Aptiv: A Sentiment Driven Stock At an Early Stage of Strategic Transformation

Summary Perspectives

Aptiv is a successful case study of how a powerful investor communication narrative can dramatically change the perception of a Company – doing work is not enough, you need to proactively market it
Historically an automotive OEM supplier, Aptiv aspires to become a technology company through its Smart Vehicle Architecture solutions, focused on providing electrified software-defined vehicles
This change of perception translated into a significant multiple re-rating during the period of COVID recovery, buoyed by the rise of autonomous driving and electrification
Aptiv has a solid platform to become an exciting industrial technology powerhouse, but there is a lot of work to be done still, and the Company is just at the beginning of this long journey
If successful at pivoting, Aptiv could create meaningful shareholder upside; however, there are a lot of execution risks which will require a pedigreed management team that has deep experience running both hardware and software businesses
Given its large automotive exposure today, we expect to see continued choppy bottom-line earnings for a while

The Business

Aptiv, formerly known as Delphi Automotive PLC, is a leading global technology and mobility architecture company primarily serving the automotive sector. At the end of 2017, Delphi Automotive completed the spin-off of its Powertrain Systems segment. The remaining portfolio comprised of electronics & safety and electrical / electronic architecture businesses formed Aptiv. Aptiv’s CEO, Kevin Clark, had a vision of creating a Smart Vehicle Architecture (“SVA”) defined by software / advanced computing platforms (‘brain’ of the vehicle) and networking architecture (‘nervous system’). Aptiv’s trademarked SVA concept seeks to create a sustainable architecture and open platform that minimizes the total cost of ownership of highly automated vehicles.

Over next few years, Aptiv made progress towards this vision with two-pronged strategy – expanding competitive advantages for its core automotive business, and at the same time increasing earnings predictability by extending its technology to non-automotive sectors. With this strategy in mind, Aptiv went through a busy period of portfolio actions that averaged 2 – 3 acquisitions and JV’s per year. Historically, Aptiv focused on acquiring businesses that manufacture engineered components in connectors and cable management solutions, while diversifying away from its automotive exposure. The Winchester acquisition in 2018 positioned Aptiv to compete with Industrial Technology players such as Amphenol, TE Connectivity, Molex and others. It wasn’t until early 2022 that Aptiv made its first significant acquisition of Wind River, a global leader of $400 million revenue that delivers software for the intelligent edge, for $4.3 billion in cash. The enterprise value represented close to 11x of Wind River sales.

We like the Wind River deal, albeit an expensive one for Aptiv. Wind River provides a contemporary, open-source intelligent edge compute, cloud-native solution that dramatically enhances Aptiv’s middleware operability and performance management, enabling Aptiv to provide the full stack solution to its customers. Traditionally a manufacturing company, Aptiv’s ability to integrate and expand Wind River’s solutions to its automotive customers will be key in achieving its Smart Vehicle Architecture vision.

Today, Aptiv is organized into two diversified segments: 1. Signal and Power Solutions (74% of 2021 sales) and 2. Advanced Safety and User Experience (26% of 2021 sales). The Signal and Power Solutions segment provides complete electrical architecture and component products including engineered component products, connectors, wiring assemblies and harnesses, cable management, and others. The Advanced Safety and User Experience segment provides vehicle technology and systems integration expertise in advanced safety, user experience and connectivity and security solutions, as well as advanced software development and autonomous driving technologies.

Since 2013, total sales have grown at a CAGR of 5%. This growth is admirable compared to global vehicle production. However, as Aptiv continues to evolve into an industrial technology company, this growth profile will no longer be sufficient (best-in-class industrial technology company – Amphenol – delivered 11% compounded annual growth rate with increasing profitability over last decade).

With respect to EPS, Aptiv has delivered very choppy performance through its history. This trend was especially pronounced in recent years where corporates were faced with a challenging macro environment, driven by sustained COVID impact, supply chain disruptions, semiconductor supply shortage, high interest rates and inflation, and geopolitical risks. The unpredictable earnings profile precisely emphasizes Aptiv’s long history of large exposure to the automotive industry, highlighting the need for diversifying its end-market exposures. Until that is fixed, we continue to expect choppy earnings going into future, which makes earnings forecast extremely difficult for this Company. This explains why Wall Street has never been good at providing accurate forecast for Aptiv.

Public company information
Note: All historical financials adjusted for the spin-off of the Powertrain segment.

Industry Dynamics and Growth Catalysts

Aptiv mainly participates in the automotive technology and components industry today. Along with the overall automotive industry, Aptiv is increasingly progressing towards software-defined vehicles as the traditional OEMS and software providers rapidly converge, driven by safe, green and connected megatrends. The last few years were especially challenging for Aptiv, as global vehicle sales and production experienced muted growth, driven by adverse impacts from COVID, semiconductor supply shortages, high inflation, among other macro-economic factors.

While OEM demand is tied to vehicle production, players in the automotive technology and engineered components industries should see an increased content per vehicle driven by increasingly complex vehicle architecture as electrification and autonomous driving become more mainstream. As a result, increasing electrification and autonomous vehicles will create additional growth opportunities for Aptiv’s advanced technologies.

Overall, the automotive technology and components industry remains extremely competitive with a large tail of small players across the world. Aptiv’s competitors can be segregated into two major groups. First is the engineered components competitors led by Amphenol, TE Connectivity, Molex, Yazaki and many others. The second group is the legacy automotive OEM suppliers including Lear, Bosch, Continental, Denso, Magna, Valeo, Visteon and many others.

As Aptiv is increasingly focused on expanding its software offering and diversifying end-market exposures outside of automotive, they will increasingly compete with other middleware players. Today, this presence is relatively small, but something to be kept in mind as Aptiv continues to become a more diversified technology platform providing a truly full-stack solution to its customers.

Valuation

Aptiv’s stock has been on a roller coaster. The stock benefitted from the rapid rise of automotive technology when COVID accelerated the penetration of electrification and autonomous driving. It was no coincidence that early-stage automotive technology companies led the initial wave of SPAC mergers. Despite its declining sales and profitability, Aptiv stock was sent to meteoric levels unseen before, outperforming all industrial technologies and traditional automotive OEM peers.

As investor optimism waned and macro became challenging, Aptiv stock nose-dived. Investors fled to high quality industrial assets with long track records of excellent operating history, quality earnings, and shareholder friendly capital allocation strategies.

Data by CapIQ
Note: Industrial Tech Peers include Amphenol and TE Connectivity. Auto OEM Peers include Lear, Continental, Denso, Magna International, Valeo, and Visteon

As a result, Aptiv’s valuation multiples reverted back to pre-COVID levels. We believe the days for euphoric valuation levels are over and multiples will continue to trade at current levels until Aptiv has proven to the market its ability to profitably grow its strategic initiatives, while reducing volatility in its operating performance.

Aptiv is now a show-me story. The market is waiting to see a successful transformation that will finally match its promises and narratives to the public.

Risks

As energy transition and decarbonization become the most important topic facing the world today, automotive technology is front and center for enabling a net-zero society. This makes automotive technology a fundamentally attractive market poised for long-term growth in the decades to come. It’s undebated that there are a lot of exciting developments happening within Aptiv, however, the biggest challenge remains the execution risk.

For the transformation to be successful, there will be a lot of work to do beyond current CEO Kevin Clark’s term. The next leader must have the right mix of business acumen that deeply understands both the legacy hardware business which forms the bedrock of the Company and the next-gen software offerings that will take the Company to next phase of growth.

A new Aptiv in the future will face intense competition from both old and new economies as more and more competitors enter automotive technology. To maintain its competitive advantages, Aptiv will need to continue to invest in software opportunities that are not cheap to acquire. Therefore, management’s ability to manage cash flow and profitability will be extremely crucial.

Closing Thoughts

We think Aptiv is a good company and has the right-to-win in the race of automotive technology; however, valuation driven by purely positive sentiment and outlook is gone. Investors are taking a more rational approach to the stock and waiting to see if Aptiv’s operating performance will match its marketing narratives. It is a show-me story today, and management has a lot of work to do.

Disclosure: This article solely represents Her Investing’s opinions. Her Investing is not receiving compensation for it, nor has any business relationships with any company whose stock is mentioned in this article.

Aptiv: A Sentiment Driven Stock at an Early Stage of Strategic Transformation