This Company Ensures a Safe Ride for Both Passengers and Investors

By Mark Lin - August 2, 2013 | Tickers: ALV, DLPH, TRW | 0 Comments

Mark is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Nobody will want to buy a vehicle from an automobile manufacturer that is in the news for several fatal car accidents involving its cars. That explains the superior bargaining power of suppliers of automotive safety products. Autoliv (NYSE: ALV), the largest supplier of automotive safety equipment globally, has an excellent track record of profitability, which is the direct consequence of high customer switching costs.

Critical nature of products leads to consistent profitability

Autoliv has been profitable and free-cash-flow positive for every year in the past decade. It is a beneficiary of both internal and external forces.

First, rating programs for automobiles are evolving and becoming more demanding. For example, the European New Car Assessment Programme (EuroNCAP) is increasing the Active Safety weighting from 10% to 20% in its assessments starting from 2004. Active safety refers to higher-margin safety systems that help avoid accidents, such as brake-assist and traction-control systems, as opposed to lower-margin, passive safety products like seat belts and airbags.

Second, Autoliv’s customers have high switching costs. The risk of damaged reputations associated with fatal car accidents far outweighs any cost savings associated with cheaper safety products provided by Autoliv’s competitors. In addition, Autoliv’s customers are also less price-sensitive, since the cost of the safety products are a relatively small portion of automakers’ budgets.

R&D spending validates management’s commitment to innovation

One way to assess management’s commitment to innovation is to calculate the percentage of sales spent on R&D expenses. From 2003 to 2012, Autoliv has consistently invested an average of 7%-8% of its gross sales in its R&D budget.

The results speak for themselves. In eight out of the past 10 years, Autoliv has had at least one new product introduced every year that was the first of its kind in the world, such as pedestrian airbags (2012), multi-volume cushion airbags (2007) and the fixed-hub steering wheel (2004). In addition, it grew revenue by a three-year compound annual growth rate of 17.3% and exhibited strong margin stability with gross margin staying within a narrow range of 20%-22% from 2009 to 2012.

Emerging-market focus driving future growth

In the second quarter of fiscal 2013, Auotliv delivered a decent set of results, increasing its quarterly organic sales and EPS by 6% and 8% year-on-year, respectively. China, which accounted for 13% of fiscal 2012 revenues, was the star performer, achieving 16% organic sales growth for the quarter. Management guided for 4% growth in organic sales for the full year 2013, with the increased demand for active safety features and China auto sales being the key growth drivers.

Light-vehicle sales and production have reached new highs in the past year, but there is still significant room for growth. It is estimated that there are 85 vehicles for every 1,000 Chinese, compared with 800 vehicles per 1,000 Americans. Autoliv is aggressively expanding its presence in China, having launched more than 100 products in the past year and already has plans for two new plants in Changzhou and Changchun. It is targeting to increase its market share in Chinese light vehicle production from 35% in 2012 to 38% in 2015.

Peer comparison

Autoliv’s peers include TRW Automotive (NYSE: TRW) and Delphi Automotive (NYSE:DLPH)

TRW is Autoliv’s closest competitor in automotive safety products, but is a less compelling play on automobile safety for a couple of reasons. Autoliv has a superior geographical coverage compared with TRW, with a presence in countries like South America, Japan and Korea. Autoliv also has a stronger balance sheet than TRW, with a net cash financial position. Moreover, TRW does not pay a dividend, but chose to reward shareholders with share repurchases amounting to $268 million in 2012. TRW reported flat sales growth for the first quarter of fiscal 2013, with weak European demand offsetting growth in North America and China. TRW’s larger Europe exposure at 42% of sales (versus 32% of sales for Autoliv) is another cause for concern. In view of this, management has guided for 1% growth in sales for the full year 2013, on the lower end of the estimates.

Delphi is a leading vehicle components manufacturer and supplier of electrical and electronic, powertrain, safety, and thermal technology solutions for the automotive, commercial vehicle, and other market segments. Unlike Autotliv and TRW, it is not a pure proxy for automotive safety, with its varied solutions providing exposure to fuel economy, automotive electronics, and active safety. Similar to TRW, Delphi has significant exposure to Europe, with 41% of fiscal 2012 sales derived from the region. In the first quarter of fiscal 2013, it saw quarterly revenue and GAAP diluted earnings per share fall by 17% and 15% to $4.0 billion and $0.88 per share, with demand weakness from Europe being a key contributing factor. The positive takeaways from the quarter were that Delphi generated positive operating cash flow for the first time in its history and initiated a regular quarterly cash dividend of $0.17 per share. Based on the midpoint of management guidance, Delphi estimated that full-year 2013 earnings per shares will register a 11% growth rate year-over-year, assuming global vehicle production increases of 2% and European declines of 5% in 2013.

Conclusion

Autoliv is attractively valued at 6.7 times trailing 12 months EV/EBITDA and sports a decent 2.4% forward dividend yield. The mission-critical nature of its products, management’s commitment to innovation and emerging market focus are all factors for its continued profitability and growth. In my opinion, Autoliv is a strong buy, based on its business quality and current valuation levels.

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Mark Lin has no position in any stocks mentioned. The Motley Fool recommends Autoliv. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!