Gentex Overvalued Compared To Johnson Controls

Includes: GNTX, JCI
by: Takeover Analyst

For investors optimistic about economic recovery, adjusting portfolios to higher beta stocks represents an attractive strategy. While securities with high betas exaggerate market volatility, they also tend to generate higher risk-adjusted returns, as theoretically applied by the capital asset pricing model. One industry that meets this metric is auto parts, which Johnson Controls (NYSE:JCI) and Gentex Corporation (NASDAQ:GNTX) are two of the leading producers.

In an earlier bullish article, I argued that Johnson Controls will be supported by margin expansion and top-line growth in Building Efficiency and Power and Global Workplace Solutions. Although I believe management is strong at Gentex, in my view, the company is just not cheap enough to provide an attractive entry point given the competitive fundamentals at the current moment.

Both companies, while similar overall, have their differences. Gentex specializes in producing automatic dimming rear-view mirrors and even manufactures windows for aircraft. Additionally, it is a producer of fire protection devices and electro-optic products. The automatic dimming rear-view mirrors are the most attractive growth segment, from my point of view, and can benefit from the "Kids and Cars Act." Its competitor, on the other hand, specializes in automotive interiors, energy optimization, and, as the name would suggest, system controls -- everything from security to heating, ventilation, and air conditioning. An innovative development at this firm also exists in the automotive battery market.

From a multiples perspective, Johnson Controls is much more undervalued. It trades at 13.5x and 8.6x past and forward earnings, respectively, while Gentex trades at 26.2x and 21.2x past and forward earnings, respectively. Moreover, the dividend yield at Johnson Controls is higher by around 38 basis points at 2.02% -- not considerable, but still a difference for a stock that I view to be safer anyway (beta of 1.33 versus 1.59 for Gentex). Analysts currently rate the market leader a "buy" and Gentex more of a "hold."

The recent third-quarter earnings call was a mixed bag with strong growth mentioned in key segments, but cautious guidance given. At the third quarter earnings call, Gentex's Senior Vice President, Enoch Jen, noted the success of the firm's core product:

Auto-dimming mirror unit shipments increased by 19% in North America in the third quarter of 2011, primarily as a result of increased mirror unit shipments for certain domestic automakers. North American light vehicle production increased by 5% in the third quarter of 2011 compared with the same prior year quarter.

Auto-dimming mirror unit shipments offshore customers increased by 38% in the third quarter of 2011 compared with the same quarter last year. The increase in unit shipments was primarily due to increased mirror unit shipments fir certain European and Asian automakers. Light vehicle production in Europe increased by 4% in the third quarter of 2011 and increased by 1% in Japan and Korea in the third quarter of 2011 compared with the same quarter last year.

Additionally, the firm is looking to expand mirror production capacity by more than a third to 30M units come mid-2012, at the latest. I optimistically model revenue growing by 54.3% to around $840M in 2011 and then by 24% and 16% in the subsequent years based on that goal. At the same time, price reductions, E&D expenses, and fixed overhead will cut into the profit margins. Supply chain issues, in particular, are a key concern for investors with the flooding in Thailand causes a drag for possibly the next two quarters.

Revenue growth was also at the high-end of guidance at 30% although the perhaps suspiciously low revenue guidance for the fourth quarter causes pause. While I typically prefer the spoken guidance to be set low in order for expectations to be exceeded and returns generated, in this instance, investors do need confidence that the firm will be able to take market share away from Johnson Controls in the future. Up to $115M in capacity expansion for Gentex is, hopefully, just one step in the right direction.

Consensus estimates for EPS are that it will increase by 18.4% to $1.16 and then by 19% and 18.1% in the following years. Six estimates have been revised downwards, 3 upwards. There is much to be said about risk due to the highly cyclical and vulnerable automarket, as I underline here in my bullish report for Ford Motor (NYSE:F). Going forward, Gentex's main goal should be to successfully contain costs and maintain gross margins above Johnson Control's (currently 36.2% versus 15.1%) while expanding scale. The stock is up by nearly a half since 12 months ago; Johnson Controls being down by nearly 10% from that same time period.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.