Our Long Idea and Danger Zone research reports are part of our ongoing effort to identify hidden gems in the market and also help clients avoid portfolio blowups. Position Update reports serve as notification that a previous investment idea’s risk/reward profile has shifted and the position has been “closed out”.

Tenneco Inc. (TEN: $63/share) – Closing Long Position – Up 4% since 5/1/17 publish date (vs. +7% S&P 500) and 19% since 8/24/17 position update (vs. +4% S&P 500).

Tenneco (TEN) was originally selected as a Long Idea on 5/1/17. At the time of the report, the stock received a Very Attractive Rating. Our investment thesis highlighted a PEBV valuation that implied a permanent 30% decline in after-tax profits (NOPAT) and TEN’s shareholder friendly executive compensation plan.

TEN was downgraded to Neutral by our rating system on 8/10/17 due to lower profitability in its most recent 10-Q. Specifically, NOPAT margin declined to 4% (TTM) from 6% in 2016. Despite the downgraded risk/reward rating, we maintained our Long recommendation on 8/24/17 due to better-than-expected 2Q17 earnings, expectations for better 2H17 margins, and the stock’s low valuation.

Following our late-August update, TEN’s Neutral rating was suspended due to the disclosure of a material weakness in TEN’s internal controls related to overseas (i.e. China) operations. While the errors themselves were noted to be “immaterial” in TEN’s amended filings, the combination of an accounting-related rating suspension and a Neutral risk/reward represents too high of a hurdle to continue recommending the stock. As such, we are closing out of our long recommendation on TEN with a modest gain.

Figure 1: Current Rating Overview

 Sources: New Constructs, LLC and company filings

This article originally published on October 11, 2017.

Disclosure: David Trainer, Kyle Guske II, and Kenneth James receive no compensation to write about any specific stock, style, or theme.

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