Source: Gentex
Most automotive suppliers sell undifferentiated automobile parts to a few big powerful automakers. As a result they have little bargaining power with their customers and low profit margins.
Furthermore, an increasing number of automotive suppliers are either facing price pressure from existing products manufactured under older, conventional technology or not investing sufficiently in research and development to churn out new products with new, advanced technology. Gentex (GNTX 1.52%), a leading manufacturer of automatic-dimming rearview mirrors and electronics, is a different kettle of fish altogether.
Revenue model still intact
Many automotive suppliers face revenue concentration risks of some sort or another, but this isn't something seen with Gentex. With respect to customer concentration, Gentex does business with more than 22 automakers, with only three of its customers accounting for more than 10% of its 2013 sales and none of them exceeding the 15% mark.
Another major concern is regarding the automotive supplier's dependence on U.S.'s Big Three automakers. A decade ago, the Big Three automakers made up close to half of Gentex's revenues. In 2013, General Motors, Ford, and Chrysler represented only a quarter of its sales. In fact, European and East Asian automakers take up most places among Gentex's list of the top 20 vehicle platforms, with North American vehicle platforms only accounting for four places on the list.
Given that Gentex has grown its revenue and earnings strongly by a five year CAGR of 13% and 22% respectively, there are concerns that Gentex's end markets are saturated. Based on Gentex's internal estimates, this is hardly the case since only 24% and 6% of all vehicles are equipped with interior and exterior auto-dimming mirrors respectively as of 2012.
Spending on the future
According to an Ogilvy study, companies that maintain or increase their advertising spend in a recession achieve higher growth in terms of market share both during the recession and for three years thereafter. The results of this study are a strong validation of companies investing for the future.
Gentex understands this dynamic very well and has invested an average 6.8% of its revenues in R&D over the past 16 years. There have been concerns over the fact that R&D as a percentage of sales exhibited a falling trend down from 8% in 2011 to 6.5% in 2013. Gentex claims in its latest 10-K that "temporary outside contract engineering and development services" are responsible for the decline.
Another automotive supplier which is a firm believer in investing for the future is BorgWarner (BWA 0.17%), a provider of drivetrain and engine applications. It has spent close to 9% of its sales on R&D expenses for every year from 2011 to 2013. The results can be assessed both quantitatively and qualitatively. BorgWarner grew its revenues and earnings by a CAGR of 9.6% and 18.3% over the past three years.
Since 2005, it has also won twelve awards at the Automotive News PACE Awards, literally the automotive supplier equivalent of the Oscars. Winners like BorgWarner are recognized for their superior innovation, technological advancement and business performance.
BorgWarner is estimating that its new businesses will contribute about $2.9 billion over the next three years from 2014 to 2016. This isn't any small amount; in fact, $2.9 billion represents about 40% of BorgWarner's 2012 sales.
Source: Gentex
Preparing for the next runway of growth
Gentex has diversified beyond the automotive industry by applying its auto-dimming technologies to products outside of cars. Since 2010, Gentex began selling electrochromic dimmable aircraft windows to the aviation industry. Current customers include Boeing and All Nippon Airways. In 2013, sales of dimmable aircraft window sales increased 62%, albeit from a smaller revenue base. This was on top of a growth rate of 56% for this product segment in 2012. Gentex is a pioneer in this product category in the aviation industry and should gain more market share with increased adoption.
Similarly, Autoliv (ALV 1.66%) was never content with being a market leader in passive safety products such as seatbelts and airbags. It was an early mover in active safety and is now reaping the fruits of its efforts. Autoliv estimates that it had a 24% market share of active safety products such as brake-assist and traction-control systems in 2013.
While the revenue contribution from active safety remains small at 4% of sales, it was the fastest growing business segment for Autoliv with a 57% year-on-year growth. Given that active safety will be included as part of the rating criteria for automobiles in Australia, Japan and the U.S. this year, Autoliv should benefit from increased demand for active safety products going forward.
Foolish final thoughts
While many investors perceive automotive suppliers as sellers of commoditized products with little pricing power, Gentex has set itself apart from its peers with its financial track record. It has maintained its gross margins within a 33%-37% range over the past nine years and has remained profitable and free cash flow positive over this period.
Gentex stands out for its low revenue concentration risks, commitment to product innovation and huge growth opportunities in its core and ancillary markets, make it one of the best picks among listed automotive suppliers.
