Gentex Corporation: Lack Of Visibility On The Demand Side (NASDAQ:GNTX)

Gentex Corporation (NASDAQ:GNTX) is coming off a disappointing quarter where it missed on the top and bottom lines, primarily from an increase in the cost of inputs and lack of pricing power during that time because it hadn’t negotiated with partners yet concerning passing some of the inflation onto them.

One of the more important pieces of information concerning the prospects of the company heading into 2023 will be the deal Gentex Corporation makes in negotiations, as it’ll have a significant impact on the margin profile of the company going forward.

While management noted that it would be hard to provide guidance for the fourth quarter of 2022 because of “high levels of volatility in customer orders and vehicle production volumes, electronic supply chain constraints, labor shortages and overall economic uncertainty,” it did say it had more clarity with revenue growth guidance for 2023, which it projected to be in a range of 15 percent to 20 percent above the full-year 2022 revenue guidance of $1.9 billion to $1.95 billion, based upon its expectations in regard to the level of light vehicle production in calendar 2023.

Based upon the high probability of an economic downturn which likely drive down demand, production volume, ongoing supply chain constraints, and an uncertain labor market, I think GNTX is getting ahead of itself in its revenue outlook for 2023.

I think it’s far too soon to come to that conclusion on the revenue side because of the lack of clarity in the numerous headwinds and the length of time it could take for them to be worked out.

One of the major things to consider concerning demand is the increasing prioritizing of spending by consumers. Because interest rates are going higher, it cost of buying a car will too, and that means a strong possibility of demand falling. That could mean manufacturers may pull back on production in order to manage their capital.

In this article we’ll look at some of the company’s recent numbers and the headwinds it will still face throughout 2023; especially in the first half of the year.

Some of the numbers

Revenue in the third quarter was $493.6 million, up 24 percent from revenue $399.6 million in the third quarter of 2021.

Gross margin in the reporting period was 29.8 percent, down from the gross margin of 35.3 percent in the third quarter of 2021. The decline in gross margin was attributed to “quarter-over-quarter basis by raw material cost increases, unfavorable product mix and labor cost increases and prior commitments to annual customer price reductions.” Management said the largest contributors to the decline in gross margin were an unfavorable product mix and the increase in costs of raw materials.

The reason for the unfavorable product mix was from supply chain constraints in its advanced feature mirrors and a drop in sales to its Tier 2 customers, which combined had an impact of approximately 150 basis points on gross margin.

Operating expenses in the reporting period were $60.4 million, up by about 15 percent from the $52.7 million in operating expenses in the third quarter of 2021.

Net income in the third quarter of 2022 was $72.7 million, or $0.31 per share, down from net income of $76.7 million or $0.32 per share year-over-year. For the first nine months of 2022 net income was $232.6 million or $0.99 per share, down by about $44 million from the net income of $277 million or $1.15 per share in the first nine months of 2021.

Cash and cash equivalents for the third quarter came in at $222.9 million, down almost $40 million from the cash and cash equivalents of $262 million at the end of calendar 2021.

Cost escalation negotiations

Probably the most important factor concerning dealing with contracting margins is the negotiations Gentex Corporation is having with its customers. They are focusing on the increasing commodity, freight and labor prices in the negotiations.

What investors will need to see is that there was meaningful progress in the negotiations to the point the results will have an immediate impact on the margins of the company.

Management sees the negotiations having an ongoing impact into 2024, based upon updated pricing. By mentioning 2024, it probably gives an idea of how long the company expects price inflation to remain a significant factor in its performance.

I think expectations need to be moderated concerning the potential results, but they should be strong enough to move the needle on margin results over the next year or two.

Inventory and supply chain challenges

A major challenge faced by Gentex in regard to supply chain constraints is in managing its inventory levels. It can’t go on doing business as usual, but it also has to be careful in how much inventory it holds.

For example, in the third quarter inventory soared to $418.3 million, up from $316.3 million. Most of the increase was from adding to its raw materials inventory. I believe the company had to do that or risk potential shortages at times when demand for products need to be filled.

The increase in inventory levels means an increase in CapEx, which also puts downward pressure on margins from the additional spending.

With a lack of clarity concerning when supply chain issues will be resolved in a meaningful manner, the company must protect this part of the business in order to support sales. That means it’s going to be tough going forward until there is a sustainable easing in the supply chain that brings the industry back close to normal levels.

This is one of the reasons I believe the clarity isn’t there for accurate revenue projections for 2023. That’s because this doesn’t only have an effect on margins, but on revenue as well.

In alignment with the growth it has forecast, the company has acquired more components associated with medium and long-term lead times in order to meet demand during a season when components may not be available in a timely manner.

This may also help mitigate some of the recent volatility related to customer orders.

Conclusion

There remain a lot of headwinds as 2023 approaches, including “component supply issues that included both scarcity and cost increases, product mix issues, labor shortages and customer order volatility,” which were also the headwinds faced in the third quarter of 2022.

While management had to make a decision concerning what it thinks revenue will be in 2023 because of the need to prepare its inventory levels for those assumptions, I think that more than likely they’re erroring on the side of caution, and the numbers are likely to be less than guided for.

On the other hand, there are steps being taken on things the company has direct control over, such as escalation negotiations, which will require nothing more than coming to an agreement for the next couple of years.

I think Gentex Corporation is going to do okay next year, but not great. There is a mixture of headwinds that are going to take time to work through, and because of that I see it as being close to impossible to accurately guide concerning revenue and its general, overall performance.

With that in mind, I think investors will have to be patient and wait for more clarity in these various areas before making a decision on taking a position in Gentex Corporation.