Get Your Part Of Future Growth

By Chad Henage - May 10, 2012 | Tickers: ALV, GNTX | 0 Comments

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Despite the recent headlines, there are encouraging reports that the economy is improving. With that in mind, companies that are in cyclical industries should benefit. This lead me to run a screen on Motley Fool's CAPS Screener for auto parts manufacturers. While picking a specific auto manufacturer is more difficult because of shifting customer preferences, auto parts are supplied to all of the manufacturers. My screen had simple but tough criteria. I wanted companies of at least $300 mil. in market cap., a 2% or greater dividend, 10% or better trailing earnings growth, and at least a 4 – 5 star rating by the CAPS community.

This screen turned up two names that I thought might be attractive, before this theoretical upturn in auto parts sales. The two companies are Autoliv (NYSE: ALV) and Gentex (NASDAQ: GNTX). While both companies provide auto parts, Autoliv focuses more on the automotive safety systems, and Gentex is more well known for auto-dimming mirrors. Gentex is more diversified, providing smoke alarms and smoke detectors, as well as alarm systems and windows for aircraft manufacturers. That being said Gentex is still primarily a play on the auto industry, as automotive products made up 98% of the company's revenue in the most recent quarter. Which company is the better buy? Let's run both companies through a few tests to find out.

On a PEG basis it seems that Gentex is the better buy. If Gentex can produce the 19% EPS growth that analysts are expecting, its higher growth rate would be well worth the higher P/E ratio. (Autoliv – 1, Gentex – 2)

One challenge with accepting earnings expectations is that companies don't always meet these numbers. While I know that historical performance isn't a predictor of future performance, it can act as a guide. Look at how each company has done versus estimates in the last four quarters:

Autoliv gets points here for both a better overall record of beating estimates by 4.6%, and because they missed only once in the last year. (Autoliv – 2, Gentex – 1)

While earnings performance is one indicator of how a company is doing, I believe that free cash flow is a better indicator of what a company can do for its shareholders. It makes sense to compare free cash flow to each dollar of assets, so you can compare companies of different sizes. Autoliv has outperformed Gentex by a large margin in this area. Autoliv generated $0.064 of free cash flow per $1 of assets in the last year, versus $0.018 of free cash flow for Gentex. With over 3 times the free cash flow per the same $1 of assets, Autoliv in theory can do much more for shareholders through dividends and share buybacks. (Autoliv – 2, Gentex – 1)

Dividends have been consistently shown to be an important part of total returns in the market. With this in mind, if you can find a company with a good dividend and good dividend growth, you usually should invest in that company. On just a current yield basis, Autoliv is more attractive with a 3.09% yield versus Gentex's 2.23% yield. When it comes to dividend growth, this is a more difficult category to determine a winner. Autoliv increased its dividend consistently until 2008 to about $1.60 a share, when it was cut to just $0.21 for 2009. By 2010, the dividend jumped to $0.65, then in 2011 and this year the company resumed its upward track, as though nothing happened. Gentex on the other hand barely increased its dividend from last year to this one, and did not raise it at all between 2009 and 2010. However, over the last 5 years, Gentex has grown its dividend by 4.47%. Long story short, the dividend cut for Autoliv's shareholders was painful, but over the long haul Autoliv has the better record. An additional reason to favor Autoliv is, Gentex's free cash flow payout. In the last three years, Gentex's free cash flow payout has increased from 67.7% to 312%. With such a high payout ratio, Gentex will either need to show huge cash flow growth, cut capital expenditures, or cut the dividend. (Autoliv – 2, Gentex – 1)

Last, let's compare the two company's balance sheets. Autoliv shows a debt-to-equity ratio of just 0.109. Gentex comes in a little better showing no long-term debt at all. Both companies have very strong balance sheets, but no debt always wins. (Autoliv – 1, Gentex - 2)

The totals are Autoliv 8 and Gentex 7. While it's very close if I had to choose, I would side with Autoliv. First, because the company has relatively low expectations for future growth in EPS and has a history of beating those expectations. Second, because a 3% dividend from Autoliv that appears sustainable is better than a 2.23% dividend from Gentex that seems unsustainable. Third, because Autoliv generates 3 times the free cash flow of Gentex, which can be used for future dividend increases or share buybacks. Let me know what you think in the comments section below.

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