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Morningstar | DLPH Updated Star Rating from 08 Aug 2018

Narrow-moat rated Delphi Technologies reported second-quarter earnings per share before special one-time items (EPS) of $1.29, $0.05 better than the sell-side consensus EPS of $1.24 but $0.06 lower than last year’s comparable proforma EPS of $1.35. We think the outperformance relative to the consensus was mainly attributable to favorable currency effect but also solid operating performance that partially offset the negative impacts from the coming implementation of World Harmonised Light Vehicle Test Procedure (WLTP) in Europe and tariffs.

Management adjusted its 2018 guidance to a range of $5.0 billion-$5.1 billion, down $100 million on the top end from the prior guidance range. Organic revenue growth of 2%-4% (excludes currency effect) was reduced from 2%-6% owing to WLTP in Europe. The new test procedure takes longer to certify vehicles, slowing the production of Delphi's European customers during the second half of this year. Management guides to an adjusted operating margin of 12.1%-12.3%, down 20 basis points from the prior range of 12.3%-12.5% due to tariffs and slightly higher input costs. Consequently, the top end of EPS guidance was lowered by $0.10 to a range of $4.65-$4.85.

Our investment thesis remains intact. Delphi Tech benefits from globally ubiquitous clean air legislation that requires passenger vehicle and commercial truck manufacturers to electrify powertrains and enhance efficiency of internal combustion engines. We expect growth products like DC/DC converters, power electronics, and powertrain electronic control modules and software to offset the effect of greater penetration of smaller displacement engines (fewer cylinders) that negatively impact fuel injector and valvetrain product volume growth. This 4-star rated stock currently trades at a 19% discount to our $52 fair value estimate. In our opinion, the shares are attractively valued relative to our estimates for revenue growth, cash flow, and returns on invested capital.

Second-quarter revenue was $1.232 billion, increasing 4% compared with proforma $1.187 billion in the prior year. Excluding favorable currency translation, revenue would have increased by only 1%. Adjusted EBIT including operating JV equity income, increased 6% to $159 million versus $146 million proforma adjusted EBIT in the second quarter of 2017. Adjusted EBIT margin expanded 30-basis points to 12.7% as operational execution was partially offset by tariffs and slightly increased commodity costs.

Powertrain group had a good second quarter, being the primary contributor behind the strong consolidated revenue results. Segment revenue increased 5% to $1.086 billion from proforma $1.035 billion a year ago. Favorable currency impact was a big driver as the segment’s revenue would have been nearly flat without the favorable translation effect. Strong growth in commercial vehicle, gasoline direct injection, and power electronics was partially offset by Europe passenger car diesel fuel injection. Powertrain adjusted EBIT rose 4% to $134 million from $129 million proforma a year ago. Margin contracted 20 basis points to 12.3%. Currency effect tailwind was offset by powertrain mix (less diesel) and increased engineering spending for new programs.

Aftermarket group revenue declined 7% as Delphi began trimming its product portfolio to focus on more profitable products and distribution channels. The change in strategy was evident by 22% year-over-year growth in adjusted EBIT to $22 million from a proforma $18 in the prior year. Consequently, margin expanded by a healthy 240 basis points to 10.2% on the improved mix and operating performance.