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On the first look, Motorcar Parts of America Inc. (Nasdaq: MPAA) stock looks awful whether you are a growth or a value investor. The stock has doubled in last 5-6 months and is trading at 64 times EV/EBITDA for the trailing 12-month basis.

The stock has been strong but looking at the new wheel hub's business potential or the financial benefits from the Fenco de-consolidation, this is just the beginning. Value investors should start to see value and earnings leverage possibilities in "clean" numbers after the company starts to report full quarterly results of the wheel hub's business, whereas growth investors may like the revenue upside potential from the new product family.

The company's offloading of Fenco has improved the balance sheet but with the launch of wheel hub business, both revenues and earnings offer a magnitude of the upside. The stock has potential to reach $20-25 level as we get more clarity on the potential of catalysts discussed.

Brief introduction to the company

Motorcar Parts of America, Inc. (NASDAQ:MPAA) manufactures, re-manufactures and distributes automobile parts like alternators, starters, steering components, brake calipers, master cylinders, hub assembly and bearings, and clutches and clutch hydraulics for passenger and truck vehicles. These parts can be clubbed as rotating electrical parts.

The company should benefit from recent market shifts, where anti-lock braking technology is being applied to the rear wheels as well, which should help not just the short-term revenue growth rate but increase the addressable market itself. As per Industry research, this category will grow at a 7% CAGR as the car population with anti-lock brakes grows and ages. The company is already established in its rotating electrical product family.

Wheel hub business to add significant value

After the bankruptcy of the Fenco Entities, the company has entered into selling wheel hub assemblies and wheel hub bearings. The company will distribute these products to its existing distribution channel after sourcing from its partner in China. The current quarter will be the first quarter reflecting the sale of these products.

As per company estimates, the size of this category is approximately $1.2 billion in the North America. The company can specifically benefit as

  1. The wheel hub assembly contains the anti-lock braking mechanisms.
  2. This technology has become mainstream on vehicles during the last decade. The company will benefit as those vehicles go for replacement of wheel hubs.

Margins for this business are lower than others and are closer to distribution business margins, which are in the 8% to 12% range.

It is safe to assume $10-15 million of revenue this quarter and $50 million of revenue for this fiscal year after the following comments by Selwyn Joffe, CEO, on the most recent conference call

"We have some strong customer opportunities. We have begun shipping. We're ramping up that program right now. We certainly expect to see double-digit millions of revenue in this quarter in that category."

"And the category is a very vibrant category. It is probably less mature than rotating electrical so there's, I think, probably more upside in the growth rates that are being projected. And so we think over the next couple of years, this is going to be a major contributor to our business."

Numbers seem conservative and here's why

For the current fiscal year numbers, upside is possible to the revenue expectations of $245 million as

  1. For the current quarter, the first quarter of the launch of yhe wheel hub business, if the company is able to do $10-15 million, which on conservative roll out should come to $45-50 million in annual revenue from the wheel hub business.
  2. The existing business is on a quarterly run rate of $51 million with category growth rate of 5-7% annually, which can come close to $210-220.
  3. Upside to the top line numbers should fall directly to the bottom line

A back-of-the-envelope calculation of the current fiscal year numbers should lead us to estimates of $255 million in revenues and $1.45 in earnings.

Motorcar Parts of America with Wheel hub's business

Revenue ($M)

$255

Legacy

$205

Wheels hub

$50

Gross Margins

27%

Gross Margins Legacy

31%

Gross Margins Wheels Hub

9%

Gross profit ($M)

$69

Operating expenses ($M)

$33

Operating Margins

14%

Interest expenses ($M)

$14

Income tax

0%

Tax credits

Share count (NYSE:M)

15

EPS

$1.45

Data Source: SEC Filings and Motorcar Parts press releases

Important notes while looking at the worksheet

  1. Going with 14% operating margins, whereas current-quarter operating margins were 18%
  2. On the earnings side, even a 10% saving on interest costs of $3.7 million/ quarter can add 6-8 cents of EPS. After the improved balance sheet, the company should be able to drive a bargain on the interest costs front.
  3. Estimates of 1% of the operating expense savings, above the estimate in a worksheet, lead us to 15 cents of EPS increase.

Estimates for the company seem quite conservative with substantial leverage to the business model.

De-consolidation of Fenco to help more than just the balance sheet

With the de-consolidation, the company will realize $30 million of tax benefits of cash and credits from the losses incurred through its Fenco subsidiary. The company should be able to realize these benefits over next 2-3 years to offset its tax payments on earnings.

The company should be able to successfully refinance its term loan, after the balance sheet's improvement post de-consolidation, which can help cut its current burden of $3.7 million of interest costs per quarter.

Earlier this year, the company's separately capitalized subsidiaries, Fenwick Automotive Products Limited and Introcan (Fenco), filed for bankruptcy. The company has already written off its investment in Fenco as disclosed in the company's fiscal 2013 year-end results. With this the company has de-consolidated its "Undercar" business segment from its financial statements.

Macro trends helping the company

The company has successfully moved from mainly supplying for Do-It-Yourself (DIY) market to Do-It-For-Me (DIFM) market becoming a majority of the revenue, as the demand for replacement parts rose.

The DIFM market for the company is growing as

  1. Its retail customers are expanding into the DIFM market
  2. It has expanded into the professional installer base via its private label offering and its offering under its own brand name.
  3. It expands into the OE manufacturers channel for distribution to the installer, for warranty replacement and general aftermarket channels.

The company is also benefiting from some of the macro auto industry dynamics.

  1. Average age of the existing vehicles in use is increasing steadily over the years to more than 11 years now.
  2. Replacement rates for these vehicles go up much more than a proportional increase.
  3. Number of cars that are 12-years or older are growing

As per Polk's latest report on average age of autos and their effect on auto parts manufacturers.

"Customers from independent and chain repair shops should be paying close attention to their business plans and making concerted efforts to retain business among the do-it- for-me (DIFM) audience, while retailers have a unique and growing opportunity with potential consumers wrenching on their own vehicles."

Relative to auto retail growth

Some of the major customers of the company are AutoZone Inc. (NYSE:AZO), Advance Auto Parts Inc. (NYSE:AAP), Pep Boys - Manny, Moe and Jack (NYSE:PBY) and O'Reilly Automotive Inc. (NASDAQ:ORLY).

Estimated Rev. growth

Stock

P/E 2013

P/E 2014

EV/ EBITDA (TTM)

P/Book

2013

2014

MPAA

$13

12

10

65

1.0

-40%

14%

Retail

AZO

$416

13

12

9

4%

5%

AAP

$81

15

13

7

4.3

5%

5%

PBY

$12

21

18

8

1.2

2%

5%

ORLY

$125

21

18

12

6.8

8%

6%

Data Source: SEC Filings and Yahoo Finance

O'Reilly (ORLY) is more affected by the aftermarket auto parts market. O'Reilly posted a 6.5% same-store sales increase in the latest quarter and is also planning to add almost 190 new locations and two distribution centers in 2013. Positive trends at its customers like AutoZone or O'Reilly are certainly good news for Motorcar parts.

Conclusion

The first leg of growth in the stock may be behind looking at the recent run up in the stock but the potential of the fundamental shift in the business is promising. The company is strategically making the right moves with launching new businesses by monetizing its strong distribution channel and an improved balance sheet. Digging into numbers might make it much more of a value play than it looks from just looking at the chart. Target is $25

Source: Wheeling Into Motorcar Parts Of America Numbers Is Leading To An Opportunity