An Auto Parts Maker in a Turnaround

 | Dec 12, 2011 | 1:30 PM EST
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It's no secret that selling auto parts has been a fantastic business for well over a decade. If you were to look at the earnings growth and stock price performance for auto parts retailers over the past 10 years, you would have no reason to believe that this country faced a financial crisis and recession in 2008.

Tucked inside the industry is a small-cap whose share price has shriveled by over 50% in a matter of months, because of reasons I believe are very temporary. The net-net for investors is more than 100% in one to two years.

After surging to a high of $16 a share earlier this year, shares in Motorcar Parts of America (MPAA) have fallen back to $7, near the 52-week low of $6.88. At current levels, the company now has a market cap of $88 million, total debt of $84 million and book value per share of $9.56. At today's stock price, the market is valuing the business at 12x trailing earnings and 5x forward earnings estimates. Regardless of the accuracy of those estimates, Motorcar's business is worth significantly more.

Built to Last

Motorcar Parts is a producer of replacement starters and alternators, and it has been in business for more than 60 years. The company's products are used not only for cars but also for agricultural and industrial uses. The company produces an alternator or starter for virtually every type of engine. Motorcar sells directly to retailers such as AutoZone (AZO), O'Reilly Automotive (ORLY) and repair shops such as Pep Boys (PBY). One thing to note about alternators and starters: A car won't operate without a starter or alternator; a malfunction requires immediate replacement.

Over the past three years, Motorcar Parts' revenues have grown from $130 million to over $160 million for the fiscal year ending March 31, 2011. Operating income over that time went from $10 million to over $25 million. Back in May, Motorcar acquired privately held Fenwick Automotive Products (Fenco). At the time of deal, Motorcar shares were trading around $13 The deal is expected to double Motorcar's revenue and expand its offerings to steering, brakes and clutches.

The Value Proposition

Since the Fenwick deal was announced, Motorcar shares have been on a steady decline. When the company reported its fiscal-first-quarter results for the period ending June 30, 2011, the numbers looked "messy" as a result of the Fenco acquisition. By messy, I mean that because of purchase accounting adjustments and because Motorcar expensed acquisition costs in the quarter, the company reported a net loss of $0.19 a share.

And last month, the company received a notice from the Nasdaq relating to its delay in filing its 10Q for the fiscal 2012 second quarter. That news sent shares down further. The company cited a delay in integrating the numbers of Fenwick acquisition. Fenco is the largest acquisition thus far for Motorcar, and the integration may be taking longer than anticipated. These bumps in the road have opened the door to an attractive entry point.

According to management, the Fenco deal will double revenue to over $300 million, lead to $20 million in savings and add $25 million to annual earnings before interest, taxes, depreciation and amortization. Motorcar already generates over $30 million in annual EBITDA, so by 2013 the company could be on track to generate over $50 million in EBITDA. That values Motorcar at around 3x current enterprise value to EBITDA. Another small-cap automotive parts company, Dorman Products (DORM), currently trades for 7x EV/EBITDA. US Auto Parts Network (PRTS) trades for 8x EV/EBITDA. Apply any of those multiples to Motorcar, and the stock should trade north of $15 in two years, a 115% upside.

Motorcar is a small growth business that has an undervalued stock price. The Fenco deal is a smart product extension for the company. The biggest risk, obviously, is that management could blunder in this acquisition. But Fenco is an established business with a solid reputation for quality. Over time, as the market gets comfortable with the new Motorcar, investors will likely bid the stock higher.

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