If you're focusing on European weakness and year-over-year slowing in China's economic growth, you're missing out on an opportunity to own AutoLiv Inc (NYSE: ALV), a global manufacturer of seat belts, airbags and other safety solutions.
The company gets an increasingly large portion of its sales in China and earnings have been weighed down by European austerity. Both of those headwinds may end sooner than you think and if so, there could be more upside as analysts revise estimates higher.
Time to focus on Europe's opportunity rather than risk
You only need to look at the recovery in U.S. vehicle sales to get a feel for how powerful a recovery in Europe may prove to Autliv's bottom line.
The company gets more than 30% of its sales in Europe and overall sales, margins and profits have been weaker over the past few years as European capacity sits unused.
But, signs suggest Europe could be on the mend. In October, light vehicle production in Europe was up 2% versus a year ago, reversing a 3% year-over-year loss in July.
That's a small signal, but it could suggest the market is stabilizing and providing a launch point for auto demand in the region similar to what we saw in the U.S. in 2009. As the U.S. economy tepidly moved higher, auto sales moved significantly higher.
Adding conviction to the potential recovery in Europe is the pickup in new car registrations in September.
Those registrations climbed 5.4% year-over-year in September to 1.19 million units, according to the ACEA. Spain, the UK and France gained 29%, 12% and 3%, respectively from a year ago, while Germany came in almost flat at down 1%. Spain's rapid rise is tied to their version of the U.S. Cash for Clunkers program which helped resurrect the U.S. auto industry.
The gain in registrations is a sharp contrast -- and potentially bullish sign -- given year-to-date registrations have fallen 4% to a two decade low. That data will be updated by the ACEA on November 19th and it will be interesting to see if September's momentum carried over. If it does, you should pay close attention because it could signal that next year will mark a shift toward higher -- rather than lower -- Autoliv factory utilization.
The pickup in European demand, coupled with export markets, helped European light vehicle production grow 2% year-over-year in the third quarter, according to IHS. Couple the chance for stabilizing European sales with a shift to higher levels of content, such as next generation active seat belts, and you has a compelling argument for earnings upside.
China's auto appetite is booming despite slower GDP growth
While attention this year has focused on a slowing in China's growth rate to the lowest levels since the 1990's, the country is still among one of the quickest growing globally. In the third quarter, the highly populated country grew 7.8% from a year ago, according to the National Bureau of Statistics. That marks acceleration from the 7.5% rate registered in the second quarter.
That growth continues to fuel the country's emerging middle class and its appetite for automobiles. During the third quarter, the country's production of light vehicles grew to 4.5 million units from 4.2 million last year, according to Autoliv and IHS. Year-to-date, passenger vehicle sales are up 20% from last year in China, according to IHS. Autoliv expects China's light vehicle production will hit a 20 million annualized run rate in the fourth quarter -- a new record.
China's auto production pick-up is likely to continue given lackluster ownership in emerging provinces. Those tier two and two three provinces are seeing their share of China's total GDP climb and that's good for wealth creation and future auto demand. Currently, private vehicle ownership is just 86 and 48 per 1,000 people in those areas.
Importantly, that growth is likely to have an outsized impact on Autoliv, given the company's organic growth in the country reached 17% in the quarter -- far above both GDP and production growth.
That should bode well for Autoliv heading into the fourth quarter, which is historically the peak sales season in China.
Overall, Autoliv's sales are expected to total $ 1.3 billion in China for this year, up from less than $300 million in 2008.
The potential impact on shares
Analysts have already taken a bullish stance on the company's earnings outlook. They're assuming Autoliv can post earnings per share of $7.46 in 2016.
If we take a look at the company's valuation, it appears current street estimates suggest there's a compelling under-valuation of Autoliv.
Applying a 15 price to earnings multiple on those 2016 forecasts, which isn't unrealistic given the preceding chart, nets a forward target price of $111.90. That's 25.5% higher than we are today.
And, while that's compelling in its own right, it could be even more compelling if analysts prove too conservative on the margin opportunity tied to sales of next generation safety products in China and higher capacity utilization in Europe. Over the past four quarters, Autoliv has outpaced their estimates three times.
Or, looking at it another way, consider the operating margin swing exiting the U.S. recession and consider this recovery in operating margin has occurred in spite of European headwinds. If Europe's drag on margins eases, it wouldn't be a stretch to see operating margins head higher rather than lower during the period.
The final take
Autoliv is guiding investors to expect sales growth of 9% in the fourth quarter versus last year and 5% versus the third quarter, thanks in part to China and Europe. If Europe and China production and light vehicle sales finish the year better than previously forecast, its likely analysts will be forced to bump up their future expectations for Autoliv's earnings. If so, shares in the company may be priced even more cheaply than the apparent 25% discount I outline here.
Additional Reading: Q3 Earnings Transcript
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.