Description

Summary

Aptiv is an opportunity to lean into the negative electric vehicle sentiment, with a real business that still works in a “higher ICE for longer world”. Aptiv generates cash and is led by a shareholder-oriented management team. After you parse through all the buzzwords in the company’s marketing materials, what you find is a leading auto supplier, in an oligopolistic industry, with tangible growth tailwinds, that is set to return ~20% of its market cap over the next 18 months. I see the business trading for <10x 2025 earnings (8x 2025 ev/ebit) and an under-levered balance sheet. The idea screens more expensive than it is as the street does not adjust their numbers for a loss-making JV which is being exited and the ensuing capital return. Near-term fair value is >50% higher than the current ~$80 share price. This is a large liquid stock, not some perennially undervalued small cap, so there are enough pieces in place to realize that value. I think we get there as the company continues to grow, buys stock, and the overall sentiment on EVs goes back to neutral from extremely negative.

Something that I believe is severely underappreciated with Aptiv is that you do not need to dream about growth. In recent years, Aptiv has been booking ~$33 billion of new business. Revenue today is ~$21 billion. Bookings typically lead revenue by 5 years. Therefore, there is strong visibility into Aptiv’s revenues growing around ~10% per year. Operating earnings should be higher from operating leverage and EPS should be materially higher from a little bit of financial leverage and capital allocation geared towards buying back shares.

The overall driver of Aptiv’s growth and underlying thesis is EV penetration. On average, EVs require 2.5x more Aptiv content than an ICE vehicle (ICE CPV of $500 vs. EV CPV of $1200). Aptiv’s incremental margins are ~30% versus a consolidated ~12% margin today. If EV penetration continues to increase, Aptiv will grow faster than the overall market.  Every 2 percentage points of EV penetration translates to approximately 15% earnings growth for Aptiv, before capital allocation.

The last point I will make before actually jumping into the business and flushing out the thesis is that I strongly believe the prevailing negative sentiment around EVs is the main reason this opportunity exists. This is not a turnaround and no major leap of faith is required. Aptiv was a thematic stock for investors to get EV exposure, without having to own Tesla (Tesla is a large customer of Aptiv’s). Now that EV sentiment has soured and Tesla is no longer in vogue, people have moved on from Aptiv. This is most notable when you compare Aptiv’s valuation (using street numbers which I am higher than) to more diversified electrification peers like TE Connectivity. As you can see, Aptiv – TE historically traded essentially on top of each other. However, with the change in EV sentiment, Aptiv has gapped out >5x unlevered and >7x levered versus TE. Meanwhile, EPS estimates for Aptiv have continued to move higher (TE unchanged) and there is room for Aptiv estimates to move even further just from capital allocation.   

Business Overview

Aptiv has two reportable segments. 1) Signal and Power Solutions (SPS); and 2) Advanced Safety and User Experience (ASUX). Given that 80% of EBIT is derived from the SPS segment and that’s where the idea lies, I’m going to spend my time there.

To be brief, Aptiv’s SPS segment is involved in the design, manufacturing, and assembly of a vehicle’s electrical architecture. Specifically, Aptiv sells a variety of engineered component products including connectors, terminals, wiring assemblies, cable management, and electrical centers. All of Aptiv’s products provide critical signal distribution and computing power that supports vehicle electrification.

Being an electric vehicle architect has historically been a good business. While overall auto production is mature and cyclical, demand for electrical content in vehicles has increased. Case in point, over the last 5-years, Aptiv’s Signal and Power Solutions has seen volumes increase by 40% against a market backdrop where global auto production has fallen by 10%.

The main driver of this growth has been the increased adoption of electric vehicles. Aptiv has more content on EV vehicles than on ICE vehicles. From 2018 to 2023, EV penetration as a percentage of total auto sales increased from 2.5% to 11% (4x).

The main moat around Aptiv’s business is OEM switching costs. Aptiv and other electric architect tier ones are involved in the initial design phase of the vehicle, right through to the assembly. The design/development of a new vehicle program is typically 2-3 years. Then on average, the vehicle program runs for 5-7 years. Once spec’d, it’s very difficult for an OEM to switch. Competitors appear very rational in working with OEMs. There are three main players which control 65% of the market: Aptiv, Sumitomo and Yazaki. Aptiv is the leader with Western OEMs and a growing China presence while Sumitomo and Yazaki dominate the Japanese. Lear is the fourth largest player with approximately 10% market share. Thereafter, players like TE, Molex and Amphenol play roles in providing specific engineered components to the OEMs and compete with the more traditional tiers ones on specific electrical verticals. 

Thesis

On average, EVs require 2.5x more Aptiv content than an ICE vehicle (ICE CPV of $500 vs. EV CPV of $1200). Aptiv’s incremental margins are ~30% versus a consolidated ~12% margin today. If EV penetration continues to increase, Aptiv will grow faster than the overall market. 

• Every car requires a low voltage architecture. Typical low voltage architecture is $500 of Aptiv content
  
  
• Low voltage architecture carries through to an electric vehicle. However, PHEVs and BEVs run on 400-800 volts from the battery. The terminals and connectors need to be more advanced to handle the power safely. Power needs to be converted to support the low voltage architecture that feeds the infotainment unit, the windows, etc. Aptiv’s architecture (and product portfolio) supports high voltage and the conversion. This additional content on a PHEV / EV is approximately $1,200 of Aptiv content.
   
• Aptiv should be a key beneficiary in the evolution towards the software defined vehicle. Today, in the topology of the car you got hundreds of meters of spaghetti wire. Wire harnesses are cumbersome to install, are heavy and cost a lot of money to put all together. As evidenced by the new generation of vehicles like Tesla’s Cybertruck or the refreshed Rivian R1T/R1S shown a few days ago, the future is going to be ethernet typology. Every device plugs into the next device. Aptiv’s smart vehicle architecture (SVA) consolidates with a central computer and then sends power out in that zone, moderating all end pieces of technology with a controller and software. Aptiv believes its addressable CPV on software defined vehicles is towards $2,300.
  • For example, if we compare Tesla’s Cybertruck to Model 3, the ethernet loop system reduces the number of wires going across the vehicle by 63% (from 490 to 155). However, the number of end-points is going up to 368 from 273. Aptiv gets paid on selling end-points (e.g. connectors, terminals, etc.), not laying copper wire
  • Aptiv already has $10bn of bookings compared to effectively zero revenue today for content related to smart vehicle architecture  

Increased power usage in cars has been a structural trend. Since the introduction of 12v electrical architecture, power usage in vehicles has increased by 8x (see chart below). This trend is expected to continue for the foreseeable future.

What’s Aptiv worth?

Aptiv has guided to $6.05 in 2024 EPS. However, if you back out the losses from an autonomous vehicle development joint venture with Hyundai called Motional, 2024 EPS is closer to $6.95.

The Motional JV hasn’t played out as expected and Aptiv is effectively walking away from any further funding commitments to the JV. Fortunately, Hyundai is more committed to the program. On the Q1-24 earnings call, Aptiv disclosed that Hyundai will acquire 11% of Motional's common equity held by Aptiv for $448 million. The transaction is slated to close by Q3-24, which means in 2025, Aptiv will not report any losses from the Motional program (nor fund the program going forward).

OCF this year is guided to ~$2.35bn. Capex guide is for ~5% of sales, so call it $1.0 billion. So FCF this year is ~$1.35bn. Layer in the proceeds from Motional sale and total cash inflows this year are ~$1.8bn.

Aptiv is guiding to $1.5 billion in total share repurchases. Aptiv has already bought back $600mm in Q1-24, so there is another $900 million in buybacks remaining. Aptiv’s Q1 guide is already reflective of share repurchases, but that means there is an excess ~$300 million not allocated to repurchases.

Lets assume Aptiv does not grow despite bookings already being in hand and spends another $1bn in capex, which I estimate is about $300 million more than they need to maintain the business. Then the business will generate another $1.5bn in FCF. Assume this is all used to buy back stock, then Aptiv will be able to retire another 7% of its float. This means no growth 2025 EPS is closer to $7.45. This puts Aptiv at about 11x on today’s share price. Not horrible for a supplier that has positive incrementals in an electrified world.

However, assuming no growth is too conservative. Aptiv has growth. Recall, the visibility here is strong given the bookings they already have in place. If Aptiv is able to grow ~7% (6-8% growth over market guidance) at their guided to ~30% incrementals, then operating income should grow 20% and earnings slightly higher. That takes our no growth 2025 EPS of $7.45 to nearly $9.00 / share. Today Aptiv is trading for $81 / share or ~9x my  normalized earnings.

That’s not all, Aptiv has the capacity to buyback significantly more stock. Management has hinted at such, especially if the share price continues to stay around current levels.

2024E EBITDA should be around $3.3bn. Year end net debt will finish the year around $5bn. This puts year end leverage around 1.5x EBITDA. An auto supplier like Aptiv can run with significantly higher leverage and still maintain its investment grade ratings. I wouldn’t be surprised to see leverage push towards ~2.0x if the share price is here or lower. That’s an incremental $1.65bn of fire power for repurchases, just on this year’s numbers. Credit Aptiv for where EBITDA should be next year, and we’re talking an incremental $2bn that can be redeployed from just a regearing of the balance sheet.   

So you bring it all together, $900mm incremental buy backs this year, at least another $1.5bn buy backs next year, funded through operations, and the potential for another >$1.65bn funded through debt, gets us to ~$4bn of total incremental buybacks over the next ~18 months. That’s nearly 20% of today’s market cap.    

EV penetration

This is not an idea to educate members on where we are in the auto cycle but if you’re asking my view, I think we are closer to midcycle than peak (or trough). Basically we are forecasted to produce 90mm vehicles this year globally. We peaked around 100mm units in 2018 so there is still upside to history. I think what makes 90mm interesting is that we are achieving this number while OEMs are seeing above-normal levels of profitability and underlying auto financing rates are the highest they’ve been over two years. OEM pricing is waning as supply constraints ease. Interest rates are anyone’s guess. Net-net, I think there are levers that can push auto production higher, but overall, I’m neutral on global auto production. If global auto production scares you or you think we are going into a deep recession, you can hedge out auto production by shorting a basket of mature ICE auto suppliers (MGA, DAN, etc.). That’s the beauty of Aptiv. It trades closer to a legacy auto supplier valuation (which are cheap) but has fundamental characteristics which should support >5% growth over global auto production.

A view around EV penetration is far more important as it relates to Aptiv. If electrical vehicles do not continue to grow, then Aptiv will perform similar to any other cyclical supplier. In 2023, there were approximately 85 million passenger vehicles sold globally. EV penetration reached 11% in 2023 (~35% penetration in China, ~20% penetration in Europe, ~7% penetration in the US).

There is a prevailing market sentiment that EV penetration is stalling out. This may be the case in the short-term as EV inventories are building (particularly in the US). Over the medium-term however, I believe regulatory changes and lower EV selling prices will support EV growth. Specifically:

1. Regulatory drivers - Automakers are compelled to produce electric vehicles due to stringent greenhouse gas emission standards globally. These standards are expected to become even stricter over the next decade. Failure to meet these regulations would lead to substantial penalties and fines.
   • United States - automakers must comply with regulations set by the Environmental Protection Agency (EPA) for greenhouse gas standards, the National Highway Traffic Safety Administration (NHTSA) for Corporate Average Fuel Economy (CAFE) standards, and Zero Emission Vehicle (ZEV) mandates from California, which are adopted by 14 other states. Non-compliance with these regulations could result in significant financial penalties for automakers.
     • EPA - By 2027, automakers will need to reach ~25% BEV penetration
     • ZEV - requirements will be enforced in 15 U.S. states starting in 2026, necessitating automakers to achieve approximately 35% BEV penetration, a significant increase from the 6% required in 2023. These requirements become even more stringent in the following years, reaching 68% by 2030. Additionally, starting in 2026, the penalty for failing to meet these targets increases to $20,000 per vehicle deviation from the mandate.
       
   • Europe - EU's Euro 7 emissions standards. These standards aim to significantly reduce vehicle emissions and promote the adoption of electric and low-emission vehicles. Specifically, restrictions on transport emissions imply that EV penetration to increase to ~25% by 2025/2026, nearly 60% by 2030, and 100% by 2035
     
   • China - China had set explicit targets for Electric Vehicle (EV) adoption as part of its efforts to combat air pollution and reduce carbon emissions. In 2020, the government set a goal of 50% EV penetration by 2035, with intermediate targets of 20% by 2025 and 40% by 2030. China is the tracking ahead of regulatory targets.
2. Cost convergence with ICE – EV costs are forecasted to rapidly decrease in 2024 and beyond. Battery costs, which have been volatile but already fell by ~25% in 2023, reaching $130 per kilowatt-hour (kWh) on global average. These cost reductions are expected to continue due to several factors: substantial declines in commodity costs, innovations in battery materials and designs (such as silicon anodes for improved efficiency), and government incentives, including a $45/kWh manufacturing credit. With these developments, many EVs could achieve cost parity with internal combustion engine (ICE) vehicles by 2026, potentially even without government incentives by 2030.

All-in-all, I believe the negative sentiment around EV growth to be temporary. Should we continue to see EV penetration increase, then I believe Aptiv is incredibly undervalued. In the event regulations and lower EV prices do not stimulate growth, I believe the current entry price is reasonable for a leading tier-one supplier diversified by customer and with an under-levered balance sheet.

Catalyst

- continued growth in ev penetration 

- buybacks