Gentex Corporation (GNTX) was founded in 1974 to produce smoke-detection equipment; however, the company is famous for creating the first commercially successful auto-dimming rear-view and side mirrors, using electrochromic technology. Gentex is continually inventing mirrors with advanced features such as compasses, parking assistance, and hands-free phone capability. However, the two most promising applications are mirrors with rear camera display [RCD] and SmartBeam mirrors, which automatically turn a vehicle's brights on or off, depending on outside conditions.
Gentex has over 700 patents worldwide, with another 300-plus awaiting approval. The company's currently approved patents expire between 2012 and 2029. Gentex also has a dominant 88% market-share, which means that the company has a huge economic moat, which should protect it for a long time.
Gentex estimates that of all the vehicles sold annually worldwide, only 23% have an interior auto-dimming mirror and only 6% have at least one exterior auto-dimming mirror. This leaves plenty of room for more growth. There are approximately 76.5 million light vehicles produced annually worldwide. Management estimates that auto-dimming mirrors may penetrate approximately 45% of the market, or 34.4 million light vehicles, over the next decade. Based on average content per vehicle of approximately $100 - this means the company has a $3.4 billion market potential, or more than three times its revenue in 2011.
SmartBeam is mostly sold in Europe, but its safety benefits could expand globally. According to some studies, drivers use their brights optimally only about 25% of the time, so Gentex hopes eventually to make this item standard because there is such a need for it among drivers.
Over the long term, Gentex's technology also could be brought to office and airplane windows. The company, in conjunction with PPG Aerospace, won a contract to supply auto-dimming passenger windows for the Boeing 787 and Beechcraft King Air 350i, which could expand to more manufacturers over time.
A more near-term catalyst that could help Gentex is the Kids Transportation Safety Act [KTSA] of 2007. It will require all new vehicles less than 10,000 lbs. in the United States to have a backup camera-based system by September 2014. There have been some delays in getting this Act passed; however, the final rule is currently expected by December 31, 2012. Passage will almost certainly cause a huge increase in the company's stock price since Gentex controls 95% of the RCD market.
The company's top five customers each account for 10% or more of its net sales. The loss of any of these customers would have a material adverse effect on the company's financial performance.
Some automakers favor placing RCD in the console instead of the mirror. Some of the company's customers have already said that they are moving RCD away from the mirror starting in 2013 and 2014. Thus, the benefit to Gentex from the new legislation may be minimal.
Another risk is that there is always the possibility that a new and superior technology will be invented and take over the auto-dimming mirror market, but I consider this risk remote.
Finally, it is possible that governments start allowing camera technology to replace all types of mirrors in a vehicle, which would be very bad news for Gentex. Although I believe this risk is more than a decade away from becoming a reality.
Management & Stewardship
Chairman and CEO Fred Bauer, 69, founded Gentex in 1974 and owns 3.3% of the company. Mr. Bauer has overseen the company's increase in market capitalization from approximately $17 million at its initial public offering in 1981 to approximately $2.5 billion as of October 19, 2012. Over the last five years alone, Mr. Bauer has presided over an increase in sales of over 75%. In addition, he is also the named inventor on a number of the company's patents.
Overall, I believe that management has achieved returns on invested capital far exceeding the cost of capital for many years, which I expect to continue. The company generates so much excess cash that it has amassed cash and an investment portfolio, mostly consisting of stocks and government bonds, amounting to nearly half of assets. It's almost as if the company is turning into a hedge fund. I also like the fact that most of the company's growth has been organic, in other words, the company is not wasting its money on worthless acquisitions.
Gentex is in excellent financial shape, with no debt and close to $560 million in cash and investments on its balance sheet.
The company is extremely profitable. Over the past decade the company has not had a single year in which it lost money. Additionally, over this same time frame the company has managed to deliver double digit returns on capital and double digit profit margins.
Perhaps why Gentex has such a low valuation is because it's not what Wall Street considers a "growth stock," it's more of what I would call a "consistent grower." The ten-year revenue CAGR is 13%, while the ten-year owner earnings CAGR is 12%.
In my fair value estimate I forecast revenue to increase about 10% on a ten-year CAGR basis and profit margin to average about 14% during my ten-year forecast period. Top-line growth is important to Gentex because margin expansion is difficult due to automakers always seeking price concessions. Using my fair value formula I came up with a fair value estimate of just under $28 per share. At today's price of $17 per share, this gives us a margin of safety of about 40%.
Gentex is a wonderful business selling for a fair price. The company's growth prospects over the next five to ten years look very good, and will ensure that it continues to create value for its shareholders. Based on the current price of $17 per share, I believe that the stock represents an attractive entry point for long-term investors.