|Shares Out. (in M):||266||P/E||23.3||20.9|
|Market Cap (in $M):||24,600||P/FCF||27.8||25.2|
|Net Debt (in $M):||2,550||EBIT||1,720||1,830|
This investment idea originated from a variant perception we had recently. When attending an auto parts symposium, we heard a steady drumbeat from presenters (and attendees) that both autonomous cars and electrification were so far away in the future that they were completely immaterial to their business prospects. It reminded us of newspapers claiming the internet would benefit them. While the auto parts industry is saying self-driving isn’t coming for years and years, some of the people who are actually working on it (Google) are saying they’re opening services to the public this very year. GM and others are saying more like 2019. So while basically half the industry thinks autonomous vehicles are coming in five years; we think they’re coming in two. It is more well known that virtually every major auto OEM is coming out with electric and hybrid models in the early 2020s. We believe EV adoption will take place faster than do most observers.
We believe we have found a reasonable way to be aligned with these trends through investment in Aptiv. Basically, Aptiv makes a lot of the stuff that goes into autonomous and electric vehicles. They should experience solid revenue growth as these trends take hold and they increase their content per vehicle. In a few years’ time, as these trends become more generally accepted and the investing public gets excited, we believe Aptiv could see significant multiple expansion as one of the few pure play options to take advantage of this investing theme. In the meantime, it is a profitable, well-run company, one that is of decent quality while not having a wide moat, that is trading as a reasonable price given its growth potential.
This is a somewhat long-term play that we intend to hold into the early 2020s when the electric and autonomous trends are fully underway. Using conservative assumptions we think Aptiv could do $7 in EPS by 2022 (consensus is more optimistic at $8) and with no multiple expansion at 20x would be worth $140, or 50% upside as a conservative base case. We think both operational results, and especially the multiple, could surprise to the upside as the trends described above take hold.
Aptiv the Company
Aptiv is the descendent of Delphi Automotive, itself once upon a time the auto parts spin off from GM. In order to be fully aligned with the above described trends it recently spun off its powertrain segment into what is now Delphi Technologies, and it renamed itself Aptiv. Headquartered on the island of Jersey (and therefore not a real beneficiary of recent US tax reform), Aptiv is a global company with revenue about equally split between US, Europe, and Asia that works with every major OEM. Though an auto parts supplier, they are no longer really a “metal bender” as the products they make are primarily electronics and wires. The company has 6,000 engineers focused on software development and ships over 40 billion lines of code daily.
Their largest segment is Signal and Power Solutions with $9.5B in revenue and $1.3B of operating profit. The segment basically makes cables and other power distribution equipment. Management expects this division to grow 2 to 5% faster than the overall automotive market.
Their other segment is Advanced Safety and User Experience with $3.4B in revenue and $300MM of operating profit. It makes sensors for automatic safety features like lane departure and automatic braking, as well as the software and computing power needed to power those systems. It also makes “infotainment displays” (most of the current revenue) and has a fledgling “connected services” data subdivision designed to help with things like secure over the air software updates to vehicles and the collection and eventual marketing of data. Management expects this division to grow 10% faster than the overall market.
While this was not our reason for purchase, we do like that this company was part of a spin off situation recently. Even though it was the parent and not the actual spinoff, our research has indicated that parents as well as spinoffs outperform the general market on a statistical basis. They did appear to do a substantial roadshow before the spinoff but nevertheless this is somewhat of a new pure-play automotive trend company and we would expect the story to continue to become more well known over time.
It’s also worth noting that this company bears little resemblance to the original Delphi that filed for bankruptcy in ‘05. They shed major divisions during bankruptcy and more recently sold their thermal systems business in ‘15 and spun off their powertrain business in Dec ‘17. Like much of the automotive ecosystem, they got religion on debt after the financial crisis and today carry only $2.5B in debt versus $2B in EBITDA which covers interest 15 times. It has been consistently profitable on both a net income and free cash flow basis since its emergence from bankruptcy in 2011 (not saying much). Their return on invested capital has been well north of 20% during this period as well; over half of management’s incentive compensation is related to return on capital. With this capital, management has been a steady purchaser of shares reducing the share count from 328MM to 266MM most recently. They have also done a number of small bolt on acquisitions in growth areas which they intend to continue to do.
A quick pitch on electric and autonomous cars
A big part of the investment thesis is the faster-than-expected adoption of autonomous and electric vehicles. The arguments for this adoption are available elsewhere but since they are an important part of the pitch, and are not universally accepted, we will offer a very brief explanation for our thinking.
For autonomous, the reason to believe adoption is around the corner is mostly due to what the companies themselves are saying. Google/Waymo has been the most vocal about their progress, saying that they’ve had fully driverless cars on the road in Arizona since mid-Oct 2017 (employees still in the car, just not the driver’s seat), and that they will have a fully driverless mobility service in Arizona in “early 2018”. GM/Cruise has said they will have a fully autonomous (no steering wheel) public ride-sharing system service across several cities by 2019. Aptiv, which has its own “turnkey” autonomous driving suite, will have a commercial test deployment in 2019. 2019 appears to be shaping up as the year of the autonomous vehicle. These specific, near-term claims of deployment to us are more convincing than the mostly vague claims of skeptics that these technologies are “many years off”. It is worth noting that one of the reasons the development of this technology has been accelerating is the continued advancement of deep learning techniques, which allow for AI to help determine how to drive through the introduction of massive amounts of data, whereas previously autonomous driving software had to be programmed to react to each individual situation. One of the main roadblocks to adoption that skeptics see are regulatory. We believe these roadblocks will largely disappear once there is a demonstrated effective autonomous driving network in place, which as stated above, we believe will take place in 2019, probably in Arizona. We believe opposition will evaporate upon proof-of-concept due to safety concerns. 40,000 people in America die every year in auto accidents, the vast majority of which are due to human error. Of course, these deaths are not nearly as emotional as the few hundreds that die each year due to school shootings or terrorism, but one can imagine that, once-proven, there will be a large constituency pushing for the removal of regulatory barriers to adoption of autonomous driving.
For electrification, the climate-change-related advantage of not directly emitting CO2 is well publicized and understood. It is worth noting that the sometimes encountered “long tailpipe” argument that electric vehicles are just as or more dirty than conventional internal combustion engine (ICE) vehicles basically does not hold unless the power charging the vehicles comes solely from coal (which is being phased out by regulation and market forces). Electric vehicles have other advantages over ICE vehicles in having much simpler engines with far fewer moving parts, meaning less maintenance and lower costs. EV acceleration is generally better as is handling due to the ability to put a heavy battery in the bottom. The problem of course is cost, which is basically a battery concern. If you get the cost of the battery down, EVs would appear to be superior. The costs of batteries have indeed been coming down, and given the massive amounts of money that are flowing into the area, we expect this trend to continue. According to Andreesen Horowitz, most analysts assume electric cars will be equal to the cost of ICE cars without subsidies by 2025. However, we think adoption will not be driven slowly by consumer choice, but rapidly by regulatory action. Climate advocates for EVs are of course, quite passionate. The main opposition to EVs is cost-based, and once EV’s achieve near cost-parity, we believe opposition will largely evaporate. We believe that once near cost-parity is achieved, regulators will cram EV’s down our throats by basically outlawing or taxing ICEs out of existence. Numerous European countries have set targets for banning the sale of ICE vehicles, but China probably has the most aggressive targets of anyone, due not to fears of global warming, but pollution. It is worth noting that all ICE vehicles emit nitrogen oxide gases and fine particulates that cause public health issues, as science and the public are becoming increasingly aware. There are of course other barriers to the complete widespread adoption of EV’s, but to keep this short it will suffice to say that we believe these barriers will be overcome in large part due to the regulatory response driven by popular concern over climate change.
How does Aptiv benefit from these trends and competitive landscape
Basically Aptiv makes the stuff that cars already need, but that they need more of when they become electric and autonomous. For autonomous, this includes things like sensors, computing power, and signal and power wiring to connect it all. For safety reasons, in a fully autonomous vehicle all the signal and power distribution needs to have redundancy in order to not fail, which means more material. We have heard Aptiv’s Multi-Domain Controller, which “fuses information from sensing systems as well as mapping and navigation data to make driving decisions,” called the “picks and shovels” of autonomous. For electric (and hybrid), Aptiv makes wires, connectors, and distributors necessary for the distribution of high voltage electric power throughout the car. They also make charging technologies.
On the most recent call, management (somewhat worryingly) declined to state the increase in Aptiv content that would be implied by electric vehicles, but our industry specialist friend informs us the increase is six fold. Lear is a competitor to Aptiv in electrical systems and they publish content per vehicle (CPV) of about $400. Considering ⅔ of Lear’s revenue is in their seating division, one might estimate their electrical CPV at $135. On the Q4 transcript, the SVP of Lear’s E-systems said that their incremental CPV for 48 volt mild hybrids was $300, and for full EVs was $2,000. $2,000 / $135 implies a fifteen fold revenue opportunity in the transition from today’s ICE to fully electric vehicles.
Unfortunately at this time we do not have have an estimate at the increase in CPV for today’s cars versus fully autonomous cars, but the related part of Aptiv’s business that provides Level 1 and 2 automated driving (active safety) recently grew at a rapid 65% pace.
To be clear, Aptiv is not the only company that makes many of these products, and they will face competition. Furthermore, there are many different companies and alliances competing for dominance in these fields, and it is not at all clear who the winners will be. We approach this investment not from the standpoint that Aptiv will necessarily be the winner themselves, but more from a standpoint that a rising tide lifts all boats. If the demand for high voltage auto electrical distribution systems increases exponentially, then all makers of high voltage automotive electrical distribution systems will likely benefit.
Aptiv works with all major OEMs (including Tesla) so Aptiv should benefit to some degree regardless of whoever “wins the race”. Even if the first to market is not a traditional OEM, the example of Tesla’s production struggles has shown that if the winner wants to take full advantage of their first mover advantage by making a meaningful number of cars they will probably have to partner with the existing auto ecosystem. Aptiv has said they have no interest in being a direct “mobility on demand” service provider like Uber/Lyft/Waymo.
Aptiv has partnered with Intel and Mobileye on their “CSLP” platform, which is their full stack “turnkey” autonomous solution which will supposedly be commercially available in 2019. So perhaps they will be a direct winner outright. Navigant recently published a report on the automated driving leaderboard and they placed Aptiv at 7th (ahead of all other parts manufacturers).
In addition to offering their full autonomous solution, Aptiv has indicated a willingness to partner with any player on basically handling any part of their system. For example, perhaps one partner prefers to use their own software and computing hardware, but wishes to utilize Aptiv’s sensor and signal technology. According to the recent Navigant leaderboard report, the current leader is GM, who is Aptiv’s largest customer. In second place is Google’s Waymo, which is reported to make their own sensors, but also recently placed an order for thousands of minivans from Fiat Chrysler, who is Aptiv’s third largest customer. Number 6 on the leaderboard is BMW-Intel-FCA, the BMW part with which Aptiv has a separate partnership to provide a next generation radar and high-end vision sensor suite powered by their ADAS multi-domain controller. Thus it is easy to see how Aptiv could benefit from the above described trends despite the fragmented and unclear competitive space.
While we believe the real opportunity is long term, Aptiv currently trades at a consensus forward PE of 18 and a good argument can be made for 20 based on sensor, connectivity, and cable companies like TEL and APH . Their forward EV/EBITDA is 11.7 and they should probably get a little credit for only being a 15% tax payer. The forward FCF yield is 3.5%. So the company is not cheap, especially for an auto parts supplier, but one has to remember that they have low debt, good return on capital, and good growth prospects. We feel somewhat guilty posting this idea to a value website but certainly you could find many growth companies that are significantly more expensive.
Basically we think for the near term they can hit management’s guidance which will provide an acceptable return (the major potential upside comes in a few years as the mega-trends really get going). This guidance assumes revenue growth consistent with previous MSD performance, and adjusted operating margins increasing from 12.5 to 14.2%. This along with $350MM of buybacks per year (compared with ~$1B in FCF and a historically high buyback rate) results in EPS doubling in 5 years.
Macro / car cycle - Aptiv is an auto supplier and not insulated from the auto cycle which is often influenced by macroeconomic concerns. One either has to not buy it now and try and time the cycle or just be ok with the risk. We choose the latter. Aptiv is somewhat insulated to regional swings by being truly global. For example US SAAR declined last year as did Aptiv’s US revenue by 6%, but this was offset by 11% growth in Europe, 5% growth in Asia, and 26% growth in South America.
Trends take longer to materialize - it could be that our core thesis is wrong and in five years there are no level 5 fully autonomous cars on the road and that EVs fail to gain meaningful adoption. This would lead to slower than anticipated growth only in line with the overall auto market.
Aptiv doesn’t benefit as much from these trends as expected - it is not impossible to envision a future where there are a few electric autonomous fleet managers, none of whom have chosen to buy many of Aptiv’s products to assemble their fleets, or Aptiv otherwise fails to take advantage of the trends they are targeting. As discussed in the write up above, we believe this risk is somewhat mitigated by Aptiv’s working with all major OEMs and willingness to engage with partners with as much or little input from Aptiv as the customer prefers.
We go completely to autonomous fleets and fewer cars are produced - perhaps the autonomous technology is so effective that people stop buying cars and instead utilize mostly autonomous mobility on demand services. This could results in fewer cars being produced and lower revenue for Aptiv. We think that both private ownership of cars and autonomous mobility on demand services will coexist for some time, certainly within our investment timeframe of five years, but it is a risk. A partial mitigant is that if everyone switches to use the cars in these fleets they will see much more use and wear out faster, somewhat muting car volume declines. Overall miles driven should increase as cost (whether in terms of one's own time or employing a drive) decreases.
Fully autonomous ride hailing systems are introduced in 2018 and 2019. Significant numbers of mass-producible EVs are introduced in 2020 and 20101. Adoption of these trends becomes more certain and acknowledged. Operational results and growth forecasts increase. Multiples expand.
|Subject||Re: Re: Shorts|
|Entry||02/24/2018 03:35 PM|
AXL potentially as well. Axles may go away and powertrains will be much simpler.
VC I disagree since they probably still have a place given all the dashboard, cockpit, infotainment, and electronics for the passengers still needs to exist.
TEN I agree
|Entry||02/26/2018 03:53 PM|
Seems like your pitch is more about autonomous and EVs rather than APTV. I'd be interested to know:
On EV/Autonomous - Do you have any detailed unique view on why adoption would be sooner besides pointing out press reports on Waymo/GM's promotional releases?
On APTV - Seems like you are just drinking the kool-aid.
1. Have you spoken to anyone who actually uses their sensors for autonomous?
2. Why is GM starting to produce their own sensors vs. buying from APTV?
3. Why is Waymo doing the same thing?
4. GM is investing $600m / year on autonomous. Waymo is probably north of $1bn. Why can APTV compete with $100-150m of investment?
5. Why has their messaging regarding autonomous change in the last 2 years. First it was all about their investment in quanergy and how solid state Lidars is the way to go. Then they stopped talking about Quanergy and started talking about how the future is their collaboration with MBLY. Now the focus is their acquisition of Nutonomy. Seems like these guys don't really have a strategy and they are way behind the leaders.
|Entry||02/27/2018 12:46 PM|
To get straight to the point I haven't found what I would consider any clear shorts, more just stuff I would want to avoid. If you believe in the autonomous and electric stories, there are lots of prodcuts/services that you can imagine there being less demand for in the future. Anything internal combustion engine related (exhaust systems, superchargers, etc), Delphi's own powertrain segment, aftermarket auto parts dealers, repair shops, etc. However, but penetration of these technologies is going to take a while, so it will take a while for the operational results of secular losers to start really getting compacted. Thus, the way I see it, if you're short, in the meantime you're more relying on macro or multiple compression. Perhaps this is just lopsided wishful thinking, but I tend to think that multiple expansion for secular winners takes place before multiple compression for losers. I have a hard time seeing the losers go down a great deal on an absolute basis if you're looking to make profits on an individual short. If you're looking for something that will just lag the market to allow you to increase gross exposure I think the names Chatam names are reasonable. Perhaps also DCI, DAN, SMP, or TSX.
|Subject||Re: Re: Re: Re: Re: Shorts|
|Entry||02/27/2018 01:20 PM|
I will be honest and say that I am not sure Aptiv is the best play on this thesis. I found it to be a reasonable play on this thesis, there maybe be better ways to paly it and I'm opening to hearing and investigating those ideas. I liked Aptiv because it has exposure to both EV and autonmous trends, and because they work with all the major players. Instead of picking the biggest winner (whcih I would think may also entail the risk of picking a loser) I was trying to pick something that would hopefully benefit in one way or another.
I think Aptiv has certain advantages in its wiring business, such as its current scale and relationships with OEMs, but I want to be clear that I don't think it has a real moat. I think its a good operator in a competetive industry that should experience significant end demand growth (and potentially receive multiple expansion due to said demand growth).
I have not looked at Infineon closely. But off the top of my head I would think they will also benefit, but perhaps less so as they are not a pure-play in automotive.
I ask in all serious if you are aware of a company that you believe is better aligned to this thesis? Do you believe Infineon fits this description?
|Subject||Re: not a clear long|
|Entry||02/27/2018 01:39 PM|
I wouldn't feel comfortable making revenue by product forecasts, because they basically would be uninformed guesses. However, I can go do Aptiv's product list and feel confident that they will all be around in 10 years, that's part of why I like this investment.
Basically the entire product suite of Signal and Power Solutions would appear to me (who does not have a technical background) to be necessary to continue to use electrical power in vehicles. As the number of sensors and devices in vehicles increase (whether made by Aptiv or not) I should think they will need cables to support. Products include wire harnesses and data cables, high voltage distribution, specialty harnesses, connectors and terminals, electrical centers, power distribution blocks, cable ties and mounts, application tools, routing channels. Again being honest, I couldn't tell you the differenct between connectors and terminals but my baseline assumption is that they will continue to be necessary to power the electronics inside cars. I am thinking these products will benefit from the trends of more electric devices in all vehicles and high voltage requirements due to EVs. Not aware of anything at risk of obsolescence. Am open to hearing otherwise.
Infotainment and User Experience is a little different. The main revenue now (~$1.7B revenue, some 2/3 of the segment) comes from Infotainment. I kind of see this sub-segment as sort of neutral to the trends above (I'm not so sure that AVs won't need cockpit interfaces), but is experiences brisk growth in its own right. Body and Security (~$600MM revenue, vehicle access and security, vehicle comfort controls, lighting system controls) I see as sort of in the same boat as Infotainment, not really benefitting from EV and AV trends, nor really being threatened by them. Active safety (multi domain controllers, sensing and perception systems, AEB, adaptive cruise) is right now experiencing growth as active saftey becomes more standard on vehicles today and I believe regulators are moving towards requiring some of these systems. I see these types of products as being aligned with the AV trend (though as Boom notes it may not be Aptiv that makes them). This is a pretty small buiness right now (~$500MM) so I think the bigger risk is lack of growth as opposed to going away. The last subsegment, Connected Services (~$100MM revenue, data acquisition, edge processing, data marketplace and analytics, OTA updates and cybersecurity), basically doesn't even exist yet in terms of how small the revenue is and given that AVs will need to be connected and these services will be neccessary.
Long story short, I am not aware of any reason that any of their product lines won't be around in 10 years. Perhaps if the future is entirely mobility on demand fleets, then Infotainment and Body and Security will suffer, but I also think we will have a mix of mobility on demand fleets and private vehicles.
|Subject||Re: Re: Re: Re: Re: Re: Shorts|
|Entry||02/27/2018 01:47 PM|
Infineon = mostly EV. But yes it's very aligned.
|Subject||Re: Kool Aid|
|Entry||02/27/2018 02:16 PM|
Your criticisms are all fair.
Yes my pitch is a bit more on EV/Autonomous than on Aptiv. Aptiv is the best/safest way I've found to play these trends. Do you have a superior or preferred way to do this? I'm all ears. It sounds like you might prefer Google or GM directly?
No I don't have any detailed unique view on why adoption would be sooner, other than what I laid out in the article. Do you have any reason to believe that Google's promotional announcements are not credible? I do happen to think that arguments I commonly see in the press, such as consumer unwillingness to get into an AV out of fear of being unable to trust a machine are kind of dumb, as are the fears of regulation stifliing adoption. There will soon be a lot of data on whether or not AVs are safer. This doesn't prove anything but just today CA decided to allow fully driverless (no steering wheel) cars: https://www.ft.com/content/2e843dc8-1b60-11e8-aaca-4574d7dabfb6 .
Yup I've probably swallowed a little kool-aid, though I tried to keep my pitch rather reserved and free of forecasts saying Aptiv would actually experience the 6 to 15 fold increase in content per high voltage vehicle that was discussed.
1. No I haven't, I've relied only on publicly available information. According to that information, BMW (#6 in Navigant study) is using their sensors as is Aptiv (#7) themselves.
2. I wasn't aware. I imagine GM thinks this will be a good business to get into and/or doesn't want to be beholden to suppliers for critical components. Would love to know if you know where I can learn more about their decision.
3. I believe Waymo doesn't want sensor supppliers to capture a lot of the value creation. Even if they don't end up making all their own sensors having the ability to source internally should keep prices in this area down and keep suppliers from earning excess profits. (I'm reasonably happy if Aptiv just earns regular economic profits on inceased business).
4. Perhaps Aptiv can't compete. I explicitly stated that I cannot be sure that Aptiv will be the "winner", but even if they are not they could experience other benefits. Perhaps Aptiv's full stack CSLP program will flop. Does this mean that GM will stop relying on Aptiv to provide the increased wiring necessary to connect the sensors? Does this mean other OEMs will start using GM's/Waymo technologies in their own cars instead of turning to Aptiv for things like multi-domain controllers? In the near term, I believe aoption of Level 2 / Level 3 autonomous in regular cars sold by all OEMs should drive Aptiv's Active Safety business. Perhaps this business eventually dies out as GM/Waymo dominate the Level 5 mobility on demand market, if that model fully takes over. In this scenario, I think Aptiv's Signal and Power distribution segment (their largest) still stands to benefit.
5. Yes I don't think they are the leader in fully autonomous solutions. However, as stated above, I don't think success in this investment is fully dependent on them being the leader. I think they see the trend coming and are trying to postiion themselves to benefit (or not get squashed) in any way they can. I both imagine and expect that some if not many specific strategic initiatives will fail and change, but that some will succeed. I don't see it as all or nothing. Thus, I don't see previous changes in strategy as necessarily indicating that they're clueless and will fail to benefit at all. Very open to being told I am wrong here.
|Subject||Re: Re: Re: Re: Re: Re: Re: Shorts|
|Entry||02/27/2018 02:20 PM|
Thanks I will look into it
|Subject||Re: Re: Kool Aid|
|Entry||02/28/2018 08:19 AM|
- I am not questioning what google is saying and I have no doubts they are making significant progress. However, they have been working on the Phoneix project for over 2 years and it will only really launch later this year. It is also not easily scalable - meaning that to enter a new city they need to spend significant time and resources mapping the area. That is why as much as I believe in autonomous and I have no doubt that in a decade or two it will be a prevailing technology - I wouldn't invest in APTV, GM or any other company on this thesis. I doubt anyone will be making money on autonomous in the next 5-10 years. In the meantime investments will have to grow and only companies with massive FCF streams and Balance Sheets will be able to continue to invest.
- The question of whether APTV wins or not is important. Of course, I don't have the answer but I am not sure there will be multiple winners. There are several questions that will need to be answered - for instance: what wil be the new business model? If the majority of miles driven will be in uber type services - I think APTV loses.
- If you invest in APTV, I think answering the question of why GM, Uber and Google are making their own sensors is critical. It goes against what any auto OEM has done in the past. Why invest billions on your own becoming a designer and manufacturer if you can outsource it? (For example - we know from the waymo/uber lawsuit that Google paid Lewandosky $120m throughout his tenure at the company to start their LiDar program. That is 1 engineer's salary). Again, we don't know the clear answer - but based on conversations with industry experts - the suite of sensors and the way they interact with the software is super critical and there is nothing commoditized about it. These companies think they can do a better job than the suppliers designing products to their own specific needs as they try to solve this complicated equation. They are also not sure the companies will be able to invest along them for 5-20 years as these programs ramp. If that is true, APTV will fall behind.
- Lastly, in the past electronics in cars were boring, low tech and did not attract significant innovation outside of Detroit. This is now the hottest space in the Silicon Valley, Israel and other innovation hubs. I would argue that there is significant innovation that is coming and will challenge APTV's core businesses that you haven't focused on. The German OEMs are leading the charge and several companies are challenging APTV. Again, I don't know whether APTV will be challenged enough or they will be able to continue to outgrow global SAAR on pure content growth (with market share losses). I am just pointing out that this is not a clean story - if you take what management is saying and they hype they are creating and run it by industry experts and tech leaders among the EU OEMs (who are really leading the technology changes) not everything lines up.