VC - Visteon: On Its Way To Meet FY26 Targets

2023-05-24 12:03:06 ET

Summary

• VC is making progress towards its FY26 goals by constantly winning deals across different OEMs and products.
• VC's successful work with OEMs creates opportunities for further penetration into their portfolios.
• The current market's discount to VC stock can be attributed to a lack of visibility into FY26. However, as earnings visibility improves in FY24, I expect investor interest to increase.

Thesis

Visteon ( VC ) stands out as a pure play on the expected growth in cockpit electronics content per vehicle, and stands to benefit from the ongoing confluence of these systems as well as the continued reduction in electronic control units that it can help foster through its SmartCore product. The company reported 1Q23 earnings that beat consensus estimates and reaffirmed its outlook for the full year. The higher-than-anticipated global output of light vehicles in 1Q appears to be the primary driver, along with various supply chain enhancements that resulted in increased production efficiency at the OEM level. Given the various indications of improvement and a stronger than expected 1Q23, I would have expected management to raise guidance. As such, the reiteration of guidance came across as a cautious move, which is not an entirely bad move given the need to tread carefully in light of the increased uncertainty surrounding the macro environment. That said, I am still optimistic on the mid-term growth to FY26, hence, I maintain my buy rating on VC. I continue to believe that VC is well-positioned for growth, given its exposure to applications for the digital cockpit, as well as a growing EV specific business.

On track to hit FY 26 targets

It is remarkable to see VC continuing to execute as planned, winning $1.5 billion of new businesses in 1Q23, which is equivalent to one quarter of the $6 billion target for FY23. In particular, the deals included OEMs from various regions and for different products. One Chinese OEM has extended their SmartCore program, an Indian OEM has purchased a new infotainment system and display, and lastly, VC continued to extend its existing BMS business to support additional EV models (and I expect EVs in the US to continue growing at a rapid rate, as demand is booming ) with existing customers at a higher CPV. I expect VC to realize the full value of these wins when the additional vehicles across multiple brands in North America begin production in FY24 and FY25. With all these growth initiatives in the books, it is not hard to see how VC can achieve its 2026 financial goals. Given VC business has a lot of fixed cost, this incremental growth should carry high incremental margin (in line with management expectations that sales can be converted at 20% incremental margin), which ultimately can double profits from FY22 levels. It is also important to note that with each business won, it paves an easier path for VC to further penetrate that existing relationship/network. For instance, having worked with OEM A for a single product would prove that VC can deliver as promised, which could potentially open up more TAM for VC as it penetrates the OEM's other portfolio offerings. This penetration carries little marketing efforts as the relationship and trust have already been built, as such the incremental margins are even higher. On top of these things, VC also has the ability to maximize its vertical integration by leveraging its operations to increase productivity through the automation of its plants and the localization of its supply chain and technical capabilities. Overall, I'm optimistic about the VC deal-closing prowess and confident that it will reach its FY26 goals.

Guidance

Despite delivering a strong Q1 earnings beat, management maintained its 2023 guidance calling for revenue of $3.95 to $4.15 billion. Given the robust beginning to the year, this seems conservative; however, there is some justification for concern about the overall macro-driven demand in 2H23. The positive news for VC is that it is not directly impacted per-se, as the first point of demand comes from consumers to OEMs. OEMs would then need to purchase from VC. If OEMs were to not increase prices (in the face of inflation) to capture more volume, this might benefit VC (if the OEM is a customer of VC). As such, I think there is a path for VC to beat its own guidance.

Valuation

Using VC FY26 guidance, the company is expected to generate $740 million in EBITDA, a 2.2x increase from LTM1Q23 levels. If we apply the same EV/Forward EBITDA multiple to it in FY25, the enterprise value will be $6.2 billion, translating to a share price of $213. This represents a 52% increase over the current share price. In my opinion, the market's discount to VC stock is due to a lack of visibility into FY26. I believe that investor interest in the stock will increase only sometime in FY24 (likely 2H24), when earnings visibility for FY26 will be much clearer (we will have FY24 results as well as management comments for FY25). Furthermore, I believe that the current interest rate environment has forced many investors to apply a significant discount to any stock that will only show value in the distant future. Investing in the stock now allows investors to benefit from "time arbitrage," as I expect VC to meet its FY26 targets.

Risks

I think a primary risk for VC is competition. While VC has demonstrated success in what it is doing, it is not to say that someone else cannot replicate it or attempt to build something that is “good enough”. The more success VC demonstrates, I believe it will become more enticing for other companies in the adjacent field to consider developing something similar that can facilitate connectivity and electrification. Although this is not a winner takes all market, if there are more competitors coming in, it would naturally mean a smaller profit pool for VC.

Conclusion

In conclusion, VC continues to demonstrate its strong position in the market and potential for growth. With a solid 1Q23 performance and $1.5 billion worth of new business wins, VC is on track to meet its FY23 and FY26 targets. I believe if VC continues to grow as guided (it doesn’t even need to beat it), the market will eventually re-rate the stock to the 'right' valuation and share price.

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