ALV - Autoliv: Global Safety Growth And Margin Improvement To Drive Valuation Upside

2023-10-25 03:56:39 ET

Summary

• Autoliv posted largely in-line third quarter results, but that included significant outperformance vs. global production as the company benefits from price negotiations and new products.
• Margin improvement plans were set back significantly by intense cost inflation, but management is clawing back margin with price, restructuring, and operating efficiency moves.
• Airbag adoption should accelerate meaningfully in India over the next few years, and Autoliv is leveraged to other technology-driven safety opportunities like driver monitoring and position/weight sensors.
• Mid-single digit revenue growth and EBITDA margin improvement toward the mid-teens can support a fair value above $105.

The two years or so since I last wrote about Autoliv ( ALV ) included a lot of challenges for this leading passive auto safety manufacturer (airbags and seatbelts), including intense input cost inflation and ongoing excess costs tied to inconsistent customer build-rates. Even so, the shares have done alright since then, rising a bit at over a time when many auto suppliers have reported single-digit or worse declines.

I thought Autoliv was a borderline prospect back in mid-2021, but I’m more bullish on the company now. Margin improvement has been delayed, not canceled, and I think 12% operating margin can happen in 2025, with further improvement beyond. I also see attractive opportunities for content growth, both in terms of existing offerings (as countries push new regulations) and upcoming, higher-value offerings. A weaker global economy and the UAW strikes are both threats, more to sentiment than fundamentals, but these shares are worth a look under $105, particularly for investors who don’t feel comfortable trying to pick winners in the electrification market.

A Noticeable Beat Versus Underlying Production In Q3

Helped in no small part by pricing actions taken over the past year, Autoliv delivered strong revenue growth relative to underlying global vehicle production. The Street did expect this, though, so the beat relative to expectations was modest (less than 1%).

Revenue rose 11% in organic terms versus the 3.8% growth that S&P estimated for light vehicle production in Q3’23. Management didn’t provide useful quantification of price versus volume other than to say that the outperformance was “mainly” driven by price increases and new launches. Airbag sales rose 15% on 6% volume growth for front airbags and 19% growth for side airbags, while seatbelt sales rose a little less than 3%.

Relative to geography, outperformance was strongest in Asia (+15%), Japan (+14%), and China (+6%), but Autoliv still outperformed in the Americas and Europe as well (3% and 2%, respectively).

Between pricing, declining input costs, and other efforts to improve production efficiency, gross margin improved 120bp to 17.9% in the quarter. Adjusted operating income rose 41%, with margin up almost two points year over year and 140bp sequentially to 9.4%. Again, though, these results were in line with expectations, as management has gone to some lengths to provide clear guidance on the margin improvement trajectory throughout 2023 after missing badly in 2021-2022 on input cost inflation.

Healthy Markets Support More Growth

The S&P recently raised its forecast for global vehicle production to 7.5% for 2023 and management lifted its organic revenue growth guidance from 15% to 17% with third quarter earnings. While the UAW strikes will be an issue for volumes at some point, only about 13% of Autoliv’s business is exposed and thus far it has been a manageable headwind.

Trends get more interesting in 2024 and beyond. The S&P (and most other forecasters) expect a sharp decline in growth in 2024 to less than 1%, with growth improving back toward 2% over 2025 and 2026. While there are still some market share opportunities for Autoliv, the bigger opportunities come from regulation-driven content growth and new product adoption.

On the former, India only started requiring front airbags in 2021 and while the government has backed off of its former plan to mandate six airbags per car in 2023, it seems as though most auto OEMs are doing so voluntarily so as to score well in India’s new government-run car safety rating program. While six airbags are the norm in a lot of the world (98% penetration on new cars in the U.S., 89% in Germany, and 65% in China, as per Jato Dynamics), penetration is around 12% to 13% in India, but could grow to 50%-70%-plus in just a few years.

While opportunities in other markets may not be as dramatic, they are still present, as the general trend in almost all regions is for higher levels of mandated safety and/or market-driven incentives (like NCAP ratings).

Beyond this are opportunities to leverage new technologies. In that prior article I discussed Autoliv having an opportunity in automatic battery disconnects in EVs (to reduce the risk of battery fires), and I still believe that’s an opportunity. Beyond that, management is looking to drive adoption of more steering wheel-based technologies like driver monitoring and more advanced sensing that can account for passenger weight and positioning to optimize safety. I believe these drivers could be worth around 200bp-300bp of underlying market outperformance over the longer term.

The Outlook

Margin improvement remains a big part of the story here. Input cost inflation should start easing more noticeably in 2024, particularly as most commodities have eased off and other components like semiconductors are no longer on allocation. Beyond that, more consistent production schedules should be a boon (eliminating premium-priced rush shipping charges), and the company has ongoing price discussions with its customers. On top of that, the company announced a significant restructuring earlier this year that will reduce about 11% of the workforce (including closing two plants), as well as a plan to continue incorporating more automation into its facilities.

I expect EBITDA margin around 12% in FY’23 improving toward 15%-16% in 2026/27. On the operating margin line, I think 12% could be achieved in 2025, and if not then likely in 2026. That should allow for Autoliv to regain mid-single-digit FCF margins in 2024 and sustain them; I don’t expect margins to move much past 7% over the long term, but that would still drive significant improvement over trailing averages and double-digit FCF growth on top of my 5% long-term annualized estimate.

Between discounted cash flow and margin-driven EV/revenue, I get a fair value range of $105 to $115. Getting to 15% EBITDA margin could unlock another $15 or so per share in value based upon what the market has paid for various margin levels in the past in this sector.

The Bottom Line

I like Autoliv’s position as a wide-moat, market-leading provider of auto technologies that are largely agnostic to drivetrain – in other words, it doesn’t matter that much how the ICE/EV transition goes for Autoliv. I also like the opportunity to drive incremental content with new technology-driven product introductions, and I think the margin improvement drivers are legitimate. With worthwhile upside from here, I think this is a name to consider, even with the uncertainties over the global economy and the UAW situation.

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