Should I Do It? Tenneco's a Tentative 'Yes'

The maker of emission systems reports mixed results, but it has upside.
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Tenneco (TEN) - Get Report shares have gained 29% year to date, but at Wednesday's closing price of $31.55, the stock is 16% below its August highs.

The company is the largest maker of automobile exhaust systems, and lately it has seen a large jump in sales for antipollution equipment because of new diesel emission controls in both Europe and the U.S. Tenneco also makes shocks and struts under the Monroe brand name.

Tenneco is also a beneficiary of the weak dollar, as nearly 60% of its revenue is generated overseas. On the other hand, the company is still levered to the top two U.S. automakers,

General Motors

(GM) - Get Report

and

Ford

(F) - Get Report

, from which Tenneco generates about 25% of its revenue.

Because of tighter pollution controls and positive currency exchange rates, Tenneco is expected to grow earnings 31% in 2008 to $2.30, following 45% expected earnings growth this year. At current levels, the company is valued at just 13.9 times expected 2008 earnings, which is a steep discount to its growth rate and also below the average

S&P 500

multiple of 14.7 times forward earnings.

Tenneco has some upside, but is now the time to buy shares in the company?

Checking the Vitals

Tenneco posted mixed third-quarter results on Oct. 31. The company earned 39 cents a share, which was a penny below expectations. On the other hand, revenue grew 39% year over year to $1.56 billion, which came in $100 million ahead of the consensus analyst estimate.

The profit shortfall came as gross margin narrowed 190 basis points from the previous year to 15.6% because of rising steel costs. Demand for aftermarket parts, where margins are twice as high as they are in direct sales to auto makers, also fell during the quarter.

That said, Tenneco has received two analyst upgrades since its quarterly report. With five buy ratings, compared with two holds and three sells, Wall Street is betting that the company can get its earnings back on track for 2008.

Tenneco also said Nov. 1 that it plans to sell $250 million of unsecured debt due 2015 in the near future, to refinance some of its $475 million of 10.25%-yielding secured notes that are due in 2013. This move follows another $831 million of debt the company refinanced back in March.

The move will save the company about $4 million a year in interest expense, and by offering unsecured notes, management should gain financial flexibility. Tenneco currently pays about $32 million each quarter in interest expense, and it had $1.5 billion of long-term debt outstanding at the end of the third quarter, with an average maturity of 2014.

The company has historically carried a large amount of debt on its balance sheet. And under new CEO Gregg Sherrill, who joined Tenneco in January, the company is attempting to actively refinance its debt and may ultimately be in a position to retire $150 million of borrowings, as permitted under the current covenants.

As for liquidity, Tenneco ended the quarter with $203 million of cash and equivalents, and it had $33 million of short-term debt and another $292 million available on its credit lines. Still, the company has a hefty debt-to-equity ratio of 372%, and its bonds are rated BB-minus at Standard and Poor's, which is below investment grade.

All in all, I believe that Tenneco is attractive to purchase at current levels. Even if the margin is lower in the emissions business, it's still projected by management to grow fast enough through the end of the decade to offset any near-term weakness in the aftermarket business.

The stock is also attractively valued on the basis of 2008 estimates, which appear achievable if the dollar remains weak and management can refinance more of its debt. With that in mind, I believe that Tenneco shares could trade back up toward the high $30s over the coming quarters.

David Peltier is a research associate at TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Peltier appreciates your feedback;

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