Description

Most of you are probably tired of seeing XPEL written up, and for the most part, I don’t blame you. There is a lot to dislike surrounding XPEL. It has a cult-like following and the CEO is deified. For the past 5 years it has been priced for absolute perfection at nosebleed valuations.It has also been a bit of a hedge fund hotel over that same time period. I, like many others on this board, have briefly perused XPEL in the past, liked what I saw in terms of the quality of the company but was instantly put off by the valuation. I told myself I’d take another look if it ever became cheap but wasn’t holding my breath it would ever happen. Well my friends, I think that day has finally come. The market reaction to Q1 2024 results were vehemently negative with the stock down ~40% after earnings as well as down ~60% over the past 9 months. I believe the reaction to these results were wildly overblown, and peeling back the layers a bit reveals nothing fundamentally wrong. Cheap may be a strong word, but I think XPEL sits firmly in the “growth at a reasonable price” bucket today.

Normalized Earnings:

I would imagine most here are familiar with xpel’s business model, risks, management, etc.. so first things first - is it actually cheap? Well if you’re basing it off of annualizing Q1 2024, the answer is undoubtedly no. We’re somewhere around 35-40x on that basis. However, there were plenty of abnormal things in Q1 that distorted the earnings. On a normalized basis, you can make an argument that we are likely at a low-teens multiple today. This strikes me as very reasonable for a company that has grown revenue 13x and operating income 24x over the past 10 years, with expectation that double digit growth may continue for many years into the future. 

So what is the difference between my normalized case and what occurred in Q1? Well, XPEL is not being run for cash flows TODAY. XPEL is investing heavily for future growth, and continued to do so through the difficult operating environment it found itself in during Q1. Everyone is entitled to their own opinion regarding that, but in my mind, it is undoubtedly the right call. PPF attach rates on new cars are still fairly low - around 8% in the US and substantially lower internationally. Most of that comes from car enthusiasts but I believe there is a very reasonable use case for the mainstream for a PPF product in some form on their vehicles. However, awareness of the product among the mainstream is very low. XPEL spending the way they are spending in order to bring that awareness is the right call in my eyes. With that being said, it would be very simple for XPEL to simply turn off these growth investments to run the business more for cash flow. This is much of the difference between my normalized case and Q1 earnings. 

So what specifically happened in Q1 to make the numbers appear so awful? 

• Their distributor in China distorted numbers due to overbuying inventory in Q4 2023 and subsequently buying almost no inventory in Q1 2024. Q4 2023 was the largest purchase this distributor has ever done in a quarter by a wide margin, but lumpiness is not unusual for this distributor. There have been many quarters in the past 5 years with similar buying patterns.

• Port delays in the US reduced sales of Porsche & Audi by ~20% which are 2 of XPEL’s top brands for PPF coverage. 

• XPEL ramped SG&A by ~36% yoy despite revenue only growing 5% yoy. Due to this, EBITDA declined to $11.7mm in the quarter vs $17.1mm in the previous year’s quarter. Part of this is due to timing on their dealer conference, but the majority is simply investment in growth.

A few notes on these occurrences. 

•  Regarding revenue growth and the China distributor issue, this distributor is always very lumpy so this doesn’t suggest any sort of issue for the region. But if we look to the rest of their geographies - ex-china, revenues grew by 12%. Rest of world (excluding China and the US), revenues grew by 31%, and this geography makes up 41% of revenues (and obviously growing). 

• The port delays apparently eased by April, and according to Ryan Pape, April saw higher revenue than March for them which is unusual for their business. 

• Here are Ryan Pape’s comments on the SG&A spend: “So excluding the impact from any acquisitions, which we'll talk about, from an SG&A standpoint, at this point, we're really more focused in the near term on holding our cost structure rather than trying to reduce it significantly. There's plenty of opportunity for our core business even in this environment to grow and to grow into that cost structure. Look, obviously, if things change, we'll change and we have to be flexible, but that's our current view.” As I said above, everyone is entitled to their own opinion on whether or not this is the right call. In my mind it is, but more importantly, obviously normalized margins are much higher than today’s margins and XPEL has shown willingness to revert the cost structure if the operating environment does not change.

How to think about normalized numbers:

If we're trying to get to normalized numbers based on Q1 results, let’s consider the above as well as the seasonality of the business. 

• SG&A Normalization: From 2012-2022, XPEL averaged SG&A as a % of revenue of 21.3%. Marketing spend as a % of revenue from 2017-2022 (accounting changed when they listed on NASDAQ, so you can’t get exact numbers before this) averaged 6.7% of revenue. Contrast this to Q1 2024 in which SG&A was 31.8% and marketing was 11.5% of revenue. 

• Seasonality: Historically, Q1 is XPEL’s slowest quarter. Since 2018, XPEL has averaged 20.5% of annual revenue in Q1. The highest it has been over this period is 22.8%. 

• China distributor channel: Since 2018, XPEL has averaged annual sales to the distributor in China of $36.5mm. It has been higher in the past 3 years, but let’s just assume it reverts back to a somewhat lower level. This would imply ~$9mm per quarter vs the $1.45mm seen in Q1 2024. 

So using the assumptions of slightly worse than average numbers: 22% SG&A as a % of revenue, normalized China revenues of $36.5mm annually, and 23% of revenues coming from Q1, and combining this with Q1 2024’s results, this would imply a normalized annual revenue of $425mm and annual NOPAT of ~$68mm. This would put XPEL at ~14.7x NOPAT. This also would suggest 7% annual revenue growth which fits well with management's guidance of 8% growth for 2024.

To me, paying 14.7x for this business seems more than fair. Very rarely do I come across businesses with massive opportunities to put incremental capital to work at 20+% IRRs which I believe to be the case here. On top of that, XPEL seems to have a management team which is prioritizing the right things for the long term, very aligned management with high insider ownership, significant competitive advantages via its software and close to zero net debt. In my opinion, a company that ticks all of those boxes deserves a multiple significantly higher than 14.7x.

Is this normalization of earnings the correct way of looking at the business, or has something structurally changed recently that has changed the cost structure? I believe only 1 thing has structurally changed about the business over the past 5 years. Around 2020/2021, XPEL started allocating capital towards buying up some of its independent installers. From disclosure around past installation acquisitions as well as speaking with independent installers myself, it seems that this revenue on average carries a ~25% EBITDA margin. Comparing this to XPEL’s 19% EBITDA margin would make one believe that these acquisitions should actually be raising XPEL’s margins, not lowering them. Rather than the business having structurally changed, I think instead that management has made certain decisions regarding growth in various avenues. Ryan Pape is very aware that most of their current end users are car enthusiasts and if XPEL wants the go forward growth trajectory to look anything like XPEL’s past, he’ll need to break into the mainstream. It appears they are currently doing so via marketing towards dealerships as this is ultimately where their product will get sold into the mainstream. I think there are 2 ways this can go - either XPEL is successful, in which case this reaction to 2024 margins will appear petty OR they fail to break into the mainstream and management brings its margins back in line with where they’ve historically been. I am not going to bank on either scenario (however, I will say I do believe partial coverings of the front of a vehicle probably do represent a very good use case to the average person), but I am ok with either outcome. 

RISKS:

There are a few risks presented by short reports that have been fretted over during the past year. These include:

• OEMs in-housing the installation of PPF

• Tesla, which has already in-housed PPF, representing a very high % of XPEL’s revenue

• PPG/Entrotech creating a film/paint hybrid that would make PPF obsolete

• XPEL’s brand positioning

OEM RISK: 

A few OEMs have announced programs to offer PPF to customers ordering custom configurations through their websites. While 3 factory programs have been announced publicly from Tesla, Rivian, and Ford, there are other OEMs that also do this on a smaller scale.

First, I think it is important to look at each of these programs individually to get a grasp of what they are really doing. Let’s start with Ford - the Ford program is a partnership with PPG that only allows buyers custom ordering a Mustang the option to cover their car with matte PPF. The Mustang has represented around 1-2% of Ford’s total vehicle sales over the past few years. I estimate that at most this program is wrapping ~2k vehicles annually (the actual figure is probably significantly lower than that). Considering that volume vs the 4.4M cars sold annually by Ford, I think it’s pretty safe to say that this is not a genuine effort by Ford to enter the PPF game. This is probably done in 1 facility by a handful of installers which is nowhere near the size of operation that would be needed to genuinely in-house PPF at Ford. 

Next we have Rivian. Rivian’s PPF program is actually a partnership with XPEL in which XPEL installs the product at a facility nearby Rivian’s assembly plant in Illinois. 

Finally, we have Tesla’s program. Tesla is offering colored-PPF installations from the PPG/Entrotech JV at some of its service centers. I think that Tesla is the anomaly among auto OEMs in that they are likely the only OEM that could actually pull something like this off. Tesla is the only OEM with service centers and without dealerships, which is exactly what an OEM would need to successfully in-house PPF. 

As for the OEM risk as a whole, I think it is mostly a non-factor with the exception of Tesla. If I were to guess, I think a few OEMs try to in-house PPF on a rather small scale, realize it comes with too many headaches, and eventually exit the business (the result of the Ford program will be our first indication on whether or not I’m right on that point). There are many barriers to an OEM being able to do this successfully:

• The warranty issue. If the OEMs are installing PPF, they have to warranty the product which they are simply not equipped to handle. If they are installing the product at the factory or at the port, they do not have any service centers capable of re-installing the product.

• Labor. Installing PPF is an incredibly difficult process. It typically takes 12-18 months to train someone to install PPF properly. Installers will tell you that the installation of PPF is a highly artistic process, and it takes the right type of person to be able to do it correctly. Without proper installers, you are likely wasting thousands on every job from wasted product. For an OEM to launch a full scale PPF operation, they would need hundreds or thousands of trained installers. That isn’t something you can simply go out and hire. Many of the people trained at installing PPF own their own shops and aren’t simply going to close up shop to go work for an auto OEM. 

• Dealerships do not want PPF pre-installed on cars from the factory. They make more money from selling the product at F&I, so their preference would be for factories to let them sell the product themselves. 

In my view, the risk of OEMs in-housing PPF is actually more of a potential benefit than a risk. The most rational way to launch one of these programs would be to partner with an independent installer capable of doing the work for you. That way, you don’t have to outlay any capital, you don’t have to worry about training and retaining thousands of installers, and you put the warranty risk on someone else. XPEL would be the clear choice considering their extensive installer network. 

However, Tesla needs to be thought of in an entirely different bucket from the rest of the OEMs. I believe Tesla is the only one that can launch (and has launched) one of these factory PPF programs successfully. With a nationwide network of service centers and no dealerships, there is nothing that stands in the way of them doing it successfully. Maintaining quality control, which is incredibly important in PPF, is a different story. Whether or not they’re able to maintain high quality as a company whose core competency is not PPF remains to be seen. There are many anecdotes of Tesla owners favoring installation from independent installers due to a higher quality installation, but it is still likely that the factory program takes much of the Tesla share. There are also issues with the colored PPF they are installing but that is an interim issue at best. There is nothing barring them from eventually partnering with a different PPF product in the future.

Tesla Revenue Concentration:

Segueing from above, how big of a deal is the Tesla factory PPF program? Culper and others have thrown out numbers claiming Tesla represents 25%+ of XPEL’s revenue. Management states the number is closer to 5% and I think any sort of rational thinking supports that number. Few points to contemplate:

• In the US, XPEL generates ~30% of its revenue directly from dealerships (which means none of that is derived from Tesla). 

• The mix of Tesla is much lower outside the US, which represents ~42% of XPEL’s revenue. 

• PPF is only ~75% of XPEL’s product revenue.

When considering these facts and running the numbers, I get to ~7% of XPEL’s revenue coming from Tesla IF you assume that 25% of all PPF installs in the US are on Teslas (which is a big if). Management knows exactly what the true number is considering nearly all XPEL installers use DAP to cut their film. Their estimate is going to be far more accurate than my estimate, and I think the numbers back up that it should be closer to 5% than to 25%. 

However, this is all conjecture. The Tesla program has been live for ~6 months. It was launched partway through Q4 2023. XPEL’s US based revenue declined 6% from Q4 2023 to Q1 2024, and that was amid port delays, a general slowdown in PPF installation in the US, and during the seasonally weakest quarter. I think this points more toward the Tesla issue being a non-event rather than a major revenue hole. 

PPG/Entrotech JV:

I don’t think I really need to cover this one much as it has been thoroughly debunked at this point. The Culper report claimed that this JV was integrating PPF directly into paint, which is simply untrue. Employees inside the JV have denied this claim. 

It is interesting to note that a hybrid paint/PPF product actually DOES exist. However, it is used on top of the factory paint and does not/can not replace paint. The product can also be sprayed on clear to resemble a typical ppf film. In the US, this is sold under the Clarity Coat name. The purpose is to be a hybrid between vinyl wraps and PPFs, where you can protect your paint while also customizing the color. It is marketed as being superior to PPF due to the ease with which it can be removed (as the product simply peels off once you get an edge) as well as the aesthetic of the finish. Unfortunately (maybe now fortunately?), I am the poster boy for why this product does not have a good use case. Being a car enthusiast myself, I was the guinea pig for this product in the US. The film is installed in a paint booth, and requires all panels, accents, window panes, etc… to be removed in order to be sprayed on (just as you would with regular paint). This means you have to be absolutely sure that the body shop doing the install is knowledgeable on the make/model of your car. It also means that the entire process is much more expensive and time consuming. In my case, the body shop was not competent and broke ~75% of the parts they removed and also took about a month to get the car back to me. So in conclusion - more expensive, more time consuming, not self healing, risk of body shop not removing & reinstalling parts correctly, all for the benefit of it being easier to remove and maybe having a better finish (PPF is nearly invisible in my eyes so not convinced on the aesthetic appeal). I used the product once. Not only would I never do it again, but there is no situation in which I would ever advise anyone else to use this product either.

XPEL’s Brand Positioning: 

There are a few claims here. First is that XPEL’s product is significantly more expensive than comparables. This is simply untrue. Installers will tell you that XPEL’s product is very competitively priced, and generally about the same price as the other premium offerings. In fact, according to installers I spoke to, XPEL isn’t even the most expensive film among this group of premium offerings. The products that are cheaper are generally poor quality films from an installation standpoint that installers would prefer not to work with. 

The previous VIC short report made a few mistakes on this point. First, grabbing XPEL prices straight from their website and comparing it to other wholesale prices. The price on the XPEL website is ~double their wholesale pricing. This report also included a vinyl wrap in the table, which is not even in the same category of product. 

The second claim is that competitors have caught up to XPEL on product quality, so XPEL’s brand advantage and product advantage are eroding. While it is true that competitors have caught up on product quality, this happened a long time ago. XPEL is not winning the industry due to its film, it is winning the industry due to its software. Ask any XPEL installer why they work exclusively with XPEL and you generally receive a 1 word answer - software. There really is only 1 meaningful competitor for software in the industry, which is Core by Eastman. It seems the biggest difference is that XPEL’s DAP has more accurate templates, which can significantly reduce waste as well as improve the overall aesthetic of the installed product. While it is true that another competitor could theoretically create software that could supplant XPEL’s DAP, I view this as very low probability. Eastman, which is the other giant in the PPF world, has tried and failed. There are plenty of smaller competitors which have been unable to gain any traction. I heard from installers that there actually was one software company that had a decent product and was gaining traction at one point, but XPEL simply acquired them (XPEL’s North 1 Technologies acquisition in 2021 for ~$7mm). If large competitors can’t create a competitive offering and XPEL can simply buy up smaller competitors with good offerings (none seem to currently exist), it is hard to see how this advantage erodes. 

To really give you an idea on the advantage XPEL has in this space, we can look to Eastman which is likely the #2 player in the PPF world. Their portfolio includes brands like Suntek and Llumar which are the next most installed brands behind XPEL. Tegus transcripts from both an Eastman Salesperson as well as an Eastman Dealer Development Representative had the following to say about XPEL:

On software:

On brand:

Bonus for comedic value:

M&A:

I would briefly like to touch on capital allocation, as I haven’t seen much discussion of this elsewhere. Management has been vocal about the fact that M&A is a big part of their strategy moving forward. The most likely acquisitions are of their distributors/installers. The distributors have a reasonable strategic rationale of bringing them closer to the end customer in geographies where they are less connected to the end customer. I am less excited about this opportunity, but it has also been a much smaller part of their M&A strategy. The majority of cash spent on acquisitions has been on installers, which I think is a phenomenal use of capital. Since 2021, they’ve spent ~$72mm on acquisitions. Upwards of 75% of that has been spent on installers, the largest being $30mm for PermaPlate which installs coatings and films for several hundred auto dealerships in the US. 

I think the opportunity to put capital to work buying installers is a phenomenal opportunity. The industry is very fragmented - mostly made up of single location mom and pop shops. There are also quite a few privately owned multi-location chains. The largest one I am aware of is around 80 locations, but there are many owners with ~2-5 locations. There is nobody else competing with XPEL for these acquisitions. Due to this, XPEL has historically been able to acquire these at 5x EBITDA. When acquiring these installers, XPEL is typically able to run them more efficiently as well as cross-sell their other products. I think a good example of that would be PermaPlate, which XPEL described as primarily being an installer of window film for auto dealerships. This acquisition gives them the relationship with those dealerships to potentially push ppf attachments to new car sales as well.

One negative regarding these acquisitions that I haven’t seen mentioned elsewhere is the potential dis-synergies associated with buying your installers. If you are buying up shops that exclusively sell XPEL products, there is a sort of cannibalization of your own revenue occurring. When the company presents “post-synergy EBITDA,” that number includes margin you were already making on product you were distributing to said installer. With that being said, this only becomes an issue when it moves acquisition multiples to a point where they are no longer attractive. Considering XPEL is buying at ~5x EBITDA and product is generally somewhere around 20% of installation revenue, I estimate the real multiples are somewhere around 6.5x EBITDA instead. I still view this as highly attractive, especially considering the potential operational improvements and strategic rationale of many of the acquisitions.

So how big is the installer opportunity? If we consider that product is typically 20% of installation, that would suggest that the XPEL-exclusive shops in the US represent a ~$900mm opportunity. If we expand globally, this represents a ~$1.5B opportunity. If we expand to buying shops that are not XPEL-exclusive, this represents a $5B opportunity. For a company with $400mm revenue, this is quite a large opportunity. With that being said, I think XPEL is more interested in buying installers with strategic rationale (i.e. buying installers with relationships to auto dealerships) rather than simply consolidating the installer market. 

Business Trajectory:

So how should we think about the go-forward trajectory of the business? While I don’t believe both their US and China geographies are ex-growth, we can look at the business through that lens to get an idea of what that might look like. ROW makes up ~33% of XPEL’s revenues and has been growing ~30% on average for the past 5 years (this actually slightly accelerated in the “disastrous” Q1). From this revenue alone, XPEL should be growing total topline at ~10%.

Since XPEL began its acquisitive spree in 2021, it has deployed $24mm on average annually. Theoretically, this number should be increasing as FCF increases due to releases from inventory and EBITDA increases, but let’s just assume they continue on that pace. If we assume they deploy $24mm on average and pay 7x EBITDA multiples (conservative for cannibalization), they are generating an incremental $3.4mm EBITDA and $13.5mm revenue annually from acquisitions. 

Putting the above numbers together, we see ~13% annual topline growth and 14% annual EBITDA growth from just acquisitions and ROW growth. In my mind, this is the worst case scenario. I think the odds of growth in the US suddenly dropping to 0% are very low. When you consider that XPEL is expanding its product line, increasing its marketing & sales spend, overall awareness of PPF increasing, as well as considering XPEL’s competitive positioning, it’s very difficult to see XPEL not growing in the US. Are we past the ~40% topline CAGRs XPEL has seen in the US over the past ~5 years? Most likely. Penetration is moving up towards the upper bounds of the auto enthusiast market. The reality is likely somewhere in the middle. 

If we assume XPEL decelerates to 5% US growth (likely harsh) for the foreseeable future, this brings the total annual topline growth to ~16%. I think this is a very reasonable number given all of the above, and still leaves us with quite a few call options that I haven’t given credit for.

Call options:

• The architectural film market has the potential to become even larger than the automotive film market.

• XPEL could successfully break into the mainstream and see penetration for partial frontal PPF akin to that of window tint, most likely via relationships with auto dealers. The global size of the window tint market is projected to be upwards of $10B. 

• I’ve only assumed ~$24mm in annual acquisitions for XPEL. Realistically, XPEL could easily do upwards of $50mm in annual acquisitions if they wanted to.

Summary:

It seems to me that XPEL remains a high quality company, with highly incentivized and capable management. They have a clean balance sheet with de minis net debt, high returns on capital at >25%, a massive potential to put incremental capital to work at high rates of return, and a very strong competitive position. The only major difference between today and a year ago is significantly more growth investments being made today at the cost of profits. For all of these qualities, as well as likely mid-high teens growth for many years moving forward, I estimate we’re paying ~15x NOPAT. This strikes me as a very fair bargain. 

Catalyst

- Financials inflect as the company absorbs growth investments 

- Continued organic and M&A growth

- Overblown nature of business risks becomes more clear