TSLA - XPEL: Tesla And Culper Created A Buying Opportunity

2024-01-12 11:31:24 ET

Summary

• XPEL operates in a relatively small and highly competitive automotive film space, primarily generating revenue from protective paint films or PPFs.
• Negative news catalysts from Tesla and Culper Research punished XPEL shares, sending them crashing over 40% from highs back in October.
• Q3 2023 results and subsequent earnings calls have provided a floor on the share price.
• The current valuation of 22x EV/EBIT marks an attractive entry point given concerns have a long way to go to materialize, if ever.

XPEL, Inc. ( XPEL ) is a small company that caters largely to a niche market of enthusiasts willing to pay thousands of dollars for paint protection films, or PPFs, to wrap their vehicles in chip-resistant protection. Revenue for the trailing twelve months only registered at ~$370 million, but this has grown from a base of ~$6 million over the past 10 years. That's a whopping 1,740% increase, accompanied by a hefty 2,900% increase in XPEL's share price.

In more recent history, October marked a bad month for the stock. A double whammy of selling the news sent the stock spiraling. Tesla, Inc. ( TSLA ) announced it will begin offering its own PPF service in two locations and Culper Research came out with a scathing short report claiming XPEL's management is lying to investors. It was an exercise in how to crash a stock over 40% in short order. This may mark an opportunity to get in.

Tesla News

On the first set of news about Tesla, XPEL will continue to shed Tesla-related revenue over time as its new competitor rolls out its offering to more locations. In a statement issued by XPEL's management in response to the news, it stated that Tesla-related revenue accounted for roughly 5% of its year-to-date PPF revenue for 2023 at the time. If that number is accurate I would estimate a ~$10.5 million hit on $211 million in full-year PPF revenue. That's a $1.4 million hit to the bottom line assuming a 13% net margin, or about 5 cents per share. That is not a great development but also not impossible to overcome either.

There are questions surrounding how accurate the 5% PPF revenue figure quoted by XPEL management is and that's not something that can be hidden for very long. I assume management is being truthful and honest here because there's already a host of law firms chomping at the bit to go after XPEL, largely based on claims made in Culper's short report.

Culper Research News

The short report by Culper Research is an entirely different animal, mostly embedded in speculation. It alleges that XPEL's Tesla business accounts for 25% to 35% of its PPF revenue, not the 5% publicly offered by the company. Culper also made claims that "the Company is concealing a massive undisclosed risk from its primary supplier which threatens to upend the Company's entire reason for being." Referring to Entrotech, which has been XPEL's primary supplier for more than a decade. Indeed, news broke earlier in 2023 that Entrotech and PPG Industries, Inc. ( PPG ) formed a joint venture where PPG intends to offer film solutions through PPG Advanced Surface Technologies. There was already familiarity between the two given that Entrotech has been using PPG paint products in their paint films already.

At best, the new joint venture marks another entrant into the PPF market and increased competition. At worst according to Culper, "XPEL is burying the uncomfortable fact that it's been leap-frogged by PPG and that its long-time supply partner has decided to understandably work with PPG rather than move forward with XPEL." Culper claims that PPG has developed methods to integrate PPF directly into paint. That's a claim that so far has been unfounded and even addressed by XPEL CEO Ryan Pape referring to the integration of PPF directly into paint stating, "That's what's been kind of developing at a slow pace, probably for the past 10 years but that's a far cry from some theoretical technology to put film inside the paint and that doesn't exist."

The existential threat to after-market PPF installation that Culper claims doesn't exist at the moment. That's not to say at some point in the future it may come into play. Even if it were available today, it's difficult to forecast the impact on current PPF technology as it's not necessarily the case that consumers would prefer factory-ordered protection over an after-market solution.

It's also unclear the impact on the joint venture between Entrotech and PPG in general. In the latest earnings call, XPEL CEO Ryan Pape put a positive spin around the news, stating, "earlier this year, it was announced that PPG had formed a joint venture with Entrotech around colored film products. Entrotech had developed over a period of many years. We welcome the PPF joint venture with Entrotech. And there are many possible opportunities for collaboration with PPG. We're actively discussing ways in which we might do that with their senior leadership."

I'll be looking for confirmation and more color surrounding the supposed discussions with PPG over the near term but it seems to me Entrotech gains the most from the deal.

Valuation & Other Metrics

The Tesla news coupled with the Culper short report has driven down the share price of XPEL. The question is where does it stand from a valuation perspective now? Current EPS estimates for rounding out fiscal 2023 stand at $1.96, placing a forward P/E multiple at 25.65. Estimates for 2024 stand at $2.33, implying ~19% growth and a forward PEG of ~1.35 which is not expensive at all.

From another valuation perspective, XPEL's EV/EBIT multiple has come down from nosebleed levels of 75x+ to a more reasonable 22x. There was a definite argument that the stock needed to have some steam let out regardless of any bad news catalysts. While year-over-year growth comps for gross profit and operating income in Q3 2023 slowed considerably at 16% and 2% respectively, it was off an elevated base and the numbers should as business operations normalize. CEO Ryan Pape referred to being in a "fever pace" in Q3 2022 in the last earnings call.

The following table highlights year-over-year trailing twelve-month trends for gross profit and operating income over the last couple of years. It's clear the Q3 2023 results contributed to the lowest trailing twelve-month growth level seen over this period, but we're still looking at gross profit growth of 25% on a 40%+ gross margin.

Profitability metrics continue to trend in the right direction with gross margins increasing some ~900 basis points over the last decade. Operating margin increased ~580 over the same period. This increased operational efficiency will pay off as XPEL firms up and strengthens revenue growth by continuing to expand globally, highlighted by recent acquisitions in Canada and Australia.

One inventory-related issue in Q3 that hopefully won't be repeated is a $1 million adjustment due to a supplier quality control issue, which also stands to benefit Q4 as the excess inventory on hand is drawn down.

Conclusion

XPEL operates in a highly competitive market with not a lot of competitive advantages, although its DAP software provides some differentiation against competitors. The majority of its revenue is generated from a relatively small global PPF market valued at roughly $560 million . However, that can be seen as a positive and largely is by XPEL's management team as CEO Ryan Pape has often referenced growing consumer awareness of the existence of PPFs in the first place. Something he mentioned five times on the Q3 earnings call.

Growing awareness and growing competition come hand in hand and the next couple of quarters will shed a lot more light on the impact of the Tesla and Culper Research news. While the Tesla news is a little more matter of fact that they intend to provide their own PPF solution, they still have to execute a successful rollout of a quality product at a price people are willing to pay. That is certainly not a given, especially considering quality control issues Tesla has had in the past .

The Culper Research report is largely their word against XPELs. They contend that PPG has developed technology to put PPF directly into the paint, but that doesn't appear to be the technology that exists today. The deal between Entrotech and PPG seems to me to be a natural evolution of an existing relationship between the two. Entrotech wants to commercialize its product to a wider market and leveraging PPG's size can accomplish that, but it can also greatly increase the awareness and size of the market for other players too. XPEL can be in a position to get smaller gains in PPF market share in a much larger market while potentially collaborating with PPG leveraging their DAP software and professional installation services.

I believe the stock has been punished sufficiently to account for the negative developments and subsequent uncertainty and offers a suitable entry point for investors. It also appears that Q3 earnings placed a floor on shares that have been firming up ever since. I have bought shares of XPEL over the last few weeks at an average price of $52.68. This is even as I remain extremely cautious on markets in general for 2024 and is reflected in the fact that I currently only have two stocks out of the universe of stocks with active buys ongoing.

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