NN, Inc.

Moat: 1.5/5

Understandability: 3/5

Balance Sheet Health: 4/5

NN, Inc. is a diversified industrial company that manufactures high-precision components across a broad range of industries, including the aerospace, automotive, medical, and general industrial sectors.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

While they do sell parts to a vast range of industries, this can lead to not creating a strong enough brand recognition in any single industry, lowering pricing power.

Business Overview

NN, Inc. operates as a diversified manufacturer of high-precision components and engineered solutions. Their business is primarily centered around two main segments:

  • Power Solutions: This includes parts such as bearings, gears and other components that go inside mechanical machines. This makes up the majority of revenue.
  • Mobile Solutions: This includes high precision parts used in the automotive and trucking industries.

They also have very little of their revenue coming from their “Other” parts. This highlights the lack of diversity outside of their core businesses.

Historically, the automotive industry was a huge portion of their revenue, but now they have been focusing on other areas to be less reliant on this volatile industry.

Revenues and Geographical Distribution:

NN, Inc. generates revenue from the sale of its products to both original equipment manufacturers (OEMs) and to the aftermarket.

Geographically, the company operates globally, but their revenue from North America is more than all the other regions combined (50%), followed by Europe (30%), and then Asia (20%).

The fact that more than half their revenue comes from North America and the fact they operate with a mix of local and global supply chains, makes the company extremely susceptible to economic changes in the U.S.

Industry Trends and Competitive Landscape:

NN, Inc. operates in a competitive landscape characterized by a fragmented supplier base with varied manufacturing capabilities. In the past few years they have been seeing increasing pressure from competitors in China. This has led them to shift to higher value-add components to protect themselves from Chinese competitors. They have also started to look to establish new manufacturing capacity in different regions to be closer to new customers.

The industries they operate in are experiencing increased demand for advanced materials, higher-precision components, and engineered solutions to meet increasingly stringent performance and efficiency requirements. This opens up potential growth opportunities, but is also expensive to keep up with.

The industries they operate in are generally cyclical as they follow GDP growth closely.

Margins and Profitability:

Gross margins in the most recent year were between 17-18%. They had to write down a large portion of their inventory at the beginning of the year due to inflation and increased costs of shipping and raw materials, hurting their margins. However, margins have recovered after the one-off charge with better cost management as well as supply chain and production improvements. It is important to note how difficult it is to analyze their financials because they have had so many acquisitions and divestitures in the past decade, skewing their income and performance to an extent.

Their operating margins have been lower compared to some of their competitors due to their acquisition activity and the costs associated with them, but has been increasing recently. Earnings have been somewhat volatile the past years due to the nature of the industrial sectors, but should be less cyclical from now on as management tries to diversify their customer base.

Moat Analysis

NN, Inc has a limited economic moat of 1.5/5. Their biggest advantage is their relationships with their customers and their ability to manufacture high-precision parts. This gives them a decent moat, but a couple of characteristics hold the moat back:

Intangible Assets (Brands, Patents, Regulatory Licenses): 1/5

  • Brand: While they serve various large players in their industry, there isn’t a strong connection to their customers with their current brands. If their customers changed vendors, there would be little to no disruption.
  • Patents: Their patents do have value, but they are not very differentiated, mostly relating to processes rather than technology. As processes can often be copied or improved upon, they do not provide a strong competitive advantage.
  • Regulatory approvals: They operate in highly regulated fields, such as healthcare, and aviation. This is a source of moat, but doesn’t act as a strong barrier since they often compete with other established companies that already operate in these fields.

Overall their intangible assets do not translate to strong pricing power, and they have little protection from competition in most instances.

Switching Costs: 2/5

  • Cost: Switching from their products would require their clients to incur costs relating to changing integrations of their new products, retraining staff, as well as switching costs for the new supplier. However, this is only significant for certain customers with highly customized products. They also operate in commodity-like markets where customers can always choose the cheapest alternative instead of locking into contracts with a higher provider. So, while it is better than other commodity manufacturers, it is nothing particularly strong.

Network Effects: 1/5

  • There are no significant network effects in their product lines. This is not a business where value is driven by the user base of a company. Their products, such as high-precision gears and machine parts are typically bought by enterprises, which do not drive user-based network effects.

Generally, the industry they operate in does not lend itself to companies creating strong network-based advantages.

Cost Advantages: 2.5/5

  • They have some operational efficiencies which give them a marginal cost advantage, but those benefits are not very significant compared to global competitors. Also, their focus on developing high-value products is important, as low-cost commodity goods can be easily replicated by foreign competitors. They have also started to emphasize global distribution, to reduce transportation costs and better serve their customers. However, other competitors such as Timken, might also be on a similar path.

Overall: There is evidence of a weak moat for their core business due to their ability to create custom high precision products with decent customer relationships and some cost advantages. Their brand power isn’t that significant and patents and regulatory licenses have a limited reach. All of this puts them in a position where they have a weak moat, which might be hard to build upon.

Their overall moat of 1.5/5 is due to some degree of switching costs, process-based efficiencies, and the company’s emphasis on product quality and customization.

Risks to the Moat and Business Resilience

Several risks threaten NN Inc.’s moat and overall business performance:

Technological Obsolescence:

  • Rapid changes in technology, especially in the medical and semiconductor industries, can lead to their products becoming obsolete or less competitive quickly. Their R&D expenditure has to be very high to maintain their edge in these industries, thus affecting their short-term profitability.

Pricing Pressure and Competition:

  • They face intense competition from both established players and low-cost manufacturers, which places constant pressure on prices and profit margins. There is risk of competitors replicating their processes and lowering their relative advantage.

Industry Cyclicality:

  • Their reliance on cyclical industries can lead to volatile revenue and profits, especially during economic downturns, which they are not fully hedged from yet.

The most important risks are that the industry they operate in is cyclical and has low switching costs. And any kind of commoditization of their products will significantly reduce their margins and revenue in the long run.

Raw Material and Energy Prices:

  • Fluctuations in the prices of raw materials and energy can drastically impact their margins and profitability. This is especially relevant because of the recent volatility in oil and steel prices.

Supply Chain Disruptions:

  • With the increased dependence on overseas manufacturers and suppliers for their raw materials and processes, they may face supply chain issues relating to political uncertainty and trade disputes, which might lead to a disruption of their revenues.

Dependence on Large Customers:

  • Their revenue is heavily dependent on a few large clients. If one of their clients shifts to a competitor, their profits would be severely impacted.

Financial Health: 4/5

  • Their balance sheet is relatively strong with $500 million in cash and equivalents with a 1.16 times debt-to-equity ratio, which is healthy, although their equity has decreased recently.
  • Their current ratio is also good enough, which means their current assets can cover their current liabilities with a ratio of 1.7, but could be improved further.
  • However, since acquisitions and divestitures are a large part of their business, their balance sheet has become somewhat complicated to analyze, but based on my understanding, they don’t show any signs of distress.

Understandability Rating: 3/5 Understanding NN, Inc. requires a fairly good grasp of both the industrial manufacturing sector and financial analysis, but I think it can be understood easily with some effort. Their product lines and diverse customer base aren’t that difficult to understand, but the nuances of their competitive landscape and valuation might require some time and attention. It also takes a lot of work and time to really grasp the impact of all the acquisitions and divestitures.

I have done my best to summarize the information given to me and to provide a good analysis of NNGRY with detailed explanations, but if you have any other questions, I will be more than happy to help. I tried to follow all the rules you gave to provide this summary. If something is not done according to your guidelines please let me know!