By: Jake Mann
The Securities and Exchange Commission has dominion over a variety of business filings, and in the hedge fund world, the most well known is the quarterly 13F form. For investors who want to track day-to-day changes in smart money portfolios, 13D and 13G forms offer up-to-date peeks at a single position.
On a typical weekday, there are anywhere from 10 to 100 13D/13G filings, and at the start of this week, one that stood out to us was an amended 13D from Mario Gabelli's Gamco Investors. Gabelli's full profile can be seen here, but in short, he manages close to $30 billion in assets and his firm has beaten the S&P 500 by a little over 2% per year since inception in 1986. While he doesn't have the same name recognition as Warren Buffett or David Einhorn, Gabelli makes his fair share of public appearances, having recently spoken on FOX Business Network about Tesla.
Let's take a look at Gabelli's latest amended 13D.
Manny, Moe and Jack
In the filing, Gabelli and Gamco disclosed a 9.5% stake in Pep Boys Manny Moe & Jack (PBY), or 5.1 million shares worth $61.6 million. Among the hedge funds we track at Insider Monkey, Gamco Investors now holds the biggest Pep Boys position, with Glenn Krevlin's Glenhill Advisors and Thomas Steyer's Farallon Capital holding the next largest stakes. While Mario Gabelli is widely acknowledged to be a value investor, it's worth mentioning that Krevlin and Steyer also maintain their fair share of value-based investments (Krevlin, particularly, focuses almost entirely on small-caps).
Why would this group of fairly successful investors be so bullish on the company? Well, we'll take you through a few reasons.
Buyout potential, value
First and foremost, the obvious reasoning behind Gabelli and Gamco's investment in the auto repair and accessories retailer is its buyout potential. In an issue of Value Investor Insight last September titled "Super Mario," Gabelli and his research team told the newsletter what their thoughts were on Pep Boys (fund managers aren't legally required to disclose any sort of qualitative reasoning behind their investment decisions, so this is a big bonus).
In the issue, Gamco's automotive analyst Brian Sponheimer called Pep Boys "unique" for the fact that it receives "more than half" of its revenue from maintenance operations. Peers like AutoZone (AZO), for example, are more reliant on supply sales, and with an array of industry factors - Sponheimer points to an all-time high average vehicle age in the U.S. and greater vehicle intricacy - serving as tailwinds for a diversified company like Pep Boys.
More importantly, Sponheimer points out that the auto repair marketplace is extremely fragmented, with less than 15% of industry revenues going to the largest players Pep Boys, Jiffy Lube, Firestone, AutoZone and O'Reilly (ORLY). It is reasonable to think that consolidation is the natural next step. While PE firm Gores Group pulled its $15/share bid for Pep Boys last year and shares fell below the $9 mark before rebounding to their current range near $12, Gamco says it thinks the stock is worth $17 to $19. This estimate is based on the firm's $140 million-$150 million EBITDA estimate within a "few years," according to Gamco, at a modest EBITDA multiple of 7.0x.
Using a couple of more traditional metrics, shares of Pep Boys trade at a mere 0.3 times sales and 1.2 times book (industry averages are 0.8 and 3.2, respectively), indicating there's still some overhang from the failed Gores Group acquisition. Thus, one can understand why Gamco expects a 40% to 60% value-based appreciation over the long term.
Any self-respecting Pep Boys investor is also keenly aware of the company's redesign initiative, and while it's no J.C. Penney (JCP) undertaking, it can still have a positive effect on the company's bottom line (we believe Gamco factored these plans into their long-range EBITDA estimates).
According to this article from the July-August issue of Retail Environments, Pep Boys is seeking to mesh the traditional auto part retail feel with that of an actual auto dealership. The company has opened a prototype designed by EWI Worldwide in Florida, featuring a dealer-like lounge area where customers can choose between in-store repairs, a do-it-yourself area, or a hybrid experience between the two. It's this three-pronged choice that's essential to the "new" Pep Boys experience.
With bullish secular trends, a depressed valuation and support from Gamco Investors, Pep Boys looks like an interesting bet on consolidation in the auto repair and accessories industry. The aforementioned redesign is the proverbial cherry on top of this company, but look to a potential buyout as the real bullish catalyst that can vault shares toward Gamco's target range.