|Shares Out. (in M):||19||P/E||0||0|
|Market Cap (in $M):||497||P/FCF||0||0|
|Net Debt (in $M):||60||EBIT||0||0|
|Borrow Cost:||General Collateral|
A poorly-positioned vendor to the big auto DIY retailers with LTM earnings that could be as much as ~85% overstated
MPAA sells remanufactured auto parts (primarily starters and alternators), mostly to AZO, AAP, and ORLY (~85% of sales to these 3). Remanufacturing involves salvaging reusable components of auto parts and combining these with new components to make an aftermarket auto part.
We believe MPAA’s LTM EBITDA could be overstated by as much as 85%+ due to its:
Further, MPAA has generated a cumulative negative $35mm of FCF since Jan. 2014, providing a measure of validation directionally to our forensic accounting analysis.
Below we haircut our adjustments by one-third for conservatism, and deduct this amount from the Street’s NTM Adjusted EBITDA estimates. We then value MPAA at 7x this adjusted NTM EBITDA, yielding a target price of $13, or ~50% lower than MPAA’s current price.
D = A – [66.6% * (B+C)]
Capitalization of Core Inventory
MPAA’s accounting is not straight-forward, and the source of much investor confusion.
Some explain MPAA’s core inventory accounting by simple analogy: the “core” of its remanufactured starters or alternators are akin to a keg shell (i.e. recyclable part of its manufacturing process).
But there’s a glaring limitation to this analogy. An MPAA “core” (the salvageable part of a given starter or alternator) eventually becomes obsolete as new car models (or model platforms) are released, and the number of cars on the road under the old model diminishes.
At a high level, the value of “cores” (or keg shells) on MPAA’s balance sheet should therefore grow in concert with sales. It would be problematic if the “Days sales inventory” of core inventory grew rapidly. This could suggest MPAA’s balance sheet is becoming a graveyard for obsolete cores and/or the capitalization of the costs of the remanufacturing process and logistics.
Given the finite life of cores (versus the theoretically infinite life of keg shells), it’s important to see cores exiting the closed-loop system at various points (i.e. with the consumer, off MPAA’s balance sheet via write-downs, via a competitors unseating MPAA, etc.); and all the while, MPAA’s sales should march along with the amount of cores on its balance sheet.
Looking through MPAA’s complex accounting, however, we see cores piling up on their balance sheet (by more than can be explained by growth):
“Core DSI - as reported” (I) = A /C
“Core inventory – as adjusted” (B) = (G*C)/360
“Total Adj. to Core Inventory” (E) = A – B
Incremental Adj. to EBITDA (F) = Et – Et-1
Adj. EBITDA less inflated Core Inventory (H) = D – F
% difference = H/D
Z: In the most recent quarter, “Long-term core inventory” has been reclassified within “Inventory – net” and “Contract Assets”. We have to make an assumption for how much of the increase in “Inventory-net” is related to the reclassification of “Long-term core inventory”. $80mm is the non-core inventory in the MRQ that would keep y/y non-core inventory DSI flat.
In the above table, we estimate how much MPAA’s LTM EBITDA may be overstated from “cores” piling up its balance sheet. We take Core DSI in Fiscal year ending in March ‘14, and keep it constant through time, using it to calculate what Core Inventory would have been at a constant DSI. We then calculate the possible contribution to gross profit from MPAA’s failure to write-off old cores. We then compare this amount to LTM EBITDA.
In the below section, we also show how MPAA is writing-down inventory at an increasing pace (via the lower of cost and market revaluations). And even so, it appears it isn’t writing down the value of their inventory fast enough (to the benefit of its adjusted results, but at the expense of future earnings).
“One-time” items that are an ongoing cost of doing business in the hyper-competitive landscape for shelf space among DIY auto retailers
MPAA’s adjusted results have also included serial add-backs. The adjustments we take issue with fall into three general categories.
Here’s the amount by which we believe LTM EBITDA has been overstated over time due to these three items:
Channel work on Competitive Dynamics
The remanufacturing space has consolidated to four major players:
Cardone doesn’t compete within remanufactured starters and alternators. In this space, MPAA and BBB Industries are clear market leaders, with Remy third, and having lost share since becoming part of BWA and now under PE-ownership. We estimate a market share split in starters and alternators of roughly 45%/35/20 for MPAA/BBB/Remy. We believe MPAA has been up until now the biggest benefactor of Remy’s conceded share, at least from a top-line standpoint.
In October 2016, BWA divested of the Remy aftermarket business to Torque Capital Partners. In Aug. 2017, BWA noted on an investor call, “We did dispose of the [Remy] aftermarket business, which is about $300 million in sales…That wasn't really a good fit for us, and the added benefit was we disposed of $300 million sales with basically no margin.”
BWA sold the Remy aftermarket business for $80mm cash. At the time, the sold business did ~$308mm in LTM sales (and BWA transferred $95mm of inventory off its balance sheet).
The massive discount which Remy sold for versus MPAA’s current multiples, as measured by P/S and P/B, is unjustified in our view by any differences in the relative quality of the businesses.
Also, Remy at the time of its sale had a DSI about ~1/3rd the size of MPAA’s current DSI, further reinforcing our concern that some of the core inventory on MPAA’s balance sheet could be obsolete or more aggressively accounted for than normal.
A Includes all inventory categories divided by LTM sales
B Source: Factset
C BWA sold its aftermarket business for $80mm cash, and took a $127mm impairment at time of sale.
BWA is talking above about a business very similar to MPAA’s. And MPAA recorded ~16% adjusted EBIT margins in the most recent fiscal year (despite generating no FCF) vs. BWA saying its comparable Remy business basically broke even. Granted MPAA operates with slightly more scale, and they have been growing where Remy has been shrinking. But we believe operating leverage and negative absorption alone could not possibly explain such drastic margin differences among two businesses that are so similar.
In addition to having no experience in aftermarket, the challenges BWA likely saw with the Remy business include:
For these reasons, MPAA has found itself in a “prisoner’s dilemma” in recent years, when it comes to new business up for rebid (whether that be its own business at risk of loss, or BBB/Remy business it’s trying to capture):
Shifting balance of power
Perhaps better appreciated among investors is how the Accounts Payable-to-Inventory ratio for AAP, ORLY, and AZO over time has been rising, as these mighty retailers have consolidated and extended payables and destocked inventory. This trend has adversely impacted smaller vendors like MPAA.
Some believe this trend is stabilizing, but our channel checks suggest AAP is likely to remain in inventory reduction mode for years to come, particularly for products like the ones MPAA sells.
Perhaps less appreciated, though, are further ways that MPAA’s competitors have flexed their muscles in recent years:
The reason this dynamic is not readily apparent in MPAA’s accounting, however, is because they use a large factoring program (and because the rebates are contra-asset accounts buried in what little net A/R remains for them post-factoring).
The factoring program arose because MPAA’s customers used their power to stretch payment terms to ~360 days.
MPAA’s factoring allows it to get paid right away by a bank partner net of a discount. That bank partner then collects receivables from MPAA’s customers 1-year later. This allows MPAA to finance its A/R using the strong credit rating of its powerful customers. There is nothing unusual about this program. And further, when interest rates were so low, MPAA didn’t mind the small ~2% concession it was making.
But this program obscures the increasingly-onerous working capital requirements MPAA’s customers are placing on it. MPAA is not only housing on its own balance sheet its customers’ inventory for the ~12 months it takes to turn, but they’re also being asked to wait 1-year to get paid or to pay a discount to get paid sooner. Finally, since their customers are also their largest raw material suppliers, MPAA has only about ~2 months of days sales payables (so no opportunity to finance inventory and A/R investments that way).
Also, with rising rates, the cost of that factoring program is only getting more expensive, or the discount MPAA is having to offer its customers is rising. This dynamic is yet one more underappreciated headwind to MPAA’s future returns on invested capital.
Applying a generous 7x EV/NTM EBITDA and 13x P/NTM FCF and P/NTM EPS to these March 2020 estimates yields an average Mar ’19 target price of $10, or ~60% below MPAA’s current price.
In many of our channel checks, people we spoke with were complimentary of CEO Selwyn Joffe. Many complimented his ability to navigate difficult industry challenges, and nearly all commented on his dynamism. But looking at his insider sales/buys dating back to 2004 shows a trend counter to the promotional and buoyant language he consistently uses to describe his business and opportunity set:
Why it’s mispriced
 The concentration of add-backs in these three buckets is not readily apparent by looking at data services like Factset, because MPAA, whether intentionally or not, has made subtle changes to the name of their add-backs items over time (causing Factset, for example, to classify items into different buckets, when in reality, they are the same).
 Source: Insiderscore.com
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