Gentex A Strong Sell With 40-80% Downside Potential Near Term, Says Spruce Point

The hedge fund issued a Strong Sell recommendation on the stock, reasoning that there is scope for 40–80-percent downside in the near term.

Gentex is into the business of supplying dimmable mirrors for the auto and airline industry, which the firm thinks is a commoditized business.

Bluffing On Margins

Spruce Capital believes the 40-percent gross margins of Gentex have been overstated at least by two times, as it is leaving costs in inventory while inflating capex through nonsensical projects.

"In our view, Gentex's rhetoric pertaining to its mirror's level of proprietary components and vertical integration is likely exaggerated," the firm said.

Shareholder Unfriendly

The hedge fund noted that the dividend growth rate of Gentex was well below the free cash flow growth, which it feels is overstated. The share repurchases the firm has affected are done with the objective of offsetting dilution, the firm said. The balance sheet also shows red flags, with the company amassing an abnormal amount of cash on its balance sheet and doing irregular Level I and Level II classifications.

The firm believes Gentex has mostly shunned M&A transactions, just to avoid outside scrutiny.

Weak Governance

Spruce Capital highlighted that the company was audited by Arthur Anderson, which was also the auditor of the now-defunct Enron and Worldcom. Additionally, the company's former Michigan partner served as the chairman of its Audit Committee for 14 years, with the company paying the lowest audit fees in the auto supplier industry.

The firm also pointed to several loopholes with its management team and also an anemic 2.5-percent insider ownership.

Apart from these red flags, Spruce Capital also pointed to several fundamental challenges, including:

• Decline in SmartBeam revenues, accounting for 10 percent of the total sales.
• Reversal in auto sales, which was a surge in the past cycle and reduced affordability.
• Gentex's Full Display Mirror, or FDM, functioning as a display, rather than a mirror, opening up the product to a wide range of competitors.
• Dim prospects for mirrors, as cameras, sensors and displays take over.

At the time of writing, shares of Gentex were down 2.44 percent at $18.03.

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