Such was the fear and panic earlier this year that investors bailed out of even the strongest long-term electrification stories, including Aptiv (APTV). In relatively short order, though, investors have flipped from, “Hey, why don’t you let me out here?” to a Blues Brothers-style “Hit it!,” with the Street once again firmly on board with the well above-average growth potential offered by Aptiv’s portfolios in vehicle electrification, safety, connectivity, and infotainment.
I liked Aptiv back in May, and the shares have done well since then – though not quite as well as BorgWarner (NYSE:BWA) or Valeo (OTCPK:VLEEY). At this point, unlike with BorgWarner or Valeo, it’s tough to argue that the Street is still overlooking some upside. I like the M&A optionality created by the capital raise in the summer, and I do like the company’s leverage to some of the most attractive growth areas in autos (and industrials), but even with my own expectations already above the sell-side, it’s tough to make the numbers work now.
Time To Go Shopping?
Aptiv management took advantage of the strong rally from March lows, deciding to raise over $2.2 billion in equity capital in June through a common and preferred stock offering (split 50/50). The company didn’t really need to do this, as the prior debt load was still manageable and I expected the company to remain free cash flow positive through the trough (on a full-year basis), but I can’t really fault opportunism.
With a cleaner balance sheet, it looks like management intends to go shopping, with management talking about the window of opportunity opening back up again in the second half of the year.
What Aptiv might buy is an interesting point of speculation. In terms of the auto portfolio, I could see the company looking to acquire more sensor assets. Looking at what the company wants to do in terms of autonomous driving and cabin infotainment, sensing is the one area that stands out as potentially benefiting from supplementary M&A. I could also see the company potentially looking for more connectivity assets, given the importance of those capabilities in both autonomous driving and infotainment.
I’d frankly be surprised if Aptiv went more in the direction of power electronics (for EV powertrains). I mean, that’s what Delphi (NYSE:DLPH) already had before the companies split, and there’s no shortage of competition in the EV powertrain space now, so I wonder what Aptiv could really do there.
One wildcard I see in play is that Aptiv could look to expand its capabilities outside of autos. Commercial vehicles represent a little less than 10% of the revenue mix and industrial sales are smaller still, but both could be areas of investment. Electrification and automation is relevant to commercial vehicles, both for on-highway commercial vehicles, as well as off-highway, where I’m thinking mostly of electrified and semi-autonomous to autonomous mining trucks produced by companies like Caterpillar (NYSE:CAT) and Komatsu (OTCPK:KMTUY). With companies like Deere (NYSE:DE) continuing to invest heavily in precision agriculture, maybe advanced electrification and automation for ag machinery is a possibility.
I also see potential in the industrial space. Aptiv has strong technology in areas like electrical distribution (with low-voltage and high-voltage capabilities), connectivity, and human-machine interfaces (or HMI) for applications like infotainment. With factory automation demanding more electrification, new forms of connectivity, and new HMIs, is it such a stretch to think that Aptiv could be looking at opportunities here?
Continuing To Outperform, Rain Or Shine
Looking back at Aptiv’s June quarter, the company certainly took a hit from the sharp decline in auto production, as revenue declined more than 44% overall in organic terms, but management pegged its outperformance versus underlying builds at 11 pts – a slowdown from the 14-point outperformance in the first quarter, but still quite good. What’s more, interest in high-voltage electrification remains strong, with that business up 3% within a Signal and Power Solutions business that was down 43%.
Management has also spent a little more effort highlighting the margin potential of the high-voltage opportunity. Aptiv can leverage its large existing low-voltage business (where the company has content on roughly one in every 3.5 vehicles) and believes it can break even at $350M in high-voltage revenue and produce equivalent margins at just $400M in revenue, helped by the fact that high-voltage products include meaningfully more connectors than low-voltage (50/50 with cabling versus 30/70) and those connectors produce significantly better margins. With high-voltage revenue already at around $350M in 2019 and Aptiv having guided to $1 billion or more in 2022, it’s not too hard to see some margin accretion potential here.
There are also longer-term attractive opportunities in areas like connectivity and infotainment. I actually think the name “infotainment” does the technology a disservice, as I expect that the cabin of autos is going to see a merging of instrumentation, navigation, climate control, and other functions into a more unified control platform. Whatever you call it, this business could leverage high single-digit to low double-digit underlying market growth, not to mention opportunities in advanced driver safety (up to and including autonomous driving).
I believe Aptiv will generate high single-digit to low double-digit annualized revenue growth off of the low starting point of 2020, driven by vehicle electrification, enhanced driver safety technologies, connectivity, and “infotainment.” Competition will be fierce, particularly in areas like safety, connectivity, and infotainment, but Aptiv has an impressive array of existing platform technologies. I also would not sleep on the possibility of non-auto sources of growth, including commercial vehicles and industrial applications of Aptiv’s core technologies.
The issue is what that’s worth. I’m actually more bullish than most of the Street on revenue growth, and I’m likewise more bullish on margin potential – the Street expects EBITDA margins to hit the 16%’s in 2022 and then flatten for a while, but I believe growth in high-voltage and more advanced safety, connectivity, and infotainment offerings could drive more margin upside.
The Bottom Line
Even with robust revenue growth and FCF margin expectations, I can’t get to a compelling fair value relative to today’s price. And then you have to consider issues like the risk of competition and the risk that the higher cost of these more advanced autos could delay adoption relative to current expectations. I do still see mid-to-high single-digit annualized return potential here, which isn’t bad, but I think it’s fair to say that Aptiv has regained its “darling” status with the Street, and it may be more challenging for the company to surpass the level of expectations that seems baked into today’s price.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.