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Morningstar | APTV Updated Forecasts and Estimates from 25 Sep 2018

Narrow-moat Aptiv reported record second-quarter earnings per share before special items of $1.40, $0.04 better than the sell-side consensus of $1.36 and $0.27 higher than the second quarter of 2017. Revenue increased 17% to a record $3.7 billion, with solid growth in all regions. Excluding favorable currency translation, mainly from a strong euro relative to the U.S. dollar, organic revenue growth was still healthy, increasing 12% year over year. However, in our opinion, Aptiv's stock is valued as though economic cycles are extinct. This 1-star stock currently trades at a 68% premium to our $57 fair value estimate, overvalued relative to our projected cash flows and returns on invested capital.

Adjusted operating income rose by 19% to a record $474 million from $398 million, representing 30 basis points of margin expansion to 12.9%. While we had already forecast higher revenue and profitability than management’s original 2018 guidance, we think the main reason for the outperformance relative to market expectations was attributable to strong 15% organic growth in North American revenue and the degree of favorable currency tailwind during the quarter.

While management raised 2018 revenue guidance on the second-quarter outperformance, guidance on adjusted operating margin was trimmed. The midpoint of the range of revenue guidance was increased by $300 million, to $14.45 billion. The range of guided revenue is now $14.35 billion-$14.55 billion, up from the prior guidance of $13.95 billion-$14.35 billion. The guidance for adjusted operating income was tightened to $1.79 billion-$1.82 billion from the previous range of $1.75 billion-$1.83 billion. This included 2018 adjusted operating margin of approximately 12.5%, down from prior guidance for a range of 12.6%-12.8%. The increase in revenue, partially offset by the margin guidance, resulted in a $0.10 increase in the low end of the EPS guidance to $5.30 to $5.40. The $5.40 upper end of the range was unchanged.

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 $14.6 billion and EPS of $5.50. Our estimates include slightly better USD/EUR currency tailwind, slightly better European volume, and higher South American growth rates relative to management expectations.

Even so, investors should take note that the median of sell-side price targets for Aptiv stands at $110. 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. Since 2014, adjusted EBITDA margin had a high of 17.5% (2016), a low of 14.8% (2014), and an average of 16.2%. 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 and a normalized sustainable midcycle EBITDA margin of 15.4%, representing a 60-basis-point increase over the 14.8% low. 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 26.2% normalized sustainable midcycle adjusted EBITDA margin (870-basis-point expansion above Aptiv’s historical 17.5% high) needed for our DCF model to generate a fair value equivalent to the sell-side consensus.