2023-06-13 09:56:56 ET
Summary
- Aptiv's 1Q23 results showed strong revenue growth but margins fell short due to FX and commodity pressure.
- Despite record sales, the company's operating margin reached only 9.1%, raising concerns about achieving high-single-digit EBIT margins.
- I recommend a hold rating due to the uncertainty surrounding margin improvements and management's decision to maintain conservative guidance.
Thesis
Aptiv ( APTV ) multiples reverted to the average multiple of ~10x forward EBITDA just as I have warned , and consequently, the share price went down ~30%. With the valuation now at a much more attractive level, I am still recommending a hold rating given my concern on the path of margin inflection. To reiterate the long-term bull case of APTV, it is a leading supplier of electrical architectures, safety products, and electronics for light vehicles. I believe APTV stock provides investors an opportunity to leverage the strongest secular growth themes within the automotive industry, namely the mega trends of electrification of vehicles and increasing penetration of active safety, autonomous driving features, and connectivity. However, the near-term uncertainty regarding whether EBIT margin can hit high-single digits is likely to leave the stock rangebound until more information is disclosed.
Performance update
As there are no recent updates about APTV 1Q23 results, below is a quick reference to make things easier to digest. APTV's 1Q23 results were in line with expectations, with revenue significantly exceeding my expectations (all-time-high quarterly revenue) but margins falling short due to FX and commodity pressure. I expect the product segment to continue experiencing high growth as active safety and high voltage continue the growth momentum from the 31% and 28% 1Q23 growth respectively. These results are particularly noteworthy considering the challenging comparisons to previous periods. Looking ahead, with bookings at $13.9 billion in 1Q23, which is two times the level in 1Q22, I believe APTV is now on track to achieve its FY23 goal of $32 billion. Despite this, operating margin for the quarter was only 9.1%.
Margin
As I have touched on most of the bullish points in my previous post, I like to direct the attention to near-term catalyst for the stock – margins. I focused on margin because it appears to be the root cause of the stock's poor performance following the announcement of earnings. Given the year's slow start (margin-wise), I think investors are understandably concerned about the trajectory of margin improvement. Despite APTV's record quarterly sales of $4.82 billion, the company's operating margin only reached 9.1%, down by about 200 basis points from the prior two quarters and below the level seen in the first quarter of pre-covid years (FY15/16/17/18). With better-than-expected volumes, my current worry is why APTV is not providing significant operating leverage. To make things worse, even with the help of customer recoveries, decelerating inflation, and the additional contribution from Wind River, the Advanced Safety & User Experience segment underperformed, resulting in margins of only 4.6%. Looking ahead, I think it is hard for investors to feel confident about the company making the year-end double-digit margin on Advanced Safety and User Experience that's required to meet management's 8-9% goal.
Guidance
I also find the current narrative surrounding the stock to be unappealing for long positions. This sentiment arises from management's decision to reiterate guidance, despite the visible indications in the results that APTV is poised to surpass or reach the high end of the guidance. For instance, even with the acquisitions of Wind River and Intercable (robust backlog and the integration), management has maintained the 2023 sales guidance range of $18.7 to $19.3 billion. Moreover, the sales figures from 1Q23 already suggest a strong possibility of achieving the upper end of the guidance. Additionally, management has expressed optimism regarding volume assumptions in the 2H23, despite their overall conservative stance and cautious approach to China and European output. Furthermore, APTV has also implemented initiatives to reduce structural costs by approximately $100 million annually. Consequently, if we remove the conservative element, it indicates that APTV is on track to achieve the upper end of its guidance, supported by its backlog, with the potential for margin improvements through cost-cutting measures. Therefore, I perceive management's decision to leave the guidance unchanged as a negative for the stock, as investors adjust their expectations to align with management's guidance. An additional catalyst would be if management were to revise the guidance upwards to reflect these positive factors, which I believe could trigger a rally in the stock.
Valuation
If we take consensus figures as the part of the market that are bullish in the business and stock, and attach APTV's average P/E over the past 10 years, the upside is attractive at 35%. The problem, I believe, is that the general market is not willing to be bullish as management is apparently not holding a bullish stance. I would go one step further to say that multiples could remain at the current level of 19x forward earnings if the momentum turns bullish. 19x forward earnings would mean that APTV is trading in line with peers like Driven Brands (DRVN).
Own valuation
Risks
A risk to the thesis is how much APTV can increase its penetration in the number of content per vehicle ahead. This is less straight forward than seen as APTV would need to compete with a myriad of suppliers before the start of the production, which means it has to be on its toes at all time to ensure its innovation is at the top of the game. As such, the inherent competitive threat is high, despite APTV having a larger scale.
Conclusion
I continue to recommend a hold rating as the uncertainty surrounding achieving high-single-digit EBIT margins creates near-term concerns. The 1Q23 results were in line with expectations, with strong revenue performance but margin remains pressured. Notably, high-growth product segments showed solid traction despite challenging comparisons. The focus on margins as a catalyst for the stock is crucial, as the lower-than-expected operating margin raises questions about achieving double-digit margins.
For further details see:
Aptiv: A Hold Given Uncertainty In EBIT Margin Trajectory