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. Timkens
Industrial and Steel margins have been expanding since 2004, and with
strong demand for the companys 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
companys 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%

Table of Contents
Company Overview

Products

Tapered Roller Bearings

Precision Cylindrical and Ball Bearings

Spherical and Cylindrical Bearings

Needle Bearings

Bearing Reconditioning

Steel

Business Segments

Automotive Group

Restructuring: Automotive

Industrial Group

Steel Group

Macroeconomic Conditions

Gross Domestic Product

Industrial Production

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

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 Timkens
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 Timkens 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
Timkens 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

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 companys 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 companys 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
Timkens 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 Timkens Auto output is directly or indirectly tied to the three
largest North America automotive manufacturers (Big 3)General Motors (GM), Ford, and
Chryslerwith 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

5
auto industry has severely impacted Timkens 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.

Timkens 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
Timkens 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

6
I feel that the market has already factored the Auto risk and exposure in Timkens (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 companys 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 Timkens 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 Timkens 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 managements 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.

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 marketparticularly Chinais fueling future growth at high
levels.

Industrial capacity is currently working near its peak in the segment. The constraint should be
favorable to Timkens 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 companys 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, Timkens 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

8
maintenance of Steel margins over the next two years. I am very bullish on the sustainability of
robust demand for the companys Steel products as well as healthy pricing in the segment in
2007.

Macroeconomic Conditions4
Key macroeconomic indicators relevant to Timkens 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 Timkens
stock performance because GDP growth signals a strong economy and business investments in
capital machinery and equipment that use Timkens 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 countrys structural development. It is
this structural development and potential output growth that demands capital-intensive products
that use Timkens 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 . Chinas structural and infrastructure building
remains key to Timkens international growth efforts.

9
U.S. Industrial Production Index: Past Trend Present Value and Future Projection Index
Value sets 1997 = 100

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

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 companys 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 Timkens
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 stocks 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

Timken is a relatively mature company within a mature and stable industry. Timken pays a
steady stream of dividends. According to StockVal, Timkens 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 companys 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. Timkens competitors are constantly trying
to imitate the companys 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 Timkens product offerings and
increased economies of scale. As a past employee of Timken, I know firsthand the scale, global
opportunities, and edge Torringtons operations has given Timken in the industry.
Competitive Pressures
Although Timken faces constant pressure from its competitors, the companys diverse business
portfolio has added flexibility that its competitors lack. Additionally, the machine tools &
accessories industry has high barriers to entry, and with Timkens 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 Timkens 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 Timkens 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 Timkens 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 Timkens financial statements.
The fiscal year 2003 numbers may not be comparable due to Timkens 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. Timkens 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. Timkens 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. Timkens strategy probably falls in between
these ranges, in which some products yield a higher margin while others seek higher turnover.

17

18
Timkens 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. Timkens 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 Timkens end of period cash position should rise to $400MM by the end
of 2008, providing ample interest coverage for the companys 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 Timkens high leverage
multiplier in order to better understand how and if the companys ROE is in fact growing.

DuPont Analysis: Summary

In my judgment, Timken is in a strong financial position indicative of the companys high and
growing ROE. I expect Timkens 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. Timkens
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 Timkens 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. Timkens Days in Accounts Payable ratio has been steadily declining to about 45.
Timken has good relationships with the companys suppliers, and this is huge positive.

Days in Inventory and Inventory Turnovers are both ratios assessing the inventory management
of Timkens 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 Timkens 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
Timkens 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 companys projected earnings growth over the
next two years and strong global demand for the companys 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

Timkens 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 Timkens 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 Timkens valuation range. The comparable analysis of industrial
suppliers yields an average industrial P/E multiple of 14.2x, right in the middle of Timkens
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 companys 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, Timkens current valuation is simply not warranted.
Timkens 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 years 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 Timkens 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 Timkens 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 Timkens revenue is
directly or indirectly tied to the Big 3GM, Ford, and Chryslerdomestic automakers.
Ongoing, Timken is adamantly restructuring the companys 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 Timkens Auto exposure. Timkens stock price
is down nearly 18% YTD, which I feel overestimates the companys 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 Timkens 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. Timkens
Industrial and Steel margins have been expanding since 2004, and with strong demand for the
companys 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 companys 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 Timkens 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 companys bearings products (see Byrd Amendment)

Weakness in any of the industries Timkens 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 Timkens Signature Product

Spherical Roller Bearings

Precision Bearings

27

28

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

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

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%