Description

Uni – Select is a long term “compounder”, an extremely high quality business with a great management team and sound business strategy, two market leading businesses with significant competitive advantages / wide “moats”, and an opportunity to deploy capital over the coming years at a high rate of return.  All the while, Uni- Select trades at an attractive relative and absolute value, generates strong cash flow and has a rock solid balance sheet.  We believe the presence of all of these factors make UNS CN an excellent long term risk adjusted return, with the opportunity to compound at a high rate over a multi-year time period.

Uni – Select (the “Company”, or UNS CN) has two business segments: 1) Finishmaster, an automotive paint distribution business that encompasses ~70% of consolidated EBITDA and operates in the US and 2) Uni-Select, a warehouse distributor of automotive parts based in Canada that accounts for ~30% of consolidated EBITDA.  Each of these businesses is a market leading business with strong competitive advantages and the ability to generate a high return on capital.  Finishmaster in particular is probably the best business that nobody seems to be aware of.  Recently the Company inked a deal to sell their struggling US auto parts business to Icahn Enterprises, which has caused the recent appreciation in the stock price over the past year.  That being said, we have established our position in the Company at these higher prices and believe that the second act of the story is likely to be significantly better than the first act and that the sale of the US business eliminates a segment that has long been a problem and will allow the Company to focus on its market leading businesses and capitalize on the unique opportunities that the Company has with respect to each.  With Finishmaster in particular, the Company has clear competitive advantages in the marketplace and is in a position of dominance vs. its competitors, affording them the opportunity to acquire those players at low prices and with little competition, further extending their lead.

UNS CN trades in Canada but their reporting currency is in USD, which makes the Company screen with typically inaccurate numbers which inflate the quoted valuation multiples shown by financial data sources.  In addition, the sale of the US business just closed a few days ago and therefore the latest balance sheet does not include those sale proceeds. All financial figures and valuation will be presented in USD for purposes of this report as that is the Company’s reporting currency. 

Finishmaster, the best business you’ve never heard of

Finishmaster or “FM” is a simple, well managed, high quality business with a great opportunity ahead of them.  They are the largest distributor of automotive paints in the automotive refinish market (selling to body shops and collision centers).  Their suppliers are the large automotive paint manufacturers, the biggest of which are Axalta (AXTA) and PPG Industries (PPG).  FM sits in between those paint manufacturers and the end users, which are the thousands of local body shops and collision centers in the US.  FM also distributes a wide range of other products to their customers (“sundries”) which is a nice additional source of profits.

The reason the business exists is simple.  Body shops don’t know in advance what type of jobs are coming their way in a given day- they might get a green Toyota, a red Ford, a metallic grey BMW or a polar white Mercedes – but they don’t know in advance.  Thus on a daily basis, body shops are ordering paint supplies in order to serve those specific needs.  They also need to receive those paints in a timely fashion, frequently on a daily basis or even multiples times in a given day.  Finishmaster serves as this critical link in the supply chain, with a network of 168 branches across the US and a fleet of approximately 800 trucks.  They stock large quantities of paint from the manufacturers, load it up on trucks and make daily deliveries to their customers.

We like a few things about this business:

1)   They are the largest player by a wide margin.  With approximately $600mm in annual sales, FM enjoys a significant scale advantage vs. its competitors.  The next largest player in the space is NCS (National Coatings & Supplies), based out of North Carolina, which does between $200m -$250m in annual sales (about a third the size of FM).  Other smaller competitors include Akzo Nobel Coatings (a subsidiary of LKQ), which we think does close to $100mm in sales and we have heard is in a state of disarray.  LKQ acquired them in 2011 and from what we have heard, it does not sounds like it has gone well.  SingleSource is another player in that same size range – they are a “monoline” distributor of PPG product.  Otherwise, the competitive set that FM is typically competing with are independent regional “jobbers” who make up the significant majority of this market.  These regional players typically have between 1 and 5 locations.  Examples of a few regional jobbers include the following:

a.       Gladwin Paint (http://gladwinpaint.com/)

b.      D’Angelo’s,(http://dbgpaint.com/)

c.       Wesco (http://www.wescopbe.com/)

d.      Color Match (http://www.colormatch.com)

2)   Scale affords FM a purchase price advantage.  Because FM is such a large buyer of automotive refinish paint products (we believe that FM is Axalta’s largest customer for example) they are awarded with preferential pricing vs. their competitors – it is unclear the exact magnitude of the advantage but we think it is in the 10% range. 

3)   Route density model; another advantage for the largest player.  Like many distribution businesses, there is a scale advantage to larger players in terms of being able spread fixed costs over a wider revenue base and by “making more customer stops in a given day”.  In addition to FM being an overall larger business than its competitors, they are also a much larger player at the local level, with individual locations that do much more in revenue than competitors.  For instance we think that the average NCS location does about half the amount of business as an average FM location.  FM’s scale thus allows them to more efficiently utilize their truck fleet, optimizing routes and density in order to be more efficient and operate at a higher margin than the competition.

4)   MSO Consolidators are driving 100% of their purchasing to FM.  The body shops are consolidating and this is a significant tailwind for FM.  There are a number of consolidation platforms (referred to as MSOs) in the collision center space.  The three big ones are ServiceKing (backed by Blackstone), The Boyd Group (public company BYD CN, owner of the Gerber Collision chain of stores) and ABRA (backed by Hellman & Friedman).  These consolidators have a nice model – they are rolling up body shops and going to the insurance companies, offering them preferred pricing in exchange for their business.  This has been a powerful model, as evidenced by BYD CN’s success and trading multiple of 11.1x 2015E EBITDA.  This dynamic has been described previously on VIC (see zzz007’s writeup of BYD from back in 2012) and it is worth understanding this powerful market driver.  The MSOs are driving business to Finishmaster in an effort to consolidate their suppliers and wring out inefficiencies.  They are typically negotiating directly with the paint manufacturers for preferred pricing on paint and then appointing FM to be their exclusive distribution partner.  From our research it sounds like the push to do more business with Finishmaster is coming from both the MSOs and also from the paint manufacturers (especially Axalta). The financial impact of this is significant incremental volume for FM at a lower gross margin, but still at a higher operating margin.  The MSO customers do not require as much sales support and will typically be able to stock more paint on site (thus reducing the number of deliveries that FM needs to make).  As such, this has been great business for FM and has driven very nice organic growth in recent years. 

5)   In addition to the MSOs, the small independents are also moving towards Finishmaster and the Company is quick to point out that only about half of their market share gains are coming through the MSO channel – they have also been highly effective at picking up incremental customers amongst the independent players as well.   Furthermore, there are other customers such as the major auto dealer groups who are consolidating their business with Finishmaster – one of these key accounts for instance is AutoNation, who is continuing to drive business in the direction of FM.   Taken together all of these channels are driving growth for the FM business.

6)   FM has a fantastic reputation in the industry.  In the course of our due diligence on Finishmaster, we spoke to large customers, competitors, suppliers and former employees.  Rarely do we hear such unanimous sentiment about the quality of a business and how well it is managed.  We like the momentum that FM has operationally and we think it will allow them to continue to extend their lead in the market.  One area where we heard that FM excels is with respect to IT systems – they are the only player with sophisticated systems (they are on SAP) which allows them to manage their business more effectively and positions them to interface well with large customer groups (MSOs) and the major paint suppliers.  They also bring strong technical resources to play and work to add value as a distributor – they have a highly experienced staff of paint professionals that helps customers get exactly what they need to complete a given job.  They do a good job with mundane yet important things like helping customers tint, adjust or match a color so that jobs are completed properly. This helps customers buy more effectively and reduce waste.

All of the above has resulted in a dynamic where Finishmaster is the dominant player in its space with a significant competitive advantage, which continues to grow.  In 2014 Finishmaster grew 9.6% organically, which highlights the positive momentum and market share gains they are experiencing.  Management is quite confident regarding Finishmaster’s ability to continue with this level of performance and market share growth.  Conversely, the Company’s competitors are in a state of continually diminishing market power.  As you might expect, this dynamic has resulted in a target rich environment for the Company to continue to consolidate its space.  The economics of these transactions are quite attractive and we think that FM has the ability, on average, to make acquisitions at a pro forma EBITDA multiple of less than 5x.  FM is typically able to achieve consistent synergies with respect to (i) overhead cost reductions by putting the acquired company on FM’s centralized systems, (ii) buying synergies related to FM’s preferred deals with the paint manufacturers and (iii) sales synergies related to FMs national distribution agreements with the major MSOs (allows FM to serve those customers in cases where it does not already have a local presence). 

The Company just began breaking FM out as an independent segment as of the most recent quarter, for the first time since the business was acquired in 2010.  Since 2010, Finishmaster has grown from revenues and EBITDA of $415mm and $26mm to our estimated LTM revenues and EBITDA of $600mm and $60mm.  Management believes that FM’s market share has increased from 17% to 21% over the past few years.  While this performance is impressive, we think that FM’s growth will accelerate due to (i) the sale of the US Auto Parts business, which will free up capital to more aggressively consolidate in the paint distribution arena and focus more resources on this business and (ii) hiring Henry Buckley from Grainger as CEO – more on this later, but we think Henry is the perfect executive to execute on Finishmaster’s opportunity to consolidate in paint distribution.  To put this into pure financial terms, the Company has no debt and now has up to $500mm of capacity to do acquisitions in a target rich environment, where they can buy assets at

Uni-Select Canada

Uni-Select Canada is the largest warehouse distributor of automotive parts in Canada, slightly larger than NAPA Auto Parts in Canada.  They operate “banners” in a business model similar to a business like True Value Hardware, where they provide a brand, buying services and distribution for their members/customers (which are known as “jobbers”).  The primary “banner” operated by Uni-Select is Auto Plus, though there are smaller banners that the Company operates including Bumper to Bumper and Cooling Depot.  They have approximately 618 jobbers in their customer base and serve as a buying group, distributor and marketing services provider for these independent players.  The Company will typically carry approximately 160,000 SKUs in its warehouses, which is vastly more than the 20k or so that a typical jobber will keep in stock – this is the essence of why this business exists, to help the jobbers get access to that long tail of parts.  The jobbers typically sell to national chains of installers, service stations, repair shops, fleet operators, collision repair shops, auto dealers and heavy machinery dealerships - unlike in the US where there is a significant DIY market, in Canada the automotive parts business is dominated by the DIFM (do it for me) segment which is why the market structure is a bit different than the retail-heavy structure that exists in the US.  In addition to operating as a warehouse distributor, the Company has a strategy to expand more aggressively into owning corporate stores (jobbers).  The Company has operated corporate stores for years but there is an opportunity to move further in this direction through opportunistic acquisitions of jobbers, frequently in connection with their retirement/succession planning. 

The competitive landscape in Canada includes the following major players:

NAPA – They are about equal in size to Uni-Select and the only other national player in the market.  That being said the Company does not really compete head to head with NAPA because it is much different being part of the NAPA network as opposed to being part of Uni-Select.  Uni-Select caters to independent entrepreneurs who want to own and operate their own businesses.  NAPA is obviously a much different model; as such there has historically been almost no switching in either direction between Uni-Select and NAPA jobbers – they target a different type of customer. 

Carquest – Carquest is the #3 player; they are focused regionally on the East, and were recently acquired by Advance Auto at 9.3x EBITDA.  Similar to NAPA, Carquest focuses on corporate stores as opposed to Uni-Select’s focus on independent jobbers.

Lordco (www.lordco.com) – these guys have a model like O’Reilly, more focused on retail sales and heavily concentrated in the Western market / British Columbia. 

In addition there are a few competing “banner” operators / buying groups that are significantly smaller than Uni-Select.  These include:

-     Leader Auto Resources (more focused on serving auto dealers and actually a customer of Uni-Select as well)

-     Modern Sales Cooperative / Autosense (http://www.modernsales.ca/index.html)

-     Colonial Auto Parts (http://www.colonialautoparts.ca/)

-     Piston Services (http://www.pistonringservice.com/)

-     Best Buy  (http://www.bestbuydistributors.ca/)

-     Auto Value (http://www.autovalue.com/aboutus.html)

-     Alliance1 (http://www.alliance1.com/)

Overall this is a business with some nice characteristics and advantages in the market, similar to Finishmaster – though not as dominant.  I would characterize market share as generally very stable across the industry but certainly growing for Uni-Select at the expense of the smaller buying groups.

Overall, there are a few things that we like about this business:

1)  Scale – they are the largest player (or roughly equal to NAPA) with all of the benefits of scale that accrue to such players in terms of buying power, leveraging fixed overhead, distribution synergies, strong IT systems (they converted to SAP years ago). 

2)  Uni-Select has excellent relationships with its customers/members, who tend to be larger jobbers that are strong in their local markets.  Turnover is extremely rare in Uni-Select’s customer base.  The Company has been an excellent long term partner for its members and has consistently worked to save money for its members and enhance their strength.  A good example of this is the Company’s alliance with the Collision Solutions Network, which is a network of collision centers offering national coverage for insurance companies.  Uni-Select’s alliance allows their members to sell products to repair shops that are affiliated with this network.  Uni-Select is more than just a distributor for its members, it serves as a value added marketer through its banner program as well – this creates a very sticky relationship with customers.

3)  The Company is growing its national accounts business – as one of two national players, Uni-Select is winning incremental business with national players such as Canadian Tire, Midas, OK Tire, Kal-Tire and Prime Carcare Group.

4)  Close to 20% of Uni-Select’s Canadian sales are in paint which is an area of significant strength for the Company.  Hence – this leadership position in paint also extends to Canada and has been a key differentiator and profitable business for the Company.

5)  Attractive acquisition opportunities abound in Canada as well.  Similar to the US strategy, the Company is looking to refocus and extend its strength in Canada as the sale of the US business is closed.  The strategy is focused on both expanding its corporate store network through acquisitions of retiring members as well as acquiring other buying groups in order to solidify the #1 market position.  Acquisitions of corporate stores tend to be quite attractive, at less than 5x EBITDA multiples.  The Company is frequently the natural buyer for these businesses when an owner is looking to transition.  Frequently (70% of the time) the Company has a right of first refusal to buy stores from their members when there is a change of control transaction.  As an example of this, in Q1 2015 the Company acquired the remaining 50% of its joint venture with Wilter Auto & Industrial Supply.  This is a $25mm revenue business that the Company had previously been a 50% owner of and was accounted for as an equity investment in the Company’s financials.  This business will be fully consolidated going forward and was acquired at a sub 5x EBITDA multiple. 

Overall we think that Uni-Select Canada is a high quality cash cow, with extremely strong customer relationships and stable end markets.  We think that they have the ability to extend the lead in their markets and be the key consolidating platform in the Canadian auto parts space. 

Management

We think that Uni-Select is already a very well-managed Company, as evidenced by the Company’s strong customer relationships, reputation and financial performance in both Canada and at Finishmaster.  And while we view outgoing CEO Richard Roy favorably (Roy engineered the highly successful Finishmaster deal in 2010), we think that the new CEO Henry Buckley brings fresh energy and is arriving at precisely the right moment to seize on the substantial opportunity at hand. 

Buckley comes from WW Grainger Inc., where he was in charge of Grainger’s Canadian operations and sales across 184 branches.  Buckley built a strong M&A capability within Grainger and was extremely highly thought of at the Company.  A number of significant acquisitions were made and integrated during his tenure which were quite successful.  The Canadian operations performed extremely well under his watch and as a result, Buckley was brought over to the US business at Grainger where he was named VP of Specialty Brands and Mergers & Acquisitions. 

The consolidation opportunities at Finishmaster and Uni-Select are quite similar to the consolidation opportunities that existed at Grainger – and it is this specific opportunity that Buckley was aware of that attracted him to the Company.  Besides already having dominant market positions, one of the factors that makes Uni-Select a great platform is that there is already very strong management at both Finishmaster and in Canada – ie, the business is already very well run and has excellent leaders in the organization, a strong culture, and an existing ability to effectively integrate acquisitions.

Since arriving at the Company last September, Buckley has taken a very methodical approach to acquisitions and has identified at Finishmaster specifically, businesses with approximately $1 billion in revenues that are likely to come up for sale in the coming years.  The biggest of these is NCS, which was discussed earlier in the writeup and the remainder of the opportunity set represents companies with less than $100 million in revenues.  In my conversations with Buckley, he has noted that he is also working to build a methodical M&A process at Uni-Select which is something that he created at Grainger as well – a more formal process of developing a pipeline, building relationships, picking areas to focus on/setting priorities, a due diligence/financial modeling capability, and then most importantly an integration team tasked with integrating and monitoring acquisitions to ensure their success.

The Company has done a few deals in recent months and has recently noted that the M&A pipeline is much larger right now than it has been in the past.  We think that the pace will accelerate now that the sale of the US parts business has closed.  Much of Buckley’s early tenure at the Company was focused on divesting the US business and developing an M&A strategy, process and pipeline.  In the coming months, we expect to start to see things move to execution phase.

I would encourage you to get to know this management team and listen to their level of focus and discipline with respect to seizing on this opportunity. 

Valuation / Comps

Uni-Select currently trades at a low 8s 2016E EBITDA multiple and a high single digit unlevered free cash flow yield.  This is an extremely attractive valuation for a business that has leading market positions, high barriers to entry, generates excellent free cash flow and most importantly has the opportunity to compound value over the coming years. 

Management has indicated that they expect to sustain at least $60mm in free cash flow (7.5% free cash flow yield).  The Company will not pay cash taxes for at least the next couple of years because of an $80-$100m after-tax loss due to write-downs of intangible assets related to IT system and portion of goodwill that will incur as a result of the sale of the US parts business. 

We expect the primary driver of return to come through deploying up to $500mm of capital into a well thought out consolidation strategy.  We see the financial returns on this investment being quite attractive to shareholders and incremental free cash flow as the Company makes acquisitions at 4-5x EBITDA (this could more than double EBITDA).  We think that this opportunity is generally acknowledged by the few sell side analysts but their thinking tends to be clouded by the history of the business being weighed down by the soon to be divested US business.  The sell side acknowledges that Finishmaster is a “jewel”, but we do not think they grasp the overall dynamics of the change in management combined with the consolidation opportunity and heightened focus of the business and management team going forward.   

We look at a wide swath of comparable companies and break these down into a few buckets as shown in the comp table below:

We think that Boyd Group, an MSO consolidator in the collision center space is a great comp for obvious reasons – it is driven by similar dynamics as Finishmaster and represents another business with a nice opportunity to consolidate.  That being said, we think that Finishmaster is “earlier” in executing on its opportunity to consolidate (they are just starting to move aggressively down this path, whereas Boyd is fairly far down the road) and also is in a superior competitive position relative to the MSO consolidators (with extremely limited competition for acquisition targets, significant synergies that can be achieved and a set of competitors who are quite disadvantaged).

The auto parts retailers are worth taking a look at as well, though these are not really direct comps and we think that Uni-Select’s businesses generally face less competition and have a much better opportunity to consolidate.  Genuine Parts we lump into this set of retail auto parts even though they have a significant industrial distribution business through Motion Industries. 

We think the industrial distribution companies are worth thinking about and are similar in terms of business quality to a business like Finishmaster, though we would note that these businesses are trading at a bit of a discount currently because of their exposure to weaker end markets (some amount of underlying energy exposure). 

Though a different business model, the paint companies’ multiples are worth noting as well.  Axalta and PPG are probably most relevant in this group given similar end markets.  Sherwin Williams is interesting since it is a vertically integrated player, though they are more of an architectural paint company.

Overall, all of these related businesses trade at a premium multiple to UNS CN, but Uni-Select has the greatest opportunity to compound value from here given their smaller size, substantial war chest, competitive position and attractive pipeline of acquisitions.  In terms of a price target today, we think that UNS CN should trade at a premium to the comps, not at a discount.  In our longer term model however, we see future share price appreciation as a function of leveraging a good consolidation strategy combined with generating strong free cash flow in the process.  In that regard, we see a path to the stock price nearly doubling in a 2 year timeframe assuming $300m of acquisitions.  We also expect that as investors see the Company’s strategy unfold and as the Company starts articulating this strategy more actively to investors, there is likely to be multiple expansion.

Not central at all to our thesis, but we are also thinking about strategic value of Uni-Select longer term to an acquirer; we think there would be many interested parties on this comp list and of course note Advance Auto’s recent purchase of CARQUEST at 9.3x EBITDA (which is comparable to UNS CN’s Canadian business).  Clearly there is significant M&A in this space and longer term the Company itself is a likely target as the business could easily be folded into NAPA, Advance, O’Reilly OR LKQ.  We would note that there is approximately $20mm of corporate overhead that is separate from the management of the two operating businesses that could be eliminated in an acquisition of the Company, along with other operational synergies. 

Summary/Conclusion

Uni-Select is an excellent business with high barriers to entry that will compound value over time as they execute on a well thought out acquisition strategy with strong financial returns.  Finishmaster in particular is a prized asset and is one of the better businesses I have come across that very few people seem to be aware of.  It is interesting to me for instance, that I have heard buy recommendations over and over with respect to Axalta (which I acknowledge is an excellent business, and was written up on VIC just a few months ago), yet very few are even aware of the identity of their largest customer Finishmaster and the quality of the business.  This is known by the few sell side analysts that cover the Company but the point has not really gotten across that Finishmaster (which was once a smaller portion of the business) is now the dominant source of current earnings and growth for the Company.  The stock does not screen well for two reasons: a) the US business was not making any money and the Company sold it for $300mm which has yet to hit the balance sheet and b) the stock price is quoted in CAD but the reporting currency is USD – hence the market cap of the Company is typically overstated and earnings understated because of the two currency dynamic which is missed by data sources.

The business is thus not well known or understood by investors, but we think that this perception will change as they start executing on their strategy and the financial statements start to show the performance of the business separate from the underperforming US auto parts business.  Further, the stock trades in Toronto and is thus less visible to US investors.  At some point I think it would be appropriate to rename the Company Finishmaster and list it in the US – I suspect there would be immediate value creation if they took this simple step.  Overall though, I am happy to let the consolidation strategy take place over the next few years as we see significant earnings power ahead as the Company increases its scale. 

Catalyst

Re-valuation of the business post US parts spinoff, organic growth, accretive acquisitions, continued MSO consolidation, investor interest increases