2023-12-11 09:28:12 ET
Summary
- Dorman Products' historical financial performance shows accelerating revenue growth and a significant increase in debt-to-equity ratio due to inventory buildup.
- Despite the debt situation, the latest results show signs of improvement, and management is actively working on reducing debt.
- Growth in the US automotive aftermarket industry and global vehicle sales will bolster DORM's growth outlook.
- My conservative valuation suggests double-digit upside potential.
Synopsis
Dorman Products (DORM) is a leading supplier in the automotive aftermarket industry. It is popular and known for providing a wide variety of automotive parts for various vehicle types. A thorough analysis of its historical financial performance reveals that revenue growth is accelerating rapidly. Notably, its debt-to-equity ratio has also increased significantly, mainly due to inventory buildup. However, the latest TTM results show signs of improvement, and management has mentioned that they are actively working on reducing the company's debt. Looking ahead, the anticipated growth in the US Automotive Aftermarket and Global Automotive Sales is expected to bolster DORM's growth outlook. Additionally, DORM is proactively aiming to capture this growth through continuous product innovation. My conservative relative valuation suggests a double-digit upside potential. Considering these tailwinds, I am recommending a Buy rating for DORM.
Historical Financial Analysis
From 2019 to 2022 , it is quite clear that DORM's revenue growth has been accelerating. In 2019, the growth was a modest 1.81%, but by 2022, it had increased to 28.88%. Due to this volatility, the CAGR is utilized to provide a smooth annual growth rate that evens out the fluctuations during this period of analysis. The 4-year CAGR for DORM stands at ~15%.
In terms of margins, they have remained fairly consistent, although I did notice a slight compression in the 2022 margins. This was primarily due to high inflation in 2022, which led to increases in SG&A and cost of goods sold (COGS), resulting in margin contraction. However, since that peak, inflation has decreased from approximately 9% in mid-2022 to the current rate of 3.2%.
As the margins of DORM are in the single-digit range, it's crucial to assess its debt situation to gauge its financial health. To my surprise, the company's debt levels have increased exponentially over the last four years. In 2019, its debt-to-equity (D/E) ratio was only 5%, but it has now soared to 81%. However, before drawing any conclusions, let's dived deeper into its cash flow situation to understand what has caused this significant rise.
Based on the following chart, it's clear that the rising debt situation at DORM was primarily driven by an increase in inventory, leading to higher working capital requirements and consequently a decrease in cash flow from operations. However, the trailing twelve months ((TTM)) data indicate a significant recovery in both inventory levels and cash flow from operations. Therefore, looking ahead, I do not foresee a further worsening of the debt situation. It would be beneficial if the management continued to address and actively reduce this debt. Encouragingly, in the 3Q23 results, management did address the current debt situation and is proactively working on reducing it, which I consider a positive sign. President and CEO Kevin Olsen said : "Over the last few quarters, we focused on reducing our debt and repaid $50 million in the quarter, for total repayments of $129 million year-to-date. We expect continued strong cash flow in the fourth quarter."
3Q23 Earnings Results Analysis
In my opinion, DORM reported strong 3Q23 financial results. In this quarter, net sales increased by ~18% year-over-year to ~$488 million, up from 3Q22's ~$413 million. This strong growth was primarily driven by DORM's strategy of implementing pricing increases to combat inflation, coupled with the introduction of new products. In my opinion, these results highlight two key points that I would like to point out. Firstly, DORM demonstrates that it has pricing power, as it successfully passed increased costs to customers without suffering a decline in sales. Secondly, the introduction of new products is a key growth driver for the company, which I will discuss in more detail later in this article.
Moving to profitability, I will be analyzing DORM's gross profit, operating income, and net income margins. Its gross profit margin showed an improvement, increasing from 31.9% to 37.5%. This improvement was primarily driven by its strategy of price increases and the sale of lower-cost inventory.
Even though there was a slight increase in SG&A expenses, this was more than offset by the improvement in the gross profit margin. Consequently, the operating income margin improved from 10.2% to 13.2%. The net income margin also saw an increase, rising from 7.4% to 8.3%, which resulted in the growth of diluted EPS from $0.97 to $1.28, representing a growth of ~31%. Overall, DORM's 3Q23 financial result is looking really strong, showcasing growth in top-line revenue, margins, and bottom line.
Addressing the elephant in the room, DORM's revised full-year revenue guidance range
When DORM released its 4Q22 results, it provided revenue guidance of $1.95 to $2 billion for the full year 2023, driven by strong demand for its product range. In 2022, although inflation was elevated, peaking at 9%, it has decreased over the years. This trend was a relief for many companies and bolstered their forecasts, including DORM.
In 2023, inflation continued its downward trend but began to plateau and move sideways since June 2023, stabilizing around the ~3% range. This is still above the Fed's target rate of 2%, prompting the Fed to leave rates unchanged . This situation created uncertainties for many companies, including DORM. Consequently, in its 3Q23 earnings, management lowered its guidance range from $1.925 billion to $1.945 billion, attributing this to softer demand and overall economic uncertainties caused by inflation which affected the Fed's interest rate decision.
However, despite the reduction, the revised revenue guidance still represents strong growth, with expected increases in the double-digit range of 11% to 12%. In my opinion, this revision is a reflection of short-term macroeconomic challenges caused by inflation and not long-term chronic issues within DORM. In addition, keep in mind that the growth drivers I discussed are long-term in nature, as they extend until 2030. I welcome this revision as I see it as a conservative approach, which takes immediate market conditions into account, giving shareholders more realistic expectations. In the long term, I continue to believe DORM's strong performance and strategic initiatives provide a robust foundation for its growth.
Strong US Automotive Aftermarket Growth offers DORM ample opportunities for growth
As you know, DORM supplies upgrades and replacement parts for a range of vehicle types, mainly in the automobile aftermarket industry. Thus, it is important to analyze the overall health and trends of the automobile aftermarket industry.
The U.S. automotive aftermarket industry is expected to grow over the next seven years at a CAGR of at least 4.1%. To provide a clearer picture of this growth, the U.S. automotive aftermarket was estimated to be worth ~$205 billion in 2022. With a 4.1% CAGR, this market is projected to expand to ~$282 billion, representing an increase of ~$77 billion. For comparison, DORM's total revenue in 2022 was only ~$1.73 billion. As you can see, the strong growth of the automobile aftermarket industry presents DORM with ample opportunities for revenue growth.
Is DORM working towards capturing this anticipated strong growth in aftermarket parts?
The answer to this question is yes. DORM did not just sit back and relax, waiting for growth to come to them. Instead, they have been actively and aggressively working to capture more market share. Just a few days ago, on 7 December 2023, DORM announced the introduction of 400 new parts.
One noteworthy release relates to DORM's exhaust manifold clamp repair kit. The reason I am emphasizing this is due to the extensive coverage it provides. This exhaust kit can cover up to ~3 million Ford and Lincoln vehicles. In addition, the chart below clearly shows that Ford is the number one car brand in the U.S.
I believe that DORM's proactive approach and strategic introduction of new products will significantly strengthen its position in the aftermarket industry. Its forward-thinking attitude not only helps maintain a robust lead in the market but also enables it to capitalize on expanding opportunities in the growing aftermarket sector.
Global Automotive Sales Expected Growth Will Bolster DORM's Growth
In 2020, vehicle sales declined to ~$82 million, mainly due to the COVID-19 pandemic. As the pandemic spread, many countries implemented lockdowns, movement, and travel restrictions. Consequently, demand for vehicles took a hit. However, as the pandemic gradually subsided, the pent-up demand caused by the pandemic led to a recovery in vehicle sales.
As of 2023, vehicle sales are expected to reach pre-pandemic levels. For the remaining years, growth is projected to accelerate, reaching ~$122 million by 2030. Compared to 2022, this represents a CAGR of ~4.1%. Therefore, I do believe that the anticipated growth in automotive sales will bolster DORM's growth outlook.
Relative Valuation
DORM operates in the automotive parts and equipment industry. The competitors I have gathered below also operate in the same industry, making this group a good representation of the market in which DORM operates.
In terms of market size, DORM is approximately 10% larger than the competitors' median. DORM's market capitalization is ~$2.4 million, while the competitors' median market capitalization is ~$2.185 million. Naturally, their operating metrics should be similar but when I dive deeper, it revealed that DORM outperformed its competitors in all areas.
In terms of forward revenue growth, DORM is ~14.97% while competitors' median is 8.93%, this represents 1.68x over competitors' median. In terms of gross profit TTM, DORM is ~33.51% while competitors' median is ~21.18%, representing 1.58x over competitors' median. Lastly, in terms of net income TTM, DORM is ~5% vs. competitors' median of ~1.94%, representing 2.58x over competitors' median.
Despite DORM's outperformance, its P/E ratio of 17.43x is trailing behind competitors' median of 19.06x. I genuinely believe DORM is undervalued in terms of its P/E ratio. I will stick to this ratio for now in order to stay conservative.
The market revenue estimate for DORM is anticipated to be $1.93 billion in 2023 and $2.04 billion in 2024. Additionally, the market's 2024 EPS estimate for DORM is $5.19. I believe these revenue and EPS estimates are reasonable, as they align with management's guidance . For 2023, management expects revenue to be in the range of $1.925 to $1.945 billion. As you can see, the market revenue estimates use the midpoint of the guidance.
In addition, my discussion on its strengths and growth catalysts above also supports this outlook. By applying its current P/E ratio, which I believe to be undervalued, to its 2024 EPS estimates, my 2024 price target for DORM is $90.46, representing an upside potential of ~21%. Even with this conservative P/E ratio, the upside is still double-digit. If adjusted to align with the competitors' median P/E of 19.06x, my price target is even higher, at ~$98.92, indicating an upside of ~32%. Looking at its 5-year average, it is also clear that DORM's current P/E ratio is below this average, further bolstering my belief that my estimates are conservative.
Risk
One risk associated with DORM is its high D/E ratio. If its debt levels are not managed effectively, the increased interest expenses could reduce its net income margins. Consequently, EPS might decline or fall below market expectations. In such a scenario, a correction in the share price could happen.
Conclusion
In conclusion, although DORM's increasing D/E ratio poses a concern for investors, management has indicated that they are actively working on reducing the company's debt. Additionally, its TTM results show signs of recovery in inventory levels and cash flow.
Apart from this, DORM's revenue is growing strongly. The anticipated growth in the US automotive aftermarket industry and global automotive sales is expected to bolster its growth outlook. DORM has been proactively introducing new products into the market to capture this growth. Additionally, their strategic product introductions targeting popular car brands also position them well for future growth.
When I conducted a relative valuation, it became clear that DORM has outperformed its competitors, yet it is trading at a lower P/E ratio. Given my conservative valuation, my target price still indicates a double-digit upside potential. Taking all these factors into account, I am recommending a Buy rating for DORM.
For further details see:
Dorman Products: Demand In Automotive Aftermarket And Global Vehicle Sales Set To Boost Growth