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COVID-19 has made life difficult for almost everyone, and Japanese electronic component manufacturer Alps Alpine (OTCPK:APELY) (6670.T) is certainly no exception. While the company had been enjoying some solid momentum in its smartphone camera actuator business, COVID-19’s impact on the auto industry has hammered the company, leading to a poor performance since my last update. Unlike many companies that have seen a hit from COVID-19, though, Alps Alpine shares haven’t recovered to the same extent.
There are certainly long-term risks to consider here. While Alps Alpine enjoys very strong share in optical image stabilizers (or OIS), it’s a highly competitive market. Likewise, management has the unenviable task of simultaneously reducing costs in its auto business while also repositioning that business toward advanced sensing, connectivity, and human-machine interface. Still, I believe the valuation is low relative to even modest expectations, and with smartphone and auto volumes picking up for the remainder of the year, these shares could do better.
Navigating A Challenging Auto Environment
Alps Alpine had some challenges in the auto business even before COVID-19 came into the picture. The company enjoys good market share across a range of switches, sensors, and modules used throughout autos (everything from doors to instrument panels to steering), but it’s a highly competitive business where it is difficult to get or keep much pricing power.
I’m encouraged by management’s recent efforts to cut costs, with the company generating JPY 3 billion in cost savings in the fiscal first quarter (the June quarter) and raising its target for the next quarter to JPY 4 billion. Some of this is coming as a result of the hoped-for synergies from its Alpine merger, but I also believe the company is restructuring such that it can successfully transition its more traditional auto electrical components operations to “cash cow” status, and redirect at least some of those earnings into product development aimed at higher-value opportunities.
To that point, the market itself is changing. As cars digitalize, older switch and sensor technology is no longer good enough, and Alps Alpine is attempting to pivot to new technologies like capacitive sensing (primarily for HMI), connectivity both inside and outside the car, and other “digital cabin” technologies. Looking ahead, infotainment systems are going to increasing fuse with instrument clusters into a sort of digital “master control panel”, driving what I expect will be high single-digit to low double-digit growth opportunities for infotainment/HMI technology providers. There is going to be significant competition here, but I believe Alps Alpine has staked out a technology/innovation lead over rivals like Denso, Bosch, Pioneer, and Faurecia, at least in certain aspects relating to sensing and HMI.
In the near term, though, there are still plenty of challenges. The auto business was down more than 40% in the June quarter, with Alps Alpine hit hard by the global decline in vehicle production volumes. Recent data have been more encouraging (the U.S. SAAR for August was better than expected, and at over 15 million annualized), and I do believe Alps Alpine will see a recovery through the rest of the year.
Ready For The Next iPhone Cycle
Alps Alpine has enjoyed a productive relationship with Apple (AAPL) for some time, with the company holding dominant share for the company’s OIS needs. As camera quality is a meaningful point of differentiation between phones, Apple has been willing to spend up to use the more expensive OIS camera actuators. At the same time, the increasing number of cameras per phone, the increasing sophistication of those cameras, and the recent increase in image sensor and camera lens size have all driven content growth and higher-value content for Alps Alpine, and this next generation of phones should drive meaningful volume and revenue for the company.
Better still, while the camera actuator business is dwarfed by the auto business, it is a higher-margin business that can help drive overall electrical component margins back towards the double-digits.
Growth outside of Apple has been more challenging. Chinese OEMs have been slow to adopt the technology, as it seems to be less of a driver for customers considering those phones. Still, OEMs like Huawei and Xiaomi have started to use OIS actuators, and Alps Alpine has established an R&D center in China to work with customers to accelerate the adoption of the technology.
While distinct from the camera actuator business, the haptics business is also worth watching. These components are used in a range of applications, but I’m most interested in the near-term opportunities created by the roll out of new gaming systems. Alps Alpine has seen strong recent demand from gaming system OEMs, presumably on increased demand from people stuck at home, and the next generation of systems should continue that momentum.
I’m bullish on the near-term leverage Alps Alpine has to the next iPhone cycle, as well as a recovery in auto production. I’m also bullish on Alps Alpine’s longer-term leverage to auto infotainment and the growing importance of HMI technology as auto OEMs try to put even more sensing and control technologies literally at drivers’ fingertips.
All of that said, there’s an “is what it is” aspect to this business that shouldn’t be ignored. The core auto components business has never been reliably high-margin, and while the shift towards more digital cabin technologies does offer the prospect of better growth and better margins, the legacy business will still have a meaningful impact on the business (including shrinking opportunities in navigation). Likewise, while the camera OIS business is appealing, it’s more like a “sauce” than the main course – it can make things better, but it won’t be the primary driver.
So, all of that being the case, I’m still expecting long-term revenue growth in the low single-digits (mid-single-digits if you use the COVID-19 period as the starting point), with long-term FCF margins in the low-to-mid single-digits. Are there opportunities to outperform on growth and margins? I think so, but I want to see more evidence of that before just assuming it in my model, particularly given the long track record of historical data.
The Bottom Line
Between discounted cash flow, margin/return-driven EV/EBITDA, and ROE-driven P/B (a metric that’s often relevant to Japanese equities), I believe Alps Alpine shares are priced for double-digit returns from here, and the company has enjoyed the same “buy the recovery” move as many of its peers. I do see risks here – weaker results in legacy auto, more competition/weaker margins in the new digital auto opportunities, more competition/weaker adoption of OIS in smartphones, et al – but I believe those risks are more than reflected in the share price today.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Originally published on Seeking Alpha