The Street Is Back On Board With Aptiv’s Above-Average Growth Potential (NYSE:APTV)


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).

The Outlook

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.





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Trump’s idea on changing Social Security funding has the potential to break an impasse on much-needed reforms


President Trump has proposed a dramatic change to how Social Security is financed. But Trump’s controversial proposal to fund Social Security with income taxes rather than payroll taxes opens the door to reforms that both Democrats and Republicans might support.

On Aug. 8, President Trump issued an executive order that would temporarily defer the collection of Social Security payroll taxes through the end of the year, meaning that these taxes wouldn’t be owed until Americans file their tax returns in April 2021.

But President Trump made clear in an Aug. 12 news conference that his real goal is to replace the Social Security payroll tax with revenues drawn from the general tax fund, the vast majority of which is income taxes. This idea faces both practical and philosophical hurdles, but could help the political parties finally come together to fix Social Security.

Read:Paul Brandus says this is one Trump tax cut you really don’t want

The first problem with funding Social Security via income taxes is obvious: the federal budget is already in deficit, which means there isn’t room to fund Social Security with general revenues without significantly cutting other programs or raising income taxes. And that tax increase wouldn’t be tiny. In 2019, the federal government collected about $1.7 trillion in individual income taxes, versus nearly $1 trillion in Social Security payroll taxes. Even if the President’s plan would replace only the employees’ 6.2% payroll tax, that would mean about an additional $500 billion in general tax revenues needed.

Moreover, funding Social Security with income taxes is also contrary to the program’s history, in which benefit were funded with a flat rate tax that applied to all earnings up to a maximum, which is currently $137,700 per year. The payroll tax contributed to the view that Social Security is an “earned benefit” rather than a welfare plan.

Read:This eye-opening experience has me rethinking how Social Security figures into my retirement planning

But most Democrats have already given up on the idea of truly earned benefits, since their Social Security proposals focus on lifting the payroll tax cap and making the rich carry more of the load.

Income-tax financing would simply take that idea in a more progressive direction. While about 15% of earnings accrue to employees with salaries above the $137,700 payroll tax ceiling, almost half of total income taxes are paid by households with incomes above that level. More than one-third of income taxes are paid by the top 1% alone.

But what it in it for Republicans? The answer is that an income-tax-financed safety retirement net need not be nearly as expensive as the current Social Security program. For instance, Australia’s Age Pension costs around one-fifth of what Social Security does, because it merely supplements households’ own savings to ensure a minimum standard of living in retirement. Canada and New Zealand also use income tax-financed programs to provide a strong base of retirement income.

Read:Australia’s safety net for retirees is generous and comprehensive — and complicated

For this idea to work, though, the U.S. would need to follow Australia’s lead by signing up every worker for a retirement savings account with automatic contributions. Those contributions could be funded using the payroll taxes that no longer would be needed to fund Social Security.

Once transitioned into place — which admittedly would take years — the result would be higher private savings, particularly for lower-income households, which reduces wealth inequality and boosts the economy. And while income taxes would be higher, total government spending on Social Security would be lower.

To be clear, this is my plan, not President Trump’s. But for income tax-funding of Social Security to work, for it to overcome 30 years of Congressional inaction on Social Security, it needs to think creatively and offer something to both sides. Because the traditional menu of reforms — payroll tax rate increases, higher retirement ages, lower cost-of-living adjustments and so forth — haven’t motivated Congress to action.

Follow MarketWatch’s coverage of all things Social Security here.

Andrew G. Biggs is a resident scholar at the American Enterprise Institute and former principal deputy commissioner of the Social Security Administration during the George W. Bush administration. Follow him on Twitter @biggsag.





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Plaza Retail REIT: A Fully Covered 8% Dividend, 50% Upside Potential And A 92% Rent Collection Rate (OTCMKTS:PAZRF)


Introduction

I only acquired positions in a handful commercial REITs during the COVID-19 pandemic, and Plaza Retail REIT (OTC:PAZRF) was one of them. My main reason for buying the stock (and its debentures) was the strong tenant mix with a substantial portion of the tenants remaining open for business as an essential store. This, combined with an acceptable valuation of the properties and LTV ratio, made me go long the stock. The moment of truth was earlier this month when Plaza reported its Q2 results and I’m glad things turned out in line with expectations.

Data by YCharts

The average daily volume of Plaza on the OTC exchange is very low and I recommend to trade in the REIT’s shares through the facilities of the Toronto Stock Exchange where Plaza is trading with PLZ.UN as its ticker symbol. The average daily volume in Canada is closer to 100,000 shares.

Plaza Retail REIT: not just any retail REIT

While commercial REITs aren’t the most popular idea right now, there’s a big difference between the larger commercial REITs that own and operate malls and the REITs owning smaller assets with usually a single tenant and multi-tenant assets with one dominant anchor tenant. Those types of assets can be riskier, but in Plaza Retail’s case I believe the risk actually is reduced as in excess of 50% of the rental income is generated by large chains that remained open and should be strong enough to continue to pay their rent.

Source: Company presentation

I bought the stock in April at around C$2.85 as the REIT was yielding almost 10% at that point and I believed the lower than average rent collection risk was not appreciated by the market. I also calculated that as long as half of the rental revenue was collected, Plaza would be able to stay current on all its interest payments and cover the G&A expenses as well as the normal maintenance expenses for the real estate assets. So around 50% was the breakeven point and any rent that was collected above that percentage would help toward covering the dividend.

Source: Q2 update

In its Q2 update, Plaza confirmed 98% of its stores were opened again and 92% of the July rent had been collected. Not only is that sufficient to cover all overhead expenses (and then some), it also protected the generous dividend and Plaza Retail REIT continued to pay its monthly C$0.0233 dividend throughout the crisis.

Yes, Q2 wasn’t great, but the situation appears to be under control

I was looking forward to the financial results of Plaza to see how the performance was impacted by the lower rent collection rates. Plaza collected only 80% of the April and May rents but this already increased to 86% in June for an average if 82% in Q2. That still isn’t a great result, but thanks to a high percentage of strong tenants, Plaza did better than other retail REITs. Additionally, the bump to 92% in July is very encouraging and perhaps we can aim for a 95% rent collection rate by the end of the quarter which would put Plaza completely back on track. The rental income deemed “lost” (as part of the subsidy plan of the Canadian government, landlords were also asked to forgive a small portion of the rent, and Plaza seems to have recorded this as a non-recoverable expense which explains why the operating expenses are higher).

Source: financial statements

As you can see above, the weak result was predominantly caused by the lower net property operating income and the C$3.9M loss related to the contribution of associates. These two elements explain singlehandedly the lower income before finance costs and taxes. And as Plaza’s interest expenses decreased YoY, the REIT actually was on track to post a higher underlying result, but given the special circumstances, the company recorded an additional C$28.6M decrease in the book value of its properties. This reduced the value by C$48.5M in the first semester, compared to an increase of C$18.1M in H1 2019.

Keep in mind that although the deferred rent was included in the revenue, the amount of rent receivable increased by C$4.15M and Plaza should be able to collect the cash in the next few months and quarters. So accounting wise, Plaza recorded the revenue as if nothing happened, but of the C$23M in pure rental income, C$1.4M (4% of the gross rent) was recorded as an expense as Plaza won’t collect it while an additional C$4.15M was added to the balance sheet as a receivable.

Source: Financial statements

An important element for retail REITs will be the occupancy rate, and Plaza was able to keep this one relatively stable at 96.2%.

Another aspect of Plaza I do like is the mortgage repayment schedule. 55% of the mortgages only have to be refinanced from 2025 on and the amount of near-term maturities is very limited.

Source: quarterly report

Additionally, only 3.7% of the leases will have to be renewed in 2020. 2021 is a more important year as 11.8% of the square footage will have to be renewed followed by 9.9% in 2022 and 14.9% in 2023.

My own NAV calculations

Although Plaza Retail REIT already valued its properties using very reasonable metrics, the REIT reduced the book value of the assets by almost C$50M in H1 2020 and this appears to be a very conservative move. After all, if we would annualize the normalized rent of C$23M per quarter to C$92M per year, the current book value of the properties of C$1.05B doesn’t appear to be unreasonably high as this implies a gross rental yield of over 9% once we take the occupancy into account.

That’s why I wanted to run the numbers myself, just to figure out what Plaza Retail REIT could reasonably be worth. I will use the starting point of the C$23M in quarterly rental income and apply a required gross rental yield of 8.5% which I think is more than reasonable. This results in the calculation below:

Source: Author calculation, based on publicly-available data

Based on my assumptions, I end up with a fair value of C$5.47/share. This doesn’t mean we will get there overnight as I expect the retail REIT sector will need some time to get the investor confidence back. But in any case, I think Plaza Retail REIT is quite cheap.

The current dividend is C$0.2333/month which works out to be C$0.28/year for a yield of approximately 8%. This yield is fully covered by the FFO (C$0.165 in H1 2020) and AFFO (C$0.143 in H1 2020) and is thus sustainable. The Q2 dividend payments were not fully covered (as the AFFO payout ratio came in at 102%) but given the strong rent collection improvement from 82% to 92%, I’m not too worried and the Q3 AFFO payout ratio will drop to the 91%-93% again according to my calculations (and excluding negative surprises). Plaza currently is also buying back its own shares on the open market and repurchased almost 0.4M shares in Q2 2020. The lower share count also will help reduce the AFFO payout ratio.

Investment thesis

I own both the common stock (at C$2.85 for a dividend yield of almost 10%) as well as the convertible debentures that are trading on the Toronto Stock Exchange. I’m not expecting the debentures to be converted, but with a YTM of 10.6% (a coupon of 5.10%, I bought the debentures in April) I’m a perfectly happy creditor and shareholder of Plaza Retail REIT and will be looking to add to my position on dips. Ideally, I’d be very interested if the share price dips back down toward C$3.

Long story short, the current 8% dividend yield will be more than fully covered thanks to the increased rent collection rate in July. Plaza’s main focus should now be on extending the existing lease agreements to create visibility and keep the occupancy rate high.

Consider joining European Small-Cap Ideas to gain exclusive access to actionable research on appealing Europe-focused investment opportunities, and to the real-time chat function to discuss ideas with similar-minded investors!

NEW at ESCI: A dedicated EUROPEAN REIT PORTFOLIO!

Disclosure: I am/we are long PAZRF. 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.

Additional disclosure: I have a long position in the common shares/units and the debentures, trading on the TSX.





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Stocks poised for gains Monday as optimism rises over potential coronavirus treatments


Stock-index futures pointed to a higher start Monday, with the S&P 500 and Nasdaq Composite set to build on last week’s record finish, as investors showed optimism over a potential COVID-19 treatment.

What are major benchmarks doing?

Futures on the Dow Jones Industrial Average
YM00,
+0.99%

advanced 283 points, or 1%, to 28,140, while S&P 500 futures
ES00,
+0.85%

rose 28.90 points, or 0.9%, to 3,421.50. Nasdaq-100 futures
NQ00,
+0.99%

were up 112 points, or 1%, at 11,674.

The S&P 500
SPX,
+0.34%

on Friday drifted higher by 0.3% in light volume to end at a record 3,397.16, marking a 0.7% weekly advance. The Dow
DJIA,
+0.68%

rose 190.60 points, or 0.7%, on Friday to end the week with a gain of less than one point at 27,930.33. The tech-heavy Nasdaq Composite
COMP,
+0.41%

logged a 2.7% weekly rise, finishing Friday at 11,311.80, its 36th record finish of 2020.

What’s driving the market?

The Food and Drug Administration on Sunday said it had approved the use of convalescent plasma, the antibody-rich component of blood taken from recovered COVID-19 patients, as a treatment for serious coronavirus cases. Medical experts said the treatment may provide benefits to those battling the disease, but that there isn’t conclusive evidence of its effectiveness, while questions remain about when it should be administered and dosage.

President Donald Trump hailed the move in a Sunday evening news conference after the administration had accused the agency without citing evidence of slowing approval in order to undermine his re-election prospects.

Also, the Financial Times reported that Trump may order the FDA to grant the same type of approval to the University of Oxford vaccine to be distributed by AstraZeneca
AZN,
+3.75%

AZN,
-1.38%
.

“Markets have started the week on a cheery note as news that President Trump has authorized the emergency use of plasma treatment for COVID-19 patents and is considering fast tracking a UK vaccine before the election boosted sentiment,” said Raffi Boyadjian, investment analyst at XM, in a note.

Expectations for a breakthrough virus treatment have been a driving force behind the market’s rebound from its pandemic-induced plunge earlier this year, Boyadjian said, though “there’s yet to be any conclusive results from any of the vaccines or treatments that are under development for the coronavirus and many investors have yet to wake up to the prospect that the pandemic could still be around in a year or two.”

Read:Are stock market investors overpricing or underpricing a coronavirus vaccine?

The S&P 500 last week returned to record territory, erasing a nearly 34% plunge that took the U.S. benchmark from a record Feb. 19 close to its March 23 low, in a rally driven largely by shares of big tech companies that have seen their businesses benefit from the pandemic, while shares of companies whose performance is tied more closely to the economic cycle have continued to lag despite some recent stretches of outperformance.

Investors are looking ahead to the Kansas City Federal Reserve Bank’s annual symposium. The event, typically held in Jackson Hole, Wyo., will be conducted via web cast this year. Fed Chairman Jerome Powell is slated to speak Thursday on how the central bank plans to achieve its twin goals of stable prices and maximum employment once the coronavirus pandemic has ended.

What are other markets doing?

The yield on the 10-year Treasury note
TMUBMUSD10Y,
0.640%

TMUBMUSD10Y,
0.640%

rose 0.8 basis point to 0.64%. Bond prices move inversely to yields.

Gold futures
GCZ20,
+0.56%

rose, with the December contract up 0.,6% at $1,958 an ounce on Comex. Oil futures
CL00,
+0.96%

gained ground as Hurricane Marco and Tropical Storm Laura converged on the Gulf of Mexico, forcing the closure of around half of its production.

In global equity markets, China’s CSI 300
000300,
+0.78%

rose 0.8%, the Shanghai Composite
SHCOMP,
+0.14%

ended 0.2% higher, and Japan’s Nikkei
NIK,
+0.28%

closed with a gain of 0.3%. The Stoxx Europe 600
SXXP,
+1.78%

jumped 1.7% and U.K.’s FTSE benchmark
UKX,
+1.80%

advanced 1.8%, getting a boost after the FDA announcement.



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Are stock-market investors overpricing or underpricing a potential coronavirus vaccine?


The stock market’s rally back to all-time highs might not have been possible without optimism over a COVID-19 vaccine. And that means progress and setbacks toward that goal could continue to drive the market in the weeks and months ahead.

Analysts at UBS rolled back the market tape to take a look at how stocks have reacted to positive and negative vaccine-related news since the coronavirus pandemic hit. They concluded that optimism around vaccine developments added around 6.5 percentage points to the S&P 500’s return since May.

If so, that certainly helped the S&P 500
SPX,
+0.34%

to take back the ground it lost during the stock market’s pandemic-inspired plunge. The U.S. benchmark closed at record highs this past week, including in Friday’s session, returning to trade above levels seen before falling nearly 34% from a Feb. 19 record to its March 23 low as the spread of COVID-19 forced the near-shutdown of the U.S. and global economy.

The UBS analysts calculated the impact by measuring the number of “shock” days, in which the S&P 500 moved up or down by at least one standard deviation versus its average daily movement in reaction to positive or negative vaccine-related news. Using their model, which gauges how much positive vaccine news contributed to a fall in a closely followed economic policy uncertainty index, they concluded that investors had priced in a 33% to 40% probability of a vaccine.

On an industry level, however, it appears prospects for a vaccine are less priced in, the analysts said. They noted that shares of companies with the most to gain — such as hard-hit hospitality and leisure stocks — from a vaccine have barely outperformed the S&P 500 since May, suggesting a vaccine isn’t really priced in across industries, they wrote.

Several companies are working toward a vaccine. The Wall Street Journal on Thursday reported that Johnson & Johnson
JNJ,
+0.88%

plans to launch what could be the largest clinical trial of a COVID-19 vaccine seen so far, enlisting up to 60,000 people world-wide. That would be double the size of other pivotal studies that have started or are expected to begin soon for vaccines developed by Moderna Inc.
MRNA,
-2.00%
,
Pfizer Inc.
PFE,
+0.41%

and AstraZeneca PLC
AZN,
-1.38%
.

Meanwhile, it might be small- and midcap stocks that would stand to benefit most from a vaccine breakthrough. The UBS analysts noted that small caps outperformed large-caps by around 2 percentage points on days when there was major vaccine news. If market participants currently see a 33% to 40% probability priced in for a vaccine, potential outperformance for small versus large-cap stocks stands at around 13 percentage points or more, they said.

The relative performance of value stocks relative to growth stocks, however, has been subdued, they said.

Cyclical stocks, which are more sensitive to the economic cycle, have solidly outperformed defensive stocks on days with big vaccine news, with even more variation at the industry and sub-industry level. UBS said that would indicate the potential for around 10 percentage points or more of outperformance by cyclicals over defensives if a vaccine is fully priced and implemented.

Analysts and investors have pointed to optimism over a vaccine as insulating the market from disappointment on other fronts, including the inability of congressional Democrats and Republicans and the White House to come up with a plan for another round of coronavirus aid. Economists warned that concerns about the economic damage caused by the pandemic could overshadow those hopes.

“Long-term optimism regarding a vaccine is secondary to near-term economic and health concerns: a jobs deficit of 13 million relative to pre-COVID, states facing budget crises, and still more than 50,000 daily COVID-19 infections,” said Gregory Daco, chief U.S. economist at Oxford Economics, in a Friday note.

The S&P 500 rose 0.7% over the last week, with Friday’s close at a record 3,397.16. The Dow Jones Industrial Average
DJIA,
+0.68%

was virtually flat on the week, finishing at 27,930.33, while the tech-heavy Nasdaq Composite
COMP,
+0.41%

saw a weekly advance of 2.7%, closing Friday at 11,311.80, its 36th record finish of 2020.

Economic data on tap in the week ahead include July durable goods orders, due on Wednesday, and personal income and consumption data on Friday. The main event might once again come on Thursday with the release of weekly data on jobless claims, after first-time applications for benefits in the latest week pushed back above 1 million, raising concerns about prospects for a continued recovery in the labor market.



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