Seeking Alpha

Weekly Short Newsletter - Week Ending September 6, 2019

by: Jan Svenda

In this week’s newsletter, we highlight a Short report about an auto parts manufacturer that is facing a vicious circle of negative cash flow and increasing leverage.

We also summarize recent Short theses on a consumer product company facing a weak fundamental outlook and a flawed M&A strategy, and an energy Yieldco with poor cash flows.

We offer an Exclusive update on Lord Baltimore's successful Short Idea on The Lovesac Company (LOVE).

(Today's Top Idea review update on LOVE is Exclusive for PRO+ Subscribers. Normally the entire Weekly Short Newsletter is Exclusive as well, but today we're making it available to other readers. Learn more about Seeking Alpha PRO+)

PART 1: Review of the week's Short Ideas - Column written by Jan Svenda

We begin by summarizing 2 Short Ideas from the week, and drilling down on the Short thesis on an auto parts manufacturer with a poor outlook which has an interesting embedded catalyst recurring every quarter.

1. Church & Dwight (CHD)

Ben Axler of Spruce Point Capital Management has taken aim at this S&P 500 company focused on personal care and consumer products and sees up to 50% downside.

The in-depth report mainly discusses the following two points.

The report tackles the M&A strategy of the company, strained financials included, which has not delivered value according to Spruce. In fact, two of the acquisitions are seeing significant revenue declines (WaterPik and Passport), and the third one (FLAWLESS) is an unproven business that is struggling to gain a foothold.

Secondly, there appear to be corporate governance red flags. Spruce Point is hinting that CHD did not effectively disclose a smaller acquisition in early 2018; an acquisition that likely boosted organic growth. There are also accounting concerns here. Spruce Point argues that CHD should also start consolidating one subsidiary instead of accounting for it as an equity investment, which falsely improves fundamentals.

The report further questions management for allegedly being over-promotional, gaming the bonus structures, and having a questionable track record.

Coupled with CHD’s excessive premium to other similar companies, Spruce Point believes the stock price will eventually be pushed lower.

2. TerraForm (TERP)

Robbert Manders believes this energy YieldCo is a compelling Short opportunity even despite the recent M&A rumors which have propped up the share price.

The report shows that TERP is trading at a premium to its peers while the present value of the contracted cash flows (through PPAs) is not supporting the current market capitalization. The company also has significant amount of debt which prohibits expansive strategy that could alleviate this.

In fact, the author believes that should TERP indeed be combined with Pattern Energy (PEGI), as per the rumors, that minority shareholders will not enjoy a boost in value given the bleak fundamentals and current valuation.

3. A detailed review of Motorcar Parts of America (MPAA)

This week I decided to drill down on a report written by Mako Research focused on this automotive parts manufacturer.

  • Summary

The major problem that Mako sees with MPAA has to do with accounting used for the main revenue stream of the business.

MPAA is a re-manufacturer of various auto parts. They source these auto parts from retail channels, re-manufacture them and then sell them to the same channels. This setup allows the company to use complex inventory accounting as the suppliers of MPAA are sometimes also its customers.

This accounting, for example, allows them to create ‘long-term inventory’ which consists of parts that are likely to return to MPAA for re-manufacturing (and potential re-sale). The author summarized the issue with this in the following manner;

Remember, assets = liabilities + shareholders equity, and assets include "non-returned cores" that are expected to be returned… but "MPAA does not directly manage, if or when that core will be returned." This is a very interesting asset.

Complex accounting is also the cause of a stark divergence between net income and cash flow. The income statement has been showing a profit over recent years, while the cash flow has been negative. A significant cash burn has driven the need to leverage up.

The author sees this trend continuing, which means that sooner or later MPAA will need to resolve the gap between net income and cash flow in order to finance its debt. Given the size of the problems, Mako does not see an easy way out.

  • Jan’s Take – Almost automatic catalyst

Mako has delivered a well-researched report that presents clear red flags and raises significant question marks about the overall business value.

What I like the most about this thesis is the argument that MPAA needs to write-down the long-term inventory (the broken-down parts, called cores, waiting to be returned). As the asset base is increasing, the write-downs should keep increasing as well. This will impact gross profit and will likely force the income statement to keep showing a loss. MPAA was previously able to show a profit. Investors can see this dynamic in the most recent quarter, which saw the write-down jump by about 100% from $2 million to $4 million, ‘impacting’ gross profit.

It is also likely that the loss will grow larger as MPAA may not be able to expand its business in a manner that improves cash flows.

Investors can readily see how the Short thesis is playing out each quarter. This should further pressure the share price which has been already slowly declining in the past year.

MPAA has a short interest of 22%. Options do exist on the stock.

Disclosure: The author Jan Svenda has no positions in any of the stocks featured in Part 1.

PART 2: PRO+ Short Top Idea Playing Out (LOVE, March 8, 2019)

Today, contributor Lord Baltimore has published a PRO+ Exclusive update on The Lovesac Company (NASDAQ:LOVE). The original Top Idea Short thesis was published 6 months ago.

This has been a successful trade so far, with shares of LOVE falling more than 40%..

In the initial Top Idea report on LOVE, despite the company's impressive growth, the author cited profitability concerns, poor customer reviews, and the risk of overexpansion.

What is Lord Baltimore suggesting today? His trade recommendation on LOVE has shifted to some degree. Read the update here.

PART 3: Full List of Short Ideas (Week ending 6th of September):

We break-down Short ideas into 5 categories:

  • Macro Thesis

Short Ideas where the company in question is facing broader business trends, including broad-based competitive pressures.

Netflix Pricing Power Capped By Competition

  • Weak Fundamentals

Worrisome company fundamentals, or where fundamentals simply don't justify the stock price.

Fastly IPO: Beautiful Company, But Not At These Prices

Domo Inc. - Poor Results And Abysmal Guidance On Lack Of Feasible Go-To-Market Approach

  • Tesla-Orientated Articles

Given the ongoing popularity of shorting TSLA we have dedicated a standalone category for it.

Tesla: The Growing Nickel Problem

August Numbers Are In For Tesla: Here's A Path To A Disappointing 97,000 For Q3

Tesla Vs. Porsche Taycan Is Like iPhone Vs. Android All Over Again

Be sure to use our Idea Filter to scan and filter for other Ideas that may fit your investment criteria.

- Wishing you a successful day.

SA PRO+ Editors Team (