In August 2022, I took a look at Dorman Products (NASDAQ:DORM) as it was adding more products to its line-up after it announced a substantial deal. While the valuation looked fair amidst a reasonable long-term track record, I was leaning a bit cautious amidst momentum cooling off a bit, as rather limited disclosure was provided on a recent, yet substantial deal.
That cautious stance saved me well, with shares down another 20% over the past year, as earnings have been stagnant, or even came down a bit. This is highly concerning as the company has taken on a lot of debt here, and I furthermore see risks to the full-year earnings guidance.
Replacement Parts
Dorman Products supplies replacement parts in the motor vehicle aftermarket industry, offering hundreds of product categories and thousands of distinctive parts. Founded in the ’70s and listed since the ’90s, the company has seen steady growth over time, delivering solid returns for long-term investors.
The company has essentially tripled its business during the 2010s as it generated $1.3 billion in sales in 2021, little over half of which it generated from retail, complemented by sales in the traditional, heavy-duty, and other market categories. The company saw some additional momentum in 2021, aided by a $345 million deal for Dayton Parts which drove a 23% increase in 2021 sales to $1.34 billion, although that 16% organic growth was not too shabby either.
The company posted net earnings of $131 million, equal to $4.12 per share, on that revenue base with adjusted earnings coming in around a dollar higher. With Dayton only contributing for a part of 2021, growth was seen as the company guided for 2022 sales to advance to $1.60-1.64 billion, with adjusted earnings seen at $5.45 per share. This momentum was recognized by investors which sent shares to a high of $120 in 2021 and 2022, although shares had fallen to the $100 mark when I looked at the shares in August 2022.
This came as the company cut the full-year adjusted earnings outlook to $5.10 per share at the time, citing higher interest rates as its reason. As interest expenses were minimal, this was a bad excuse. With net debt of $180 million being very modest, this was set to change as the company announced a $490 million deal for SuperATV, thereby adding $211 million in power sport parts sales.
The greater than 2 times sales multiple marked a big premium to Dorman’s own valuation, and while the deal was set to be accretive to margins, this was not quantified. This made me a bit cautious as leverage would jump to around 2.3 times, all while the business traded at a market multiple. With some operating headwinds seen, and leverage ticking up after an apparent more expensive acquisition, I was quite cautious.
Coming Down
Since August of last year, shares of Dorman have been trading in a $75-100 range, now trending towards the lower end of the range at $78 per share. By February of this year, Dorman posted 2022 sales at $1.73 billion, far ahead of the original guidance due to inflationary pressures and the added dealmaking over the summer. That was about the good news as adjusted earnings of $4.76 per share came in just twelve cents ahead of the year before, missing even the revised earnings outlook during the year.
Net debt jumped to $688 million which was a bit high for my taste. After all, reported EBITDA came in at $215 million, resulting in a leverage ratio above 3 times. 2023 sales were set to advance to $1.95-2.00 billion, with growth driven by continued inflationary pressures and the full-year contribution of SuperATV. Moreover, adjusted earnings per share growth was seen lagging compared to sales (again), with adjusted earnings seen between $5.15 and $5.35 per share.
In May, Dorman posted a 16% increase in first quarter sales to $467 million, although that organic growth slowed down to just 3% and change. Even as adjusted earnings per share were more than cut in half to $0.56 per share, the company maintained the full-year outlook.
By August, Dorman posted a 15% increase in second quarter sales to $481 million. Adjusted earnings per share fell from $1.29 per share to $1.01 per share, but they improved substantially from the very soft first quarter earnings numbers. Net debt came down to $620 million which is comforting and badly needed with earnings under pressure here.
With 31 million shares trading at $78, the market value has fallen to $2.4 billion, and the enterprise valuation to about $3 billion. This is after factoring in the debt incurred with the two more expensive deals over the past two years, with deleveraging badly needed as earnings have been under a lot of pressure.
Final Thoughts
Right now, I completely understand why shares are down a third from their highs, despite the continued sales growth. Margins have taken a beating and earnings per share have been stagnant, the result of continued margin pressure.
Moreover, there is the issue of debt and while some deleveraging has been seen, it is the current dismal EBITDA performance that pushes up leverage ratios. Quite frankly, I wonder if a current 14-15 times multiple might not be cheap enough here, certainly not after the softer first half of the year leaves real risks to the guidance in my view.
Deleveraging is badly needed as the company incurs interest expenses at a run rate of around $50 million, equal to over one and a half dollars (pre-tax) which is distracting earnings here. Note that part of these expenses relate to factoring programs on accounts receivables, as otherwise, the effective rate would have been extremely high here.
It is the question behind the M&A moves, the leverage incurred, and current operating woes that makes me still a bit cautious, as I find it too early to buy the dip at Dorman here.
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