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XPEL: 3 Underappreciated Drivers of Value Creation

XPEL has been written several times on VIC by devo791 and mip14.  All those write-ups are of very high quality (the first one by Devo is brilliant!) and so are the discussion threads.  I am assuming that the reader is familiar with those pitches and XPEL business as I will not be repeating basic facts and information about XPEL. 

Instead, what I want to focus on is three drivers of value creation that are discussed less often. 

Those drivers are:

(1)   Gross profit margin (GPM) expansion

(2)   Rivian opportunity

(3)   Vision (architectural window film) opportunity

Driver #1: Gross Profit Margin Expansion

In 2021 (I believe with 3Q 2021 results) XPEL management communicated that their goal was to reach ~40% GPM some time in 2022 (probably exiting the year).  Throughout 2022, while many companies were blaming inflation for weaker GPM, XPEL continued to hold its line that it would reach ~40% target.

What was somewhat lost on the market (in my opinion) is that XPEL actually exceeded that target by a large margin in 3Q 2022 if we make an FX adjustment.  See the numbers below.

Hence, 1Q 2023 and 2Q 2023 GPM (while still impressive) should not be a surprise.

It is worth explaining the Services GPM dynamics.  On May 25, 2021, XPEL closed its acqusition of PermaPlate Film which is a “a wholesale-focused automotive window film installation and distribution business based in Salt Lake City, Utah”.  By acquiring PermaPlate, XPEL has increased its headcount and labor costs and made the labor utilization rate an imporatnt variable.  Shortly thereafter the car inventory shortage started (one could argue that it was already in place when XPEL made its acqusition).  With car dealers not getting enough inventory to put on their lots, PermaPlate team did not have as much work to do.  Yet, the labor costs were fixed or semi-fixed.  XPEL faced a decision: keep paying the people even though the utilization of the labor resource is low or cut people.  XPEL kept the people, which is the right decision, in my opinion.  However, it caused a hit to the Services GPM.  

With that historical overview behind us, let’s focus on a more exciting topic: the future.  How high can GPM go? 

On 4Q 2022 CEO Ryan Pape said:

“we still have runway to improve this, really driving from all the things that we've discussed, the focus on cost product mix, channel mix, et cetera.  It's an open question based on where we see the most growth of how high it can go in coming years, but another 200 basis point improvement by the end of 2023 is certainly not beyond the realm of possibility and what we're actually expecting to exit the year on.” [emphasis added]

When B. Riley analyst followed up about the GPM expansion, CEO Ryan Pape provided more color on timing:

“It's probably more second half loaded, just knowing how things typically go because you've got inventory in the pipeline and other decisions that either have been made or things that take a while to see the benefit of. So probably, second half loaded is more likely. I think if we were at that 200 basis point exit run rate, that would be good. And if we can do it sooner, it's certainly possible that I think we want to make sure we get that at a minimum.”

So, two major takeaways here.  First, moving from ~40% GPM to ~42% GPM by the end of 2023 is “not beyond the realm of possibility”.  Second, a pretty conservative CEO who I do not recall being promotional ever says that “it’s an open question … how high it can go in coming years”. 

Management has clearly underpromised and over-delivered here because 1Q 2023 GPM was 41.89% which is within a striking distance, and 2Q 2023 GPM was 43.03% or 103 bps above the guide for the exit GPM (at the end of 2023). 

This is what CEO said on 1Q 2023 EC:

“As you recall, we guided to around 42% gross margin by the end of the year, and we’re a little bit ahead of schedule on that, which is great.  We continue to see some margin benefit from lower China mix, as we’ve discussed in the past, and we continue to gain leverage on fixed costs embedded in gross margin.  And then the preponderance of the continued gross margin improvement is mainly the result of our ongoing work around our building materials [NOTE: I think it should be bill of materials but the transcript provider did not catch that] costs and a little bit of pricing benefit from last year.  SO even though we’re here sooner than we planned, still expect to finish the year at 42% range, plus or minus a few basis points.  We may bounce around a little bit Q2 and Q3 as we get there with the difference mix of prodcuts and different mix of channels, but all in all, really good, very happy about that”.

Here is an additional color from 2Q 2023 EC:

“We had nice gross margin performance in the quarter, gross margin coming in at 43%. I mean, very pleased with the gross margin initiatives that we've had and the results.  We continue to see reductions in build material costs for some of our products, which is 1 of the biggest contributing factors to this gross margin expansion along with channel mix, where we're growing in more profitable channels, and then product mix, where some of our new products are higher gross margin.  We've also been a good partner to our suppliers, and that's benefited us in the gross margin line in terms of negotiating discounts and other concessions as the global supply chain continues to recalibrate, and we sort of get out of the position that everyone's been in over the past 2 years.  So that's a contributing factor as well.  It remains possible that we'll finish the year a bit higher than our forecast of 42%.  But we're still holding to that view, not necessarily expected to end at 43%, although it's possible.  We do have expectations of driving gross margin incrementally higher from that 42% in the next years, and this is in part based on the future revenue mix.  We've got an increasingly complicated mix of revenue, each with their own drivers, and that's going to be a driver of what that sort of terminal gross margin can be but we do see it going higher than where it is kind of over the next 24 months, I would say.”

It is possible that GPM would indeed bounce around 42% and this is where the GPM for the entire year would end up.  It is also possible that the management is being very conservative.

What drives GPM expansion?  There are multiple puts and takes.  Below I lay out several of my hypotheses.  I break the discussion into the qualitative section and the quantitative section. 

Qualitative Section

Positive factors:

1.  Price increase

2.  Economies of scale / higher purchasing power

3.  Geographic mix

4.  Product mix

5.      Some costs moved from COGS into OpEx (related to channel mix)

Negative factors:

1.      FX

2.      Input costs such as raw materials

3.      Inflation

Price Increase

XPEL increased pricing on November 1, 2022, even though the price increase was not rolled out across all regions. 

In my opinion, XPEL has substantial pricing power since XPEL often relies on a friendly middleman go-to-market strategy.  In many cases it is an installer who picks which PPF would be installed (not always though since XPEL brand has been growing and more and more consumers come not for PPF, but for XPEL PPF).  PPF is ~20% to 25% of the overall installation job cost.  Hence, if an installer simply passes an increase of 4% to the end consumer, the end consumer would see an increase of mere 1%.  In other words, I would not be surprised if XPEL could consistently increase prices in the future. 

Economies of Scale / Higher Purchasing Power

XPEL has entered into a new, renegotiated agreement with its main supplier Entrotetch.  Details of that agreement are not known to the investing public.  However, I would not be surprised if XPEL was able to obtain better pricing due to its larger scale and higher purchasing volumes.

I would think that due to the higher volume and bigger scale, XPEL was able to get better pricing from other suppliers too. 

Geographic Mix

Recently China sales have not been growing at the same rate as the rest of the business.  Since XPEL goes to market via a distributor in China, XPEL’s business in China should have lower GPM than the rest of its business.  Thus, not-growing-as-fast or even declining sales in China was tailwind for the GPM.  As China rebounds, it could present a headwind.

Product Mix

There are a few points here:

-          Window tint could be accretive to the overall GPM

-          Fusion (ceramic coating) should have a very high GPM

-          Ultimate should also come with higher GPM

-          Vision is likely to be GPM accretive

-          General move towards services via M&A also brings consolidated GPM up

Other than the China factor, I view most positive factors as sustainable.

Some Costs Moved from COGS into OpEx

As XPEL’s business has evovled and changed, some costs moved from COGS into OpEx per applicable GAAP rules.  For example, if a company ships a product to a third party distributor in a foreing country, shipping costs are included into COGS.  However, if a company ships the same prodcut to its own “branch” that functions as a distributor in a foreign country, then such costs are included in SG&A.  As XPEL bought several of its distributors pursuant to its “get closer to the customer” mantra, some costs shifted to SG&A. 

Now, let’s talk about negative factors.

FX

FX has been a headwind in 2022.  It is likely to become neutral in 2023.

Input Costs Such As Raw Materials

Holding all else equal / constant, rising input costs must have been and likely still remain a headwind.  As those stabilize, the headwind should cease. 

Overall Inflation

What I wrote about input costs should apply to the overall inflation, including labor inflation.  Similarly, as inflation stabilizes, it should stop being as big of a headwind.

Negative Factors: Conclusion

Looking at these negative factors, I appreciate even more how remarkable XPEL’s GPM expansion has been!

Quantitative Section: What Incremental Margins Signal

The best quantitative approach to analyze XPEL’s GPM is via the incremental margins lenses.  I think incremental margins are very telling here.  Below I compare incremental margins with the base margin for Product, Services, and Consolidated. 

Here are a few observations. 

First, I would note that incrmental margins have fluctuated and woud likely fluctuate quarter-to-quarter.  I am not overfocused on such quarterly fluctuations and instead I am focusing on the overall trends. 

Second, the Product incremental GPM is significantly above the base GPM.  It is quite likely that there is still significant room for improvement there.

Third, the picture is less clear with the Services incremental GPM.  It is possible that ~60% base GPM is the peak there.  It is also possible that we just need to see a bit more car inventory normalization which would lead to higher utilization of the labor by XPEL.  Time will tell. 

Conclusion

To conclude, I believe that XPEL has a good shot at getting to 45% or higher GPM in the next few years.  If that happens, the entire GPM expansion would likely flow to the EBITDA / EBIT margin.  That couple with some operating leverage at the OpEx level could bring XPEL’s EBITDA margin above 25%. 

Driver #2: Rivian Opportunity

Slightly more than a year ago (on July 12, 2022) XPEL announced its OEM partnership with Rivian.  Consumers buying Rivian vehicles are offered an opportunity to order preinstalled PPF.  This is a very nice move by XPEL because (1) Rivian buyers are very much target customers for XPEL (buying an expensive EV and we know that XPEL is over-indexed towards EVs, mostly Tesla) and (2) XPEL goes direct with the OEM that before the announcement was selling very few cars; thus, the chance of upsetting the installer base is quite small. 

From a consumer perspective, going OEM direct is also a superior customer value proposition.  This is how it works today: a consumer places a car order, the car gets delivered, the consumer picks it up and drives to an after-market installation shop to install PPF, a consumer gets the car back with PPF installed.  Many shops are booked several days or even a few weeks in advance.  Hence, a consumer may need to either not drive a car while waiting to get a spot with an installation shop or drive a car risking any scratches.  Put it simply, this is a pretty lousy consumer experience. 

Compare this with what Rivian and XPEL are creating.  You place an order for a Rivian, you are offered to select a PPF package, your car is ready and it comes with the PPF already installed.  Much better than the current setup!

But “show me the money!”  Let’s attempt to quantify what Rivian partnership could bring to XPEL’s bottom line. 

There are few key variables that we need to estimate / make assumptions about. 

First, Rivian’s production.  I am by no means an expert on Rivian and what the future holds for it.  I believe that Rivian had pretty optimistic product targets that so far have not played out.  When I make my estimates for Rivian production, I am looking 1-2-3 years out.  I am using 50K in my bear case, 75K in my base case, and 100K in bull case.  Again – these numbers may not materialize, and Rivian may fail as a commercial enterprise.  Time will tell.  You can use your own estimates / guesstimates. 

Second, we need to estimate the ASP that consumers woud pay.  I am using $1,500 in the bear case and $2,000 in the base and bull cases. 

Third, attach rate.  I am using 15%, 35%, and 50%.  I think these numbers are very much achievable due to (1) Rivian is very expensive; if you are sending $100K+ on a car, you can probably afford to pay $2K-$3K for a PPF wrap; (2) Rivian is an SUV and many people would use it in more demanding conditions and environments than driving in a city; (3) XPEL is over-indexed to EVs.

Fourth, Rivian’s take rate / revenue share.  This is a hard one.  I go with 50% take rate for Rivian, but I admit that this is a pure guess.  It can be lower or it can be higher.

Fifth, gross profit margin on this revenue stream.  I am using 42% which is fairly close to XPEL’s current consolidated GPM.  I do not believe that Rivian initiative should be dilutive to the GPM.  It is even possible that it would be accretive to the GPM.  True, Rivian’s take is substantial.  However, XPEL’s installers would be working only on a couple of Rivian models / SKUs.  It means that installers could get incredibly efficient.  This is very different from an after-market installer who wraps Tesla on Monday, BMW on Tuesday, Volvo on Wednesday, etc. 

Sixth, the associated OpEx.  I think it should be de minimis.  I am using 5% of revenue.

Seventh, tax rate.  I use 21% to 25% tax rates.

Using these assumptions will enable us to get to the incremental EPS.

Finally, we need to put a multiple on this incremental earnigns stream.  I am using a range of 20x to 40x. 

Below I present the math. 

The potential upside varies greatly: from negligible 1.4% to significant ~25.8%. 

#3: Architectural Window Film (Vision) Opportunity

On the surface, this is an unexpected twist in the XPEL story.  XPEL is an automotive company that has built its reputation both in the eyes of installers and consumers, built its installer base, built its distribution, and has added multiple products to the distribution (PPF, window film, ceramic coating).

However, I would argue that this is a limiting view.  I do not believe we should be limiting XPEL to the automotive sector and boxing it in that bucket.  XPEL’s core strength is building distribution and servicing a large base of installers by providing winning customer service and support.  Sure, XPEL has an excellent product and outstanding software (DAP that is being currently expanded into several adjacent modules).  Very true.  But it is customer service and support that have enabled XPEL to win hundreds of installers. 

Now XPEL wants to bring that culture and playbook to another vertical: commercial and residential real estate.  However, at this point in time XPEL has learned from its prior mistakes and has a better understanding of what works and what does not. 

XPEL is likely to follow its PPF (automotive) model: winning best installers in specific markets, building awareness of the benefits of the product for end consumers, converting installers that are currently using an incumbent brand.

It is also possible that some XPEL automotive installers may follow XPEL into architectural film and launch that as their second line of business.  Based on my research, some are doing that but the number appears to be fairly small so far. 

XPEL does not provide a breakdown of its Vision revenue in its filings and press releases.  However, management started providing commentary on the earnings calls a few quarters ago.  By collecting those comments and engaging into triangulation, one can get decent estimates for the current size of the business and its growth rates.  Please note that not all numbers match perfectly and some seem to contradict each other.  I attribute it to rounding.

Here are relevant data points based on my math:

Below I provide selected quotes. 

3Q 2022 EC

“Our VISION line, which is our commercial residential window film product that Ryan mentioned earlier, was about 11.5% of our total window film revenue and this product segment more than doubled compared to Q3 2021.”

4Q 2022 EC

“Our Q4 VISION product line, which is our architectural window film, revenue grew 95% to $1.2 million, and on a year-to-date basis, VISION revenue grew 98% to $5.7 million.”

1Q 2023 EC

“Our Q1 vision product line revenue grew 6.4% to $1.2 million, and this was up a little over 13% sequentially."

“Our vision product line tends to be seasonal with December, January and February is low months, but we have momentum in this line as March was a pretty strong month for us.”

2Q 2023 EC

“Included in our window film product line is our architectural window film product branded as VISION. Revenue for the VISION product grew a little under 52% to $2.4 million, which represented approximately 12% of total window film revenue and 2.4% of overall revenue, so really good performance there.”

How big can Vision get?  Nobody knows!  And any guess at this point in time would be just … well, a guess.  Additionally, any large number thrown out right now would be a wild guess. 

Let’s say I put a number out there: $120M in Vision revenue in 2027.  Does it sound crazy?  Of course, it does.  We are talking about a company that is run-rating less than $10M right now.  Am I serious about 12x growth in a few years?  Yes and no. 

On the one hand, 12x does sound like an astonishingly high number.  I am having a difficult time thinking that it is possible.

On the other hand, I am looking at an incredibly large market (new construction and retrofit), a compelling product, and a team that took XPEL from ~$18M in revenue in 2013 to a revenue run-rate of $400M+ (as of 2Q 2023), which is a cool ~22.5x.  Maybe 12x (or higher) is possible. 

Below is an admittedly rough math on Vision’s potential impact on XPEL EPS and stock price.

***

Importantly, in my opinion, these three drivers of value creation come on top of blocking and tackling what XPEL is doing.  It comes on top of driving PPF penetration up, getting close to a customer via M&A, growing the installer base, getting higher coverage per car, etc. 

Disclaimers

I do not hold a position with the issuer such as employment, directorship, or consultancy.

I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

1. Continued GPM expansion

2. Rivian partnership ramping up and / or other similar partnerships with other OEMs going live 

3. Growing Vision sales