Morningstar | Veoneer Losses Continue in 3Q, Guidance Tweak Disappoints Market, Maintaining $24 FVE
Narrow-moat-rated Veoneer, supplier to the global automotive industry of autonomous driving technologies, reported a third-quarter earnings per share of negative $0.78, in line with the consensus but $0.40 worse than the proforma third-quarter 2017 result. Management also said that it now sees downside risk to its $3.0 billion 2020 revenue target and that the 2020 EBIT margin target of 0%-5% would be delayed by one to two years. However, management sees upside potential to the $4.0 billion 2022 revenue target.We had already anticipated EBIT margin to be negative in 2020 on higher SG&A and R&D spending on new business development and a hefty launch schedule. Additionally, we continue to forecast 12% average annual revenue growth during our 10-year Stage I forecast on automakers' adoption of autonomous technologies. Consequently, we maintain our $24 fair value target. Even though the stock has experienced selling pressure of more than 15% on management's guidance changes, the 2-star-rated shares of Veoneer remain overvalued, currently trading at a 36% premium to our $24 fair value estimate.
The stock market has been enamored with ADAS, HAD, and AD technologies due to growth potential that significantly outpaces the growth potential of global light vehicle demand. We may be slightly more bullish than the market's assessment of Veoneer's growth potential but disagree with the premium valuation attributed to the shares. Because of the sophisticated nature of ADAS, HAD, and AD technologies, the company needs heavy R&D investment for several years as vehicle programs incorporate the new technologies, becoming standard equipment in some instances, during the next 10 years. Pro forma 2017 revenue was $2.3 billion but R&D at 16.2% of revenue resulted in an operating loss of $79 million. We estimate R&D as a percent of sales peaks at 22.4% in 2019 before the growth in sales begins to overtake R&D expansion.
We expect a high level of R&D investment to persist throughout our 10-year Stage I forecast as automakers launch more vehicles containing Veoneer technologies, resulting in our 14.8% normalized sustainable midcycle EBITDA margin assumption. We would have to believe that Veoneer could generate a 23% normalized sustainable midcycle EBITDA margin to force our DCF model to generate a fair value equivalent to the current $44 sell-side consensus price target. In our view, the market treats Veoneer's valuation as though economic cycles no longer exist.
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