- My Rating - Neutral/SELL (short term)
- Future earnings growth expected to be around 7% per annum instead of 9.46% per annum as forecasted
- The cost of raw materials are expected to grow - reducing gross profit margin. The margin in 2014 was 39.4%, however it has dropped to 38.4% in Q1 2015
- Light Motor vehicle production is set to grow at 2% in US, flat growth in Europe and -4% growth in Japan in 2015
- Return on Equity is expected to reduce to 16% by 2017.
Gentex Corporation (NASDAQ:GNTX) is a global, high tech electronics company that manufactures high-quality products for the automotive, aerospace and commercial fire protection industry. The company primarily utilizes the skills of electronics and micro-electronics, software design, chemistry, glass coating/fabricating, mechanical design and engineering to create its products. Its main product is the automatic-dimming rearview mirrors and camera based driver assistance systems for the global automotive industry. The company also provides commercial fire-protection products for the US market and dimmable aircraft windows.
Automotive applications are the largest business segment for the company. The company continues to be the leading-producer of automatic-dimming rear-view mirrors in the world and is currently a dominant supplier to the automotive industry. It captures a market share of 90% worldwide in 2014 which is up from 88% in 2013. The company is currently supplying mirrors and electronics modules to almost all major car companies like Audi, BMW, Daimler, Honda, Jaguar and Lexus etc.
The company also owns 480 patents and 20 registered US trademarks that relate to the electrochromic technology, rear-view mirrors and/or HomeLink products. The company owns a number of foreign registered trademarks and patents as well.
The company's share value has gone down 3.2% since January 2015. The company has averaged 10% top-line growth of the last 3 years mainly due to the 17.4% growth experienced in 2014. The net income however has grown at a much higher rate of 29% in 2014.
In this article, I will evaluate the company's future outlook combined with the industry's future outlook to support my quantified downside of the company.
Company's Future expectations
- Revenues expected to grow at 7% per annum
- EPS of 2015 to be $1.07
- Gross Margin to be maintained between 38.5% to 39.5%
- Operating margin would stay in the range of 29%-30%
- Return of equity to reduce to 16% by 2017
The automotive sector is moving to cars with technology enhanced features and Gentex's revenues have increased by 17.4% in 2014 compared to 2013. Based on the results of Q1 2015, the company reported a 10% increase in revenues compared to Q1 2014. The automotive sales increased due to an 11% increase in the auto-dimming mirror shipments. Internal automotive mirror unit shipments increased by 14% compared to the previous year due to certain European and Japanese automakers. However, Gentex achieves most of the growth (as shown in the figure below) through the "Other" countries (Korea, Mexico, Hungary, Canada, China and the United Kingdom).
The China automobile market subsequently contributes a major portion of the growth of these "Other" counties. However, China's automobile sales are going to slow further in 2015. The China market is expected to grow at less than 10% in the near future and hence I expect the revenue for the FY 2015 to be approximately $1.47 billion which represents a growth of 6.74%. The company has reflected improvements in product mix, as well as purchasing cost reductions. This is visible through the increases in the gross profit margin over the years. However, in the Q1 2015, the gross product margin has reduced by 30 basis points compared to the margin in Q1 2014. This reduction has mainly occurred due to costs associated with new technology investments and exchange rate fluctuations.The company intends to keep the gross margin ratio in the range of 38.5% to 39.5% in the near future. Due to this I expect the EPS for the company to be $1.04 per share which represents a growth of 6%. Despite the $0.01 earnings surprise achieved in Q1 of 2015, the EPS for the FY 2015 seems to be in line with the analysts' expectations. I anticipate the revenue growth to be around 7% and the earnings growth to be approximately 8% per annum for the next three years.
The operating expenses, however, have been well maintained. Operating costs have reduced by 60 basis points compared to Q1 2014. The company continues to demonstrate great cost control.
Return on equity is the measure of profitability of the company that calculates how much profit a company generates with respect to the Shareholders' equity. The return of equity of the company has increased from 16.8% in 2013 to approximately 19% in 2014. This ratio has been constantly increasing over the years. It has increased from 16% in 2011 to almost 19% in 2014. However, I believe the Return on Equity will drop back to 16% by the end of 2017.
Current Price: $17.44
My valuation: $15.69
I have used a three-year DCF model to come up with my valuation. The revenue growth for the company is based on the growth of each of the three segments of the company. The growth is approximately 7% per annum for all the three years. The company is working towards reducing its costs and I believe the company can bring it down to 60% of the revenues in the next years. The R&D costs have stabilized at 6% of the revenues. Also, I do not see any significant capital expenditures for the company. The company has also got its effective tax rate down to approximately 30.5% which has been taken into consideration in the calculations.
(Assumption: Long Term Growth Rate = 3.5%)
The current Weighted Average Cost of Capital for the company is 10.7475%. The number of shares outstanding is 295.25 million.
Based on all these numbers, I would say a fair valuation for the stock would be $15.95
Gentex Corporation looks overpriced to me at this stage. The company might be worth examining further as it is still making money. GNTX might be a good stock to own in the future, however, this is not the right time to own the stock. I would recommend aNeutral/Sell rating to the company.
What could make the stock turn around?
The current US regulations have not allowed Gentex's product - SmartBeam to enter the market. SmartBeam automatically turns the vehicles headlights on or off and can also let the headlights be on at all times and is sold mostly in Europe. However, if the US overhauls the outdated headlight regulation (FMVSS 108), there is a potential for the SmartBeam product to grow in the US.
Under a new rule issued by the National Highway Traffic Safety Administration (NHTSA), all passenger vehicles are expected to have rearview cameras by 2018. The rearview cameras could eliminate side-view mirrors and could also eliminate the rearview mirrors in the future. Although this development still seems to be a decade away, it could still offset the increase in revenue caused by the entry of SmartBeam in the US market.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.