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Morningstar | ALV Updated Forecasts and Estimates from 19 Nov 2018

Narrow-moat-rated Autoliv, a leading supplier of safety components as well as advanced driver-assist systems to the global automotive industry, reported third-quarter EPS of $1.35, missing consensus EPS of $1.62 by a whopping $0.27 and coming in $0.12 lower than last year's EPS of $1.47. The underperformance was due to lower-than-expected Europe volume, especially in seat belts. The 3-star-rated shares of Autoliv currently trade at just a 2% premium to our $80 fair value estimate, reasonably valued relative to our estimates for cash flow and returns on invested capital.

The lower-than-expected European volume during the quarter was driven by the WLTP emissions certification process, which caught automakers flat-footed. Several vehicle lines were not certified by the Sept. 1 deadline, and consequently, automakers halted sales of certain models. Consolidated revenue increased 4.1% to $2.0 billion, airbag group revenue increased 6.1% to $1.4 billion, and seat belt group revenue declined 0.1% to $676 million. Excluding the negative effect of currency, consolidated, airbag, and seat belt revenue would have increased 6.4%, 8.4%, and 2.6%, respectively. Adjusted EBIT margin contracted 100 basis points on the unfavorable operating leverage to 9.5%.

Management lowered 2018 guidance for the second time this year. Organic growth had been expected to be 8% but was revised to 6%. The currency translation estimate was unchanged at 2 percentage points, for total revenue growth of 8%, down from 10%. Adjusted EBIT margin guidance was reduced by a little more than 50 basis points as prior guidance was for more than 11% but is now forecast at "around 10.5%." We adjusted our 2018 estimates to 7.9% revenue growth from 9.6% and adjusted EBIT margin of 10.7%, down from 11.2%. The revision had little impact on our $80 fair value estimate.

Our long-term investment thesis for Autoliv is intact. The company benefits from the growing global demand for vehicular safety equipment, specializing in passive safety systems like seat belts and airbags. Management targets 2020 revenue of $10.0 billion and adjusted operating margin of 13%. Owing to a solid backlog on net new business, we see no reason to disagree with management, forecasting 2020 revenue at $10.1 billion on a 7% organic growth assumption and slightly favorable currency translation. With an adjusted operating margin of 13%, we forecast adjusted operating income of $1.3 billion versus our 2018 estimate of $940 million.

Even so, in our view, the sell side values Autoliv's stock as though revenue will grow and margins will expand into perpetuity. During the past 10 years, Autoliv’s high, low, and median adjusted EBITDA margins have been 16.1% (2010 on massive restructuring), 10.2% (2009), and 13.6%, respectively. However, in 2016, EBITDA margin was 12.6% while last year it was 12.4%. Margins have contracted on the higher cost to invest in autonomous technologies. Despite the recent contraction, with the spin-off of the loss-making autonomous driving group Veoneer in July, we assume a normalized sustainable midcycle margin of 14.9%, 130 basis points higher than the 10-year median. For our discounted cash flow model to reach a valuation equivalent to the sell-side consensus price target of $98, one would have to believe that Autoliv could produce a normalized sustainable midcycle EBITDA margin of 18.1%, 200 basis points above the 10-year high and 450 basis points higher than the 10-year median. We think the market has valued Autoliv's stock as though economic cycles have entered extinction.