EUR 850.00 For Business Accounts Only

Morningstar | APTV Updated Forecasts and Estimates from 13 Nov 2018

Narrow-moat Aptiv reported third-quarter earnings per share before special items of $1.24, $0.04 better than the sell-side consensus of $1.20 and $0.09 higher than the third quarter of 2017. Revenue increased 11% to $3.5 billion, with solid growth in North America. Currency translation had only a slight $16 million negative impact to revenue during the quarter. Advanced Safety and User Experience group reported an impressive 13% revenue growth, while Signal and Power Solutions reported a healthy 9% increase. However, in our opinion, Aptiv's stock is valued as though economic cycles are extinct. This 2-star stock currently trades at a 39% premium to our $57 fair value estimate, overvalued relative to our projected cash flows and returns on invested capital.

Adjusted operating income rose by 7% to $420 million from $394 million, representing 40 basis points of margin contraction to 12.1%. Excluding negative effects of currency translation and commodity cost, adjusted operating income margin would have expanded 30 basis points. We think EPS outperformance relative to market expectations was attributable to strong 20% growth in North American revenue and 2 million fewer shares outstanding, both versus the same period last year.

Management lowered 2018 revenue and adjusted operating margin guidance. The midpoint of the range of revenue guidance was lowered by $125 million to $14.325 billion. The range of guided revenue is now $14.275 billion-$14.375 billion, down from prior guidance of $14.350 billion-$14.550 billion. The guidance for adjusted operating income was cut to $1.73 billion-$1.75 billion from the previous range of $1.79 billion-$1.82 billion with margin guidance of 12.1% to 12.2%, down from prior guidance of 12.5%. We reduced our full-year 2018 estimates to just slightly above the high end of management's guidance, which did not have a meaningful impact on our fair value estimate.

Our investment thesis remains intact. We think Aptiv will benefit substantially from automakers' need for more robust electrical architectures and their increasing demand for electronic devices, electronic controls, as well as connected and autonomous technologies. The company's narrow moat rating stems from its ability to regularly innovate, its customers' high switching costs, and the cost advantages of Aptiv's global presence and low-cost-country manufacturing strategy. We assume 2018 performance ahead of management guidance with revenue of $14.38 billion and EPS of $5.20. Our estimates include slightly better USD/EUR currency tailwind and slightly better European volume relative to management expectations.

Even so, investors should take note that the median of sell-side price targets for Aptiv stands at $96. While Aptiv is a premier automotive supplier with significant growth potential, in our view, sell-side analysts' price targets value Aptiv stock as though revenue growth and margin expansion continue in perpetuity. Our $57 fair value estimate already takes into consideration Aptiv's substantial growth potential and high level of profitability relative to the industry.

Estimating Aptiv historical financials using predecessor Delphi Automotive information, since 2012, revenue growth has averaged 7% per year. Including the four years prior to a 2005 bankruptcy and the six years since becoming publicly traded again, the 10-year historical adjusted EBITDA margin had a high of 17.2% (2016), a low of 3.2% (2001), and a median of 14.8%. Because we do not have data for a cyclical downturn to include in our historical analysis, we view pre-bankruptcy performance as a relatively decent proxy.

We assume annual average growth of 9% in the first three years of our Stage I before going into midcycle assumptions, resulting in 1% and 4% revenue declines in years four and five. We assume average adjusted EBITDA margin of 16.6% during our Stage I forecast, with a 2020 17.5% peak and a normalized sustainable midcycle EBITDA margin of 15.5%. One can begin to appreciate how sell-side analysts value the stock as though economic cycles no longer exist, in the light of a stratospheric 23.4% normalized sustainable midcycle adjusted EBITDA margin (a 620-basis-point expansion above Aptiv's historical 17.2% high) needed for our DCF model to generate a fair value equivalent to the sell-side consensus.