Description

Standard Motor Products is listed on the NYSE and has achieved an impressive record of mediocrity. The stock is about the same price it was 20 years ago. SMP is a manufacturer of automotive replacement parts. Through two major acquisitions, SMP is the dominant supplier in two product areas (air conditioning and engine management). The stock fits a traditional value model, since the price is below book value and six times management’s targeted 2005 earnings of at least $2.00 per share. Why is the stock so cheap? No one believes management, which has little credibility with investors. In fact, following a recent stock offering both of the investment bankers rated the stock under perform. Management has always been members of the founding family, the good news being at least they own a lot of stock. In fact, Larry Sills periodically buys stock in the open market. In sum, the company sells into a very stable market, isn’t going out of business and management has publicly forecast the more recent acquisition should add $1.50 + to EPS by 2005. Even if they miss by a lot, the company should still earn north of a $1.00 in 2005.
SMP has restructured over the past five years and is now the very dominant supplier of two large product lines to the automotive aftermarket. This very large industry supplies parts to repair cars and trucks through three channels: auto new car dealers, auto retailers such as Autozone, and independent distributors such as NAPA. SMP now has well over a 50% market share in the non auto dealer markets. The sweet spot of this market are cars 6 to 10 years old. This segment declined from1996 to 2001, but should now increase 3% per year through 2006.
In June 2003, SMP acquired its major competitor in engine management systems from Dana. Dana had in turn bought this business in a very poorly executed acquisition about 5 years earlier. Management claims this will be extremely accretive by 2005 adding over $40 million to operating profits. Simply put, SMP is shifting all of the Dana production into its own facilities. Total headcount will decline by about 20% and 7 of 9 facilities will be closed. The incremental contribution just assumes the new business can be brought up to the level of SMP’s own plants. There is no significant contribution from the benefits of being a more dominant player with modest competition. The consolidation should be complete by the end of 2004. Standard has not lost a single customer from the merger.
The second product line is air conditioning parts. In 1997, SMP did a similar transaction when it swapped its brake business for Cooper’s air conditioning line. SMP went from a weak #4 in brake products, to a 50+ % share in air conditioning. However, Standard has never achieved the benefits from this transaction. This product line is highly seasonal, and 2003 was one of the 10 coolest summers in the last 100 years. The repeated disappointments with this line plays a major role in investors show me attitude toward the more recent transaction. However SMP would be a play on global warming. (Just kidding)
To finance the transaction SMP did a secondary at $10.50 per share to fund half the purchase price. The balance sheet is okay with debt about 50% of total capital. About 2/3 of the balance sheet is inventories and receivables. If you take out all the non-recurring items from 2003, SMP should earn about $.75 per share. Depending on weather, the pace of consolidation and management not messing up, the company should earn $1.00 to $1.50 in 2004.
One potential negative which appears worse on the surface is an exposure to asbestos litigation. When SMP manufactured brakes it bought brake linings made from asbestos. It didn’t manufacture the brake linings. As asbestos litigation has rippled through the manufacturing sector, SMP has been caught up in the net. To date the company has paid about $1 million to settle claims. The vast majority are dismissed, and the outside estimate of 50 year liability is about $30 million for which a reserve has been taken.
We have followed Standard Motor for about 30 years. We have great conviction about the stability of the end markets and Standard’s strong market position. Looking at a 20 year chart, there really is only modest ( 2-3) points of risk in the stock, barring a massive energy shock. On the other hand, management makes a pretty good case why they should be able to get this one right. With the aid of a hot summer in 2005, $2.00 per share could easily exceed $2.50. In either case the stock should be at least twice the current price. Furthermore, how bad can a stock be if both major bracket underwriters have the stock rated under perform at a lower price than they just did an underwriting

Catalyst

The integration of the acquired engine management systems from Dana