After declining 50% over the last year, 4Q12 will present a great opportunity to take a long position in Gentex Corporation (GNTX) for medium to long term investors willing to wait for the following catalyst to pan out in FY13.
- Long: Gentex Corporation
- Current share price: $17.13
- Potential Return: $5 -$8. Shares may bottom out at $15.00
- Market Capitalization: $2.45B; Dividend Yield: 3%
- Cash: $400M; Total Debt: $0.00
- Shares Outstanding: 142M
- Gross Margin: 33%; Operating Margin: 21%
- EBITDA Margin: 26% ; FCFF (ttm): $60M
- Sector: Consumer Goods; Industry: Automotive
- Trading timeline: 18 months; Important time: 31-Dec-2012
- Main Catalyst: Passage of KTSA Act, Cyclical uptrend in automotive sector, Active share buyback program and a Healthy dividend yield, Growth in emerging markets; Strong Fundamentals and Balance sheet
- Speculative Catalyst: GNTX's clean balance sheet, leading market position and positive cash flow might make it a potential takeover candidate. Furthermore, Fed Bauer, GNTX's CEO since 1986 holds 3% of the firm and is currently 70yrs old. The upturn in the automotive cycle in addition to the above factors might put GNTX in play in the future.
- How might I trade: Be a buyer between $15 -$16 a share
The potential passage of the Kids Transportation Safety Act of 2007 (KTSA) in December 2012, improving macro drivers in the global automotive industr,y and an active share buyback program supported by strong fundamentals present a compelling opportunity for investors looking to benefit from investing in a stock that has fallen approximately 50% over the last year. The downtrend in the share price of GNTX is a result of specific events, most of which were out of the control of the firm.
One of the major events is the prolongation of the passage of the "Kids Transportation Safety Act of 2007" that was first signed into law in February 2008. It required all new vehicles in the US to increase field of view while backing up, thus potentially opening up a huge market for GNTX RCD mirrors in the US. The final implementation of this law was once again delayed in February 2012 thereby negatively impacting the firm's share price.
Another major catalyst has been the macro headwinds in the automobile sector. With 45% exposure to EU, GNTX has been negatively impacted by the downturn in the global and specifically US and EU automotive industry over the last 3 years. Adding to the automotive downtrend were the floods in Thailand and the Japanese tsunami, causing major disruptions in supply chain. These disruptions, I believe, have also been partially responsible for short term margin compression - another negative for the share price.
Despite the negatives, this might be a good investment for medium to long term investors. One catalyst is the imminent passage of KTSA in FY12/FY13 which will open up substantial revenue opportunities for the firm. With the reelection of President Obama, whose administration has been much more sympathetic to social issues, the passage of this act seems much more likely. Another is the cyclical uptrend in the US auto industry starting in FY12 which should benefit GNTX over the next two years.
Adding to the turnaround in the auto industry in the US is GNTX's expansion in certain European and Asian markets which will further support GNTX's growth over the next two years. The change is evident by the reported revenue mix. Of the total revenue, Asia has grown from approximately 11% in 2001 to approximately 19% in 2012 of the total. In addition to these major drivers, an active share buyback program and a healthy dividend yield of 3% adds to the attractiveness of holding GNTX shares in the medium term. Furthermore, shareholders should find comfort in GNTX's strong balance sheet, healthy operating & gross margins, a 15% ROE and a 26% EBITDA margin.
Business Overview -
Gentex Corporation is a supplier of automatic-dimming (auto-dimming) rear-view mirrors and camera-based lighting-assist features to the global automotive industry. The Company also provides commercial smoke alarms and signaling devices to the North American fire protection market, as well as dimmable aircraft windows for the commercial, business and general aviation markets. The Company is involved in designing, developing, manufacturing and marketing interior and exterior auto-dimming automotive rear-view mirrors that utilize electrochromic technology to dim in proportion to the amount of headlight glare from trailing vehicle headlamps. The Company also manufactures non-automatic-dimming rear-view automotive mirrors with electronic features.
(Source: Google Finance)
Automotive products - GNTX is engaged in automatic-dimming (auto-dimming) rear-view mirrors and camera-based lighting-assist features to the global automotive industry. The firm effectively controls 88% of the global auto-dimming mirror market, making it a virtual monopoly. The automotive segment constitutes 98% of the total GNTX revenue. With the global auto market poised for a rebound, GNTX's market leading position might turn out be a positive going forward. Despite major declines in the auto industry, especially in 2008 and 2009, the growth rate in revenues for GNTX in the automotive segment since 2006 has averaged 15%. It should be noted that the firm did undergo revenue decline in FY09.
Moreover, this segment reported a compounded 19.7% organic growth rate over the past 25 years. In FY11, GNTX sold 21.5m automatic-dimming mirrors. The average selling price for the mirror was $46.39. According to the latest presentation, the current average content per vehicle is approximately $60 - $65. GNTX also is a leader in technology with the introduction of features such as SmartBeam Technology that optimizes forward visibility by automating high-beam usage, which allows drivers to better identify and react to potential hazards in the road ahead. GNTX is currently working on new technologies such as lane departure warning, forward collusion warning and optical detection, which will increase GNTX's pricing power going forward.
The US represents a large geographical exposure for automotive mirror sales, representing 33.3% of the total revenue. Germany constitutes approximately 25%, with Japan at 7% and the rest of the world representing 34% of the revenue. As of 2Q12, the growth rate in mirror shipments in North America was 33% while offshore growth was 12%. As of FY2011, Volkswagen represented 15% of total revenue, GM at 12%, Toyota (TM) at 12%, Hyundai at 11% and Mercedes at 11%. QoQ, the operating margins for this segment have slightly declined to 21.4% as of 3Q12.
Other Segments - Other segment represents products consisting of fire safety products and Dimmable Aircraft Windows. After initially declining in FY08 and FY09, this segment reported incremental operating margins and revenue due to double digit gains in dimmable aircraft window sales. Currently, GNTX provides windows for the Boeing 787 dreamliner and certain other aircrafts and is currently negotiating contracts for sale of aircraft windows in other aircraft models. For 9M12, the segment reported 12% growth YoY with operating margins were inching back to 5% - 6% levels.
MAJOR CATALYST -
Kids Transportation Saftey Act - KTSA 2007 was signed into law in February 2008, after the new administration of President Obama took charge. The law required all new vehicles in the US to increase the field of view while backing up. This law is a boon to GNTX which can provide rear camera display in its existing mirrors it already sells to automotive manufacturers around the world. The National Highway Traffic Safety Administration (NHTSA) initiated the rule making process in FY08/FY09. The law required that all new vehicles below 10,000 lbs will be required to have backup camera-based systems by September 2014 with 40% of all vehicles in compliance by Sep-2013. Currently, only approximately 15% -20% market uses read camera display (RCD) mirrors in the US, however, with GNTX controlling 88% of the market and the final rule to be published in December 2012, the law opens up substantial revenue opportunities for the firm.
Assuming the top 20% of the cars will use navigation systems and with another 15%- 20% cars already in compliance, it still leaves 60% - 65% of the US market in non-compliance, if the law passes. Some industry estimates indicate that RCD mirrors will add approximately $75 per unit and that US car production will be 14M in FY14. A positive for the passage of this ruling is the reelection of President Obama whose administration has been very proactive on social issues. His election creates a much greater likelihood that this act will be passed.
Supporting Macro Drivers - Positive Macro Drivers - GNTX revenues are directly proportional to the increase in automotive sales around the world. After a substantial downtrend in the global auto industry, especially the EU and North America in FY08 and FY09, the industry is poised for a strong comeback. I believe this will be a positive for GNTX going forward. US car production peaked at 16M vehicles in FY07, only to decline to 10M in FY09 and has remained below 14M since. With the replacement rates for cars between 12M -13M vehicles in the US, some believe that the pent up demand over the past three years will cause vehicle production to accelerate in the US over the next few years, with FY14 car production reaching 14M vehicles.
Similarly, Canadian, Chinese, German and Japanese markets are expected to increase production too. The current downtrend in the EU is getting priced in the shares with some of the reduction in demand negated by increased production in the US markets. Recession in the EU is supposed to be in the middle of this crises, and GNTX with its 30%+ gross margins and 20%+ operating margins would have held up relatively well, if it was not for the delay in KTSA rulings and a simultaneous slowdown in emerging markets along with supply disruptions, thanks to mother nature, leading to incremental costs.
With the turnaround in major EU economies expected in FY14 in addition to the growth in US markets, GNTX is positioned to perform much better and may see expansion in its P/E and revenue multiples thereby positively impacting its shareholders. Additionally, it's believed that emerging markets such as China and India can provide GNTX substantial upside in the long term. With auto dimming penetration rate less than 10% in Asia, GNTX can benefit from the growing Asian markets. Chinese car production is forecasted to reach approximately 19M cars by FY14. GNTX revenues from Asia have increased from 11% in 2001 to 19% in 2012, however further penetration in these markets through third part vendors or via direct sales will add to GNTX's bottom-line.
Share buybacks and history of increasing dividends - After initially announcing a repurchase in FY02 for 8M shares, GNTX has bought back a total of 28M shares to date. The most recent purchase announced in 3Q12 was of 2M shares, bought between $15 and $18 per share. Furthermore, the board authorized a purchase of additional 4M shares to be bought back as the firm deems it fit. Even though this only constitutes 3% of the current outstanding float, there is a possibility of the firm increasing its buybacks given GNTX's history and strong balance sheet.
Additionally, another reason to hold the stock is GNTX's decent dividend yield of 3%. The firm has a history of consistently increasing its dividend and currently pays a dividend of $0.13 per quarter. While investors wait for the positive macro and regulatory catalysts to be priced in the stock, they can benefit from the ongoing share buyback program and more importantly, the current dividend yield providing a floor to the stock price.
Strong Fundamentals to wither economic downturn - GNTX enjoys a strong balance sheet which should provide a sense of relief to its shareholders in these volatile times. GNTX has approximately $400M in cash on its balance sheet with no debt. Over the last 24 quarters, GNTX reported average 34% gross margins, 22% operating margin and a 26% EBITDA margin. The firm has also reported an average 15% ROE since FY06. Although it's true that in recent quarters GNTX has reported compression in its margins due to pricing pressure and rising costs, I believe over time that incremental revenue from product innovations and positive outcomes of both the regulatory and macro catalysts should alleviate these concerns and help GNTX's multiple expansion.
Assuming a very conservative scenario of flat to lower sales of mirrors in FY13 compared to the sales in FY11, the passage of the Kids act in early 2013 instead of December 2012 and "other segments" reporting a 10% growth, shares should at least be valued at $18 - $19 a share. On a more positive side, assuming that mirror sales reach 23M mirrors in 2014 from 21.5M in FY11, the share should "at least" return 30% to 40% by 2014 in addition to a current 3% dividend yield. This assumes the mirror penetration rate in the US market to be 65%, in the EU to be 40% and in Asia to be 20% from the current 10%.
In addition, I expect GNTX to gain 50% of the "target" market share (or 40% of the total RCD market) in the US, after the Kids Safety act is passed. I have assumed forward P/E of 12.7x while EV/Sales of 1.6x and EV/EBITDA of 6.6x. It is expected that reduction of one time capex charges should also help the firm generate greater FCF in 2013. Over the next 18-24 months, positive macro drivers, in addition to a healthy balance sheet and the passage of KTSA should help GNTX undergo margin expansion.
Investors who are willing to wait while getting paid 3% on their investment will benefit from the capital gains coming from the turnaround in the auto industry which will be looking for economical yet technologically savvy solutions for the drivers around the world. This will benefit GNTX and thus its shareholders. Assuming that the Kids Safety Act does not pass and given the current market volatility, the shares should bottom out at a minimum of $15 share.