Dorman Products – Adding More Products (NASDAQ:DORM)

Dorman Products (NASDAQ:DORM) has been a very well-established business. Founded late in the 1970s, the company has been a listed business since the early 1990s, with its founding family still being a major shareholder. The company has steadily grown the business, and keeps doing so, having been a solid compounder of long term capital gains.

The Business

Dorman Products is a leading supplier of replacement parts in the motor vehicle aftermarket industry, offering hundreds of product categories and over a hundred thousand distinctive parts.

The company generated some $1.3 billion in sales in 2021, of which just over half of sales are generated from the retail segment, complemented by traditional and heavy duty and other markets. In terms of category, revenues are generated from powertrain, chassis, automotive body and hardware sales.

The company operates in a large aftermarket sales in which it holds a near 3% market share, as the company has seen solid growth, having steadily grown sales from roughly $400 million in 2010 to more than triple it through 2021.

Part of the 2021 growth came from a deal being announced in the summer of that year, with Dorman announcing a $345 million deal of Dayton Parts in August, exactly a year ago.

The Valuation

In February of this year, Dorman posted its results for the year 2021. Revenues rose 23% to $1.34 billion, the result of 16% organic growth and the remainder from the contribution of Dayton which only started adding to the results in the second half of the year. The company posted a net earnings result of $131 million, or $4.12 per share, with adjusted earnings coming in roughly half a dollar per share higher, as the discrepancy stems from acquisition related costs, something I am happy to adjust for.

The company guided for 2022 sales at $1.60-$1.64 billion which looks better, but is mostly the result of the anniversary of the Dayton purchase, with the revenue guidance largely in line with the fourth quarter revenue run rate. Adjusted earnings are seen at a midpoint of $5.45 per share and given the strong balance sheet, it seems reasonable to see shares trade around the $100 mark for most of 2021.

Shares peaked at $120 in November of last year and July of this year, but now trade at $98 per share again. This values the 31.7 million shares at $3.1 billion, just below 2 times sales and around 18 times earnings. Part of the retreat in the share price recently comes as the company cut the full year earnings guidance late in July, now seeing earnings at a midpoint of $5.10 per share on the back of higher interest rates, while keeping the sales guidance flat.

This comes as the net debt load of the business stand as at $180 million, far below 1 times leverage. With quarterly interest expense of $1.5 million, that seems like quite a lame excuse in my opinion.

Deploying More Capital

Despite the impact of rising interest rates on the profit and loss account of the business, Dorman announced a substantial deal in August. The company reached a $490 million deal to acquire SuperATV, or $445 million if one factors in tax benefits, although earn-outs might boost the transaction amount by a hundred million based on the 2023 and 2024 performance.

The deal is substantial in its size, but furthermore noteworthy as it is an independent supplier of power sports parts. With a $211 million sales contribution, the deal comes at a more than 2 times revenue multiple (excluding the earn-out), a huge premium compared to Dorman´s own valuation. The company expects that the deal will be accretive to margins and earnings per share, indicating superior profitability, but that does not reveal the earnings multiple being paid for the activities of course, nor did the deal presentation.

With operating margins of Dorman at large posted at around 10%, the deal should likely at least boost operating earnings by $25 million, as some minimal accretion could be expected, yet I think this will be fairly minimal after accounting for interest costs, so I think that accretion is limited at the get go. Assuming 12% margins we see $25 million earnings accretion as a 4% cost of net debt results in $20 million in additional interest cost, leaving minimal accretion of about ten cents per share. Net leverage will inch up quite a bit to 2.3 times, somewhat in contrast to the financial conservative practices of the business in recent times.

What Now?

Seeing earnings power just above $5 per share this year, while leverage has inched up a bit following the recent deal, I am a bit cautious here. Dorman now trades at a market multiple at around 18 times earnings, while leverage is fair and this is a somewhat cyclical business in all likelihood.

While the long term trend and performance is quite strong, the reality is that with emerging headwinds, the future is not that great in the near term. This comes amidst inflationary pressures mounting and perhaps implications on demand as well with consumers and business strapped for cash currently.

Hence, the current valuation is more than fair. However, I see no reasons to be involved here as the latest and substantial deal does not come with enough financial disclosure if you ask me, which combined with leverage increase and softer momentum makes me a bit cautious here.