Motorcar Parts Of America: Time To Re-Kick The Tires

| About: Motorcar Parts (MPAA)

Summary

Thesis worked fine after the previous note, but concerns have emerged over the past few months.

The macro backdrop as well as growth catalysts, with new products and market share gains, is still strong.

The stock, after the recent correction, is trading at a significant discount to auto parts retailers, even if one ignores the acquisition premium.

Since my previous note on Motorcar Parts Of America (MPAA), the stock has worked well, up almost 125%, as much of the long thesis played out, but over the past few months, concerns around the changing macroeconomic environment have emerged raising doubts over the company as well as the stock's ability to carry on with the current momentum.

Concerns are starting to emerge, at least looking at the stock that is down almost 20% over the past few weeks, be it the impact of a potential slowdown in the broader economy on auto sales, which were down 6% last month, a cyclical slowdown expected in the auto industry after a few years of strong sales, easing commodity price tailwinds and broader pricing pressures. All in all, worries related to the changing macro environment, but getting overly cautious because of these concerns may be unwarranted.

Much of the long thesis covered in the previous note was based on the opportunity offered by the wheel hubs business, the financial benefits from the Fenco de-consolidation, potential earnings leverage and the potential for topline growth from the new product family. Benefits from strategically shifting towards new businesses, while monetizing its strong distribution channel and decent balance sheet were just starting to take shape. No doubt, a few things have changed and part of the thesis is played out over the past few quarters, but the business once again offers equally good reasons for a closer inspection.

No, the macro situation has not changed much

The macro backdrop for the auto food chain, in general, was very favorable over the past few years and one cannot assume the same dynamics forever, but for MPAA, the situation continues to be favorable.

As a manufacturer and re-manufacturer of automobile parts like the rotating electrical parts, wheel hub assemblies & bearings and brake master cylinders, the company provides parts at a lower cost than newly manufactured parts and makes available the parts that are no longer manufactured. The company also recycles materials, including metal and corrugated packaging.

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Average age of vehicles operational in U.S. Source: Bureau of transportation statistics

The significance of re-manufacturing and recycling materials is that the average age of vehicles and pricing of commodity scrap have a major bearing on the fundamentals, more than the impact experienced by the average auto parts manufacturer. Looking at the average age of vehicles in U.S., as the chart above shows, the macro backdrop for the company continues to be strong.

Indeed, as the number of cars in the 12+ year old category grows, not just the failure rates of parts in those vehicles grows but the same may help the average price and margins as well because of the use of more sophisticated and higher priced parts in those models compared to the earlier models. Some of the positive impacts of this 'aging cycle' is visible in the results of auto parts retailers, including AutoZone (NYSE:AZO), which is almost 48% of the revenue for MPAA, and Advance Auto Parts (NYSE:AAP), another major customer.

Good execution and growth catalysts should help pull it through

Barring weather-related volatility here or there, the performance has been great, with consolidated revenues growing at a double-digit rate and wheel hub assemblies & bearings as well as break master cylinders growing significantly above that.

Going forward, the business should benefit from growing market share as the customers gain share in the DIY and the professional installer markets, the markets that are growing. Besides riding with the customers, the business should benefit from the introduction of new products, some of which are expected to start shipping by the August/September timeframe, and a significant increase in Chinese, Malaysian and Mexican operations, which should also help drive operating leverage.

The gross margins, which came out higher than the top range of the guidance, in spite of getting negatively impacted by product mix and lower scrap revenues, should benefit from the ramp of new products and weak raw material prices.

A re-adjusted entry ticket price seems like a good deal

Definitely, the stock has run-up from the initial recommendation, but measuring against the earnings improvement, the increase still offers room on the upside. The stock is trading around 11-12 times next year's earnings, significantly lower than auto-parts retailers like AutoZone, Advance Auto Parts and O'Reilly Automotive (NASDAQ:ORLY) that are trading between 16-18 times, even though Motorcar Parts of America is expected to grow at a significantly faster rate, around 11-13%.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.