Autoliv: fair value oförändrat på 780 kronor trots Covid-19

AKTIE: Fortsatt fokus på säkerhet kompenserar delvis minskad bilförsäljning, men Covid-19 kan göra att efterfrågan inte återhämtar sig förrän under 2022. Som marknadsledare klarar Autoliv att hantera prispress, vilket talar för stigande vinster långsiktigt (19 maj 2020).

Morningstar Equity Analysts 2020-05-19 | 16:48
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Business Strategy and Outlook  |  19 May 2020

Autoliv is the global market leader and is well positioned for growth in vehicular passive safety content. An ability to innovate and then commercialize technology has helped support profitability and returns. Rising New Car Assessment Program, or NCAP, safety standards will require auto manufacturers to use active safety features to even be considered for a five-star crash-test rating. Autoliv's passive safety products interact with active safety systems in occupant collision protection. As consumers in emerging markets become wealthier, demand for safety content should increase. In addition, as roads become crowded and traffic fatalities increase, developing countries may require similar vehicle safety legislation to that required in Europe and the U.S.

Autoliv has demonstrated technological leadership. The company and its predecessors introduced two-point seat belts, the retractable seat belt, seat belt pretensioners, side-impact air bags, and various pedestrian collision safety technologies. It annually spends about 5% of sales on research and development and holds 6,000 patents, mainly in airbags and seatbelts. Additionally, Autoliv has produced an average of 4 percentage points of returns in excess of its cost of capital since 2002.

Slightly more than 80% of Autoliv's work force is located in low-cost countries, compared with about 30% at the end of 2002. We view this as a strategic positive for Autoliv as the firm pursues business in developing markets, leading to a leaner cost structure and enabling the firm to spend larger amounts on research and development without compromising margins. It also positions the company to take advantage of its customers' objective to use more global, common vehicle architectures.

Fair Value & Profit Drivers  |  19 May 2020

Our fair value estimate on the shares of Sweden-traded Autoliv ADRs is SEK 780 using a currency spot rate of SEK 9.7309/$1. We use a 9.6% weighted average aftertax cost of capital to discount Autoliv's future cash flows. Autoliv's revenue cyclicality and operating leverage result in our above average systematic risk rating. Consequently, our cost of equity assumption is 11%. Given the company’s conservative balance sheet, we assume a 78% equity capital weighting with a 6.5% cost of debt. We also assume a 28% long-run effective tax rate.

Autoliv demonstrates the ability to innovate, providing a slight buffer to revenue cyclicality as well as operating leverage, something that we would expect from an auto-parts supplier with an economic moat. Excluding currency translation, Autoliv guides to revenue growth exceeding the year-over-year percent change in global light-vehicle production by 3-4 percentage points based on penetration of innovative safety products. Including currency translation, we model an average 5% revenue growth in our five-year forecast, including a 2020 revenue drop of 19% for COVID-19, a 6% rebound in 2021, followed by a return to more normalized global light vehicle production in 2023.

Management guides to 13% adjusted EBIT margin (before special items) in the long term. We model adjusted EBIT margins that contract from 9.1% in 2019 to 5.9% in 2020 due to the negative operating leverage from COVID-19 factory closures, but then expand to a normalized sustainable midcycle of 11.0% in the final year of our forecast, 180 basis points above the 15-year historical 9.2% median. Margins had been steadily contracting because of rising spending for Veoneer's advanced driver assist and autonomous driving technologies as well as investment needed to support customers that were impacted by the worldwide recall of defective Takata airbag inflators. Now that Veoneer has been spun-off and the company has caught up with the influx of airbag inflator demand, once the COVID-19 crisis is past, we believe the company will make progress toward its 13% adjusted EBIT margin long-term objective.

Scenario Analysis  |  19 May 2020

We have modeled three scenarios around the rate of global demand for Autoliv's top line. The base scenario (SEK 780 fair value) assumes annualized revenue growth of 5% during our Stage I forecast, including a COVID-19-induced drop in 2020 revenue by 19%, with a 2021 rebound in the 6% range, and a 30% recovery in 2022 (2010 recovery after the 2009 Great Recession was 40%) on a return to more normalized global light vehicle production in 2022. Our adjusted EBIT margin assumptions average 9.2% during our Stage I forecast, on margin contraction in 2020 to 5.9% from 9.1% in 2019, with margin expanision through the remainder of our five-year forecast to an 11% midcycle. Our midcycle assumption is 200 basis points below management's long-term 13% target but 180 basis points above Autoliv's 15-year historical 9.2% median adjusted EBIT margin.

Our best-case scenario (SEK 1,200 fair value estimate) assumes a 10% annualized revenue growth rate for a less severe COVID-19 impacted 2020, with a stronger demand rebound on the other side of the crisis, relative to our base scenario. We assume a 14% 2020 decline in revenue, followed by 12% rebound in 2021, and a 35% recovery in 2022. Our adjusted EBIT margin averages 11.3% during our Stage I forecast via enhanced operating leverage on better-than-expected volume relative to the base case.

In our worst-case scenario (SEK 480 fair value estimate), we model flat annualized revenue growth over the five-year Stage I period on a more severe COVID-19 downturn in 2020 with a 24% revenue plunge, a modest 1% rebound in 2021, and a more limited 20% recovery in 2022. We also assume adjusted EBIT margins that average 6.7% during our Stage I forecast to reflect a scenario in which demand fails to meet management's expectations, resulting in a slow response to cut costs. We consider the probability of the upside or the downside scenarios actually occurring to be one in four.

Economic Moat™

The sources of Autoliv's narrow economic moat rating include its intangible assets and high customer switching costs, and to a lesser degree, its cost advantage. Some safety product areas are also oligopolistic, resulting in a slight efficient scale moat source benefit. The company's moat also benefits from a substantial global manufacturing presence, highly integrated and long-term customer ties that result in sticky market shares, and moderately improved pricing power from a well-diversified customer base.

Autoliv's consistent technology innovation enables favorable pricing relative to many automotive industry suppliers, increasing the company's dollar content per vehicle. New innovations typically debut on European and North American luxury vehicles, where average safety content is in excess of $500 per vehicle. In general, automakers are willing to pay for components and systems that provide substantial product differentiation, weight reduction, enhanced safety, or reduced cost, as is the case with Autoliv. Having a diversified global customer base provides Autoliv the opportunity to maximize pricing of its innovative product technologies by selling to a broader group of clients.

Autoliv's customers would incur prohibitively high switching costs should they decide to withdraw business in the middle of a vehicle program, especially when Autoliv has a supply agreement for a complete set of passive safety systems. Costs for switching to another supplier would include the substantial lead time and investment to develop and validate new components, the potential for production disruptions, and the cost of moving equipment and tooling. The whole process of changing a critical supplier like Autoliv might cost an OEM as little as a few million dollars to as much as several hundred million dollars, depending on the size and scope of the components or systems being replaced.

Automotive original equipment manufacturers, or OEMs, prefer vendors like Autoliv that can supply components and systems on a global basis. To reduce costs, some of the underlying safety components of a particular vehicle sold in the United States may be the same as another vehicle that might be sold in Europe, South America, or Asia. As emerging-market countries develop, a greater number of these safety components may become common to more than one region. Also, some countries have local content laws that require a certain percentage of components to be sourced from within that country. Winning a contract to supply a major component or system for a global vehicle program requires a supplier with a substantial global manufacturing presence.

With more than 80% of Autoliv's global work force now located in low-cost countries, the company has a lower fixed-cost base than other automotive suppliers without a moat. Developing a global footprint like Autoliv's--with production facilities in 27 countries--would require a huge capital investment, a substantial barrier to entry for potential competitors, particularly given the challenges for auto suppliers' to consistently turn an economic profit.

Close ties with OEM customers are integral to success in the automotive industry supply base and create another significant barrier to entry. New-vehicle lead times can run as long as 36 months. Autoliv's engineers participate very early in the development process, especially when an all-new vehicle platform is being developed, because safety is not only important to consumers but also mandated by governments.

Once launched, most vehicle programs have a five- to 10-year life cycle, assuring Autoliv long-term contractual streams of revenue, albeit subject to volume changes dependent on consumer demand for specific models, and overall economic conditions. When a vehicle nameplate has a complete redesign, including active and passive safety systems, and Autoliv is the supplier for the predecessor program, the company typically becomes the incumbent supplier for the redesigned successor vehicle program. In total, Autoliv potentially has a six- to 13-year tie-up (development and production) with each customer's vehicle program. We view Autoliv's diverse, well-established, long-term, highly integrated customer relations, supplying hundreds of vehicle programs, as an invaluable barrier to entry.

Moat Trend
Autoliv's stable moat trend rating stems from its ability to continually generate intellectual property and the high cost for customers to switch to competing suppliers. While demand and capacity cycles may create transient economic value destruction, automakers' reliance on Autoliv to develop intellectual property and customers' high switching cost to change suppliers during long-term contracts prevents Autoliv's competitive advantages from eroding, even though economic value may be destroyed in cycle troughs.

Automakers' capital intensity limits investment to only development of vehicles and assembly capacity. Consequently, OEMs are heavily dependent on suppliers like Autoliv to develop intellectual property in their respective areas of expertise. Automakers recognize that aggressively and permanently cutting supplier pricing would result in less or no intellectual property development. However, OEMs must balance between suppliers' returns and the price paid for components and systems to maintain their own vehicle pricing in the highly competitive mass-production global automobile market. Because of this industry dynamic, a suppliers' intellectual property moat sources are not likely to weaken or strengthen, supporting Autoliv's stable moat trend rating.

Autoliv's switching cost moat source is also stable. Customers would incur prohibitively high switching costs should they decide to withdraw business during the latter stage of development or during the production phase, especially when a supply agreement is for a complete system. Costs for switching to another supplier would include a lengthy delay in getting a vehicle to market, the substantial lead time and investment to develop and validate new components, the potential for production disruptions, and the cost of acquiring new or moving existing production equipment and tooling. The whole process of changing a critical supplier might cost an OEM as little as a few million dollars, to as much as several hundred million, depending on the size and scope of the components or systems being replaced.

Risk & Uncertainty

Commodity costs and declines in global vehicle production, such as the current harsh macroeconomic environment induced by COVID-19, present the biggest risk to Autoliv. Economic profitability may be at risk if oil, steel, and copper prices return to highs experienced during periods of relatively high global economic expansion.

Annual contractual price reductions for OEM customers are an auto industry norm, so Autoliv has to aggressively employ kaizen, kanban, and Six Sigma Lean manufacturing programs to advance cost savings. To maintain pricing and margin, Autoliv also requires continual investment in innovation. A loss of focus in cost reduction or technological development could result in an erosion of profitability and return on invested capital.

Additionally, the company operates in a capital-intensive industry subject to cyclical demand. As a result, Autoliv has a high degree of operating leverage, so sudden declines in volume can have a meaningful impact on profit, which we expect in 2020 from COVID-19. Conversely, any increase in sales following large cost-cutting measures significantly raises profits. The potential changes to profitability brought on by the firm's operating leverage and cyclical demand results in our high fair value uncertainty rating.

Financial Strength
We view Autoliv's financial health as relatively strong for an auto-parts supplier. The company has excellent liquidity, with approximately $1.5 billion in cash as of April 2020, including the drawdown of its $1.1 billion revolving credit line. Over the past 10 years, total adjusted debt/EBITDAR has averaged an investment-grade credit level of 1.6 times. While credit facilities are unsecured and there are no financial covenants on the firm's debt, management seeks to maintain a net debt/EBITDA ratio within the range of 0.5-1.5 times. Owing to the coronavirus pandemic, this ratio was at 1.7 times at the end of the first quarter 2020. Overall, Autoliv's financial health and free cash flow generation is much better than many in its peer group. We view the company as being well positioned to withstand a challenging decline in global new vehicle demand, as is the current situation arising from COVID-19 induced industrywide factory closures.

Autoliv has generally maintained a conservatively financed balance sheet. Capital requirements have been met with funding from operating cash flow and the company's unsecured revolving line of credit. Over the past 10 years, total debt/total capital has averaged 14.5%, while net debt/total capital, which takes into consideration the company's cash position, has averaged 4.4%. Total adjusted debt/EBITDAR, a leverage metric that takes into consideration a company's use of operating leases, has averaged less than 1.6 times but exceeded the average in 2018 at 2.3 times after taking on debt in conjunction with the Veoneer spin-off. Veoneer received a $970 million cash infusion from Autoliv to fund heavy R&D spending.

Stewardship |  19 May 2020

Our Standard stewardship rating reflects Autoliv's solid cash generation, financial reporting transparency, and returns to shareholders. Over the past 10 years, Autoliv has returned approximately $2.9 billion to shareholders mostly through common stock dividends but also some share repurchases. Due to the COVID-19 pandemic, the company suspended its dividend after the first quarter of 2020. Upon the spin-off of Veoneer in July 2018, Mikael Bratt became the president and CEO of Autoliv, replacing Jan Carlson who held the position since 2007 and who became president and CEO of Veoneer.

Before assuming his current position, Bratt was president of Autoliv's passive safety group since May 2016. Before joining Autoliv, Bratt had been with the Volvo Group for 30 years, most recently serving as the executive vice president in charge of Group Truck Operations and previously as the Volvo Group CFO. We expect Bratt to continue Autoliv's track record in creating shareholder value.

We like that management creates shareholder value by returning profits to shareholders through dividends and share repurchases, which we expect to resume post-COVID-19 crisis. After the 2009 Great Recession, the company resumed its dividend effective for the third quarter of 2010 and increased it 17% for the fourth quarter of that year. Since 2012, the dividend payout ratio has been above a very healthy 35% of net income.

A share-repurchase program is still in effect. The company reactivated its share-repurchase program in the fourth quarter of 2013. Since then, Autoliv has repurchased over $1.0 billion worth of its stock and, at the end of 2019, had 3 million shares remaining under its current authorization. Autoliv also deserves credit for its financial transparency. The company provides more detailed information than many of the parts companies we cover.

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