The Vanguard Mid-Cap Growth ETF (VOT) has lost 10% of its value in the past year compared to the S&P 500 (VOO) gain of 2.25%. There are 182 companies in this ETF, and I have analyzed the performance of 100 top holdings in the ETF. These 100 companies make up 80% of this ETF. There are 12 companies in the top 100 that have lost over 20% in the past year (Exhibit 1). Aptiv (APTV), ANSYS (ANSS), and Xylem (XYL) have sold off over 20% but play in attractive markets and can take advantage of secular growth trends in the coming years.
Exhibit 1: 12 Companies in the Vanguard Mid-Cap Growth ETF have Lost Over 20%
Note: You can access the performance of the top 100 companies from my Google Drive.
Digitization of the Automobile Bodes Well for Aptiv
Aptiv – a supplier to the automotive industry – has lost 21% of its value in the past year. The company’s stock price, currently at $106, is back to where it was in November 2020 and has dropped over 40% from its 52-week high. Automobiles are becoming software-defined vehicles, and Aptiv is making all the right moves to be a significant player in this world. For instance, it recently acquired Wind River Systems for $4.3 billion. Wind River provides software solutions for devices – cars, medical devices, industrial robots, and others. This acquisition can make Aptiv a high-value player in the edge software market for devices across multiple industries. This acquisition may help Aptiv gain scale and a competitive edge that could increase profit margins in the long run.
In 2021, the company saw strong revenue growth of 15% year-over-year with revenues totaling $15.6 billion but saw its operating margins erode due to supply chain disruptions and inflation. For instance, the company had an operating margin of 11% in 2017 and 2018 (Exhibit 2). Aptiv has had higher operating margins than Magna (MGA) but lower margins than BorgWarner (BWA) (Exhibit 3).
Exhibit 2: Aptiv Revenue, Operating Income, and Operating Margin
Exhibit 3: Aptiv, BorgWarner, Magna International Operating Margin
But, given the doldrums that the U.S. auto market is in at this time, I do not expect Aptiv to recover its margins anytime soon. Also, the Federal Reserve Board’s determination to squash inflation is taking interest rates higher. The higher interest rates might take a further toll on the auto market. Given these circumstances, Aptiv might underperform further. It is already trading 8% and 26% below its 50-day and 200-day moving average.
The company currently generates a poor return on invested capital of just 4.74% and a return on equity of 7.2%. Aptiv trades at a forward EV to EBITDA multiple of 12x while Magna and BorgWarner trade at 5x. There have been 11 downward revisions on EPS in the past three months and no upward revisions. The company is expected to earn $3.95 per share for the year. That would leave the company trading at a P/E of 26x, very expensive given the lack of consistent and robust revenue and earnings growth. The sector median P/E is 12x, and the company has traded at an average forward P/E of 31x. Overall, I like the company as a long-term holding, and I have opened a position at $107.79, but I would wait for it to drop to the mid-nineties before adding to my position.
Simulation Software Offers Great Cost and Time Savings for Manufacturers
ANSYS is a leader in engineering simulation software that has lost 20% of its value in the past year. ANSYS’ software helps companies increase speed and efficiency and reduce costs during product development from the design stage to final testing and validation (Exhibit 4). This company has always been expensive to own. It trades at a forward GAAP P/E of 48x against its five-year average of 53x and the sector median of 24x. The company’s forward EV to EBITDA multiple is 27x, a slight discount from its five-year average of 29x.
The company has steadily grown revenues at a CAGR of 10% (Exhibit 5) over the past decade. Its revenue grew from $798 million in 2012 to $1.9 billion in 2021, and its growth has accelerated in the past four years with a CAGR of 14.8%. We are in the midst of secular changes in multiple industries. The automobile sector is transitioning from internal combustion engines to electric vehicles, and the transportation sector is moving ahead with autonomous cars. Tesla wants to launch its robotaxi soon. The energy sector is moving to add more renewables to the power sector. Russia’s invasion of Ukraine has changed the defense calculation for countries across the globe. Almost every country is looking to be self-sufficient on the energy front, and they are looking to spend more on defense. These trends bode well for ANSYS’ business, and it should see good revenue growth for years to come. Companies save money and time by using ANSYS. ANSYS offers its software on a deeply discounted basis to start-up companies, and Lucid Motors (LCID) is a graduate of that program. In this video, Peter Rawlinson, CEO of Lucid Motors, describes the value that ANSYS brings to their business.
ANSYS has a superior EBITDA margin of 33.2% compared to 29.7% for PTC (PTC) and 17.7% for Autodesk (ADSK). ANSYS trades at a forward EV to EBITDA multiple of 26x compared to 20.9x for Autodesk and 16.9x for PTC. ANSYS serves attractive end markets – automotive, energy, aerospace, healthcare, and it looks oversold with its RSI and MFI technical indicators at 34 and 24, indicating near oversold levels. ANSYS is an excellent company to own for the long term.
Exhibit 4: ANSYS Plays in Critical End Markets
Exhibit 5: ANSYS Growing Revenue at a Double-digit CAGR
Xylem May be Essential for the Water Industry
Xylem is a company selling water technology products to utilities, industrial, commercial, and residential sectors. The company has lost 23.3% of its value in the past year. The company saw organic revenue growth of 4% and grew its adjusted EPS by 21% in 2021. The company’s Measurement and Control Solutions [MCS] business segment is seeing good order growth, and orders grew by 23% in 2021. The semiconductor chip shortage limits the production of products in its MCS segment. It is not surprising that Xylem is seeing good order growth given the water scarcity across the globe. The company understands the challenges and opportunities presented by worldwide water scarcity (Exhibit 6). The United Nations is calling water scarcity the next pandemic.
Exhibit 6: The World Faces Severe Water Scarcity
Xylem has seen a decline in gross and EBITDA margin due to supply chain constraints and inflationary pressures (Exhibit 7). The company hopes that its margin will improve in the second half of the year.
Exhibit 7: Xylem Revenue, Gross Profit, and EBITDA
Xylem’s customers worldwide invest in digital solutions to help better manage water and reduce water use and loss (Exhibit 8). The company is looking to expand its digital solutions by investing more in digital solutions via acquisitions or partnerships. The company also sees a high single-digit growth rate in revenues from 2021 to 2025 from its water utility customers. Overall, the company sees organic growth of 4% to 6% in revenues until 2025. This company has traditionally traded at a premium to its sector. The company is trading at a forward EV to EBITDA multiple of 19.3x compared to its five-year average of 18.5x and the sector median multiple of 10x. The company is forecasted to earn $2.57 for the year. I will consider this stock below $80, ideally closer to $75. At $75 the company would be trading close to a P/E of 29x based on its forecasted EPS.
Exhibit 8: Customers Need Digital Solutions to Manage their Water Resources
ANSYS is my favorite stock among these three beaten-down companies in the Vanguard Mid-Cap Growth ETF. I might have bought Aptiv a little too early, but I can add to it if it drops further. Finally, Xylem is an excellent stock to own for the long term. It faces short-term headwinds, and it may be a perfect candidate to consider if it drops close to $75. All three companies operate in attractive markets that have a long growth runway. They may not stay cheap for long.