EUR 850.00 For Business Accounts Only

Morningstar | Veoneer Reports Full-Year Losses In Line With Our Expectations; Maintaining $24 Fair Value Estimate

Narrow-moat rated Veoneer, supplier to the global automotive industry of autonomous driving technologies, reported full-year 2018 earnings per share before special items (EPS) of negative $3.17, $0.26 worse than the consensus EPS of negative $2.91 but the exact same as our -$3.17 estimated EPS. The proforma full-year 2017 EPS was negative $1.11. Management reiterated the warning it first gave with its third-quarter results--there is downside risk to its $3.0 billion 2020 revenue target and the 2020 EBIT margin target of 0%-5% would be delayed by 1-2 years. However, management sees upside potential to the $4.0 billion 2022 revenue target.

While that guidance remained unchanged, the company said that level 4 and level 5 (the highest autonomous level) programs are being delayed as automakers find the degree of complexity greater than the industry's original expectations. Within this context, as well as softening light vehicle demand in some world regions, management expects 2019 organic sales to be flat to slightly down with weakness primarily in the first half. Operating margin and operating cash flow are expected to be weaker in first-half 2019 with improvement in the second half.

We had already anticipated EBIT margin to show losses into 2021 on dramatically increasing SG&A and R&D expense as Veoneer aggressively grows order intake. Contracts for autonomous technology that are in the development phase represent immediate spending without associated revenue for up to 48 months. 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 50% since it was spun off from Autoliv at the beginning of July 2018, the 2-star-rated shares of Veoneer remain overvalued, trading at a 15% 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. For full-year 2018, revenue was $2.2 billion but R&D at a hefty 20.9% of revenue resulted in an operating loss of $197 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, averaging 15.3%, as automakers launch more vehicles containing Veoneer technologies. We assume a 15.3% normalized sustainable midcycle EBITDA margin in year 10. We would have to believe that Veoneer could generate a 19% normalized sustainable midcycle EBITDA margin to force our DCF model to generate a fair value equivalent to the current $33 sell-side consensus price target. In our view, the market treats Veoneer's valuation as though economic cycles no longer exist. The 2-star-rated stock currently trades at a 104% premium to our $24 fair value estimate.