HLLY - Holley: Demand No Longer Seems Sticky Following Soft Guidance

Summary

• The company’s sales declined by 7.1% in Q2 2022 despite an acquisition during the period.
• Holley blamed the weak results mainly on supply chain disruptions, chip shortages, and reseller destocking.
• However, the revised 2022 guidance suggests that the second half of the year won’t be much better, despite some orders being pushed into Q3.
• I have doubts that demand for Holley’s products is sticky, and I think risk-averse investors should avoid this stock.

Introduction

Sometimes, you just get it wrong. In early June, I wrote a bullish SA article about high-performance automotive parts supplier Holley (HLLY) in which I said that demand for the company’s products looked sticky, and I gave it a price target of $14.40. Less than three months later, Holley’s market valuation is down by over 40% and the company recently posted weak results for Q2, which is typically its strongest quarter. Looking at the revised 2022 guidance, it doesn’t seem like the remainder of the year will be much better and now I have doubts that demand for Holley’s products is sticky. Let’s review.

Overview of the recent developments

In case you haven’t read my previous article about Holley, here’s a brief description of the business. The company specializes in the design and production of high-performance products for car and truck enthusiasts including carburetors, fuel pumps, fuel injection systems, nitrous oxide injection systems, and superchargers among others. It’s the leading player in this sector in the USA, and it claims its sales are about 2-3 times larger than the sales of its nearest competitor. Holley’s brands include Accel, Flowmaster, MSD, and Stilo just to name a few.

The company listed on NYSE in March 2021 through a merger with a special-purpose acquisition company (SPAC) company and its quarterly revenues surpassed the $200 million mark in Q1 2022. It seemed like this would be a very good year for Holley from a financial point of view despite high inflation rates and a looming recession as according to the company’s corporate presentation , 82% of car and truck enthusiasts consider budgets on parts recurring expenses and about 54% of its clients earn over $75,000 per year. In addition, around 64% of Holley's clients frequently trade in their cars and trucks to begin new personalized vehicle builds.

Those sound like a convincing arguments that Holley could be a compelling investment opportunity during a recession, but as a retired automotive engineer remarked on my first article about the company, this didn’t save it from bankruptcy during the Great Recession. In fact, Holley emerged from Chapter 11 bankruptcy for the second time in the span of three years during 2010 as its sales slumped from $112 million in 2008 to $90.2 million in 2009.

Sure, Holley is a much different company today than a decade ago following a total of 15 acquisitions since 2014 and over a third of gross sales coming from products introduced since 2016. In addition, Holley now has a strong focus on the direct-to-consumer ((DTC)) business model. However, it seems that the business still isn’t recession-proof as net sales slumped by 7.1% to $179.4 million in Q2 2022 despite the acquisition of safety equipment maker RacePak during the period. Adjusted EBITDA, in turn, slid from $37.2 million to $16.9 million. Yeah, net income looked strong, but this was due to a $23.2 million change in the fair value of the warrant liability as the share price decreased.

Holley blamed the decrease in net sales mainly on supply chain disruptions, chip shortages, and reseller destocking. However, it’s concerning that there is softer consumer demand in certain categories, such as electronic tuning. You see, people tend to buy tuning devices when they buy a new car, and this means that sales in this area usually decline when new car sales slide. So far in 2022, car sales in the USA haven't been good.

Looking at the future, Holley expects that the receipt of goods from global suppliers will accelerate in the second half of 2022, but the revised guidance for the year seems concerning as net sales are now forecast to come in at just $765 million to $790 million. This means that H2 figures will barely surpass H2 figures despite Holley claiming that its past-due orders at the end of Q2 2022 are more than three times the net sales decline from the prior year. What I find even more concerning is that adjusted EBITDA forecasts have been cut even more severely than net sales as this could limit M&A opportunities.

In addition, Holley has a large debt load. As of July 3, the company had debts of $636.8 million and the vast majority of this amount is due in November 2028. The weighted average interest rate on Holley's borrowings under the credit facility was 5.2% as of July 3 and interest expenses during the quarter were $9 million.

Overall, I think that Holley’s financial results in Q2 2022 were weaker than most investors anticipated, but there were headwinds like supply chain disruptions, and chip shortages that just couldn’t be avoided, and they pushed demand into Q3. However, the updated guidance doesn’t envisage a large rebound in sales or profitability and I’m concerned that a global economic slowdown or a recession could push Holley into the red. As a result of the revised guidance, I’m losing faith that demand for the company’s products is sticky and I think it’s possible that the company could run into liquidity issues once again if we get another Great Recession.

Investor takeaway

Holley was among the few companies that listed through a SPAC deal that I considered undervalued thanks to its high growth rate and demand stickiness for its products. However, the company has a large debt load and my faith in this stickiness is shaken following the underwhelming Q2 results and especially after the soft revised guidance for the full year.

It seems that the second half of 2022 won’t be much better in spite of a significant amount of demand being pushed into Q3 and I’m no longer bullish on this company. In my view, risk-averse investors should avoid Holley’s stock.

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