Description

Motorcarparts (MPAA).  The Company is one of the leading in the re-manufacturers of replacement alternators and starters (A&S).  This story has been a long time in coming, but the stock to date hasn’t meaningfully moved up, giving investors the opportunity to invest in the completed turnaround before the true financial picture is evident in calendar 2008.  The Company’s conclusion of its move of production to Mexico, more transparent financial statements and increasing cash flow should cause the stock price to double in value in the next 12 – 18 months.  In addition, MPAA will eventually benefit from a weakening economy since people will be more likely to drive older cars for longer periods of time.

 

Industry Background

 

The remanufacture of alternators and starters is approximately a $1.2 billion business in the United States according to Frost and Sullivan.  The three largest competitors (Remy (formerly Delco Remy), MPAA and BBB Industries) dominate business with a combined market share of approximately 60%.  The sale of replacement A&S is split nearly equally between “do-it-yourself” retailers (Autozone, O’Reilly, CSK and others) and professional installers. 

 

This industry is entering a period where sales should grow at low to mid single digit rates for years to come.  The average age of American automobiles on the road is growing at 1.3% per year and is currently approximately 9 years old.  New automobile sales in the US grew at mid single digit rates throughout the late 1980’s and early 1990’s.  Coupling these facts with a mean time between failures of about 7 to 8 years  indicates that many cars are entering the replacement zone of this necessary part over the coming few years.  The only counter to this trend is the effect of high gasoline prices, where drivers attempt to reduce miles driven (thus delaying the need for a replacement A&S) by taking alternative transportation or driving less.

 

Company Background

 

MPAA has been in the automotive replacement parts business since the late 1960’s.  The current management team has been in place since 2001.  The Company has grown revenues approximately 70% since fiscal 2004 (March 2004) and added cost efficiencies through the transition from US to offshore based re-manufacturing.  The transition to offshore production will be finished by the end of the March 2008 quarter when the remaining US based business is shifted to their plant in Tijuana, Mexico.  This restructuring has begun to payoff for MPAA with material improvement of gross and operating margins.  However, the improvement in the finances for the last two years have been obfuscated by accounting restatements, one-time charges for the Mexico transition and one-time marketing expenses for new business wins such as Auotozone and General Motors.

 

Since March 2004, MPAA has changed its accounting for revenues from gross sales to net sales.  It also changed its accounting for inventory, moving some inventory from current assets to long-term assets.  While these changes did not materially affect stated profits, they did cause a delay in filing timely statements and large fees to their accounting firm.

 

Over the last three years MPAA has won significantly increased business from Autozone (AZO) and forged new relationships with General Motors (GM) and Pep Boys (PBY).  The AZO relationship moved from a traditional sale to a consignment relationship back to a traditional sale again over a three year period.  The ultimate result of this was increased inventory on AZO’s shelves and increased AZO revenues for MPAA.  Ultimately, if AZO were to ever leave this relationship they would owe MPAA in excess of $40MM, which makes it highly unlikely that a competitor would be able to take this account.  The GM and Pep Boys relationships required MPAA to pay about $6 million in one-time upfront marketing allowances to secure these accounts.  The result of these factors was understated gross and operating margins.  Going forward these expenses will not be a factor in the financial statements.

 

The move of US production to Mexico has taken a little more than two years.  Over this time period MPAA has been forced to maintain duplicative workforces and management teams to make sure that the transition was seamless for their customers.  It is difficult to measure the additional costs to the Company on an annual basis; however I estimate it was between $5MM and $10MM per year based on the Company’s general and administrative costs prior to opening Mexico.  In addition, as layoffs in LA occurred there have been recurring severance expenses.  So far MPAA has disclosed severance of about $1MM.

 

The final layer of costs to flow through the income statement will be the write-off of the higher cost inventory to account for the Company’s lower cost of producing in Mexico.  The remainder of this charge should hit profits over the next four quarters as MPAA works through the remaining US produced inventory.  The 2^nd quarter inventory write-down to account for lower production costs was $600k.  The one-time US Customs accrual was $1.5 million.  Adjusting the fiscal 2008 second quarter gross margin by these two charges brings it to just over 30%. My projections have them improving to the 35% - to 36% range for fiscal 2008.  I am using a $375k per quarter non-cash inventory write-down number for the next year, since MPAA will have been fully operational in Mexico for over a year.    Shown below are the income statements from fiscal (March 31 FY) 2004 to 2009.  Please note that fiscal 2007 revenue is $12MM higher than normal on an “apples to apples” basis due to the reversal of sales methodology in the AZO relationship.

 

 

3/31 Fiscal Year End	FY 2004	FY 2005	FY 2006	FY 2007	FY 2008	FY 2009
	Actual	Actual	Actual	Actual	Proj	Proj
Total Revenue	$80.3	$96.7	$108.4	$136.3	$137.8	$146.3
Gross Profit	21.4	28.7	25.4	21.3	40.7	50.6
% margin	26.7%	29.7%	23.4%	15.6%	29.5%	34.6%
% Production Offshore		13.0%	32.0%	64.0%	90.0%	95.0%
G&A Expenses	9.6	11.6	14.3	18.2	16.7	14.0
Sales and Marketing	2.0	2.8	3.5	4.1	3.3	3.7
R&D	0.6	0.8	1.2	1.5	1.1	1.5
Operating Expenses	12.2	15.2	19.1	23.8	21.1	19.1
Operating Income	9.2	13.5	6.3	(2.5)	19.6	31.5
% Margin	12.2%	14.0%	5.8%	-1.8%	14.2%	21.5%
Interest Expense	$1.0	$1.8	$3.0	$6.0	$5.2	$4.0
Interest (Income)	($0.0)	($0.1)	$0.0	($0.1)	$0.0	$0.0
Pretax Income	8.3	11.8	3.4	(8.4)	14.4	27.5
Income Taxes	$2.9	$4.5	$1.3	($3.4)	$5.5	$10.4
Net Income	$5.4	$7.3	$2.1	($5.0)	$8.8	$17.0
% Margin	6.7%	7.6%	1.9%	-3.6%	6.4%	11.6%
Diluted Shares	8.4	8.6	8.5	8.3	12.0	12.0
Earnings Per Share	$       0.65	$       0.85	$       0.24	$     (0.60)	$       0.74	$       1.42
EBIT	$9.2	$13.5	$6.3	($2.5)	$19.6	$31.5
plus: Depreciation	2.4	1.9	2.0	1.8	3.1	3.3
EBITDA	11.6	15.4	8.3	(0.7)	22.7	34.8
% Margin	14.5%	16.0%	7.7%	(0.5%)	16.5%	23.8%
One-time Adjustments
Upfront Marketing Allowance			2.4	3.3
Autozone reversal				4.0
Mexico Startup			0.7
Mexico G&A			0.7
Sarbanes Oxley			0.3	2.4	0.5
SEC Review			2.0	0.1	0.1
Severance				0.3	1.0
123R				1.6	0.6
Shareholder Reimbursement				(0.7)
Customs Duty					1.5
Inventory Write-down					0.6	1.5
Adjusted EBIT	9.2	13.5	12.4	8.4	23.9	33.0
Adjusted EBIT Margin	12%	14%	11%	6%	17%	23%
Adjusted EBITDA	11.6	15.4	14.4	10.2	26.9	36.3
Adjusted EBITDA Margin	14%	16%	13%	7%	20%	25%

 

 

 

comparable companies and competitors   

 

The auto replacement parts industry in the US is a highly fragmented business with thousands of competitors and hundreds of thousands of unique SKU’s.  Replacement parts manufacturers have very large customer concentrations due to the limited number of purchasers, which include car manufacturers (GM, Ford, etc.), automotive retailers (Autozone, Pep Boys, etc.) and warehouses.  Sales of parts that are essential for the operation of cars are recession resistant.  The A&S sector of this industry is about $1.2 billion in sales and is dominated by four large competitors.  MPAA’s two largest competitors are Remy and BBB.

 

Remy is the old AC Delco business that was spun off from GM.  Remy went through a prepackaged bankruptcy due its highly leveraged state and emerged with lower debt levels in early December.  The replacement A&S business is a small part of their overall business, which includes making OEM parts.  The OEM business is dependent on the new car manufacturing cycle and on the gross margins the auto majors allow the suppliers to make.  Weakness in the OEM business was the primary driver of the bankruptcy.

 

BBB was purchased in a June 2007 leveraged buyout at a reported 9 times last twelve months trailing EBITDA.  Since they are a private company there is no breakdown of their margins or operating units.

 

There are not any perfectly comparable companies to MPAA that trade publicly.  The closest ones that trade publicly are Aftermarket Technology Corp (ATAC), Standard Motor Products (SMP) and Dorman Products (DORM).

 

ATAC remanufactures and distributes drive train products used in repair of cars in the aftermarket.  Since their business is a mix of distribution and remanufacture their gross margins are significantly lower than MPAA’s running in the mid to low 20% range.  Sales growth has average 5% per annum over the last five years.

 

SMP manufactures new and used replacement parts for electrical, air conditioning and other automotive needs.  Its gross margins tend to run in the mid 20% and EBIT margins in the 3% - 5% ranges.  SMP has had flat sales over the last few years.  One lingering problem for SMP is asbestos liabilities that remain on their balance sheet due to a brake subsidiary that they divested a long time ago.

 

DORM distributes aftermarket automotive parts to retailers and warehouses.  DORM has maintained gross and EBIT (earnings before interest and taxes) margins in the mid 30% and 10% range, respectively.  Sales have been growing at an 8% annual clip over the last five years.

 

The aftermarket auto parts group is trading between 6.25 and 7.7 time trailing latest twelve months (LTM) EBITDA (earnings before interest, taxes, depreciation and amortization), which is in line with where they have traded over the last two years.   On a price to earning ratio (P/E) basis the group is trading between 10 and 15 time LTM earnings.  Eliminating SMP (which is not growing and has asbestos problems) from this comparison, the group is trading between 12 and 15 times LTM earnings.

 

At 12/14/2007	ATAC	DORM	SMP
Market Value Equity	$ 618.46	$ 246.41	$ 146.65
+Cash	20.72	6.15	19.45
-Debt	-	25.72	254.58
Enterprise Value	597.74	265.98	381.78
Share Price	$   27.96	$   13.93	$    7.96
LTM Sales	523.67	321.14	791.95
EV/LTM Sales	1.14	0.83	0.48
LTM EBIT	63.46	35.96	37.31
EV/LTM EBIT	9.42	7.40	10.23
LTM EBITDA	78.37	42.53	49.77
EV/LTM EBITDA	7.63	6.25	7.67
EPS	$    1.85	$    1.10	$    0.83
P/E Ratio	15.11	12.66	9.59

 

MPAA’s historical financials make it difficult for a casual onlooker to value the business in relation to its comparable competitors.  MPAA has grown revenues at a 14% compounded annual rate over the last few years by capturing new accounts and market share in the professional installer and do-it-yourself categories. However, the profits from this growth over this time period have been masked by charges and expenses for new customer upfront fees, accounting restatements, severance, duplicative workforce, customs duties, Sarbanes Oxley implementation and inventory write-downs.  This cornucopia of noise has created an opportunity to profit from MPAA’s successful transition from a largely US to a greater than 90% offshore re-manufacturer.

 

Prior to undertaking this endeavor to lower manufacturing costs, MPAA was operating at gross and EBIT margins of about 28% and 12%, respectively.  The move to Mexico and increased production in their Malaysia facilities has shifted labor costs from California where average fully loaded labor costs around $15 per hour to areas where costs are less than $5 per hour.

 

The capital expenditures used to build the Mexico facility and the inventory needed to secure and maintain large new customers was initially funded through the use of working capital and bank debt.  On May 27, 2007, MPAA raised $37 million of net proceeds in a PIPE through Roth Capital.  This was used to pay off the Company’s bank facility and to reduce accounts payable, leaving MPAA with a clean balance sheet.  I would expect the Company to use this strong balance sheet to attract additional customers and make selective acquisitions. 

 

VALUATION

 

Using the valuation ratios from it publicly trade peers yields are range of share prices from $8.83 on the low side to $23.27 on the high side.  Using the acquisition multiple paid for BBB yields a share price of $20 per share today and $27 based on next year’s EBITDA.  Using these comparable valuations, I believe that MPAA will trade into the low $20 per share range based on the Company’s successful transition to an offshore producer of aftermarket replacement parts.  Even today I believe investors are undervaluing the Company’s shares by at least 35% based on this year’s adjusted EBITDA multiples.

 

MPAA Share Price @	FY 2008	FY 2009
6.25x Adjusted EBITDA	$   14.02	$   18.89
7.7x Adjusted EBITDA	$   17.28	$   23.27
12 P/E	$    8.83	$  17.03
15 P/E	$  11.04	$  21.28

 

Catalyst

1. Increased visibility of successful transition to offshore re-manufacture of aftermarket automotive replacement parts yielding increased cash flow and profits.
2. Acquisition by competitor or industry participant at higher share price.