2023-04-23 06:31:18 ET
Summary
- Aptiv is a leader in the Auto Parts & Equipment Industry. While the valuation is elevated, to me, this is justified by their edge.
- The company has turned around from a clunky legacy supplier at the heart of Detroit's downfall 15 years ago to a modern mobility master.
- The company has a mix of sprawling legacy assets, geographic, and customer diversification, and is increasingly vital to auto industry OEMs.
- The firm has done an excellent job at gaining exposure to the highest growth and most disruptive trends in mobility.
- The company is positioned for long-term value creation and is more attractive than a pure-play auto stock from a risk aversion standpoint.
There's a growing trend across America in converting classic cars into electric vehicles. In other words, the process retains the timeless aesthetic of iconic models while replacing what's under the hood with a new battery electric engine. Classic exterior, cutting-edge, and green interior. I think this is a fitting metaphor for Aptiv (APTV) as a company.
The firm is old guard auto to the core in some ways. It was originally spun off from General Motors and would eventually play an integral part in that behemoth's bankruptcy by itself reaching insolvency. However, a path of adversity and emergence from a high-profile bankruptcy has forged an industry leader with a leading-edge technology portfolio attached to high-growth trends.
However, it also retained the benefits of being ingrained in the global auto infrastructure. The company has those 'classic' elements of its past reminiscent of Detroit's heyday but is also simultaneously a formidable technology company with nearly 20,000 engineers and over a hundred factories in 40 countries.
It has a vast international footprint and entrenched decades-old relationships across the global auto industry. But these legacy strengths are now paired with the cutting-edge technology virtually any OEM producing a modern car needs. Like the converted classic cars, it is somewhat of an anomaly, simultaneously a throwback and at the vanguard of one of the most important technological megatrends of the 21st century.
According to a survey, people convert mainly to enhance performance, not to save the planet. One enterprising tinkerer bought a classic car and converted it to full electric using battery packs and the rear subframe from a crashed Tesla (TSLA). The gearhead said, "This was my way of taking the car that I like -- my favorite body-- and taking the modern technology and performance and mixing them together." Again, this quote captures what I like about Aptiv, going with the metaphor.
Aptiv 2023 Investor Conference
The company's sprawling and global manufacturing is classic Detroit. Still, its leading technology portfolio, accretive acquisitions, and capable management are wielding these assets effectively to generate shareholder value. Much of the baggage has been resolved in bankruptcies of the past. To spell it out more directly, though, Aptiv is a very global company.
It also knows the auto industry well and designs its products with the core incentives of its end users in mind. The Smart Vehicle Architecture allows auto OEMs to plug and play various components in order to reduce their costs and simplify manufacturing. In the capital intensive, ultra-high barrier auto manufacturing business this service is a lot more attractive to participants than prose can properly convey. Its solution is particularly attractive for OEMs building a new EV model from scratch. SVA can dramatically reduce costs.
So far, the tide of globalization is rolling back in areas like semiconductors. However, the benefits of globalization from a labor, supply chain, and geographic diversification standpoint all appear likely to remain within Aptiv's grasp. Of course, being global always presents risks, but the firm's management capably uses the diverse and vast physical assets instead of being bogged down by them. Aptiv is a rare modern example of a company still leveraging the benefits of globalized labor markets and supply chains and whose truly business doesn't seem affected dramatically by superpower showdown.
Aptiv 2023 Investor Conference
Aptiv has built a company that I want to own for ten years. The company's increasing intangible value from its industry-leading technology portfolio is justification for its valuation above peers. More reliance on software revenue will mean higher margins in the future, but it has higher margins than the industry median.
Here's the thing: a lot of Aptiv's success to date has been the impressive traction of its Smart Vehicle Architecture which is on the hardware side. However, the company's strategic plan is to become more reliant on revenues from software which aside from the margin expansion also begets recurring revenues. There's exciting things going at this company.
Aptiv has gained considerable inroads and competitive advantage in high-growth areas of the automotive sector. The natural cyclicality of the industry is somewhat mitigated for Aptiv by the gargantuan push major auto OEMs are making toward electric, which results in sustained CAPEX to the company's benefit.
Of course, Aptiv benefits from the spending at the beginning of the value of chain and is thus largely insulated from the failure of any particular model or company. So, as there is a prodigious clash of the Titans amongst auto OEMs, Aptiv is selling its wares to most, if not all of them.
Aptiv 2023 Investor Conference
The lead in technologies is becoming considerable and the company has a far great breadth of offerings across the manufacturing process and vehicle architecture than its competitors. Still, I also think a lot of these technologies will take years, or even a decade or more, to realize their full commercial potential.
There are a lot of promising areas for future growth that I think make it a better risk/reward trade-off than many leading ideas on the EV motif. The basic idea is that you don't have to worry about Tesla's margins or whether a GM model has its tax credit expire. Aptiv is getting paid regardless. So, you can sit back and let the Titan's clash.
A Look Under The Hood
There's a really easy smell test I like to do when looking at any company, regardless of how complicated its business model and technological processes are. It's simple, and anyone can do it with a little research. Familiarize yourself with the company's business, listen to a few earnings calls and investor events, and then look at the company's official mission.
How does it measure up with what you have just learned and observed? I think this is even more important for a company like Aptiv, which has elevated valuation across many metrics compared to peers.
On this simple test, Aptiv passes splendidly. The firm's mission statement is to enable a safer, greener, more connected future of mobility. This is exactly what the firm has done. On the physical side of the car, the Smart Vehicle Architecture is a compelling product from the viewpoint of OEMs. It helps significantly reduce costs for them across the whole value chain, or just where they need it most. However, as impressive as the company's efforts have been to date in the hardware area, what really excited me is the software side.
For the growth hounds, there's some truly amazing stuff that seems like it will inevitably an integral part of the heralded autonomous vehicle revolution . The company's mission statement is simple, and it is wholly congruent with management's actions and the firm's strategic direction. It is not mealy-mouthed, and the company has repeatedly demonstrated competence in orienting itself toward this mission across multiple axes.
Aptiv had a fantastic 2022 under trying circumstances. The company generated record new business. There was $13.4 billion in new business spread pretty evenly across segments. The firm has executed despite the onerous challenges related to auto industry supply chains. It remains dominant across the metrics most important to OEMs that want to produce EVs at scale.
The firm has also completed two strategic acquisitions that bolster its competitive moat and give it access to its considerable existing customer base. One of the appealing characteristics of Aptiv's technology suite is that while it is certainly positively leveraged to the rise of EVs, it is also not wholly dependent on it.
The company held its investor event in Boston about two months ago, and it significantly raised long-term targets, showing the confidence of a seasoned and capable management team. Aptiv's CEO, Kevin Clark, has been with Aptiv since 2010. He started out as CFO and has also served as COO. He knows what the Street wants to hear, what the OEMs and his other customer need, and is focused on generating long-term value. His steady hand is a major plus. This is a guy who has the necessary experience and brains to build long-term shareholder value.
Risks and Where I Could Be Wrong
The Auto Industry is notoriously difficult and there are few companies whose past illustrate this point more pointedly than Aptiv's own storied corporate journey. There's a reason why the history of the industry is littered with bankruptcy. The high capital intensity means that strategic errors can quickly result in failure. Inflation, supply chains, and labor are all vital elements of a very complicated orchestra that is required in auto manufacturing and margins tend to be pretty thin for the OEMs themselves.
This risk is for the auto industry is a benefit to Aptiv, whose value proposition to many customers is reducing costs. However, Aptiv is still exposed to the cyclicality of the economy. I mentioned this is mitigate by the EV CAPEX explosion, but it is not eliminated by it. The economy is facing a lot of risk and the company could under pressure from diminishing demand for autos, if economic weakness is sustained. On the other hand, a mild recession might not affect demand all that much particularly if it occurs concurrently with easing inflation and the continued ungumming of supply chains.
Commodities costs are obviously quite crucial to Aptiv itself and to the overall adoption of EVs. The War in Ukraine is one ongoing risk to businesses who rely on commodities as crucial inputs. The company has successfully weathered the risks so far though, which were considerable given its European manufacturing footprint, and I expect this to continue. Aptiv's debt levels seem sustainable and comparable to the industry, but this could always change if the banking crisis or another driver of financial instability occurs given the intensive nature of its industry.
The biggest risk is of course there's a premium valuation in a high rate environment. The company enjoys a premium multiple compared to peers but its 5-year Return on Equity is middle of the road. If the Fed stays higher for longer, or has to hike more in the event of persistent inflation, there could be significant pressure on the valuation particularly if coinciding with a recessionary environment.
Conclusion
Aptiv is an old guard auto parts company that came from the heart of Detroit that has transformed itself into a revolutionary technology company at the vanguard of modern mobility technology. The company has proven so far that it is capable of rewarding shareholders in a manner that is superior to peers, but I believe the firm's detailed plans for making itself an indispensable partner to the leading auto manufacturers is an endurable and shrewd strategy that ensures it is tied to a transformational trend without being overly reliant on any one actor.
There's a lot of ways you can choose to invest in emerging trends. You can pick new entrants with flashy designs that have never built a car, you can pick old stalwarts, or of course Tesla. They all have drawbacks and advantages. Any one manufacturer may fail or succeed in their efforts at the prodigious R&D efforts necessary to reach fully autonomous driving. Start-ups are even more likely to fail at breakthrough solutions in such a complex technology. I think Aptiv's unique history and relationships, growing technological lead, and seasoned management are all reasons to be bullish on this stock.
For further details see:
Aptiv: Sit Back And Watch The Titans Clash