Description
MPAA IS ONE OF THE LEADING RE-MANUFACTURERS OF REPLACEMENT ALTERNATORS AND STARTERS FOR IMPORT AND DOMESTIC CARS IN THE UNITED STATES.
Their products are mainly sold to do-it-yourself installers through Autozone (AZ), CSK Automotive and O’Reilly Automotive and to a lesser extent to professional installers through traditional warehouse distributors. The Company is in the final innings of a turnaround story relating to the replacement of management due to accounting misstatements and the retooling of their manufacturing methods. It should be re-listed on the NASDAQ sometime in calendar year 2005 and is benefiting from increased business from its largest customers and a sound financial base.
MPAA has been in the automotive replacement parts business since the late 1960’s. In particular, the replacement of alternators and starters in cars is always done by remanufacturing used units. MPAA sources these parts by purchasing whole units from brokers, junkyards and automotive parts retailers. These used units are disassembled, cleaned and reassembled with replacement parts, tested and then shipped to retailers, manufacturers and wholesalers throughout the United States.
In 1997 and 1998 the Company had accounting irregularities that were perpetrated by the then CFO and CEO. These people were replaced and the Company settled a civil suit in 2002. All legal problems regarding this issue are now completely behind the Company. In February of 2003 the current CEO took control and began to work on bringing MPAA back from its near death experience. He instituted lean manufacturing methodologies, which has increased gross margin and decreased the turnaround time in re-manufacturing units from days to hours. Recently, MPAA won the Frost & Sullivan 2004 Product Quality Leadership Award for its segment of the automotive parts market.
With the filing of the March 2004 annual report, MPAA was in compliance with Nasdaq listing by having 5 years of audited financials and is in the process of reapplying for listing. This is delayed by the second quarter’s (September 30, 2004) accounting change to record revenues net of the cost of repurchased AS cores. This has NO effect on Operating or Net Profits as it is simply a reclassification of the cost of these repurchases from its customers and is an offset to COGS and revenues.
I believe that the common stock of MPAA is undervalued using a number of metrics and has the ability to double in price as the market begins to recognize its value and earnings potential.
THE ALTERNATOR AND STARTER MARKET PROVIDES STABLE REVENUE FLOW AND CONSOLIDATION OPPORTUNITIES.
Alternators and Starters (AS) are the electric generators/motors that power the electrical systems in automobiles. Each car manufactured has one of each and the complexity and design of each unit varies depending on the make, model and year of the car. The car manufacturer stops making that particular AS once a car is off production for that model year. When that AS wears out (prime repair age of 7 years), the car owner needs to purchase a re-manufactured AS. With the average age of autos in the US at 9 years and growing and the increasing demand for mnore electronics in cars, demand for AS has been growing. The increasing complexity of automotive electronics also leads to increased pricing for alternators.
Consumers have two methods of installing AS. One is to do-it-yourself (DIY) and the other is to use a professional installer. MPAA primarily (90%+) sells to the DIY through relationship with large automotive retailers. It largest customers are Autozone, CSK Automotive and O’Reilly Automotive. The professional market is a revenue opportunity for MPAA that it has begun to exploit with a deal with one of the largest automotive wholesalers. At its December shareholders meeting, management stated that this relationship is going better than expected due to MPAA’s superior product quality compared to the company it replaced.
AUTOZONE DEAL RESULTED IN UNDERSTATED REVENUES IN THE FIRST HALF OF FY 2005, BUT WILL INSURE STRONG SECOND HALF, ROBUST LONG-TERM GROWTH AND AN IMPROVED COMPETITVE POSITION
In May of 2004, MPAA signed a deal with Autozone that made the Company its exclusive supplier of imported and the larger of two suppliers for domestic AS. While MPAA was already a vendor in this area, the deal should increase sales for fiscal 2005 (March FYE) and beyond. As part of the deal MPAA agreed to purchase all of AZ’s AS inventory and only bill AZ for AS’s as they are sold (consignment). Autozone will be paid for the inventory over a four year period of time in a backend weighted transaction as shown in the following table.
Fiscal Quarter Inv. Payment to AZ
Q2 2005 1,200,000
Q3 2005 2,600,000
Q4 2005 2,700,000
Q1 2006 3,180,000
Q2 2006 3,270,000
Q3 2006 3,270,000
Q4 2006 3,270,000
Q1 2007 1,141,000
Total 20,631,000
After two years, if the transaction is going well, MPAA will buy the remaining $24 million of inventory in the same manner.
An important difference resulting from the AZ deal is the change in revenue recognition from Pay-on-Delivery to AZ to Pay-on-Scan (sale to AZ’s customer). For the second quarter ended September 30, MPAA disclosed that shipments to AZ were $9.6MM above recorded sales for the first five months of the relationship, effectively understating reported revenues. This will translate into additional sales of $7.7MM for the second half of FY 2005 based on AZ’s turning the inventory every 7.5 months. The effect of the deal is neutral to balance sheet cash over time but MPAA will build inventory that turns about 2x per year at its largest customer. This inventory must be purchased by AZ if it ever wants to break the deal, so MPAA will have a long term investment in the largest automotive retailer that will be booked as inventory. The Company estimates that this number is currently $36MM and will grow to $60MM when they exercise the second option, creating a nearly insurmountable barrier to entry for any competitor.
MANUFACTURING EFFICIENCIES PROVIDING IMPROVED MARGINS.
MPAA switched to lean manufacturing in 2002, which has significantly improved turnaround time and gross margins when re-manufacturing AS. Cores are received in its Los Angeles, California facility and separated by product family and part number. Each lot moves to a station that only works on that particular AS. In a matter of an hour it moves from a useless core to a clean, tested working AS. This process has high degree of automation and maximizes recovery of materials. Specifically, the Company recognized a 40% gain in capacity, 20% reduction in labor content and 63% reduction in work in process inventory. Gross margins have responded correspondingly rising approximately 600 basis points from FY 2002 to FY 2004. In the first two quarters of FY 2005, gross margins were impacted by increased overtime hours needed to handle the quick ramp up in sales to Autozone. These margins should normalize in the second half of FY 2005, since the ramp-up is done.
MPAA also has a manufacturing facility in Malaysia where it produces some AS for the US market. The Company recently announced it will be opening a plant in Mexico that will lead to lower labor costs over the long term. The plant will open at the end of fiscal 2005 (March) and slowly ramp until it is running at full speed by that year’s end. Since MPAA uses lean manufacturing, it will be able to move one product line at a time over to the new plant and help mitigate the risk of the move. MPAA’s Southern California Plant will be shutdown at the end of this process. For FY 2006 this should lead to significantly lower cost, which will hopefully translate into increased margins.
MULTIPLE REVENUE GROWTH OPPORTUNITES.
MPAA has a number of opportunities to increase its revenue base. The first involves increasing the number of SKU’s it handles by broadening its product base to includes motorcycles, watercraft, heavy-duty trucks, fork lifts and other adjacent categories. Since the process is the same to work on these AS products it is just a matter of creating the distribution to handle the increased output. The second opportunity is to penetrate these additional markets. The professional installation market is traditionally reached through using wholesalers. Recently the Company announced a new relationship in this area. The third and final growth opportunity is acquisitions. There are two large companies operating in this market other than MPAA. Both are subsidiaries of larger companies and according to MPAA management ripe to be sold due to their performance. A small number of other re-manufacturers are available and could add to MPAA’s market share in the professional market.
SECOND QUARTER RESULTS AND RE-STATEMENT OF REVENUES AND COST OF GOODS SOLD.
MPAA had a solid second quarter with revenues growing 6% year over year. Operating profit was flat due to the costs associated with the ramp up in the AZ business. According to management, these costs are now behind the Company.
During the quarter, the Company and the SEC concluded that MPAA should state its revenues on a net and not a gross basis. This has caused MPAA to delay filing their 10-Q and its auditor’s to withdraw their opinion on the 2004 audit until the restatement is finished. I talked to the Grant Thornton partner at the Company’s annual meeting last week and they confirmed that the re-audit is only on how to show the revenues and that it shouldn’t affect operating or net profit. This re-audit will be done a quickly as possible, but no one will guarantee the date to me. I expect it to be done in early January, since December is a short month.
VALUATION MULTIPLE SHOULD EXPAND TO INDUSTRY NORM.
MPAA trades at a discount to its relevant peers and the market despite its very realizable growth opportunities. MPAA trades at 4.6x EBITDA with $12.5MM of trailing EBITDA and an enterprise value of $58MM ($64.5MM Market Value Equity – $10.7MM Cash + $1.3 Debt), MPAA also has Net Operating Loss carry-forwards of $11.7MM and $7.5MM for federal and state taxes, which will be used over the next couple of years. The closest two public comparable companies are Standard Motor Products (SMP, NYSE 12X EBITDA, 33.5x trailing 12 months EPS, 26X forward EPS) and Aftermarket Technology Corporation (ATAC, NASDAQ 8x Normalized EBITDA, 14x trailing 12 months EPS, 12X forward EPS). Using these figures in the chart below, yields a value for MPAA of between $13.50 and $27.80 per share. The FY05E numbers are calendar year for the comparables and March 2006 FY for MPAA.
Another company to use for valuation purposes is Edelbrock (EDEL), which is going private in a management buyout at about 30x EPS and 7x EBITDA. I think this sets a good floor valuation since EDEL was a quasi-public company with management owning over 50% of the shares and taking high compensation in a business that hasn’t grown in over 5 years. Using these numbers, MPAA’s is worth $21.98 and $9.28, respectively in a base scenario.
PE Ratio EV/EBITDA
LTM FY05E LTM FY05E
ATAC 14.0 x 12.0 x 8.0 x NA
SMP 33.5 x 26.0 x 12.0 x NA
Average 23.8 x 19.0 x 10.0 x 8.0 x
MPAA Proj Stock Price $16.80 $27.80 $13.48 $18.22
My projections used for MPAA in the table above are shown below. Fiscal year 2005 projections on sales growth are based on management’s detail of the revenues it will garner from the AZ deal and the wholesale deals signed this year. Management reiterated these numbers in their annual meeting last week. The fiscal year 2006 projections are based on the current business plus the recently announced new business deals and a market growth rate of 3%. FY ’06 is the first year I project with normalized business operations, eliminating charges related to legal expenses and other restructuring costs, and allowing the company to reap the benefits of its restructuring of manufacturing and customer agreements. FY 2007 is expected to benefit from the move of manufacturing to Mexico, where employment costs are 10% of the US.
March 31, FY 2003 FY 2004 FY 2005 FY 2006 FY 2007
Actual Actual Est. Est. Est.
Revenue $78.8 $76.6 $88.9 $100.8 $103.8
Total Revenue $78.8 $76.6 $88.9 $100.8 $103.8
CoGS 61.4 53.4 62.4 67.8 67.7
Gross Profit 17.4 23.1 26.5 33.0 36.1
% margin 22.1% 30.2% 29.8% 32.8% 34.8%
G&A Expenses 8.9 9.6 11.8 13.4 13.8
Sales & Market 1.1 2.0 2.0 1.9 2.0
R&D 0.6 0.6 0.6 0.6 0.6
Other (0.1) 0.0 0.0 0.0 0.0
Op. Income 6.9 11.0 12.1 17.1 19.7
Other Expense 0.0 $0.0 $0.0 $0.0 $0.0
EBIT 6.9 11.0 12.1 17.1 19.7
% Margin 8.8% 14.3% 13.7% 17.0% 19.0%
Interest Exp 2.0 $1.0 $1.5 $1.8 $1.8
Int. (Income) (0.6) ($0.0) $0.0 $0.0 $0.0
Pretax Income 5.6 10.0 10.6 15.3 17.9
Income Taxes (5.0) $3.6 $3.9 $5.4 $6.3
Net Income $10.6 $6.5 $6.7 $9.9 $11.6
Diluted Shares 8.5 8.4 8.4 8.2 8.2
EPS $1.24 $0.77 $0.81 $1.21 $1.41
EBIT $6.9 $11.0 $12.1 $17.1 $19.7
plus: Deprec 2.4 2.4 1.8 1.6 1.6
plus: Amort 0.0 $0.0 $0.0 $0.0 $0.0
EBITDA 9.3 13.3 13.9 18.7 21.3
Conclusion: Over the past three years MPAA has restructured its infrastructure, including management and manufacturing, while improving its financial stability and eliminating SEC overhangs. I believe the company is fast becoming the supplier of choice for related products amongst major auto-part retailers and wholesalers as evidenced by the new Autozone (AZO) and wholesale agreements. The recognition of Pay-on-Scan sales shipments already made, improving margins, strong cash flow, a clean balance sheet plus acquisition opportunities provide stability and growth avenues. Re-listing and earnings growth normalization ( following one-time charges) should provide upside based on multiple expansion and cleaner earnings picture, which should enable the stock to reach my price target of $16.00 per share in 2005.
Catalyst
1. Earning per share and revenue growth – MPAA is well positioned to generate increased revenues and earnings per share.
2. New Business Relationships- May 2004 Autozone deal has lead to an increase in shipments of $9.6MM (over 10% sales growth) that will be recognized in the second half of FY 2005.
3. Industry consolidation – MPAA will play a role in industry consolidation. The management team is financially motivated to be either an acquirer or acquiree.
4. Nasdaq re-listing –MPAA will have 5 years of audited financials. This fact, coupled with their profitability will enable MPAA to re-list on NASDAQ.