Why I Bought Dorman At $70 After The Q2 Selloff

Aug. 19, 2019 8:08 AM ETDorman Products, Inc. (DORM)
The Prospector profile picture
The Prospector
959 Followers

Summary

  • Shares got crushed nearly 20% after the company reported Q2 earnings.
  • Earnings sharply missed expectations due to higher-than-expected facility consolidation costs.
  • Additionally, the company slightly revised revenue expectations lower for the year.
  • Dorman's ops problems are temporary and provide a great entry point given auto aftermarket market dynamics and the increasing likelihood of a recession.
  • After initiating a position in the low $80s, I added at $70 and wouldn't be surprised to see shares hit $100 within the next 12 months.

Thesis

Like Q1, Dorman Products (NASDAQ:DORM) grew revenue by 7% in Q2. But Doorman revised full-year revenue guidance downward and believes it is on pace to grow revenue 7-9% for the year, compared to the 6-10% full-year revenue growth estimate the company had provided last quarter.

The biggest issue to hit Dorman this quarter was EPS. The EPS came in dramatically below expectations, and the company revised full-year EPS guidance down to $3.06-3.30, vs. the prior expectation of $4.22-4.38. That's a drop in full-year EPS expectations of ~25%.

The EPS drop looks to be temporary due to higher-than-expected operational costs as the company consolidates production and distribution facilities. The facility consolidation is expected to be done by year-end, and operations should normalize in 2020.

I view the problems facing the company as temporary. I think the bull thesis for Dorman remains strong and added to my position at $70. Given the macro trends in the auto aftermarket and the increasing likelihood of a recession, I think conditions are lining up to favor Dorman and wouldn't be surprised to see the stock hit $100 within the next 12 months.

Q2-19: Ops Transition Costs Drive Down Margins

Revenue growth for the quarter was in line with expectations. The real issue for Dorman was higher-than-expected costs due to ongoing consolidation of distribution and production facilities in Tennessee and Pennsylvania.

The company recently constructed a new distribution facility in Portland, Tennessee. Prior to this, Doorman operated a legacy distribution facility in Portland. In 2017, the company assumed operations of a distribution facility in Montreal as part of its acquisition of MAS Automotive Distribution. The Montreal operation is being folded into the new Portland facility.

In addition to this, the company is also consolidating a newly acquired production facility in Pennsylvania with the operations of its preexisting Michigan production facility.

The consolidations were supposed to be complete halfway through the year, but Doorman is delaying completion until the end of the year in an attempt to minimize disruption to clients. Costs of this transition have been higher than expected, but the company expects operations to resume as normal beginning in 2020.

It has also been impacted by tariffs in the ongoing trade war with China, but those increased costs have been passed on to the consumer, and tariffs have not impacted EPS.

Looking Ahead

Beyond the China tariff issue, the market dynamics look good for Dorman.

Source

There are a couple of factors favoring the company. Though fears have subsided in recent months, an economic slowdown would likely benefit Dorman. Additionally, the average age of cars on the road continues to climb.

Though Dorman had strong Q1 and Q2 revenue growth of 7%, its strongest performance in the last decade came when the country struggled to recover from the financial crisis. Growth peaked in 2013 with nearly a 17% revenue growth rate. As the company's revenue growth has slowed in the years since, car sales have continued to tick upward and have leveled off in the 17 million per year range.

Source: YCharts, which aggregates sales data from the federal government

Doorman believes it is in a position to exceed the growth of the general automotive aftermarket (3.5%) in the years ahead. Any recession aside, the company expects growth to result from the aging of cars on the road. The average age of vehicles is increasing.

Source

In addition to the above graphic, a 2016 article by Automotive News cited research that showed the fastest-growing age group of vehicles on the road through 2021 were those 16 years or older. The number of old cars on the road was expected to increase from 62 million in 2016 to 81 million in 2021, an increase of 31%. The high quality of vehicles is a reason cited for the improving lifespan of cars.

Valuation

The company looks like less of a value from an EPS standpoint after the earnings hit the company expects this year. But the EPS problems are temporary, and we are likely to see a resumption of strong EPS growth beginning in 2020 once facilities have been consolidated and operations continue as normal.

Prior to the cost hiccups in Q1 and Q2, the stock had approached $100 in anticipation of continued strong EPS growth. Once the facility cost issues are ironed out, I expect the stock to approach $100 again and wouldn't be surprised to see this occur within the next 12 months.

Conclusion

The recent sell-off provides a better entry point for a company that expects continued strong revenue growth in 2019 and improved operational efficiency beginning in 2020. I view the shares as a value and may consider adding to my position on any further weakness.

This article was written by

The Prospector profile picture
959 Followers
Long-term focus, with some exceptions. Self-taught investor. I started investing my own money in 2010 and have outperformed the S&P 500 in the years since.

Disclosure: I am/we are long DORM. 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.

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