Dorman Slashes Inventory Without Sacrificing Margin

by: Alan Brochstein, CFA

The vastly altered landscape in the automobile retail industry, including the collapse in available credit last fall, concerns over the viability of the manufacturers and now the implosion of the dealer networks for Chrysler and General Motors (NYSE:GM), is creating several opportunities. While it took a while for some of my ideas that I shared in the Fall regarding taking advantage of these massive changes to play out, several of them have:

PX 10/17/08 PX 05/15/09 Change
Auto Parts Advance Auto Parts (NYSE:AAP) 27.58 40.66 47.4%
AutoZone (NYSE:AZO) 106.60 158.01 48.2%
O'Reilly Automotive (NASDAQ:ORLY) 22.47 36.17 61.0%
Pep Boys (NYSE:PBY) 4.12 6.15 49.3%
Salvage Copart (NASDAQ:CPRT) 32.09 29.19 -9.0%
LKQ (LKQX) 14.66 15.25 4.0%
Finance AmeriCredit (ACF) 8.67 10.24 18.1%
Pawn Cash America International (NYSE:CSH) 36.09 20.03 -44.5%
EZCORP (NASDAQ:EZPW) 13.52 11.68 -13.6%
S&P 500 940.55 882.88 -6.1%

So, while the market has been down, the four ideas produced a monster of a return from the first idea, a mixed return from the second, an excellent return from the third and a dud from the final area. At the time, I disclosed that I was long ACF and EZPW. I failed to pull the trigger on the auto parts players.

I followed up in February with a suggestion to buy Dorman Products (NASDAQ:DORM), when it was trading below 9. Well, egg in my face, as it traded as low as 6.12 a couple of weeks later, but I am happy to report that it has participated in the rally, trading as high as 12.50 in April and settling in a bit lower subsequently.

The company makes replacement auto parts that are cheaper than the OEM replacement parts, and I expect that the aging of our cars due to the economic crisis should help the company to actually grow through the recession. In that original article, I concluded:

My own expectation is that the stock may trade as high as 16 later this year, though it will require a couple of things to happen. First, the margin erosion must stop by mid-year. Despite the higher inventory than the company should be holding, I am optimistic that the improved sell-through should help clear that overhang. The company reports on 2/27, so we may learn more about the outlook for margins then and perhaps see signs of inventory improvement. Second, someone will have to notice! I think that the fact that the stock trades at tangible book value but should continue to offer a decent free cash flow yield (once it works through the inventory), that it has little debt, that its growth outlook isn't nearly as bad as for companies in general due to the secular theme of cars being on the road longer, and that its margins have plenty of room to expand as input prices have now corrected and the pressure is lifting off of its customer base could be the catalysts. I base my 16 target on a couple of different assumptions:

  • 1.5X projected 2009 ending book value
  • 13.3X my projected 2010 EPS of 1.20 (sales growth, margin improvement)

I had noted as well that it had an impressive list of institutional rosters but that I was concerned about a build-up in inventory.

I am happy to report that the company dramatically reduced inventory without sacrificing margin in the most recent quarter. Also, with 3/31 filings now complete, all 4 of their major holders maintained or even expanded their positions during Q1. I had added it to my Top 20 Model Portfolio (and have owned it myself), but I increased the size of the position in the model after their recent report.

While the stock is higher than when I first suggested it, so is the market. Further, it remains cheap, as my original year-end target was 16. I think that 15 should be pretty easy, and 18 is possible. The main reason, though, that I am more excited at an even higher price is that I expect the dealer network collapse to benefit the company in the long-term. As dealerships close, customers will either have to drive further or go to an independent repair shop, where they can get serviced for less money and with Dorman Products parts. Finally, the chart looks great [click to enlarge]:


The stock has outperformed the overall market over the past 16 months (and longer). It has an excellent balance sheet and trades at just 1.1X book value (1.2X tangible book value), affording it downside protection (absent crazy markets like March!). The PE is just 10X one-year forward expectations (single analyst), which is very cheap considering the strength of the balance sheet and the likelihood of actually growing. It seems as if the stars are aligning in the firm's favor, including the better times for the three companies that comprise 1/2 its sales: AAP, AZO and ORLY. As I said last time, if you like this one, be very careful buying it as it is EXTREMELY thin.

Disclosure: Long DORM