Fairly Valued Auto Parts Stock
Recently, I’ve been playing around with the idea of how to use the O-Metrix score better to identify potential stocks, and one company that came up was Standard Motor Products.
The O-Metrix score was 8 which means that it is an A grade stock, based on the following numbers.
(The numbers used to identify SMP differs slightly from the OSV Stock Valuation and Analysis Spreadsheet which I used to perform the fundamental checks in this analysis.)
- EV/EBITDA of 6.37
- PE of 6.7
- Projected PE of 10.7
- Expected long term growth of 12%
- Dividend yield of 2.04
Quick Overview
Standard Motor Products is one alternative way to play the aftermarket car parts industry. The company has a long history in the auto parts industry. There is strong family insider ownership but the language in the annual and quarterly reports reflect shareholder friendly ideas and practices.
Although management gets paid a bit too much in my opinion, the last 5 years has seen good improvements and the company has been able to post its highest profits during this period.
However, with the large short term debt coming due and limited growth prospect in a very competitive industry, Standard Motor Products is not the best investment at the current price.
(Still worth learning about though)
Business Description
Standard Motor Products makes replacement parts for motor vehicles in the automotive aftermarket industry. The parts are mainly divided into two segments, engine management and temperature control.
For more information, go to their website to see the details of their product segments.
Management
The company was established in 1919 and listed on the public exchange in 1977. Standard Motor Products is run by the Sills family where Lawrence Sills is the third generation Sill, and he is also CEO and Chairman. Two of his brothers are on the board. His son is also the Vice President of the Engine Management Division so the company is not independent, but it is independent where it counts.
The three brothers are not part of any committees. How much influence they can exert on the committee members is a different matter that I don’t have the details to get into confidently.
Among the three brothers, they own 15% of the company. The CEO owns the least at 3.1% compared to the two directors who own 6% and 5.8%.
Executive compensation came out to be 0.8% of revenue which is getting up there in terms of well paid management. A small company that gets close to 1% is in my opinion, overpaying their executives whether it be through salary or options.
The company did well in 2011, but the CFO and COO both earned 100% of their 2010 salary.
Throughout the year, insiders sold shares between $18 – $20 while buying on the open market at $13.
Market and Business Growth
In the aftermarket industry, business is competitive. There is a huge variety of products and choices, but Standard Motor Products has done well by building its portfolio of brands.
Maybe you know or use some of these brands:
Standard®, BWD®, Intermotor®, GP Sorensen®, TechSmartTM, OEM®, Four Seasons®, Factory Air®, EVERCO®, ACi®, Imperial® and Hayden® and through private labels, such as CARQUEST®, O’Reilly Import Direct® and Master Pro®, NAPA® Echlin®, NAPA® Temp Products and NAPA® Belden®.
What I found interesting to note about their business and growth discussion is that, a lot of the verbiage and strategic focus is set on making sure the company is run efficiently. Well, every company says this, but it shows in the results for Standard Motor Products.
I won’t get into the detailed numbers already, but CROIC since 2008 has been impressive. Before the 2008 crash, SMP was generating a CROIC of 0.2% from 2003 to 2007. Compare that to 19.5% 2008 to TTM.
Standard Motor Products certainly has taken advantage of being a small cap to move its business around to continually squeeze out profitability.
The aftermarket parts industry is stable but seasonal.
Regardless of how the economy is doing, people will need parts for their cars. It is one of the reasons why Autozone (AZO) has done so well, and SMP is another way to play the car parts industry.
Expected Growth via Reverse Valuation
To see what the market is expecting, a reverse DCF and a reverse Graham will provide a good indication of the expected growth.
Using the following inputs for the reverse DCF,
- 12% discount rate
- $44m in owner earnings
Standard Motor Products has to grow by 7.8% annually to meet the current stock price. I mentioned earlier that the expected long term growth is 12% which would also make SMP worth $23.
Using the reverse Graham Formula, the expected EPS growth is 1.6%.
Strategic Advantage/Moat
From the end customer point of view, there is no moat when it comes to car parts. It’s much too easy to choose any competing product based on price or the package description.
However, one thing that Standard Motor Products focuses on is customer service.
I wrote about how customer service is an underrated moat and how you should start thinking about it.
Well, SMP does just that and since they sell commodity products, they have explicitly made customer service one of their top business strategies.
Provide Superior Customer Service, Product Availability and Technical Support. Our goal is to increase sales to existing and new customers by leveraging our skills in rapidly filling orders, maintaining high levels of product availability, providing insightful customer category management, and providing technical support in a cost-effective manner. In addition, our category management and technically skilled sales force professionals provide product selection and application support to our customers.
The company does this by performing instructional clinics, teaching over 50,000 technicians annually how to diagnose and repair complex systems related to their products and helps the sales people be teachers and trainers.
This way, they are creating an environment where the technicians will feel more comfortable and recommend the use of the their products as opposed to some other brand without any service or training.
Risks
Every company has risks. Here are some of Standard Motor Products.
- 5 largest customers make up 63% of sales
- Competitive industry
- Has in the past reduced prices to remain competitive. Not a good business to compete on price.
- Tight margins will get squeezed further if there happens to be another recession
- Lots of liability claims and litigation associated with car parts, especially related to abestos which requires a reserve account ranging from $27m to 67m until 2059. Currently has $27.5m of asbestos accrual to date.
What’s it Worth?
2011 was a good year for the company. Revenue was up 8% and gross margins was the highest in 10 years at 26.2%. But the most impressive part is the turnaround from 2008 onwards. Even before the recession hit, SMP was barely profitable despite having similar revenue numbers.
Working through the financial statements, I got to the inventory section and noticed a nice trend.
Here is a more graphical form of the inventory analysis.
Notice sequentially, that the inventories works in progress has been increasing compared to smaller changes in the finished goods. This is often a sign that the company is expecting increased sales and is creating additional inventory to meet demand.
One issue with the balance sheet is the short term debt. Short term debt makes up 28% of total debt and the short term debt to equity ratio is 34%. How the company manages to work things out will be important without having to tap into their credit lines.
FCF is plenty so I’m confident that SMP will be able to retire it.
I’m looking at owner earnings and SMP hasn’t done too well with increasing it consistently. It all over the place. But seeing as how the TTM revenue is similar to the last fiscal year, owner earnings will come out similar if not slightly less.
Using a conservative owner earnings number of $44m for the DCF valuation along with a discount rate of 12% and 6% growth, the intrinsic value comes out to $16. If 12% growth is used, the value comes out to $23.
Here is a sensitivity matrix showing you the valuations with various discount rate and growth assumptions.
I won’t go through all the valuations methods with this company, but from the stock valuation and analysis spreadsheets, SMP looks to be valued in the $16 to $23 range.
Verdict
- Management: B
- Growth: C
- Moat: B-
- Risk: B
- Valuation: B
- Overall: B-
Download the Companion PDF Report
To view the full details of this company in the finest of details, download the 14 page companion PDF.
Disclosure
None
