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Morningstar | ALV Updated Forecasts and Estimates from 25 Sep 2018

Narrow-moat Autoliv, a leading supplier of safety components as well as advanced driver assist systems to the global automotive industry, reported earnings per share before special items, or EPS, of $2.22, an impressive $0.35 better than the consensus of $1.87 and a whopping $0.74 higher than last year's EPS of $1.47. We think the outperformance was attributable to a much lower than expected effective tax rate of 8%. The 2-star rated shares of Autoliv currently trade at a 28% premium to our $80 fair value estimate, overvalued relative to our estimates for cash flow and returns on invested capital.

The lower than expected tax rate reported during quarter, was driven by the reversal of valuation allowances previously taken against deferred tax assets on the spun-off Veoneer operations. Including a normalized effective tax rate of around 27%, EPS would have been $1.75, still a very respectable $0.28 per share increase over the previous year but $0.12 per share lower than the consensus.

Management lowered 2018 revenue guidance lower for the year on customer launch delays and 2 percentage points less currency tailwind. Organic growth had been expected to be 10% but was revised to 8%. Currency translation was estimated to provide an additional 4 percentage points and is now expected to add only 2 percentage points. Adjusted operating margin guidance was maintained for the 2018 full-year with Autoliv excluding Veoneer forecast to be more than 11%. However, effective tax rate guidance improved 100 basis points to 27%, down from the previous 28% forecast. Our model currently estimates 9.6% revenue growth, an 11.2% adjusted operating margin, and EPS of $7.80, just slightly ahead of the sell-side consensus.

Our long-term investment thesis for Autoliv remains intact. The company benefits from growing global demand for vehicular safety equipment, specializing in passive safety systems like seat belts and airbags. Management confirmed 2020 guidance for $10.0 billion in revenue and adjusted operating margin of 13%. Owing to a solid backlog on net new business, we see no reason to disagree with management and model 2020 revenue at $10.2 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 $1.0 billion.

Even so, in our view, the market values Autoliv stock as though revenue grows and margins expand into perpetuity. During the past 10-years, Autoliv's high, low, and median adjusted EBITDA margin has been 16.1% (2010 on massive restructuring), 10.2% (2009), and 14.1%, 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 on plateau U.S. and near-plateau European light vehicle demand, we maintained a normalized sustainable midcycle margin of 14.6%, 50 basis points higher than the 10-year median. For our DCF model to reach a valuation equivalent to the sell-side consensus price target of $119, one would have to believe that combined Autoliv/Veoneer could produce a normalized sustainable midcycle EBITDA margin of 21.3%, 520 basis points above the 10-year high and 670 basis points higher than the 10-year median. We think the market has valued Autoliv stock as though economic cycles have entered extinction.