Gentex Targets Further Gross Margin Expansion

Strategist

David Whiston

Gentex manufactures auto-dimming rear- and side-view mirrors that use electrochromic technology. These mirrors automatically darken to eliminate headlight glare for drivers and have many other applications. With over 2,200 patents worldwide, some valid through 2048, and nearly 90% market share, up from 77% in 2003, Gentex has a narrow economic moat it should be able to protect for a long time, in our opinion.

The growth prospects for auto-dimming mirrors look strong. We estimate that in 2023, over 35% of all light vehicles produced had interior auto-dimming mirrors, and exterior auto-dimming mirror penetration is far below interior. Demand remains healthy with annual revenue growth often exceeding industry vehicle production growth. Growth will come from increased vehicle penetration as more automakers make the safety benefit of auto-dimming technology available and as Gentex's research leads to new, advanced-feature mirrors that ultimately become standard products.

Active safety is a very fast-growing field, so more camera products are likely to show up on other vehicle programs and Gentex develops its own cameras. A recent example is the full-display mirror, which the driver can toggle between a normal auto-dimming mirror and a display image while driving at high speed. Other growth areas include biometrics in mirrors and nanofiber chemical sensing technology, which we see having application in autonomous ride hailing, dimmable sunroofs, universal toll payments, and a partnership with Simplenight for booking entertainment or e-commerce activities in the vehicle. Gentex also owns HomeLink, an in-vehicle connectivity system linking the vehicle to one's residence for garage or Internet of Things applications.

The future beyond autos (98% of revenue) looks bright to us, too. The company supplies auto-dimming passenger windows for the Boeing 787 and 777X and the Airbus A350. Gentex is also exploring healthcare smart lighting applications with the Mayo Clinic, movable lighting in airplane passenger cabins, nanofiber sensing that could have security uses outside of the auto industry, and using its camera technology to help the visually impaired.

Business Strategy & Outlook

Gentex's cost advantage from economies of scale, its customers' switching costs, and intangible assets give the firm a narrow moat. Patents, innovations such as SmartBeam, and a consistent world-class manufacturing process have enabled the firm to increase its auto-dimming mirror share to 89% in 2023. We see this as representative of a moat because Gentex does not give any reason for a customer to try another auto-dimming mirror supplier nor leave room for many competitors. The firm's technological leadership increases our confidence that Gentex will hold, if not keep increasing, market share. Given that the company is patient with its engineers to encourage innovation, we do not think Gentex will lose its competitive edge. Its research and development spending as a percentage of revenue is one of the highest in our supplier coverage. Gentex was the first to market with electrochromic automatic-dimming mirrors, so the company enjoyed pricing benefits from the early adopters of the technology. Its unique product and its ability to commercialize the technology and continually make patent-protected innovative changes to the automatic-dimming mirror has enabled Gentex to generate returns on invested capital vastly superior to other auto suppliers. The company's market share gain from the low 80s in earlier years shows the superior quality of its product and the reliability of Gentex to deliver on time, suggesting that customers would face switching costs to move over to Magna Mirrors.

Auto suppliers are not chosen purely on price. A firm has to be reliable and get it right every time while also serving an automaker globally. There are not many suppliers that can do that, let alone mirror suppliers that can. Once a supplier has the business, it is extremely rare to lose it, especially during a vehicle program, because automakers then have to remove tooling from the supplier, which can cost millions. An automaker would also have to incur expensive validation testing of a new supplier, all while the production line is not making any vehicles and decimating an automaker’s ability to recoup its fixed costs. Gentex also has traditionally kept a debt-free balance sheet, partly so its cash hoard ensures it can keep its supply chain moving (such as in the Great Recession or after the 2011 Japan tsunami) and thus will never be the reason an automaker has to stop its production line. 

This consistent reliability is not something that just anyone who can get a loan to start a mirror company could do easily or quickly. Automakers' move to more global platforms is very good news for Gentex since a supplier must be able to service original equipment manufacturers consistently all over the world. A regional player cannot do this, and we think a small firm would be hesitant to borrow lots of money to add new facilities and overhead all over the world without any guarantee of winning new business. Automakers want the same supplier on a program all over the world due to scale benefits for them and reliability with a vendor that knows the vehicle program.

Gentex expands its share and keeps competitors at bay by bringing many, often patented, offerings (SmartBeam, HomeLink, FDM, telematics, and so on) into the electrochromic mirror, which, along with the company's consistent quality (in the mirror and ease of integration of the mirror into the vehicle's other systems), makes it hard to beat in a proposal. These add-on features make the automaker money too because they are typically bundled with other non-Gentex features in an expensive tech or safety package on a vehicle. This allows the automaker to offer a variety of trims without having to redesign a vehicle's interior at great expense. Gentex has also told us that the customer (the automaker) makes more money on Gentex products than Gentex does, which helps the switching cost moat source because a customer has little reason to switch on something it is buying for $40-$45 and selling as one part of a multi-thousand-dollar option package. Also, with growth potential in vision systems (FDM, camera monitoring systems), the connected car via HomeLink and the integrated tolling module service, and large area dimmable surfaces (sunroofs, airplane windows), we don't think autonomous vehicles automatically mean doom for Gentex.

However, the company is probably not a wide-moat candidate, in our opinion. Even Gentex faces customer demands for annual price reductions of about 2%-3%. Gentex's gross margins declined to 32.6% in the recession years of 2008 and 2009, from 43.2% in 1999. Suppliers are at the mercy of the automakers' production schedules and relentless annual demands for price concessions. Each automaker's volume makes the supplier very dependent on this large source of revenue. Furthermore, the auto industry is so cyclical that in bad times even the best parts suppliers cannot avoid large declines in return on invested capital and profit. In Gentex's case, ROIC was more than 40% in the late 1990s but fell to about 15% in 2009, before rebounding to about 25% in subsequent years. Cost-cutting helps ease the pain, but it does not restore all lost profit. We model ROIC in the low-20s during our five-year forecast period.

Narrow

Economic Moat

Gentex

Gentex Corp. is a technology company, which engages in the design, development, and manufacture and supply of digital vision, connected car, dimmable glass, and fire protection products. The firm operates through Automotive Products and Other segments. The Automotive Products segment operates in virtually all the foregoing facilities. The Other segment operates in certain Zeeland, Michigan facilities, as well as research and development offices in Salt Lake City, Utah and Santa Clara, CA. Its products include automatic-dimming rearview mirrors, dimmable aircraft windows, and commercial smoke alarms and signaling devices for the fire protection industry. The company was founded by Fred Bauer in 1974 and is headquartered in Zeeland, MI.

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Gentex Corp. engages in the business of designing, developing, manufacturing, marketing, and supplying digital vision, connected car, dimmable glass, and fire protection technologies including automatic-dimming rearview and non-dimming mirrors and electronics for the automotive industry, dimmable aircraft windows for the aviation industry, and commercial smoke alarms and signaling devices for the fire protection industry. It operates under the Automotive Products and Other segments. The Automotive Products segment focuses on operating virtually all the foregoing facilities. The Other segment includes dimmable aircraft windows, fire protection products, nanofiber, and medical. The company was founded by Fred Bauer in 1974 and is headquartered in Zeeland, MI.

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