AB Dynamics motors on China contract

During that time, we continually baulked at the lofty rating on the stock – its ratio of enterprise value to cash profits is currently double the average of its peers, but we would have done well to heed Warren Buffett’s dictum that “it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”. Whether ‘wonderful’ is an apt description for any stock is debatable, but the point is that some stocks are marked up well above the average of their peers for good reason – and we think AB Dynamics falls into this category.

The Wiltshire-based group designs and makes advanced testing and measurement equipment for the global automotive industry; the sort of kit that’s used both in the laboratory and on the test track. It assesses critical areas, such as braking (including autonomous emergency braking), steering, testing of powertrain assemblies, development of vehicle safety systems, kinematics (the features or properties of motion in an object) and compliance testing. AB doesn’t publish its client list, but we know that it has been engaged by all the top 20 automotive manufacturers, including Honda, Toyota, Ford and Volkswagen, and by outsourced testing and compliance organisations.

Our decision to restore our buy recommendation is partly based on a recent contract award with the China Automotive Technology and Research Center (CATARC), “the leading organisation in China for the testing of intelligent and connected vehicles”. It represents AB's “largest ever order” for driving robots, in a country that is already the world's leading auto market, with sales of 23.9m cars, sports utility and multi-purpose vehicles in 2016. Now that it is an established supplier to CATARC, AB is entrenched in a market that The China Association of Automobile Manufacturers expects to grow at around 4 per cent annually. But it’s the roll-out of non-conventional vehicles, such as plug-in hybrids, pure battery electric and fuel-cell electric models, that is generating increased demand for testing and evaluation technology and services. Tim Rogers, chief executive of AB Dynamics, notes: "With the new suite of driving robots and the guided soft target which will be delivered later in 2017, CATARC has positioned itself as a major player in global vehicle safety testing business."

The expansion of this segment of the Chinese market – and, indeed, emerging markets generally – is linked to the increased importance of so-called original equipment manufacturers (OEMs), who make the parts that auto makers incorporate into their branded vehicles. This type of commercial arrangement within the automotive industry is acting as a catalyst for the growth of independent, third-party testing services. Analysts at management consultant McKinsey predict that by 2020 global profits for automotive OEMs will rise by almost 50 per cent. That growth is presenting significant opportunities for AB.  

Per-capita vehicle ownership is much lower in emerging markets than in the west, though that is obviously changing. However, an increase in the overall number of vehicles won’t necessarily drive volumes for AB’s testing services; that depends more on the number of new car launches. So, one potential drag on growth is the increased demand for car leasing over outright ownership. Some analysts feel this could lead to a reduced number of new launches from car makers.   

Nevertheless, aside from the China deal, another factor driving demand for AB’s technology is tightening performance and safety standards throughout the automotive industry. There has been intensifying focus in this area because of the Volkswagen ‘diesel-gate’ scandal, but standards were already becoming more stringent and increasingly uniform due to the rise of OEMs in global markets.

Euro NCAP (the European New Car Assessment Programme), a voluntary vehicle safety rating system which originated in the UK but is now backed by the European Commission, recently announced its 'Roadmap to 2025', which details that testing will rely on vehicle targets like the Guided Soft Target and the Soft Pedestrian Target from AB Dynamics.