of antidumping orders; eight antidumping orders are currently in
effect and the revoking of these fair trade conditions could put downward pricing
pressure on the company’s bearings products (see Byrd Amendment)
Weakness in any of the industries Timken’s customers operate, as well as sustained
economic malfeasance (slowing US GDP growth), could adversely impact profitability
and margins
Timken operates in 29 countries on six continents, so global political instability and other
international risks could pose a threat to operating costs and the business environment
Continued drag on cash flow due to large contributions to underfunded pension plans (in
2005 the company contributed approximately $240mm to its pension plan, above the
minimum requirement of $150mm, which reduced pension underfunding to around
$650mm)
26
27
Tapered Roller Bearings – Timken’s Signature Product
Spherical Roller Bearings
Precision Bearings
27
28
1
Adapted from the 2005 Timken Company 10-K
Adapted from the 2005 Timken Company 10-K
3
GM, Ford, and Chrysler Company 10-Ks, Reuters
4
StockVal
5
Wall Street Journal
6
Financial Forecast Center
7
2005 Timken Company 10-K
8
Wikipedia
9
2005 Timken Company 10-K
10
Explanations of ratios: Michigan State University
11
Companies for comparable analysis: Merrill Lynch
12
2005 Timken Company 10-K
2
28
Timken (TKR)
Historical
Segment Revenue
Revenue
Automotive
Industrial
2000 A
Total Bearings
Steel
Less intercompany sales
Net Steel Sales
Total Reported Sales and Revenues
Revenue % Growth
Automotive
Industrial
1,530
2,245
------
1,561
2,380
------
1,763.0
1,633.0
2,941.0
2,894.0
3,292.0
3,586.0
3,640.3
3,775.4
3,940.8
1,076
197
------
960
146
------
981
156
------
1,027
133
------
1,384
162
------
1,760
178
------
1,813
167
------
1,849
169
------
1,868
169
------
879.0
814.0
825.0
894.0
1,222.0
1,582.0
1,645.5
1,680.1
1,698.6
2,642.0
2,447.0
3,766.0
3,788.0
4,514.0
5,168.0
5,285.8
5,455.5
5,639.3
-
-10.6%
-4.4%
------7.4%
12.0%
0.2%
-----5.6%
-7.5%
4.7%
------1.6%
13.3%
14.2%
-----13.8%
5.0%
12.6%
-----8.9%
-6.0%
8.0%
-----1.5%
-2.0%
8.0%
-----3.7%
2.0%
6.0%
-----4.4%
2.2%
6.8%
-----1.4%
4.7%
-14.7%
-----8.4%
34.8%
21.8%
-----36.7%
27.2%
9.9%
-----29.5%
3.0%
-6.0%
-----4.0%
2.0%
1.0%
-----2.1%
1.0%
0.0%
-----1.1%
53.9%
0.6%
19.2%
14.5%
2.3%
3.2%
3.4%
-
-7.4%
-
------
Historical
2000 A
----------------
Reported EBIT
Total Bearings
Steel
Total Timken
2008 E
1,561
2,079
------
Total Reported Sales and Revenues
Operating Margin
Automotive
Industrial
2007 E
1,661
1,925
------
Timken (TKR)
Total Timken
Corporate (reconciliation)
2006 E
1,582
1,710
------
-
Total Bearings
Steel
2005 A
1,396
1,498
------
Net Steel Sales
Segment Profitability
Operating Profit
Automotive
Industrial
2004 A
1,510
1,431
------
-
------
2003 A
751
882
------
-10.8%
-25.9%
------7.4%
Steel
Less intercompany sales
2002 A
840
923
------
------
Total Bearings
2001 A
-----------
2001 A
2002 A
2003 A
2004 A
2005 A
2006 E
2007 E
2008 E
25
54
-----79
19
-----98
40
-----138
(12)
38
-----26
12
-----38
3
-----41
11
73
-----84
33
-----117
(1)
-----116
16
128
-----144
(6)
-----138
(1)
-----137
16
178
-----194
55
-----249
(2)
-----247
(20)
200
-----180
220
-----400
(3)
-----397
(78)
249
-----171
280
-----451
(26)
-----425
(15)
292
-----277
202
-----478
4
-----482
31
309
-----341
170
-----510
(9)
-----501
3.0%
5.9%
-----4.5%
2.2%
-----3.7%
-1.6%
4.3%
-----1.6%
1.5%
-----1.6%
0.7%
5.1%
-----2.9%
4.0%
-----3.1%
1.1%
8.5%
-----5.0%
-0.7%
-----3.6%
1.0%
10.4%
-----5.9%
4.5%
-----5.5%
-1.2%
10.4%
-----5.0%
13.9%
-----7.7%
-5.0%
12.0%
-----4.7%
17.0%
-----8.5%
-1.0%
13.0%
-----7.3%
12.0%
-----8.8%
2.0%
13.0%
-----8.6%
10.0%
-----9.1%
Timken (TKR)
Income Statement
Net Sales
COGS
Gross profit
SG&A
Impairment and restructuring costs
Operating profit
Net interest (expense) / income
CDSOA
Other (expense) / income
EBT
Income tax expense (benefit)
Net income (GAAP)
Common shares outstanding
Weighted average shares outstanding for fully dilluted EPS
EPS (GAAP)
Consensus EPS
Consensus net sales
Historical
------
------
-----------
2000 A
2,643.0
2,142.1
-----500.9
367.5
27.8
-----105.6
(28.4)
0.0
(6.6)
-----70.6
24.7
-----45.9
2001 A
2,447.2
2,046.5
-----400.7
363.7
54.7
-----(17.7)
(31.3)
29.6
(7.5)
-----(26.9)
14.8
-----(41.7)
2003 A
3,788.1
3,149.0
-----639.1
521.7
19.2
-----98.2
(47.3)
65.6
(55.7)
-----60.8
24.3
-----36.5
2004 A
4,513.7
3,675.1
-----838.6
587.9
13.4
-----237.3
(49.4)
44.4
(32.4)
-----199.9
64.1
-----135.8
2005 A
5,168.4
4,109.7
-----1,058.7
661.6
26.1
-----371.0
(48.2)
77.1
(9.4)
-----390.5
130.3
-----260.2
2006 E
5,285.8
4,149.4
-----1,136.5
687.2
40.0
-----409.3
(47.0)
40.0
(10.0)
-----392.3
129.5
-----262.8
93.2
93.5
2007 E
5,455.5
4,255.3
-----1,200.2
692.8
30.0
-----477.4
(45.0)
20.0
(20.0)
-----432.4
142.7
-----289.7
93.2
94.5
2008 E
5,639.3
4,370.5
-----1,268.8
699.3
10.0
-----559.6
(43.0)
20.0
(10.0)
-----526.6
173.8
-----352.8
60.0
60.7
59.9
59.9
60.4
61.6
89.4
83.2
91.3
90.8
93.2
92.5
$0.76
($0.70)
$0.84
$0.44
$1.50
$2.81
$2.81
$2.70
$5,263.00
$3.07
$2.99
$5,417.00
$3.69
$3.60
NA
2000 A
19.0%
13.9%
-0.3%
151.0
249.4
98.4
105.6
9.4%
3.7%
4.0%
2.7%
1.7%
2001 A
16.4%
14.9%
1.9%
152.5
180.3
27.8
(17.7)
7.4%
1.1%
-0.7%
-1.1%
-1.7%
63.0%
-55.0%
2002 A
18.4%
14.1%
1.5%
146.5
264.2
117.7
78.6
10.4%
4.6%
3.1%
3.4%
2.0%
93.6%
39.8%
2003 A
16.9%
13.8%
-0.5%
208.9
288.9
80.0
98.2
7.6%
2.1%
2.6%
1.6%
1.0%
1.6%
40.0%
2004 A
18.6%
13.0%
-0.5%
209.4
422.7
213.3
237.3
9.4%
4.7%
5.3%
4.4%
3.0%
19.2%
32.1%
2005 A
20.5%
12.8%
0.9%
218.1
634.7
416.6
371.0
12.3%
8.1%
7.2%
7.6%
5.0%
20.4%
33.4%
2006 E
21.5%
13.0%
-0.5%
228.1
660.4
432.3
409.3
12.5%
8.2%
7.7%
7.4%
5.0%
32.6%
33.0%
2007 E
22.0%
12.7%
-0.5%
238.1
700.5
462.4
477.4
12.8%
8.5%
8.8%
7.9%
5.3%
40.1%
33.0%
2008 E
22.5%
12.4%
-0.5%
248.1
784.7
536.6
559.6
13.9%
9.5%
9.9%
9.3%
6.3%
44.7%
33.0%
Timken (TKR)
Income Statement - Drivers
Gross Margin
SG&A as % of revenues
Other expenses as % of revenues
D&A
EBITDA (EBIT+D&A)
EBIT (operating profit - other expense)
Reported operating profit
EBITDA % Margin
EBIT % Margin
Reported Operating Profit % Margin
EBT % Margin
Net Margin , continuing operations
Incremental Margin
Effective tax rate
2002 A
2,550.1
2,080.5
-----469.6
358.9
32.1
-----78.6
(29.8)
50.2
(13.4)
-----85.6
34.1
-----51.5
93.2
95.5
Historical
35.0%
Timken (TKR)
Balance Sheet
Current Assets
Cash and cash equivalents
Receivables, net
Inventories
Deferred income taxes, other assets
Total current assets
Historical
2000 A
2001 A
2002 A
2003 A
2004 A
2005 A
2006 E
2007 E
2008 E
11
355
490
43
899
33
308
429
58
828
86
560
694
36
1,376
29
602
696
50
1,377
51
706
875
207
1,839
65
712
998
108
1,883
61
753
1,012
111
1,937
210
777
1,038
115
2,139
471
803
1,066
118
2,458
1,364
151
150
2,564
1,305
150
249
2,532
1,678
302
517
3,873
1,609
173
531
3,690
1,583
152
368
3,942
1,547
204
359
3,993
1,557
200
360
4,054
1,564
200
360
4,263
1,570
200
360
4,588
209
239
137
2
587
129
258
254
0
641
217
375
298
0
890
121
425
430
79
1,055
157
502
335
37
1,031
159
501
411
0
1,071
159
512
449
0
1,120
159
525
464
0
1,147
159
539
479
0
1,177
Debt
Accrued pension cost
Posteretirement benefits liability
Other liabilities
Total liabilities
305
238
394
35
1,559
368
317
407
18
1,751
778
742
477
28
2,915
613
424
477
31
2,600
621
469
490
63
2,674
562
247
514
103
2,497
562
97
514
63
2,356
562
47
514
65
2,336
562
47
514
68
2,368
Shareholder's equity
Total liabilities and shareholders' equity
Rounding error
Check
1,005
2,564
782
2,532
1
0
959
3,873
1
0
1,090
3,690
1,270
3,942
2
0
1,497
3,993
1
0
1,702
4,058
4
0
1,932
4,267
4
0
2,224
4,592
4
0
PP&E
Goodwill and other intangibles
Miscellaneous receivable, other assets
Total assets
Current liabilities
Notes payable, short term debt
Accounts payable
Salaries, wages, and benefits, other
Income taxes
Total current liabilities
0
Timken (TKR)
Balance Sheet - Drivers
Historical and Projected Financials
LTM Sales
LTM COGS
EBIT
Net Income
Interest Expense
Tax Rate
Tax-Adjusted Interest Expense
Normalized Tax Rate
Days receivables
Days payable
Days inventories
Inventory turns
Other current assets as % of sales
Other LT assets as % of sales
Salaries, wages, and benefits as % of sales
Income taxes liability as % of sales
Accrued pension cost as % of sales
LT benefits liability as % of sales
Other LT liabilities as % of sales
0
Historical
2000 A
2001 A
2002 A
2003 A
2004 A
2005 A
2006 E
2007 E
2008 E
2,643
2,142
98
46
28
35.0%
18.5
35%
2,447
2,047
28
(42)
31
-55.0%
48.5
35%
2,550
2,081
118
51
30
39.8%
17.9
35%
3,788
3,149
80
36
47
40.0%
28.4
35%
4,514
3,675
213
136
49
32.1%
33.6
35%
5,168
4,110
417
260
48
33.4%
32.1
35%
5,286
4,149
432
263
47
33.0%
31.5
35%
5,455
4,255
462
290
45
33.0%
30.2
35%
5,639
4,370
537
353
43
33.0%
28.8
35%
49.0
40.7
83.5
4.4x
45.9
46.0
76.5
4.8x
80.2
65.8
121.8
3.0x
58.0
49.3
80.7
4.5x
57.1
49.9
86.9
4.2x
50.3
44.5
88.6
4.1x
52.0
45.0
89.0
4.1x
52.0
45.0
89.0
4.1x
52.0
45.0
89.0
4.1x
1.6%
5.7%
5.2%
0.1%
9.0%
14.9%
1.3%
2.4%
10.2%
10.4%
0.0%
13.0%
16.6%
0.7%
1.4%
20.3%
11.7%
0.0%
29.1%
18.7%
1.1%
1.3%
14.0%
11.4%
2.1%
11.2%
12.6%
0.8%
4.6%
8.2%
7.4%
0.8%
10.4%
10.9%
1.4%
2.1%
6.9%
8.0%
0.0%
4.8%
9.9%
2.0%
2.1%
6.8%
8.5%
0.0%
10.0%
10.0%
1.2%
2.1%
6.6%
8.5%
0.0%
10.0%
10.0%
1.2%
2.1%
6.4%
8.5%
0.0%
10.0%
10.0%
1.2%
Timken (TKR)
Historical
Cash Flows
Net income
Adjustments to reconcile net income to cash
D&A
Gain on disposals of property, plan and equipment
Deferred income taxes
Common stock issued in lieu of cash to benefit plans
Non-cash restructuring charge, other
Investments, other assets
2000 A
$
46
2001 A
2002 A
$
(42) $
39
209
45
51
(17)
(73)
(3.9)
3
-----180
(44)
(51)
(3)
81
10.0
(7)
-----206
(163)
10
-----(153)
(102)
(13)
16
-----(99)
(85)
6
Net change in cash -- increase (decrease)
(44)
(24)
71
-----3
(1)
-----3
(40)
(3)
(12)
-----(55)
(3)
-----23
FCF (Net Income+D&A+Working Capital-Capex)
(10)
11
------
Cash provided by operations
Cash flow from investment programs
Capex
(Acquisitions)/Divestitures net of cash acquired
Other
------
Cash used in investment programs
Cash flow from financing activities
Dividends paid/other
(Purchases)/issuance of common stock
Net Change in debt
Cash provided by financing activities
FX
Cash BOP
Cash EOP
-----------
153
11
1
17
23
1
42
(23)
(53)
(0)
4
(1.3)
(73)
-----153
2003 A
37
147
6
17
5
(14)
13
Change in operating assets and liabilities
Receivables
Inventories
Other assets
Accounts payable
Other liabilities
Change in operating assets/liabilities
151
$
2004 A
136
$
2005 A
260
2006 E
$
263
$
2007 E
290
$
2008 E
353
209
6
62
3
10
218
228.1
238.1
248.1
93
0.0
0.0
0.0
0.0
0.0
0.0
(28)
33
(20)
(98)
(8.1)
(120)
-----203
(114)
(130)
28
(73)
2.7
(287)
-----139
(29)
(160)
(21)
(47)
5.2
(253)
-----319
(41.0)
(14.0)
(3.0)
10.6
(151.3)
(199)
-----292
(24.2)
(25.8)
(3.6)
13.1
(33.5)
(74)
-----454
(26.2)
(28.1)
(3.9)
14.2
17.8
(26)
-----575
(127)
(693)
157
-----(663)
(155)
47
-----(108)
(226)
(49)
32
-----(243)
(238)
0
0
-----(238)
(245)
0
0
-----(245)
(254)
0
0
-----(254)
(49)
-----(81)
3
-----49
(42)
235
209
-----402
5
-----(54)
(47)
26
-----(21)
12
-----22
(55)
40
(41)
-----(56)
(5)
-----15
(58)
0
0
-----(58)
(60)
0
0
-----(60)
(60)
0
0
-----(60)
-----(4)
-----148
-----261
77
121
76
(16)
93
54
208
321
11
33
33
86
86
29
29
51
51
65
65
61
61
210
210
471
Timken (TKR)
Analysis of FCF
Net Income
D&A
Non cash charges/income
Working capital (Includes pension outlays)
Less Capex
FCF
FCF Per Share
FCF as % of EBITDA
$
13
3
56
5
-----(79)
(32)
Historical
2000 A
45.9
151.0
28.7
(72.6)
(162.7)
(9.7)
($0.16)
-3.9%
2001 A
(41.7)
152.5
66.2
2.7
(102.3)
77.4
$1.29
42.9%
2002 A
38.7
146.5
27.5
(6.7)
(85.2)
120.8
$1.96
45.7%
2003 A
36.5
208.9
76.9
(119.7)
(127.1)
75.5
$0.91
26.1%
2004 A
135.7
209.4
81.0
(287.1)
(155.2)
(16.2)
($0.18)
-3.8%
2005 A
260.3
218.1
93.3
(252.9)
(225.6)
93.2
$1.01
14.7%
2006 E
262.8
228.1
0.0
(198.8)
(237.9)
54.3
$0.58
8.2%
2007 E
289.7
238.1
0.0
(74.1)
(245.5)
208.2
$2.20
29.7%
2008 E
352.8
248.1
0.0
(26.1)
(253.8)
321.0
$3.36
40.9%
DCF Valuation
11/17/2006
Ticker: TKR
Constantine Elefter
Terminal Discount Rate =
Terminal FCF Growth =
10.5%
4.0%
Year
2006E
2007E
2008E
2009E
2010E
Forecast
2011E
2012E
2013E
2014E
2015E
2016E
Revenue
% Growth
5,286
2.28%
5,455
3.21%
5,639
3.37%
5,808
3.00%
5,983
3.00%
6,177
3.25%
6,378
3.25%
6,601
3.50%
6,832
3.50%
7,071
3.50%
7,319
3.50%
Operating Income
Operating Margin
409.3
8.53%
477.4
8.77%
559.6
9.05%
522.8
9.00%
538.4
9.00%
555.9
9.00%
574.0
9.00%
594.1
9.00%
614.9
9.00%
636.4
9.00%
658.7
9.00%
(17.0)
-0.32%
(45.0)
-0.82%
(33.0)
-0.59%
(2.9)
-0.05%
(3.0)
-0.05%
(3.1)
-0.05%
(3.2)
-0.05%
(3.3)
-0.05%
(3.4)
-0.05%
(3.5)
-0.05%
(3.7)
-0.05%
Taxes
Tax Rate
Equity Income, net
% of sales
129.5
33.0%
0.0%
142.7
33.0%
0.0%
173.8
33.0%
0.0%
171.6
33.0%
0.0%
176.7
33.0%
0.0%
182.4
33.0%
0.0%
188.4
33.0%
0.0%
195.0
33.0%
0.0%
201.8
33.0%
0.0%
208.9
33.0%
0.0%
216.2
33.0%
0.0%
Net Income
% Growth
262.8
289.7
10%
352.8
22%
354.1
0%
364.7
3%
376.6
3%
388.8
3%
402.4
4%
416.5
3%
431.1
4%
446.2
3%
228.1
4.32%
95.90%
(198.8)
-3.8%
237.9
4.50%
238.1
4.36%
96.99%
(74.1)
-1.4%
245.5
4.50%
248.1
4.40%
97.77%
(26.1)
-0.5%
253.8
4.50%
232.3
4.00%
88.89%
(29.0)
-0.5%
261.4
4.50%
239.3
4.00%
90.91%
(29.9)
-0.5%
263.2
4.40%
247.1
4.00%
93.02%
(30.9)
-0.5%
265.6
4.30%
255.1
4.00%
95.24%
(31.9)
-0.5%
267.9
4.20%
264.0
4.00%
97.56%
(33.0)
-0.5%
270.6
4.10%
273.3
4.00%
100.00%
(34.2)
-0.5%
273.3
4.00%
282.9
4.00%
100.00%
(35.4)
-0.5%
282.9
4.00%
292.8
4.00%
100.00%
(36.6)
-0.5%
292.8
4.00%
208.2
284%
321.0
54%
296.0
-8%
310.9
5%
327.2
5%
344.2
5%
362.8
5%
382.4
5%
395.7
4%
409.6
3%
Interest and Other- net
Interest % of Sales
Add Depreciation/Amort
% of Sales
% of Capex
Plus/(minus) Changes WC
% of Sales
Subtract Cap Ex
Capex % of sales
Free Cash Flow
YOY growth
NPV of free cash flows
NPV of terminal value
Projected Equity Value
Free Cash Flow Yield
54.3
$1,931.4
$1,977.6
3,909.0
1.39%
Terminal
P/E
EV/EBITDA
Free Cash Yield
49%
51%
'06-10 Cash/Op's
Shares Outstanding
2,753
93.5
Cash/Op's % of Sales
Current Price
30.38
Implied equity value/share
41.81
Upside/(Downside) to DCF
37.6%
Total Debt
Total Cash
1,193
286
9.5%
Terminal
Value
6,553.6
14.7
7.8
6.25%