Just about everything is going against auto parts suppliers like Autoliv (ALV 0.45%) right now. A combination of soaring raw material costs and falling light-vehicle production (LVP) volumes are causing significant sales shortfalls and squeezing profit margins. As a result, there's a lot of negative near-term news flow. However, ignore the negativity, a stock like airbag, seat belt, and steering wheel manufacturer Autoliv offers a rare value opportunity for smart investors. It's not just about Autoliv's 2.5% dividend yield; this stock has significant growth potential.
What went wrong
The latest fourth-quarter results from the company highlight many of the near-term issues. Autoliv's net sales fell a whopping 15.8% in the quarter on a year-over-year basis. Meanwhile, the adjusted operating margin slumped from 12.4% in the fourth quarter of 2020 to 8.3%, resulting in a 43.2% fall in operating income to $174 million.
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It's not hard to find the reasons why. Global LVP fell by 13% in the quarter due to semiconductor shortages and the impact of a resurgence of COVID-19 cases on production. Meanwhile, ongoing raw material cost inflation hit profit margin. For an idea of how bad current trends are, CFO Fredrik Westin outlined that raw material cost headwind was $105 million for the full year, of which $100 million came in the second half of 2021.
Moreover, raw material cost headwinds are expected to continue through 2022 due to the structure of its contracts that roll over and therefore absorb the higher costs with a time lag.
See what I mean about near-term negative news? That said, the longer-term outlook is excellent, and Autoliv is a compelling way to play a multi-year recovery in LVP.
Three reasons to buy Autoliv
First, the company is currently trading with elevated costs, but they are highly likely to diminish over time as the economy reopens. Eventually, Autoliv's supplier contracts will roll over to lower prices than the elevated ones they are paying now.
Second, the supply chain issues will ease, and auto-chip semiconductor manufacturers are already making massive investments in expanding capacity to meet demand. For example, the largest auto-chip producer, Infineon, is investing 2.4 billion euros in 2022 compared to 1.5 billion euros in 2021 and 1.1 billion euros in 2020. To be clear, it takes time to ramp up semiconductor manufacturing capacity, so that situation won't change overnight. However, the investment is there, and manufacturing capacity will increase eventually.
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As Autoliv's management points out, leading industry forecaster IHS Markit predicts global LVP will increase by 9% in 2022. Given Autoliv's regional mix, order backlog, and product launches, CEO Mikael Bratt expects the company's organic sales to grow 20% in 2022. That's a figure that includes assumptions for semiconductor shortages throughout the year.
Third, Autoliv's long-term trends and dominant market position continue to make it an ideal way to play a multi-year recovery. During the earnings call, Bratt said, "We estimate that the order intake share was 50% in 2021." It's a figure ahead of the 45% market share that Bratt says Autoliv intends to win and defend, and it's an indication of just how strong the company is in the passive safety market.
It's a desirable market to be in. There's a growing emphasis on safety, whether it's front-center airbags, active seatbelts, knee airbags, more advanced steering wheels, or even active hood lifting systems to protect pedestrians. As such, management believes it can significantly outgrow LVP growth over the long term via increasing its content per vehicle (CPV) over time. That's why Autoliv is one of the best auto part stocks in the market.
A stock to buy
Given that 2022 is likely to be another semiconductor-shortage impacted year, management's guidance looks pretty good. The outlook calls for a 20% increase in organic sales, with an adjusted operating margin of 9.5%, operating cash flow of $950 million, and capital spending equivalent to 5.5% of sales.
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Using the analyst consensus estimate for sales of $9.6 billion in 2022 and the capital spending ratio above, capital spending will amount to around $528 million. If you strip that figure out of operating cash flow of $950 million, it leaves $422 million in free cash flow (FCF). Given the current market cap of $9.13 billion, Autoliv would trade on 21.6 times the estimated FCF in 2022.
That's a very attractive valuation for a company set for double-digit revenue growth in 2023. With costs, hopefully, coming down as a share of sales, Autoliv should generate substantive margin expansion in 2023. Throw in a 2.5% dividend yield while you wait for Wall Street to wake up to the stock, and it makes for a compelling investment proposition.
