Motorcar Parts of America Stock Analysis

Analyzing MPAA, trading at a deep discount to its net asset value

Business Description

To me, value investing is about buying ugly, out of favor companies, and I think Motorcar Parts of America MPAA 0.00%↑ fits the bill. I wrote up Motorcar Parts at the end of March where it was trading at $8. At the time I thought the stock was pretty cheap, but then the price slid down to $5 so I wanted to do a deeper analysis. MPAA often loses money on a GAAP basis, but I think it is trading at a deep discount to its replacement value. Motorcar makes used car parts and currently has a market capitalization of $100M. The stock has been a rollercoaster: trading over $20 a share in mid 2021, long decline to $5 by 2023, then it climbed back up to $10 late 2023, and now its back at $5. Despite poor profitability and stock performance, MPAA has grown revenue from $428M in 2018 to $723M in the trailing twelve months.

MPAA sells new and remanufactured auto parts to retail auto stores like Advanced Auto. The company also has a small but growing division that develops testing and diagnostic tools. The auto parts consists of 37k SKUs such as alternators, starters, wheel hubs, various brake components, and turbochargers. Last year 67% of their sales was in starters/alternators, 11% wheel hub, 18% brake, 4% other. Motorcar Parts does not own its facilities, it leases them primarily in Mexico, but also Malaysia, California and Canada.

Most of the parts that MPAA sells are items that you change once or twice if you are driving your car for the long haul. The average age of cars on the road is the longest its ever been, which means more repairs. Additionally, new cars are quite expensive now days, so MPAA may have tailwinds if people are forced to drive used cars.

One thing that complicates Motorcar Parts balance sheet is the use of “cores” in their business. Usually when you buy a starter from the parts retailer, you give them your worn out part in exchange for the new one. The worn out part is the core, which MPAA disassembles and remanufactures. This gets messy on the balance sheet because Motorcar Parts has large assets and liabilities representing the cores at various stages of their life cycles.

The company also has labor costs and leases in foreign currency. MPAA hedges the currency risk. However their income statement is muddied by the non-cash charge “Foreign exchange impact of lease liabilities and forward contracts”.

Cause for Undervaluation

I think there are several reasons why Motorcar Parts is so out of favor. The recent decline started when they reported earnings in February and had a $37M tax asset valuation adjustment. This was a non-cash expense, but made their GAAP income look terrible.

Next, back in March 2023 it was announced that MPAA would issue $32M in convertible notes to Bison Capital. Bison Capital is a fund that helps recapitalize lower-middle market companies. The notes pay an interest rate of 10%, are convertible at a stock price of $15 a share, and Bison got a seat on the board. These notes hurt the stock price because may dilute existing shareholders, and the financing is not cheap. However, if the Bison Capital board member can help Motorcar Parts cut costs, then it may be for the best.

The third reason why I think MPAA is trading below fair value is because of the dramatic rise in interest costs. Motorcar Parts has a $115M revolving facility that now has 8% interest. The interest payments for the convertible notes issued last year just started at the beginning of April, so that is about $3M a year. But MPAAs largest interest expense comes from their receivables discount program. I wasn’t familiar with this, but it seems that Motorcar Parts sells their accounts receivables to a bank at a discount in order to get cash quicker than waiting for their customers to pay. The balance for this type of financing is nearly $350M. Last year MPAA was paying 1.9% interest, but now it costs 5.3%. This means MPAA pays out over $26M in interest for this receivables program. Overall, due to the recent increases in interest rates, Motorcar Parts pays nearly all of their EBITDA in interest. It doesn’t seem like MPAA has a large amount of debt, its just expensive variable rate debt.

Lastly, I think Motorcar Parts is out of favor because the market dislikes anything related to traditional internal combustion engine cars. The last few years have seen much hype about electric vehicles, which do not have starters and alternators (although they still have brakes and wheel hubs). Other parts manufactures tied to traditional cars have sold off, and there appears to be a narrative that these companies are in secular decline. I think traditional cars will remain on the roads for a while, and these cars will need replacement parts. Additionally, there is data that shows that used cars are being driven longer, so this should provide a tailwind to MPAA.

Valuation

When valuing Motorcar Parts of America, I decided to use the replacement cost method since the company usually earns below its cost of capital. A few months ago when I wrote about MPAA, I estimated replacement value to be about the same as their stated book value. For this analysis, I will try to more accurately estimate their replacement value based on Bruce Greenwald’s Value Investing book. In that book, he analyzes Magna International, a maker of car parts for new cars. Greenwald makes some adjustments to assets such as land, buildings, equipment, intangibles, to better reflect the cost an competitor must outlay to compete.

Starting out, we have total assets of $996M mainly consisting of $14M in cash equivalents, $93M in accounts receivable, $394M in inventory, $343M in core assets, $40M in PP&E. Most of the assets have a corresponding liability that mostly offsets the asset. The notable liability is the $115M revolving credit loan.

The first step in adjusting asset values is to look at MPAAs property, plant and equipment. The company leases its facilities so we don’t have to do anything for buildings and land. Motorcar Parts has about $40M in equipment, with about $60M of depreciation. Adding back the depreciation gets an estimated replacement cost of $100M.

Adjusting the intangible assets becomes a little more tricky. First, we remove intangibles and goodwill from the balance sheet. Then we estimate the reproduction value of Motorcar Parts book of business, skilled labor force, and product development. Greenwald estimates the value of book of business by applying a 10% commission rate that a hypothetical sales agency would charge a company to gain customers. In the case of MPAA, they do about $700M in revenue, so it would cost a competitor $70M to acquire that level of business.

Next is the labor force. Motorcar Parts has 5,600 employees, but 5,200 are involved in the production process. There is no cost associated with obtaining production staff, but there is a hypothetical cost to use a staffing agency to recruit skilled employees. Assuming the 400 non-production employees have an average salary of $100k, and the hypothetical staffing agency charges 1/3 of a years salary, it would cost $13M to replace the skilled labor.

Finally in regards to intangibles, there is the replacement cost to develop the product portfolio. MPAA sells 37k different products, but most of these are disassembling and remanufacturing pretty basic components. Mostly, they aren’t developing new products, just have to figure out how remake the starter, and it probably isn’t too much different between a Honda Accord and a Ford Fusion. That being said, they do spend some money developing diagnostic tools and manufacture other components. MPAA spends about $10M a year in R&D. Assuming it would take a competitor 3 years to develop an equivalent product line, the replacement value comes out to be $30M.

Piecing this together, the values for equipment is updated, goodwill and intangibles are replaced with my updated fair values. The original $996M in assets then becomes $1,169M. As for the liabilities, I’ll leave them at their stated value. This gets an estimated equity value of $454.3M. Currently MPAA has 19.6M shares outstanding, but I will assume the notes will convert, bringing the share count to 21.7M. Using the diluted share count gets an estimated book value of $20.90. Current, non-adjusted equity and book values are $281M, and $14.30.

With MPAA trading around $5 a share, the company seems massively undervalued based on my reproduction valuation, and still quite undervalued based on regular book value. I believe the current stock price has potential for high returns if the stock reverts closer to book value. However, Motorcar Parts has some issues so caution is required.

As mentioned earlier, the company struggles to produce GAAP earnings, partly due to non-cash items like tax assets and foreign exchange moves, partly because of their poor margins, and it appears the company has focused on growth over earnings. The margins are poor largely due to interest expense, and too much overhead costs. If, potentially big if, MPAA can get their interest costs under control and reduce costs, the stock would probably climb back to its previous highs. Motorcar Parts has often traded above book value, so I think a fair value of $12-14 a share is reasonable, even though it is way below my estimated reproduction value.

As an example, MPAA traded at 1.3x book at the end of 2019. Their fiscal year ended in March 2020, and here is snapshot of their operating performance: $536M in revenue, 22% gross margin, 6.5% operating margin, interest expense about the same as EBITDA, negative net income. These figures are not much better than the current situation, but the stock was trading at a much higher valuation.

Usually I don’t invest in companies with poor operating performance as Motorcar Parts of America, however I think their deep discount to stated asset and reproduction cost provides a margin of safety. If I do end up buying shares, I will give it a year or two to assess how the interest and margins are doing, and hopefully it will revert to fair value by then.