Autoliv is a Growth Stock Hidden in a Mature Industry

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When most investors think about the auto parts industry, they tend to envision a mature, cyclical industry that grows at roughly the same pace as GDP and lacks attractive growth opportunities. However, adopting this kind of mainstream perspective may cause investors to overlook Autoliv, Inc. (NYSE: ALV), a manufacturer of automobile safety equipment that has a long history of innovation and, in my opinion, the potential to grow its profits much more rapidly than the auto industry as a whole during the coming years. I believe Autoliv is the best-positioned player within the auto safety equipment manufacturing niche, as direct competitor TRW Automotive (NYSE: TRW) is strapped down by poor financial healthy that has crimped its ability to spend on research and development (R&D), and therefore continue innovating cutting edge safety equipment. Autoliv’s modest valuation multiples, especially compared to those of other auto part suppliers with similarly strong competitive positions, such as Gentex Corporation (NASDAQ: GNTX), means that Autoliv shares should appeal not only to growth investors but to value seekers as well.

Proud Heritage and a Bright Future

Autoliv has long been one of the largest and most successful automobile safety equipment manufacturers in the world. Since its founding six decades ago, the Swedish company has pioneered safety innovations such as the three-point seat belt and side-impact air bags. As the auto industry has evolved over the decades, the dollar amount of safety equipment installed in the average vehicle has steadily increased, partly due to regulatory demands, and partly due to consumer preferences for higher auto quality standards. As the emerging economies in Asia, South America, and other places continue to become wealthier, consumers in those nations will likely demand increased safety features in their cars. In its June 2013 presentation, Autoliv demonstrated that a huge gap exists between the safety equipment dollar content per vehicle in developed countries versus those in developing economies.

Safety Equipment Content per Vehicle, by Country

<table> <tbody> <tr> <td><strong>China  </strong></td> <td>$210</td> <td>        </td> <td><strong>U.S.  </strong></td> <td>$440</td> </tr> <tr> <td><strong>India</strong></td> <td>$60</td> <td>    </td> <td><strong>Germany  </strong></td> <td>$470</td> </tr> <tr> <td><strong>Brazil</strong></td> <td>$140</td> <td> </td> <td><strong>Japan</strong></td> <td>$375</td> </tr> </tbody> </table>


As consumers in developing economies such as India, China, and Brazil become wealthier, it is likely that they will also demand vehicles with the latest safety features, helping to close the gap in safety content per vehicle between developing and developed countries depicted in the chart above. Therefore, even if the absolute number of vehicle sold around the globe does not grow at a particularly rapid rate, Autoliv can still expand its profits at a robust clip because of the seemingly inevitable rise in the dollar content of safety equipment per each vehicle sold.

Can Autoliv Fend Off the Competition?

Although Autoliv is not the only player within the auto safety equipment sector, it is the best positioned manufacturer within the niche, in my opinion. Autoliv’s major competitor within the sector is TRW Automotive, which has similarly enjoyed a long and successful history of innovation. However, TRW’s relatively poor financial health has crimped its ability to spend on R&D, which is critical to innovating and fleshing out the development pipeline of cutting-edge safety equipment.

TRW’s debt to equity ratio at the end of 2012 was 0.38, while the firm covered its interest expenses with operating income 10.1 times in 2012. By contrast, Autoliv’s financial health metrics look much healthier, with a debt to equity ratio at the end of 2012 at 0.15, and an interest coverage ratio of 17 times in 2012. TRW’s poorer financial health relative to Autoliv may have contributed to TRW skimping on spending on R&D. In 2012, TRW only spent $164 million of its own funds on R&D (or just 1% of sales), while Autoliv spent $455 million of its own funds on R&D, representing a whopping 5.5% of sales. Autoliv’s increased R&D spending relative to TRW will allow it to innovate better safety equipment products than its competitor, in my opinion, strengthening Autoliv’s competitive position within the auto safety equipment space going forward.

Thoughts on Valuation & Conclusion

Despite its tremendous growth potential, Autoliv is still trading at decent valuation multiples. As of July 9, 2013, Autoliv was trading at 15.1 times trailing twelve month (TTM) earnings, which is pretty close to the P/E ratio for the broader U.S. market such as the S&P 500 despite Autoliv’s better-than-average growth profile. Granted, TRW was trading at 9.2 times TTM earnings as of July 9, but TRW is also a much weaker competitor than Autoliv, as I previously explained. A better comparison to Autoliv might be auto mirror manufacturer Gentex. Like Autoliv, Gentex is a strong, entrenched player within its niche sector (automobile mirrors) with a history of innovation and a strong R&D budget to keep the innovation pipeline flowing and competitors at bay. For example, Gentex’s 2012 R&D spending represented a solid 7.7% of total revenue. However, Gentex was also trading at a steep 20.1 times TTM earnings as of July 9, 2013. By comparison, investors can scoop up Autoliv, another solidly positioned auto part supplier with a very attractive growth profile, at a much more reasonable 15.1 times P/E ratio. Given its modest valuation, solid competitive advantages, and a robust growth profile, Autoliv is undoubtedly an interesting stock for investors looking for growth at a reasonable price.

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John Park has a long position in Autoliv. The Motley Fool recommends Autoliv and Gentex. The Motley Fool owns shares of Gentex. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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