Maximizing Long-term Cash Flow
Our value-creating process focuses on long-term cash flow with an aim of providing funds for competitive returns to shareholders – in addition to maintaining earnings momentum and an adequate financial position. We therefore focus on growing earnings per share, while efficiently managing the capital required to take full advantage of Autoliv's growth potential.
Topline growth
One of Autoliv's targets is to outperform the global occupant restraint market.
This target has been met every year for the last several years except for 2005 due to a 3% decline during the year in West European vehicle production. Our market has risen by an average rate of 5% since 1997 (see graph) when the new Autoliv company was created. At the same time, Autoliv's sales have grown at an annual average rate of 8.6%, and by approximately 5% excluding acquisitions and currency translation effects.
The market is driven both by global vehicle production and higher safety content per vehicle (partially offset by price erosion). On average, these trends have caused the market to rise annually by 2.0% and 3.1%, respectively, since 1997.
In 2005, the market grew by nearly 4% to $17 billion as a result of the strong vehicle production in Asia. Vehicle production dropped in Western Europe where the safety content per vehicle is much higher than in Asia. As a consequence, the global average in safety content per vehicle remained around $265 as in 2004.
Market share gains
Our Company has the potential to outperform the market by being better positioned in the market's growth areas, such as side airbags and advanced seatbelt technologies. We have strong positions in the emerging markets in Asia where both vehicle production and the safety content per vehicle are growing relatively fast.
Compared to most of our competitors, we also have a better position with Asian vehicle manufacturers who are rapidly increasing their production volumes. Consequently, we expect to continue to increase our market share long-term, even though that may not be possible in 2006 due to the continued decline in West European vehicle production.
Market Growth
Our market should continue to grow, mainly as a result of new technologies and new regulations that increase the safety content per vehicle. The most important new regulation is the proposal from the U.S. Department of Transportation to introduce new side-impact test requirements for all new vehicles in the United States. This regulation is expected to be adopted in 2006.
In addition, global light vehicle production is expected to continue to grow. However, most of this growth will occur in China and other emerging markets, where the safety content per vehicle is still very low. At the same time, several high-end vehicles are already very well equipped with safety features. Consequently, the average sales value per vehicle for our industry is not expected to grow as fast as in recent years.
Cost Control
Nearly 50% of our revenues are spent on components and other direct materials from external suppliers. Of these costs, the raw material portion is 36% corresponding to 18% of sales, while the remaining 64% (or 32% of sales) is value added in the supply chain. Of revenues, 26% is used for salaries and other costs for employees (most of whom are in manufacturing).
R,D&E (Research, Development and Engineering) currently absorbs 6%, and S,G&A (Sales, General and Administration) about 5% of sales. Both R,D&E and S,G&A expenditures are primarily salaries.
Direct Material
Our long-term target is to annually reduce direct material costs in line with the decline in market prices for our safety systems. We have met this target in the past. However, in 2005, we reduced material costs by less than 1% due to higher steel and other raw material prices. The steel content in components corresponded to 7% of sales.
The most efficient cost-reduction method is redesigning and replacing existing designs and components with new, more cost-efficient ones. For instance, we recently started to introduce a passenger airbag that has 40% less weight than the previous product generation. Using fewer components also accelerates the manufacturing process, thereby reducing costs even more.
Another cost-reduction method is our supplier consolidation program which is expected to reduce the number of suppliers from over 2,000 to less than 500 before the end of this decade. By then we also expect to have increased our component sourcing in low-cost countries from less than 15% in 2004 to 50%.
Labor Costs
For several years we have met our target to improve labor productivity by at least 5% per year in order to offset higher labor costs. In 2005, labor productivity (measured as a reduction of labor minutes per manufactured unit) improved by 7%.
In addition, we continue to reallocate jobs to low-cost countries. In 2005 alone, we increased headcount in these countries by 1,400 to 40% of total headcount and reduced headcount in high-cost countries by 2,400.
Thanks to these measures total labor costs have been reduced to 26% of sales from 28% in 2001 despite pricing pressure from customers, salary increases and expansion in R,D&E.
Short-Term Cash Flow
Roughly one-third of Autoliv's costs are relatively fixed. As a result, our short-term earnings are highly dependent on capacity utilization in our plants and are therefore sales dependent.
Cash flow also depends on the timing of payments from customers (primarily the ten largest vehicle manufacturers). Short-term cash flow could therefore swing substantially from month to month.
Total production levels in our major markets are good overall indicators of our capacity utilization, but the production levels of individual vehicle models are most critical, since many under-utilized production lines cannot be used to supply another car model.
Cash Requirements
At the end of 2005, working capital stood at 8.3% of sales, which is in line with our policy not to exceed 10%. We expect to meet this target also for the next few years (although it may fluctuate between quarters).
We should also be able to continue to conform to our policy that the leverage ratio should be significantly below three and our interest coverage ratio significantly above 2.75 (for definitions see page 60). These ratios were 1.1 and 14.1, respectively, at the end of 2005.
Furthermore, we believe depreciation (including amortization) will be adequate for covering anticipated capital expenditures during the next few years. The need for additional manufacturing capacity could, however, be affected by, for instance, the above-mentioned new side-impact test regulation in the United States.
Capital employed
During the past five years, it has been possible to grow sales by 55% and double operating income. At the same time, we increased capital employed by a mere 10%.
This improvement in capital utilization reflects a number of initiatives, such as plant consolidations, outsourcing and moving to low-cost countries where less capital-intensive manufacturing processes can be used. It is also a reflection of the fact that growth in sales and profits have been achieved without any major goodwill-increasing acquisitions. As a result, goodwill and other intangibles now correspond to less than 25% of sales compared to more than 50% at the start of the company in 1997. Since our market tends to increase, it should be possible to continue this trend and grow business organically rather than by major acquisitions. As a result, we should be able to continue to grow earnings faster than capital employed.
5% ANNUAL MARKET GROWTH
8% ANNUAl sales growth
Cost breakdown
Of Autoliv's revenues, 49% is used for buying components from external suppliers. The second most important cost to control is labor, which represents 26% of sales, including 10% for direct labor in manufacturing and 16% in indirect labor in overhead and research and development. Other costs which also represents 16% of sales include depreciation, freight, insurance and a variety of other small cost items.