Recommendation: HOLD Estimated Fair Value: $57 $78*

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Clarence Daniel
5 years ago
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1 Recommendation: HOLD Estimated Fair Value: $57 $78* 1. Reasons for the Recommendation Autoliv is a multinational firm with operations in 29 countries, and this provides the company with great growth prospects. The firm has exposure to all the major markets of the world including the emerging markets such as China and India where the auto parts and equipment sub industry expects to derive the majority of its growth in the coming years. Autoliv will draw most of its growth from the emerging economies as consumers demand for vehicles increases in these economies. Global light vehicle product (LVP) has increased rapidly as the economies of countries such as China, India, and Thailand have continued to grow at rapid rates. Autoliv is well positioned to take advantage of these rapid growth rates due to its geographical footprint as well as its investments in capital expenditures in growth markets. Thanks to the strong consumer demand for light vehicles in both developed and emerging economies, Autoliv expects the demand for its airbags and seatbelts- the company s biggest contributors to revenues- in passive safety to continue to grow. Autoliv projects that its growth due to the increase in light vehicle production will be greater than the estimated annual light vehicle production growth rate because the company believes it is very well positioned in all the major world markets through its subsidiaries and joint ventures to take advantage of the rising demand for safety systems in light vehicles in the developing economies as well as in mature economies such as that of the United States, Europe, and Japan. The increase in light vehicle production globally is a positive sign for Autoliv, whose safety products (seatbelts, airbags, other active safety systems) are a component of a wide range of vehicles from all the major car manufacturers in the world. The growth in light vehicle production also signals that Autoliv s safety systems will be in demand for the foreseeable future. Another driver of growth for Autoliv and the auto parts and equipment sub industry at large stems from stricter safety regulations in vehicles. A recent trend in the auto parts and equipment sub industry has seen an increase in demand for light vehicles coupled with an increased demand for safety equipment in these vehicles. Stricter standards for vehicle safety means that Autoliv will see increased demand for its core products. In the United States, for example, all light vehicles sold in 2013 will be required to have side curtain airbags for head protection in collisions. Furthermore, by 2017 side curtain airbags will be required to prevent occupants from being ejected in rollovers. Brazil has also taken steps to enforce stricter safety rules in its vehicles. The South American country has decided to mandate frontal airbags in all light vehicles by Europe is also in the process of phasing in a tougher EuroNCAP crash-test program. Government regulation and stricter safety standards present greater growth prospects for Autoliv as the company s safety systems will be more widely demanded and used in vehicles. In addition to the increased demand for passive safety systems in light vehicles, Autoliv expects that active safety systems (night vision, vision cameras, radars, active seatbelts) that can prevent or reduce the chances of an accident will see very strong growth trends in the coming years. For this reason, the company has stepped up its undertakings in active safety, which calls for a $70 million increase in R&D expense in The demand for active safety systems has been growing rapidly in recent years due to the new innovations that active safety presents, which help to reduce the probabilities of getting into an accident.

2 The global economic outlook is a major factor for Autoliv s performance and growth prospects. Currently, the global economy has experienced a slowdown and financial markets have been extremely volatile. Growth prospects for the world economy have also been adjusted downwards. However, we expect that the developing economies will continue to grow at high rates over the long run. The developed economies of the United States, Japan, and countries in Western Europe should also begin to rebound in the longer term. If the global economy continues to stay in a depressed state, this could be a concern for Autoliv whose performance is largely influenced by the macroeconomic state of the world. However, it seems very unlikely that the world economy will experience a lengthy period of slow growth, and it is expected that Autoliv will continue to grow at a high rate as the developing economies continue their trend of rapid growth. A rebound in the mature economies will also aid Autoliv in achieving greater performance and results. Autoliv s greatest advantage over its competitors is its commanding 35% market share in the production and sale of passive safety systems. Its closest competitors, TRW Holdings and Takata Corporation, possess about 10% market share each. Since the majority of growth in the auto parts and equipment sub industry will stem from the increased production of light vehicles, passive safety systems will be in greater demand than active safety systems. This provides Autoliv with a great competitive advantage over its competitors. The growth in passive safety systems due to increased light vehicle production in China, India, and other emerging countries is expected to drive Autoliv s growth. Looking at Autoliv s multiples, I find that the company is fairly valued. Comparing Autoliv s trailing twelve months and forward P/E to its historical P/E suggests that the stock is currently undervalued. However, this undervaluation can be attributed to the antitrust investigation Autoliv is facing. Analysts also forecast a relatively low growth rate for Autoliv when compared to the industry median, and this could also be attributed to the antitrust investigation. Because Autoliv has a lower growth rate than other firms in the industry, it is reasonable that Autoliv is currently trading at a lower forward P/E when compared to the industry median. Furthermore, Autoliv s trailing twelve months P/E is also lower than the industry median, which can be explained by the antitrust investigation. Autoliv has a higher return on equity in comparison to the industry; however it has a lower price-to-book ratio than the industry median, which indicates that the stock is undervalued. The firm also has higher profit margin than other competitors and is trading at a price to sales ratio that is higher than the industry median, which is consistent with what one would expect. Autoliv s higher operating margin also explains its higher EV/Sales ratio in comparison to other firms in the industry. 2. Company Analysis Autoliv has considerable strength over its competitors in terms of market share of passive safety systems. Autoliv commands a 35% market share in the sale and production of passive safety systems, whereas its closest competitors (TRW Holdings and Takata Corporation) possess about 10% market share each. Autoliv is also very well positioned in all the world markets through its subsidiaries and joint ventures. Since it has operational facilities situated near its customers in all the major car production countries around the world, Autoliv is able to facilitate rapid delivery of its safety products to its customers. The company is able to supply its products to customers in a quick manner using just-intime delivery systems that accommodate the specific requirements of each customer. This provides the

3 company with a competitive edge over its closest competitors, Takata and TRW. Autoliv s active safety system products in particular are very innovative and are designed with the latest technology. The demand for their active safety systems has picked up in recent years, and the company is spending more on R&D each year to improve their active safety systems and meet the growing demand for active safety products. Autoliv is a supplier to all the major car manufacturers around the world, and the company s products are used in various models of vehicles from light to premium vehicles, and sedans to SUVs. Another strength of the company results from its power to acquire other smaller companies that gives Autoliv greater exposure to various developing markets. Furthermore, Autoliv possesses numerous patents that provide the company with a competitive advantage in developing products that its competitors cannot deliver. One of Autoliv s weaknesses is a result of its customers bargaining power. The major car manufacturers have exercised their power to demand lower prices, and so Autoliv must resort to quoting fixed prices over long periods of time for its products. In some instances, the car manufacturers require prices for Autoliv s safety systems to drop over time. Therefore, the company faces the tough challenge of reducing its fixed costs over time to make up for the reducing revenues. Another weakness that Autoliv currently faces concerns capacity utilization. The company states that it is approaching maximum capacity utilization, and it must expand its production facilities in order to meet the growing demand for its products due to the increased production of light vehicles globally. Autoliv s greatest opportunity stems from the rapid increase in global light vehicle production, at least in the short term. In addition, as the emerging countries continue to grow at rapid rates, consumers in those countries will demand more cars, which will result in increased demand for safety products such as those manufactured by Autoliv. Autoliv has a great opportunity to take advantage of these high growth rates in the developing economies, and the company is currently well positioned to do just that through its subsidiaries and joint ventures. Autoliv also has the opportunity to expand their production in the emerging markets, and it seems the company is seeking to expand in these countries through the expansion and development of new facilities in countries such as China, India, Brazil, and Thailand. Stricter safety standards and regulations by governments regarding automotive safety also present Autoliv with an opportunity to grow. As countries such as India, China, and Brazil continue to grow, stricter standards regarding automotive safety will benefit Autoliv if they are able to foresee the demand for safety products in these countries correctly. The threats that Autoliv faces as a business are similar to the threats that the auto parts and equipment sub industry faces. The cyclical nature of automotive sales and production due to the state of the world economy is one of Autoliv s major threats. A sluggish global economy is detrimental to Autoliv s performance as it is to other companies within the sub industry. The current unfavorable global economic condition due to debt concerns in the Euro Zone as well as the United States could hurt Autoliv s growth rates and affect the company s operating margins negatively. A worldwide reduction in demand for vehicles in general is a major concern for Autoliv. Another internal threat to Autoliv can result from the lack of commercial success of a vehicle model equipped with Autoliv s safety systems. Furthermore, changes in consumer trends can affect Autoliv s revenues negatively. Another concern to the company is the lack of sales diversification. In 2010, five of Autoliv s largest customers accounted for

4 53% of the company s sales which is a cause for concern. Autoliv also faces operational and exchange rate risk due to its multinational nature. Finally, Autoliv faces legal threats due to an antitrust investigation by the U.S. Department of Justice and the European Commission that could adversely impact the firm s earnings. The antitrust investigation is still ongoing and the firm expects that the decision (fine or penalty) by the Department of Justice could be material. The company s CEO has publicly stated that it is hard to quantify the results that the investigation will have on the company, but the investigation is expected to affect Autoliv s earnings materially in the year in which the results of the investigation are announced. 3. Industry Analysis Autoliv is included in the consumer discretionary sector. The consumer discretionary sector is made up of manufacturing as well as services segments. The manufacturing segment includes automotive, household durable goods, textiles, and apparel and leisure equipment. The services segment includes hotels, restaurants and other leisure facilities, media production, and consumer and retailing services. The total market capitalization of the consumer discretionary sector is $2.5 trillion. The automobiles and auto components industry group includes companies that produce passenger automobiles, light trucks, motorcycles, scooters and three-wheelers, parts and accessories for automobiles and motorcycles, and tires and rubber. Autoliv, which is a part of the auto parts and equipment sub-industry, is a manufacturer of auto parts and accessories such as steering wheels, air bags, and safety belts. The auto parts and equipment sub-industry consists of manufacturers of parts and accessories and motorcycles, excluding companies that produce tires and rubber. There are a total of 49 companies that make up the auto parts and equipment sub-industry. The total market capitalization of the sub industry is $ billion. Autoliv s total market capitalization as of October 20, 2011 is $4.89 billion. The auto parts and equipment sub industry is very competitive, and the sub industry has experienced significant consolidation during the past fifteen years. Autoliv has also engaged in the consolidation by acquiring numerous companies over the years to increase its market share. Companies in the auto parts and equipment sub industry compete on the basis of price, manufacturing and distribution capability, product design and quality, and product delivery and service. Autoliv has a favorable status in regards to the means of competition within the sub industry in comparison to its competitors. The outlook for the auto parts and equipment sub industry is bullish as the production of light vehicles accelerates globally due to increased demand from the emerging economies. Consumers in countries such as the United States, Japan, and Europe are also demanding smaller vehicles to combat higher gasoline prices. Stricter safety regulations from governments will also help the sub industry to grow at a relatively rapid rate. As countries develop, they tend to implement stricter automotive safety standards which will benefit companies like Autoliv as well as others in the auto parts and equipment sub industry. Furthermore, as the global economy begins to recuperate the auto parts and equipment sub industry should experience higher growth due to increased demand for vehicles and safety parts all across the globe. One resounding concern for the sub industry has to do with antitrust investigations by the U.S. Department of Justice. Currently, Autoliv and Magna Corporation are being investigated for antitrust practices, which could result in a material impact on both companies earnings. The threat stems from the

5 fact that the antitrust investigations could be extended throughout the entire sub industry which would lower the earnings prospects for firms within the sub industry. However, in the long run the growth prospects for the auto parts and equipment sub industry are very favorable, and I believe Autoliv is well positioned globally to take advantage of the high growth prospects of the sub industry. * Methodology The estimated fair value ranging between $57 and $78 was derived using the free cash flows to equity model. The high fair value estimate of $78 was obtained by estimating an annual nominal growth rate of 8.09% for Autoliv by evaluating the firm s growth potential in North America, Europe, Japan, and The Rest of the World. Taking into account a three-stage growth model, I forecast that Autoliv s high growth rate of 8.09% will transition into a stable annual growth rate of 6.2% over a period of ten years. These growth rates were calculated based on the global economic outlook as well as the auto parts and equipment sub industry outlook. The lower fair value estimate of $57 was derived after taking into account the antitrust investigation and the effects the investigation could have on Autoliv s earnings and future operating prospects. To price in the effect of the antitrust investigation, I adjusted Autoliv s high growth rate downward from 8.09% to 7.0% beginning in 2013 (the year in which I believe the company may be penalized), and also lowered the company s stable growth from 6.2% to 5.0% in the year 2020.

6 Appendix: Multiples Comparable Firms Firms P/E (ttm) Forward P/E PEG Ratio P/B P/S EV/EBITDA EV/Sales Growth ROE Profit Margin Operating Margin Visteon Corporation % % 13.63% 4.06% Lear Corporation % 21.98% 3.99% 5.78% TRW Automotive Holdings % 40.56% 5.86% 8.13% Gentex Corporation % 17.77% 16.35% 22.95% Commercial Vehicle Group % % 1.63% 5.18% Johnson Controls Inc % 15.95% 3.98% 4.87% Strattec Security Group % 9.56% 1.98% 3.75% Stoneridge Inc % 15.58% 1.97% 3.58% Wonder Auto Technology % 17.20% 11.04% 11.45% Autoliv % 21.15% 7.94% 11.52% Average % 96.87% 6.84% 8.13% Median % 19.46% 4.93% 5.48% Sources: Google Finance and Yahoo! Finance *growth rates are average growth rates from analysts covering the stock. The growth rate used in the DCF are based on fundamental growth rates. Historical multiples P/E ttm Your Firm S&P P/B ttm Your Firm S&P P/S ttm Your Firm S&P Source: Morningstar, Inc.

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