2023-12-12 06:26:02 ET
Summary
- Dorman Products' sales growth has been solid, aided by acquisitions, but margins have come under pressure.
- The company's debt from acquisitions raised concerns about leverage, but there has been some modest deleveraging.
- Despite a cut in full-year guidance, the worst leverage concerns appear to be in the past, making the stock a potential buying opportunity on dips here.
In September, I believed that shares of Dorman Products ( DORM ) were still pressured by an M&A overhang. While sales growth was solid, aided by dealmaking, margins were taking some pressure, which was concerning given the debt taken on in connection to acquisitions.
All this made me a bit cautious, and while the cut in the full year guidance did not come unexpected, I am happy to see some modest deleveraging, alleviating most of the leverage concerns, although shares are only regarded fair value at best here.
About Replacement Parts
Dorman Products provides and supplies replacement parts in the motor vehicle aftermarket industry, offering thousands of distinctive parts in many hundreds of categories. Founded in the 1970s, the company has a long history and has delivered on strong results, thereby delivering on solid returns for long term investors.
The company tripled sales in the 2010s to $1.3 billion in 2021, generated from retail, heavy duty and other market categories. A $345 million deal for Dayton Parts that year added to growth, although organic growth coming out of the pandemic was solid as well. On a $1.36 billion revenue base in 2021, the company posted net earnings of $131 million, for earnings just topping $4 per share.
With further growth seen in 2022 (with earnings set to advance comfortably above $5 per share) and Dayton contributing for an entire year, both sales and earnings were set to advance further. This momentum pushed shares up to highs around the $120 mark in both 2021 and 2022.
Some stagnation arrived later in 2022 as the company cut the full year guidance a bit, while announcing a substantial and rather expensive deal, as it paid $490 million to acquire SuperATV in order to add $211 million in power sport parts sales. The deal was taking place at a big premium in terms of sales multiples, as leverage was seen around 2.3 times.
Coming Down
Since the more expensive deal over the summer of 2022, shares have traded in a $75-$100 range, trading at $78 in September. This came after 2022 sales of $1.73 billion topped the original guidance, although adjusted earnings of $4.76 per share rose just modestly from the year before, missing the original outlook by a mile.
Net debt rose further to $688 million, worrisome as adjusted EBITDA fell to $215 million given the lower profitability, for a leverage ratio just over 3 times. The company guided for 2023 sales to rise to $1.95-$2.00 billion on the back of the contribution of SuperATV, with adjusted earnings only seen up to $5.15-$5.35 per share
Through September, the company has posted the results for the first half of the year with reported sales up 15%, yet earnings were down year-over-year, with earnings only coming in at $1.57 per share in the first half of the year. Fortunately, net debt came down to $620 million, needed given the suboptimal earnings.
Trading at $78, the market value of the firm had fallen to $2.4 billion, for a $3.0 billion enterprise valuation. Continued margin pressure, the resulting earnings pressure and higher leverage ratios made me cautious as I wondered if a 14-15 times earnings multiple was cheap enough. This came as I saw risks to the full year earnings guidance after a soft performance in the first half of the year, making it a bit too early to get involved.
Stuck
Since September, shares of Dorman have traded in a $60-$80 range, now trading at $76 per share after shares dipped to the $60s in October.
The dip coincided with the release of the third quarter results on the final day of October. Shares fell despite an 18% increase in the third quarter sales to $488 million, with operating margins improving three point to 13.2% of sales, for operating profits of $64 million. Net earnings of $40 million, equal to $1.28 per share, rose thirty-one cents on the year before. Retained earnings and good working capital management made that net debt fell to $573 million.
Despite somewhat resilient results, the company cut the outlook, as I feared in September. Full year sales were now seen at a midpoint of $1.935 billion, down forty million from the midpoint of the previous guidance, while the adjusted earnings per share guidance was cut by eighty cents to $4.35-$4.55 per share, not unexpected either.
Over the past month and change, shares have rallied from $60 to $76, marking a decent 25% rally in a rather short period of time, mostly as markets at large have risen amidst lower interest rates. Amidst the lower earnings power, the multiple has risen to about 17 times earnings, which looks reasonable, as the worst leverage concerns appear to be a thing of the past, despite the lower earnings power.
And Now?
While the cut in the full year guidance did not surprise me, the extent of the cut was substantial, and the move to the $60 mark created an excellent buying opportunity with the benefit of hindsight.
Given all of this, the pullback to the $60s looks quite interesting as operating margins are down a bit (leaving room for a recovery) while leverage concerns are rapidly becoming a thing of the past. That is comforting, as the run-up in the share price in response to no company specific news was substantial, pushing up expectations a bit too much for me here, leaving me watching with caution from the sidelines.
For further details see:
Dorman Products: Margin Headwinds Do Not Create An Appealing Situation