Gentex Is a Stable Option in a Volatile Auto Parts Sector (NASDAQ:GNTX)

These are not good days for the automotive supplier sector. Global car sales are weakening in most major markets, and the timelines for introducing new platforms, especially new EV platforms, are much more confusing than before. This is difficult for powertrain suppliers as BorgWarner Inc. (BWA), but for suppliers with ambiguity regarding drive systems, such as Gentex Corporation (NASDAQ:GNTX) considering the higher standards of ADAS features, it’s not that bad at all.

When I last wrote about Gentex (in early 2022), I thought there was significant near-term headwinds to warrant staying on the sidelines, and the stock fell another 20% or more at its lowest point before resuming growth on improving volumes, improving mix, and better cost leverage. Since my last article, the stock is up about 11%, roughly in line with another powertrain-agnostic supplier. Autoliv, Inc. (ALW)) and surpassing most other providers.

I am more bullish on Gentex now. I have some concerns that the 2024 auto production expectations are too high (and Gentex tends to be conservative in its forecasts), but I like what I see in the mix improving as the company sees better adoption of higher-value products like its Full Display Mirrors. Investors should be aware that this stock often trades disproportionately to short-term auto production/sales sentiment, but mid-single-digit revenue growth and a return to low 20% free cash flow margins could support a worthwhile return from here.

Second-quarter growth likely depends on mix

I don’t think the circumstances are favorable for Gentex to beat sell-side expectations based on improved underlying vehicle production volumes. While S&P was expecting a 3% year-over-year improvement in light vehicle production in Q2’24 when Gentex last reported, sales since then have been pretty weak. I haven’t seen any global production reports for Q2 yet, but I would expect it to fall short of that 3% target when the numbers are released.

This doesn’t automatically mean Gentex missed out on revenue, but it does make the comparison more difficult. Gentex undersold North American production in Q1 (and oversold overseas a bit), and I’m a little concerned that OEMs may continue to reduce inventory in the face of weaker demand.

This is offset by the ongoing mix improvement. This has been a significant driver over the last two quarters, with ASP growth of 7% in Q4’23 and almost 10% in Q1’24 (with a 1% QoQ decline in Q1’24). Assuming OEMs continue to prioritize their higher margin and feature-rich models, I believe this could continue to support revenue growth in Q2 and I think 7% to 8% revenue growth is achievable.

If this happens, and Gentex does indeed see greater demand for mirror products with more features, margins should improve and profits in the $0.53-$0.55 range may be achievable.

Even if that happens, I think there will be a lot of focus on mirror units and any revisions to management’s expectations for 2024 production growth, not to mention specific guidance on revenue and gross margin. So it’s not unreasonable to think Gentex could see a modest improvement but still lower guidance for the second half of the year due to weaker global auto demand.

Blend remains key driver, but management is expanding its target markets

Given the recent quarterly results and the March Investor Day, it is clear that organic growth in the core mirror business is the priority today. However, this is not the sole priority as management intends to deploy its core technologies in other target markets.

Management has shelved needed capacity additions during the pandemic, but has been much more active recently, with capex in fiscal 2022 ($150 million) and fiscal 2023 ($188 million) more than double the average of the previous three years. While first-quarter capex is on a year-over-year basis at a lower amount (around $120 million), management is forecasting more than $225 million in 2024, so expect to see more capacity additions as the year progresses.

In addition to building capacity to handle further unit volume growth, management continues to seek to gain share based on product performance characteristics and increase ASPs through stronger adoption of more advanced products. The company’s Full Display Mirror (or FDM) essentially transforms the rearview mirror into a display unit and has an ASP about 10 times higher than its standard products.

One sec General Motors Company (GM) was a strong early adopter, other OEMs have also included the product in recent launches and it remains a multi-year growth engine. Further growth of this product should be aided by Gentex introducing new versions that integrate more driver and cabin monitoring features, especially as the EU mandates driver monitoring systems in new models.

Thinking a little bigger, management intends to apply its core technologies to new products, such as tinted surfaces (sun visors, privacy glass, etc.) and sensors to monitor cabin air quality.

Gentex management has also been looking for growth opportunities around its core capabilities. The recent introduction of HomeLink Smart Home Solutions is obvious, given that the company already sold vehicle-to-home communication systems (enabling remote control of garage doors, gates, home lighting, etc.); this new iteration controls and monitors those functions through a single app.

The company recently launched PLACE, a smart home threat detection product that leverages the company’s expertise in fire protection (smoke detectors and carbon monoxide detectors/alarms) to create a wireless smart home threat detection product.

Taking it a step further, the company is an investor and collaborator ADASKYa small company with a proprietary long-wave infrared (LWIR) sensor offering thermal sensing. More ADAS platforms are incorporating thermal sensing to complement visual sensing technologies and improve animal and pedestrian detection.

Gentex has also begun to market products derived from the acquisition. eView earlier this year. This small company uses components like cameras to help improve vision for the visually impaired. I’m less confident about this product, given the completely different marketing and distribution requirements, but it’s at least an interesting technology, and the price tag ($19 million) wasn’t high.

Appearance

I have some modest concerns that management may be spreading its goals too thin with some of these recent acquisitions and product launches. Smoke/CO detection in homes is not a stretch, and I understand ADASKY’s logic, but eSight is more of a stretch to me, as is the company’s partnership with The power of comfort in wireless power transmission. On the other hand, there is probably a limit to how far you can go with mirrors, and a broader approach to ADAS and the car’s cabin (safety, communications, infotainment, etc.) makes strategic sense.

My FY24 revenue expectations are below the Street and management estimates; it’s not that I don’t find management credible, but I’m more bearish on auto volumes. I’m also below the Street in FY25, but I’m looking at five-year growth of around 6% and long-term revenue growth of just under 5%.

On the margin side, I expect almost 150bps YoY improvement in FY’24 due to improved mix, favorable price/cost tailwinds, operating leverage, etc. I think EBITDA margins can return to 30% or higher over the next four years, but I think competition and increased R&D spend could make it quite difficult to get back to 30% margins. On the cash flow side, I expect a fairly rapid return to 20%+ FCF margins as capital expansions wind down, and a slow improvement towards 20% or lower over time will drive high single-digit (around 9%) FCF growth.

Discounting these cash flows gives me a fair value of close to $39. This is harder to achieve with conventional EV/revenue and EV/EBITDA based margins/returns, but that’s because Gentex’s higher margin and more stable business mix doesn’t fit the typical profile of an automotive supplier. However, a multiple of 12x doesn’t seem out of place, and that also gives me around $39 in my 12-month EBITDA estimate.

Summary

The only real problem I have with recommending Gentex is the risk that the car business will falter this year, and the stock’s earnings and mix improvement won’t make up enough to satisfy the Street. That said, I love the company’s history of innovation and its ability to consistently generate well-above-average margins; trading at a discount, I think it’s worth a look for long-term investors.