Seeing Value in Rearview Mirrors

 | Dec 04, 2012 | 1:00 PM EST  | Comments
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Real Money readers have often heard me refer to investing in quality, attractively priced businesses as the holy grail to investment. The economy doesn't matter, we are quick to say, if one invests in a quality business that's selling at an attractive price. Just buy a quality, attractively priced business, Warren Buffett preaches, and let the upside take care of itself. 

So what does a quality, attractively priced business look like? It looks like Gentex (GNTX), a leading producer of electronic products for the automotive industry as well as a maker of fire-protection products. Shares in Gentex are currently fetching $17.75, off from a 52-week high of $32. The market is currently valuing Gentex at $2.5 billion, or an enterprise value of $2.1 billion when you account for the $400 million in cash that's on the company's debt-free balance sheet. Let's see how Gentex fulfills the value investor's two conditions of quality and an attractive valuation.

Gentex's boilerplate description is actually misleading, as it sounds as if Gentex makes dozens of products when in fact the company has three product lines: interior and exterior auto-dimming rearview mirrors for automobiles, fire-protection products for commercial customers (namely smoke alarms) and dimmable aircraft windows. Currently, rearview mirrors account for 98% of revenue. Where Gentex stands out is that it's the innovator in the marketplace. It's not the company that is making the basic rearview mirror and hoping to hold on to a shrinking part of the market. Of Gentex's 3,700 employees, 20% are focused on research and development.

In 2011, Gentex sold 88% of the auto-dimming mirrors to more than 30 automotive customers in 25 countries. Gentex estimates that there are 76 million light vehicles worldwide and that over the next decade, 45% of those vehicles will be equipped with auto-dimming rearview mirrors. The company equates that to a $3 billion market potential, assuming $100 worth of mirrors per vehicle.

In addition to the future market potential, Gentex has a cumulative installed base of 193 million units. The biggest value proposition of auto-dimming mirrors is safety, and these mirrors have long been endorsed by the National Highway Traffic Safety Administration. Insurance companies love these mirrors, and because they constitute a very small portion of a vehicle's overall component cost, these mirrors are likely to be part of more vehicles going forward.

The other tailwind is that new car sales appear to continue trending higher. Used cars are older than they have been in many years, and that provides a catalyst for new vehicle sales. So making a bet on Gentex is a backdoor way to bet on the growth of new car sales. Many value investors, including Mohnish Pabrai and Berkshire Hathaway's new investment managers, have piled into General Motors (GM). This suggests a belief in the growth of new-car volume.

And is Gentex attractively priced? Let's see what $2.1 billion gets you. First, you get a company that has grown sales by an annualized rate of 20% over the past 25 years. Looking back to 2002, Gentex has remained completely debt-free, and over that decade, the company's unlevered return on equity has averaged 15%. Over the past 10 years, sales have grown from $400 million to over $1 billion while profits have moved from $85 million to nearly $180 million. Shares outstanding have declined from 152 million to 145 million in 10 years. In 2003, Gentex began with a $0.03-per-share dividend. Today, shareholders are collecting $0.52 a share, good for a 3% yield. Operating margins are very attractive at 27% of sales.

So why have shares declined nearly 50% in the past year? In a word, Europe. Today, Gentex ships 45% of its mirrors to Europe, compared with 29% back in 2001. Investors have reacted to the slowdown in Europe by dumping shares. But the selloff has severely discounted the superior quality of this business and its products. Perhaps the next six to 12 months will be slower than usual for Gentex because of Europe. But those who are willing to sit tight for the next two to three years are looking a company that is perhaps worth $35 to $50 a share.

Owning Gentex not only gives you an excellent business at a quality price, it also offers a 3% dividend and a free call option on Europe and the rest of the world. It's a scenario that value investors relish. I haven't bought shares yet, as I have a little digging to do, but it's a high probability that I will buy the stock sooner rather than later.

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