Updated July 5. Warning: This post contains more than you ever wanted to know about automobile airbag technology.
But “more than you ever wanted to know” is “what you need to know” to value the prospects of airbag and auto safety sector leader Autoliv (ALV.) I added Autoliv to my Jubak Picks portfolio on April 29, 2016 on the strength of its market dominance in traditional auto safety technology–seat belts and airbags–and its growing position in the new driver-assisted safety technologies such as radar and vision systems for things like crash avoidance and lane guidance. (For more on Autolive and those technologies see my March 29 Sector Monday post http://jubakam.com/2016/03/autoliv-another-auto-technology-stock-for-the-age-of-autonomous-vehicles/ .)
On June 29, however, Autoliv announced that Toyota Motor (TM) would recall 1.43 million vehicles with defective airbags that had been produced by Autoliv. (The vehicles recalled include the Prius hybrid, Prius plug-in and the Lexus CT200h manufactured during October 2008 to April 2012.) Most of the recalls are in Japan ( 743,000) but the effort includes 495,000 in North America.
Now a recall of 1.43 million vehicles that contain your product because of a defect in that product is never a good thing. And it’s especially not a good thing when it comes while a major competitor, Takata, is in the midst of a recall that has reached 60 million vehicles and includes at least 13 deaths apparently caused by defective airbag inflators sending pieces of metal flying in the passenger cabin.
My first thought when hearing of the recall involving Autoliv was “Oh, no! The airbag maker I recommended because it wasn’t Takata has the same huge problem.”
That, fortunately, doesn’t seem to be the case.
The defect in Autoliv inflators is a result of substandard welds by a subcontractor. Autoliv’s side-curtain inflators use compressed gas and a solid propellant to inflate the airbag. (Side-curtain airbags are designed to provide protection in the case of a side-impact crash. The Takata airbags involved in that recall are, primarily, driver and front-passenger airbags.) A defective weld in the metal tubing used in the inflator caused a crack in the inflator. During hot weather, the compressed gas could become over-pressurized and break through the crack in the inflator. Autoliv says that the process for manufacturing the inflator was changed in 2012 and that the problem, while serious, is a contained defect limited to a flaw in manufacturing at a subcontractor.
At least that’s what Autoliv says. The facts seem to support the company position. The side curtain airbags that partially inflated were all in parked cars subject to hot weather. The recall is, so far, limited to Toyotas made from 2010 to 2012 as you’d expect if the defect were corrected by 2012. And, again so far, since the airbags that partially inflated were in parked and untenanted cars there have been no deaths or injuries.
The problem with inflators at Takata is very different. Takata’s propellent, the explosive that helps inflate the airbag, is based on a solid compound called ammonium nitrate, which can break down over time when exposed to moisture or high temperatures. Once ammonium nitrate has broken down, it can burn violently and cause the inflator to over pressurize and explode. (Autoliv does not use ammonium nitrate.)
In the early stages of the investigation into injuries and deaths involving its airbags, Takata blamed the problem on mishandling and improper storage of propellant during assembly. And there’s no doubt that manufacturing problems were involved. Reuters has reported that documents it reviewed show that in 2002, for example, a Takata plant in Mexico allowed a defect rate six to eight times above acceptable limits.
And the New York Times has published stories saying that Takata knew about the airbag issues as early as 2004 and conducted secret tests to verify the problem instead of notifying safety regulators. Takata has vigorously disputed the Times’ stories.
One of the big issues in the Takata investigation is why the company used ammonium nitrate at all in its airbags. Back in 1998 Takata had developed a new propellant, based on tetrazole, that promised to be a reliable and effective propellant. Takata, in fact, praised the compound as giving it a technological edge over its competitors. In spite of that, however, Takata had switched to an alternative formula, using ammonium nitrate, by 2001.
The company says that its engineers determined that ammonium nitrate produced gas more efficiently and with fewer emissions.
Experts in mining and explosives have offered the New York Times and the U.S. Congress a different explanation. “It’s cheap, unbelievably cheap,” Paul Worsey, an expert in explosives engineering at the Missouri University of Science and Technology, told the Times. Ammonium nitrate is more suitable for large demolitions in mining and construction, he noted. “It should not be used in airbags.” (Takata disputes that cost was a factor in the move to ammonium nitrate.)
As best as I can figure right now, Takata has a huge problem that goes right to heart of the company and its products. Autoliv has a serious but limited product defect problem to fix. The company has pegged the hit from the Toyota recall at a range of $10 million to $40 million net of any insurance recovery.
If this is the case, though, why, you should ask, have shares of Autoliv taken such a huge hit recently? They closed at $124.48 on June 23, dropped to $113.50 on June 24, and then closed at $107.46 on June 27.
Those dates should ring a bell. June 23 was the data of the Brexit vote in the United Kingdom and June 24 and June 27 were the dates of the big Brexit sell off in global markets.
Autoliv, a company headquartered in both Auburn Mills, Michigan, and Stockholm was, first of all, vulnerable to the immediate knee-jerk selling in everything with any link to the United Kingdom and the European Union. Second, right now Autoliv is particularly vulnerable to any slowdown in the European auto sector–such as might happen with the post-Brexit vote chaos–because in its guidance last quarter for the second quarter and the rest of 2016, the company upped its forecast for revenue growth in 2016 from its prior forecast on the basis of a recovery in its European business. That news led to a substantial pop in the price of Autoliv shares to $125.72 on May 4 from $112.95 on April 25. (I added Autoliv to my Jubak Picks portfolio on April 29 in a timing decision based on the strength of that guidance.) If Brexit is going to lead to a slowdown in growth in the European auto sector, then it’s only reasonable for the stock to give back the gains it posted on that improved guidance.
If I didn’t own Autolive in my portfolio now, I’d be sitting on the sidelines waiting to see if I could get it at the July 1 close of $106.90 or slightly lower after the company reports second quarter earnings on July 22. My expectations are that the company’s guidance for the rest of 2016 won’t be as positive (Ya think?) as it was in the first quarter before Brexit. I don’t know if it will be negative enough to push the stock down further or if the recent drop has priced in these lower expectations. But I’d be looking to see if I could pick up a bargain on any market over-reaction
This is all short-term stuff. The long-term story at Autoliv in traditional auto safety and the new safety technologies lumped into the driver-assisted category is intact and still promises substantial growth in the years ahead. So I’ll be holding these shares here with that perspective. And if I were allowed by the format of this portfolio, I’d be adding shares to this position on the drop.
When I added these shares of Jubak Picks on April 29, I set a target price of $149 a share by the end of 2016. Given Brexit and the pull back in shares that’s almost certainly optimistic now, but I’m going to leave that price in place until after the company reports on July 22.
The shares currently trade with a yield of 2.14%.
