Description

Long XPEL

Note: MIP wrote up XPEL ~1 year ago but did not submit it for one of our 2 annual ideas. This idea is submitted as an annual idea because we continue to think XPEL is undervalued (our favorite idea/biggest long) and is finally “investable” for more VIC members (NASDAQ listing).

XPEL has been written 3 times on VIC (twice for an annual submission) and has been well explained by participating VIC members. The purpose of this pitch is to review XPEL’s business model, refresh our investment thesis, frame the fundamental changes in the company, and evaluate the forward returns at this point. We will also discuss what we got wrong when we wrote XPEL a year ago.

XPEL sources, distributes, and installs aftermarket automotive products, including paint protection film (PPF), headlight protection film, automotive window films, architectural films, and auto ceramic coating products. In the 1H19, ~73% of XPEL’s revenue was generated from paint protection film, ~9% of XPEL’s revenue was window film, and the remaining sales came from ceramic coating products, software, installation labor, and training classes. Over half of XPEL’s sales come from the US, with the remainder largely coming from China, Canada, and Europe.

XPEL’s business model is driven by its relationship count with installers and its ability to grow its brand. Currently, XPEL has over 2.4k customers and counting. Its worth noting that certain international regions, where XPEL works with a national distributor (e.g. China, South Africa), only count as 1 customer. A year ago, XPEL had around 2k customers which means that its relationship count is growing by ~20% in countries where it operates directly. I encourage members to track XPEL’s customer relationship count overtime (or check out waybackmachine) and notice how many more installers XPEL works with today versus a year or two ago. As XPEL builds more relationships, XPEL generates more revenue, can invest more in its brand/come out with more products, and therefore create more value for its installers. This cycle has been playing out for many years and has manifested itself in XPEL profitably, growing its sales by 10x over 7 years.

XPEL is also using this installer base to sell more products. For example, XPEL recently launched XPEL Fusion, which is a ceramic coating for cars. On a gross profit basis, XPEL makes as much on an XPEL Fusion sale as it does on an average paint protection film install and XPEL’s invested capital into this product is negligible! In addition, dealers are happy to sell more XPEL products because installers realize most of the revenues in the value chain and benefit from XPEL’s “free” lead generation. Interestingly, XPEL is now selling many architectural protection films since ~20% of its customer set overlaps with this market. Though its too early to tell if XPEL will be successful in this market, it is a large, established addressable market which has the potential to diversify XPEL away from automotive cyclicality.

A common question asked by investors is if XPEL will “hit a growth wall,” since its unlikely the penetration of automotive paint protection reaches that of window film. We somewhat agree. It is extremely unlikely that every car is installed with paint protection. Nevertheless, we do know that XPEL generates around ~$10/Canadian auto SAAR versus the US ($4), UK ($2), China (<$1), Continental Europe (<50c), Asia Pac (~30c). In addition, management has said at a high level the penetration of paint protection film is extremely spotty by region and they are attacking the US and global map to fill in the blanks and they expect to be able to build relationships with new installers for many years into the future. XPEL’s management has mentioned, for example, that Europe feels like the US did 5+ years ago. In addition, XPEL’s window film business continue to become a larger % of the overall market and we know this is a large, established market with entrenched, conglomerate competitors who have bled share to XPEL in the paint protection industry for many years. We think XPEL will organically grow its sales mid-teens annually over the next 5 years through a mix of “SSS”, new installer relationships, and new products.

The reason why we are uniquely excited about XPEL now is its ability to deploy capital in acquiring installers and distributors. Over the last 10 quarters, XPEL has gone from $3m in net debt to $4.3m in net cash (significant for a small cap company). XPEL has occasionally made installer acquisitions but has put these acquisitions on hold in order to focus on the recent NASDAQ uplisting. Now that XPEL has completed that process, management is focused on reinvesting capital into installer/distributor acquisitions. Historically, XPEL has spent ~4x EBITDA acquiring installers and ~5-6x EBITDA acquiring distributors. If these valuations hold, XPEL will be able to meaningfully accelerate revenue growth inorganically while maintaining a net cash balance sheet. For example, we estimate that XPEL will have ~$10m in net cash by the end of the year. If XPEL puts that capital to use, it will boost XPEL’s EBITDA by ~$2m or over ~10% our estimate for 2019E EBITDA.

Its worth mentioning that XPEL’s recent listing on the NASDAQ was very important. Other then the fact that more investors can own the company, the potential for sell-side coverage, and improved liquidity, XPEL legitimacy as a NASDAQ company is a free call option on greater brand awareness. If even one potential customer hears about XPEL because its listed on the NASDAQ, that’s real business that XPEL would not receive on the TSV.

MIP wrote XPEL ~1 year ago and got one thing very wrong: China. The way we looked at it a year ago was that there were 3 states of the world. One in which China continued to take off, another where China continued to grow moderately, and a third where China’s 2018 revenue growth was unsustainable. We thought that even if it’s the latter we wouldn’t lose that much money. Well, it turned out to be scenario 3. XPEL’s China revenue is likely to decline from $32m last year to <$20m this year. The reason for this decline is that the end usage of XPEL’s products last year was significantly less than the amount of product XPEL shipped. In other words, XPEL built inventory throughout China. For context, XPEL works with a distributor in China, which works with subdistributors, which works with installers. XPEL has a lot less visibility on sales in China and makes an inferior GPM on sales in China. In addition, XPEL has much more competition in China then it does in other markets. In the most recent quarter, management said that despite another Q/Q decline in China sales, end demand is improving and XPEL’s new line of China specific products is gaining traction. Currently, XPEL wraps 20-30k cars a year in China, which is an extremely small fraction of the China auto market, and we believe long-term that number is likely going to go up.

Trading for $10.52/shr, XPEL trades for 18x 2020 EPS and 15x 2021 EPS, cheap multiples for a growing, net cash, profitable company. Though the stock “isn’t as cheap” as it was a year ago, we think the story has improved dramatically (NASDAQ listing, ability to focus on M&A, improving gross profit margins, continued organic growth). In a bear case, we think XPEL generates an 11% IRR over the next 5 years (+12% earnings growth, +5% average FCF yield, -6% multiple contracting to 16x fwd P/E). In a bull case, we think that XPEL generates a 48% IRR over the next 5 years (+33% earnings growth, +5% average FCF yield, +10% multiple expansion to 30x fwd P/E). However, this framework does not give XPEL credit for deploying capital at high rates of return through M&A. Our DCF spits out ~$20/shr which is based on $360m in sales in 2030 with a 20% EBIT margin (9% WACC; 3% growth). We have dramatically taken down our organic sales growth rate over the next 10 years and frankly think we are being too conservative. As an FYI, if XPEL generates $10 in sales for every car in the world, XPEL will generates ~$814m in total sales. Though we think this is unlikely, this math does not take into account new products such as XPEL Fusion, window film, architectural films, and owning/operating installers and distributors. Long-term, we think XPEL has a very reasonable chance of being a $1b Mcap company 3-5 years from now (~4x 2024E sales), especially if management is able to continue to execute like they have been. Overall, we think XPEL is worth $20-25/shr right now (DCF + value in high ROIC M&A opp’y) and is now set to be a long-term compounder.

P.S. I think someone asked about EPS estimates a year out… In 2020, we have $141m in sales, 35% gross profit margins, 15% EBIT margins, 24% tax rate, and $16m in net income or $0.58 in EPS.

Catalyst

Sell-side coverage/consensus estimates

Russell 2000 inclusion

M&A