Keeping Competition in the Rearview- An Overview of Gentex

Overview

An overview of Gentex Corporation
My thoughts on the stock’s current value
If I believe it’s a good buy

Company Background & History

Gentex was founded in 1974 and headquartered in Zeeland, MI. Gentex is a leader in automotive accessory production as they are the largest player in the interior auto dimming mirrors market with a 91% market share. They are a global entity with offices and production across the US, Europe and Asia. They also hold various trademarks and patents across the different markets, ensuring their competitive advantages and retention of their market share. Through the company’s history they have evolved from being a standard mirror producer for automobiles to having a wide range or mirror related products which is not limited to cars as they also have partnerships with different airlines as a market for expansion upon. Gentex has an extensive workforce with 5,000 employees worldwide.

Macro

Auto production is going to always be the highest influencing factor in the demand for Gentex’s products as they are so highly dependent in the auto industry. This is a fairly mature industry as automakers have regularly outsourced various parts of cars to other companies such as mirrors. However, the market has rapidly evolved as consumers have demanded more technology within their vehicle forcing companies like Gentex to evolve and advance the technology within their given product line.

The US has seen a fairly stable level of auto production, and this is expected to continue in the future with 2024 and 2025 flatlining on production at around 11.7M cars being produced. This helps ensure Gentex’s market opportunity will not get smaller over time and remain constant. Further the advancement of EV’s should not play an impact in Gentex’s ability to keep market share as they can be used in cars universally and have relationships with several established automakers that have been a part of the shift to EV’s.

Financial Analysis

Gentex has a uniquely clean balance sheet. This can be attributed to them prioritizing liquidity and paying off debt when available and using cash. The last time they took out debt was during a large acquisition in 2013 where they took out $265M and this was then completely paid off by 2016 and haven’t incurred any furth debt since then. This results in Gentex only having $261M in total liabilities and $2,065M in shareholders’ equity

Historically ROIC has always been double digits with the five-year average being 19.2%. When we compare this to their WACC, which is 10.2% we see when it comes to value creation Gentex does a good job. Their WACC is also higher than what it should be as their WACC is the same as their cost of equity as they have no debt taken out so we could expect the value creation to be even higher if they want to take on debt in the future. Gentex continues to create new patents and products and in doing there they have always seen a solid ROIC from this investment, so they have not given us a reason to see any differences from this moving forward.

Margins have been something that Gentex have recently been focused on retaining as they have historically had a stable long term gross profit margin of around 35% which recently dropped to a record low 31% in 2022. However, this had been attributed to rising supplier shortages and is expected to normalize in 2023 onwards. From operating margins down to net profit margins, the business runs fairly lean with historic operating margins of 24% and net profit margins of 20%. Gentex has also delivered shareholders with a conservative dividend yield with the 5-year average being 1.6%. However, one area they have been strong within is their share buybacks as they have taken out on average 4.3% per year. They also do this at favorable prices as proven by them purchasing 0.9 million shares in Q2 2023 at an average price of 27.28 representing a 12.6% discount to market value.

Governance

Gentex makes it clear that shareholder value is something they are trying to create through capital allocation such as repurchases and dividends. Gentex has been fairly conservative with their growth strategy not taking out any debt in recent years. This means they have been very selective on capex projects and subsequently had strong ROIC’s to match that smaller capital expenditure.

They have made a series of small acquisitions over the past few years with the most recent occurring in 2021. The only acquisition in company history of notable size was in 2013 when they acquired HomeLink products created by Johnson Controls for $700M. This M&A history is not concerning as it indicates they are more focused on in-house development of their own technologies and believe this is the best option to allocate their capital as opposed to hunting down acquisition targets. Something notable Gentex does is that when they do acquire it is usually something that they are using to integrate within their product as opposed to a stand alone product. Gentex has committed to make share buy backs a priority as they grow and have done so successfully with an average of decreasing overall share count by 4.3% on an annual basis since 2017.

Gentex has a Executive compensation structure that rewards ROIC and EBITDA with a 50% weighting on each. This rewards positive capital allocation and is favorable for creating future value growth. This method rewards management by making investments in the best interest of the company while also trying to increase top line growth and minimizing operating expenses.

Historically Gentex has been in hot water as in 2015 and several quarters between then and 2018 they were found guilty of manipulating their EPS to meet research estimates and hit their compensation targets. Subsequently they were fined $4 million dollars.

Competitive Analysis

Gentex has distinguished themselves from their competitors by offering the most innovative product in the market for auto makers. This has allowed them to gain significant contracts for many leading auto manufacturers. However, there are still a few other competitors with the largest being the Canadian company Magna. From a direct competitor standpoint Magna offers lower quality and cheaper goods than Gentex and mirrors are not their leading product as they focus on different aspects of the cars meanwhile Gentex is a pure player.

Gentex currently holds 2,017 patents worldwide and has 537 further patents awaiting approval. This solidifies their position in the market as being innovative in their designs and goals to expand their TAM while creating new products with various different value adds to help increase their average revenue per product. Due to the few number of competitors in their market they operate within and certainly no competitors with the auto diming and Full display mirror (FDM) capacity and innovations which they have. They also have relationships with a total of over 35 OEM’s accounting for the majority of vehicles produced in the US. Partners include the likes of GM, Toyota, Nissan and Merecedes.

Gentex has been able to gradually increase their average revenue per unit by innovating their products offering more technology in their products. They have recently been forced to pay higher prices to their suppliers while there was a shortage in 2022. However, that has since reverted in 2023 allowing Gentex to increase margins to historical levels. Being able to achieve these margins for the length they have indicates that their moat is strong, and they don’t face significant competition as this would definitely deteriorate their margins over time if that was the case.

Security Characteristics and Portfolio Considerations

Currently, there are no insiders within Gentex who hold a significant portion of the stock with the CEO having the largest holding from an insider with $5M. Within the five largest instructional holders four of them have reduced their position quarter over quarter, however these reductions have not been significant to any of their overall positions within Gentex.

The beta for Gentex is 1.02 which illudes to the fact they follow the market fairly tightly only being marginally more volatile. They have had a fairly solid record of outperforming their peer group with Gentex beating them by 10% over the last 5 years. Gentex’s float is 99.8%, which reflects the company’s stock being very liquid which is attractive to investors wanting to buy and sell large quantities of the company and not impacting the price by doing so.

When considering Gentex as an addition to the portfolio the dividend is not attractive enough to look at it for our Equity Income portfolio leaving the main possibility being our core equity strategy for which it is already a current holding. The company offers exposure to an industry that we otherwise have very little exposure in, so it currently plays a key part in the diversification of the portfolio. Thus, while there is still upside available, we should look at holding the company until that upside is reached or a better alternative is found before selling off the current holding. If the price were to drop significantly, we may also look to purchasing more to add to the current holdings.

Valuation

When valuing Gentex I used a discounted cash flow (DCF) model. I ran three different DCF’s depicting a bear, base and bull case for different scenarios of what could happen for the company in the future. For my base case I implied they would continue to grow at a rate of 18% over the next four years before dropping down to 10% as 18% has been their historic revenue growth rate and 2024 and 25 guidance has indicated that they should be able to achieve this growth moving forward. I also assumed that their operating margins would become stable at 25%, which was their historic average and had achieved in the trailing 5 years with margins having expanded out to 28% at times.

In my bear case I took out a significant amount of revenue growth, cutting it down to 5% and lowered margins to 20%. For this to happen I would expect to see a slow down in demand of Cars globally as well as competitors like Magna become a larger player as some OEM’s may be opting for lower priced parts to produce a cheaper car for the consumer.

In my bull case I see Gentex expanding more OEM relationships in becoming the industry standard technology to have in all cars. I see them achieving this by continuing to offer and innovate their products to continue to build their reputation and solidify their dominance in the industry. For this I have them growing at 18% per year for the next 10 years and keeping margins at 25% which should be enough deter competitors from trying create a similar product to enter their market.

Assuming historical capital expenditures as a percentage of revenue along with the same method for depreciation and amortization and utilizing some historical averages to create and overall percentage leads us to a base case price of $34.70 after projecting out free cash flow going 10 years into the future. The reason why I feel comfortable with referring to some historical figures when it comes ton the business is because they have been able to attain a strong and long growth rate without many large impacts to margins across the board. When weighing the different scenarios with implied probabilities of 50% for base and 25% for bull and another 25% for bear we get to a target price of $34.05 which represents a 5.4% upside to fair value.

Risks

If the automotive industry began to weaken and struggle that would strongly negatively impact the performance of Gentex because they are very strongly reliant on auto production to sell their products to OEM’s. If a company like Magna was able to penetrate the mirror market further this may put some more pressure on Gentex as they are a much smaller company on the whole

They also face risks of other companies developing technology within their cars and glass that may make Gentex’s innovation redundant or unnecessary. This also goes for in car monitoring. If the cars main interface is able to do this it will destroy a lot of value that Gentex has created for themselves.

Conclusion

Gentex is a company which offers a strong moat for investors due to their large market share, continuous innovation and current partnerships. This immediately makes the company a very attractive opportunity along with its strong outlook for continued growth in the future. The main problem which negates a couple of these is its current valuation. At the level it is at right now it requires a significant growth rate and even with further long-term growth and margin expansion it will make it fairly hard for Gentex to see large capital appreciation moving forward. With its predicted upside to only be 5.4% it is not enough to get excited about, however it gives us an understanding that if the price were to decrease it would present an excellent buying opportunity due to the strong of prosperity of the company.

Fergus Washington-Smith is an Investment Analyst at Aurora Asset Management, an Indianapolis-based subsidiary of Aurora Financial Strategies which is located in Kokomo, IN. He can be reached via email at fergus@auroramgt.com. Investment Advisory Services are offered through BCGM Wealth Management, LLC, a SEC registered investment adviser. This blog does not constitute advice. This is not an offer to buy or sell securities. Advisor is not licensed in all states. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. BCGM Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results. Clients may own positions in the securities discussed.