Some of the best ways to find undervalued investments is to look in places that other investors tend to ignore.
There are a number of "unsexy" industries and companies that produce goods and services we use every day, but they don't receive the media attention that an Apple (Nasdaq: AAPL) or Google (Nasdaq: GOOG) does. And so many retail investors miss out on great opportunities.
One such industry is auto parts. There are nearly 250 million vehicles in North America alone. Almost everyone I know has a car (sometimes two). Those vehicles all need servicing, and they all break down from time to time.
And while some people choose to take their vehicles to an auto parts servicer -- a strategy known colloquially as DIFM, short for "do it for me" -- others prefer to get their hands dirty with a DIY ("do it yourself") approach. Regardless, it has to get done.
Enter Motorcar Parts of America (Nasdaq: MPAA). This company is one of the nation's top manufacturers of aftermarket auto parts. And a company that caters to both sides of the very large replacement parts market, DIYers and DIFMers alike.
One of the big tailwinds for Motorcar and its customers is that the average age of vehicles on the road is over 11 years. That's old for cars, and older cars need more servicing -- the market for replacement parts is, in part, driven by the age of vehicles. It's also encouraging that as the economy strengthens, auto owners will look to complete previously put off repair projects.
DIY Vs. DIFM
The DIY market includes those who purchase parts from the DIY retailers and install parts themselves. Motorcar counts among its customers the majority of auto parts retailers, including AutoZone (NYSE: AZO), Advance Auto (NYSE: AAP), NAPA Auto Parts (owned by Genuine Parts Co. (NYSE: GPC)), O'Reilly Auto Parts (Nasdaq: ORLY) and Pep Boys (NYSE: PBY).
DIY is generally less expensive than DIFM, but it's also more tedious and time-consuming (not to mention that you have to have the know-how). The professional installer market is the DIFM market. This market is serviced by the traditional warehouse distributors, the dealer networks and the commercial divisions of retail chains. Generally, the consumer in this channel is a professional parts installer.
Motorcar has previously catered more to the DIY market, but the company is now attacking the faster-growing DIFM market. The DIFM market makes up about 80% of the replacement auto parts market, while DIY is only 20%. Motorcar has begun selling its products under its own brand name (private label) directly to suppliers that focus on professional installers.
An Underappreciated Market
This has been a transition year for Motorcar, which wrapped up the write-down of its Fenco assets (a botched acquisition by Motorcar) after Fenco declared bankruptcy. The market still hasn't fully digested this write-down -- which led to a $20 million loss in the second quarter -- but that's mainly a problem of perception. The loss also led to a $30 million tax credit that will be used to offset future profits.
These recent issues have overshadowed Motorcar's entry into the wheel hub business, a $1.2 billion market in North America. The real reason that wheel hubs are such a great opportunity is that they contain the car's anti-lock braking mechanisms. This technology has been implemented only within the past decade, so we should see a steep rise in the number of vehicles that require replacement wheel hubs in the next few years.
Furthermore, anti-lock brake technology is now being applied to rear wheels, which means an even larger market. The failure rates for anti-locking brake mechanisms are similar to what Motorcar sees in its other segments, meaning there should be a similarly strong market for replacement parts. Motorcar expects the segment to have a fairly significant impact on revenues starting in the current quarter.
Motorcar trades at less than 10 times earnings, less than the average price-to-earnings (P/E) ratio of 15 of its major peers. Motorcar also has superior profit margins, clocking in at a net profit margin of 4.7%. Putting a P/E multiple of 15 on Motorcar's expected 2015 earnings gives the stock 50% upside to $20.
Risks to consider: The biggest risk is the health of the U.S. economy. A downturn or recession will cause automobile owners to postpone auto repairs, at least for a while.
Action to take --> Buy Motorcar for upside to $20. The stock has already doubled this year, but the investment remains compelling, and it has more than a few catalysts. The wheel hub business is a completely new segment for Motorcar and should have a meaningful impact on its top and bottom lines over the next several years.