Is Delphi an Attractive Key to the Auto Industry?

By Tom Gibbs - April 24, 2012 | Tickers: DLPH, GM, VLKAY | 0 Comments

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Delphi Automotive (NYSE: DLPH) has come a long way since its pre-2009 General Motors (NYSE: GM)-controlled days.  In the completion of its messy spin off from the parent automaker, Delphi was forced to spend several years in bankruptcy protection and sold 11 businesses, closed production at 41 sites, and cut its U.S. workforce by nearly 90%.  Left as merely a shell of its former self, the auto parts and components manufacturer has:

• Grown Revenues: $16 billion in revenues in 2011 is up from $11.1 billion in 2009.  The quarterly filing that the corporation released yesterday highlights an additional 2.4% revenue increase between Q1 2011 and Q1 2012 to $4.1 billion. 
• Increased Business Bookings: First quarter 2012 new business bookings of nearly $8 billion compares with the sub-$5 billion in new business the corporation generated in the first quarter of 2010.  (Bookings represent the lifetime revenues associated with a given business program.)
• Expanded Business Diversification: Delphi has not only broadened its customer portfolio (it works with no less than 50 individual vehicle/motorcycle manufacturers), but it has also more deeply penetrated emerging markets.  More than 90% of its revenues were generated in North American and European markets in 2005, and today nearly a quarter of revenues stream from emerging nations in the Asia Pacific and South American markets. 

Despite appreciating by more than 45% since its late-2011 IPO, there is still a substantial amount of pessimism surrounding Delphi’s mid-term operating experience.  Reduced consumer spending and automaker overcapacity in the European sector, as well as slower-than-expected growth in the Chinese auto market, are but two of the macro drivers plaguing the entire auto industry.  Selling for slightly more than 8x 2012’s earnings, and with significant room to grow faster than the unit volume growth rate in the greater auto industry, Delphi appears to offer an attractively diversified holding at current market valuations. 

Where Growth Will Come

Delphi operates within several of the auto components markets, including electrical (connectors, wiring assemblies), powertrain (fuel injection, combustion, electronic controls), safety (displays, body controls, navigation systems), and thermal/HVAC systems.  Several long-living key trends within the industry will continue to fuel solid growth going forward.

• Fuel Efficiency: All of the most important growth markets within the auto industry are increasingly being governed by heightened fuel economy standards.  The U.S. government's CAFE regulations, which are targeting a 54.5 mpg average fuel economy rating for passenger vehicles by 2025, as well as similar regulations signed within the European Union and China, are making all automakers and parts suppliers scramble to drastically boost their products’ efficiency.  Although efficiency gains can be reaped through the tweaking of auto design on many different levels, it will be most cost effective for automakers to focus on more economical fixes before overhauling their entire product lines with hybrid propulsion systems, for instance.  Lighter weight materials in wiring and interior component parts, for instance, as well as more efficient HVAC systems, are not only several of Delphi’s key core competencies but are also the areas that will be exploited by all automakers on all autos in their race to meet fuel efficiency standards.  Components including Delphi’s miniaturized/light-weight cables and ultra-thin and light interior components will allow automakers to eke out meaningful fuel efficiency gains across their entire product portfolios relatively inexpensively (in terms of input costs and the time it takes to incorporate the products into auto designs). 
• Safety: Governments are also continually tightening safety regulations, and consumers, who increasingly understand the benefits of having additional safety equipment on their vehicles, are becoming less willing to have some of these safety features being installed optionally.  The EU Transport Policy, which seeks to reduce road fatalities by 50% between 2011 and 2020, for instance, is regulating the mandatory use of collision warning systems in commercial vehicles in 2013.  Likewise, the U.S. DOT, which has cited that more than 200 deaths and 17,000 injuries occur every year from backover accidents (a vehicle backing into other vehicles or pedestrians), has proposed mandatory back-up cameras in all vehicles by 2014.  The level of safety regulation in the auto industry will never become relaxed, and the suppliers of such safety equipment will be the beneficiaries of such proposed legislation.
• Connectivity: Auto technology has made phenomenal progress on the communications frontier since the installation of the first in-dash radio system.  Today, consumers do not only have satellite radio options from entertainment providers like Sirius XM, but have the ability to remain completely connected to the outside world via smartphone integration and GPS technology.  Although the demand for these optional extras will not be reinforced by government regulation as will fuel efficiency and safety standards, the consumer demand is no less robust.  A large majority of the unique product purchase decisions by consumers are fueled by the package of goods that are included with a given automobile, and it is generally the “coolest” product for a given amount of money that wins the purchase dollars.  As a result, one of the largest trends within the industry is to integrate affordable luxury within family passenger cars – hands-free calling features, auxiliary connections between radio systems and MP3 players, and turn-by-turn navigation systems are increasingly being included on traditionally non-luxury models. 

The expected market growth rates for each of these individual product segments – safety 4.7%, fuel efficiency 5.4%, and connectivity 11.7% CAGRS by 2014 – are expected to give way to a Delphi revenue growth rate that will exceed the growth in vehicle units sold within the greater industry. 

Europe Exposure

One of the primary downsides to any investment within the auto industry is that there is an inevitable exposure to several unfavorable markets.  The greater economic issues within the European segment are undoubtedly going to plague the operations of automakers and auto parts suppliers alike for the foreseeable future, and Delphi is no exception.   The corporation did generate 45% of its sales from European-based operations in 2011, as compared to 32% in North America and 16% in the Asia Pacific realm.  The total risk associated with Delphi operations, however, is less reliant on consumer demand for autos in the European market than many would expect. 

European-based automakers, including the primary three German manufacturers – Volkswagen (NASDAQOTH: VLKAY), BMW, and Mercedes – are increasingly generating more and more business from international markets.  Mercedes, which assembles the vast majority of its cars in Europe and which manufactures almost all of its powertrain components in Germany, sold 38% of its units in the European market in 2011.  This is down from 50% in 2010.  The same holds true for Volkswagen and its luxury arm Audi.  The vast majority of the brand’s capacity lies within the European sector, yet emerging markets are increasingly representing a higher proportion of total sales.

• Audi Sales
• Europe – 60% of total in 2010, 55% of total in 2011
• China – 20% of total in 2010, 24% of total in 2011
• South Korea, Mexico, Brazil, and India experienced growth rates (2011 vs. 2010) of 30.9%, 46.8%, 68%, and 83.5%, respectively

As long as Delphi supplies input components to automakers that sell cars within the European market, it will not be completely isolated from the market’s woes.  As popular European makes continue to enjoy swiftly growing demand in emerging markets and erase more and more reliance on the European market for revenue streams, however, Delphi’s already overstated exposure will also decrease.   

The corporation’s new business bookings also show that growth in the auto market’s fastest growing segments is also insulating Delphi from additional European risk.  Although 45%, 32%, and 16% of 2011 revenues stemmed from European, North American, and Asia Pacific markets, respectively, new business bookings within the first quarter were in favor of additional penetration in non-European sectors – 36% of new business was written in North America, 33% in Asia, and 25% in Europe. 

It is currently one of the most favorable times to invest in the auto industry.  Significant growth is being experienced in emerging markets due to increasing populations and discretionary consumer incomes (nearly 30 million units are expected to be sold in China by 2020, up from 18 million in 2011), and even developed and mature markets are experiencing strong rebound growth due to the huge level of pent-up demand that was built during the recent recessionary low period.  Delphi offers an attractively inexpensive opportunity that limits exposure on the success of one given automaker, and because the corporation is the supplier of key component parts that underlie some of the most highly demanded vehicle features today (safety, fuel efficiency, connectivity), Delphi’s future growth trajectory will be more robust than the simple growth in unit sales that the auto industry will experience over the next several years. 

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