This Niche Supplier May Provide Superior Returns

William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Recent years have been tough with unemployment rising to double digits in the latter part of 2009 (see chart below). Unemployment has declined slowly but steadily to the current rate of 8.1% but is still above the pre-recession norm of 5-6%. Businesses and consumers alike suffer during times of high unemployment. I am always on the lookout for companies that can be profitable during good times and bad. Dorman Products, Inc. (NASDAQ: DORM), a supplier of automotive replacement parts for the automotive aftermarket, is the company that benefits from frugal times.

<img src="http://media.ycharts.com/charts/f4ddd5397588b804803e32b3aa05f78e.png" />

US Unemployment Rate data by YCharts

According to Dorman Products’ SEC filings, the average ownership of a car is now 10.8 years which means that people realize that it’s cheaper to hang onto a car longer even though that might require more replacement parts along the way. Since Dorman Products focuses mainly on automotive replacement parts in the aftermarket, selling to well known retailers such as Autozone and Advanced Auto Parts, they stand to gain momentum from increased demand for automotive parts as the collective age of the American vehicle increases.

Dorman Products is focused on a more specialized product line, mainly automotive parts, while their listed competitors (Napa’s parent company Genuine Parts Company (NYSE: GPC) and Federal Mogul (NASDAQ: FDML) deal in other types of parts. Genuine Parts Company supplies industrial products such as bearings and motors under another well known name in the heavy industrial sector called Motion Industries. Genuine Parts Company also provides office products through a company known as S.P. Richards Company. Federal Mogul supplies parts for all manner of vehicles in rail, marine and aerospace.

Dorman Products small size makes growth easier. Genuine Parts Company and Federal Mogul have much higher revenue streams but are growing at a far slower rate than Dorman Products. The rate of revenue growth over the past five years for Dorman Products is nearly four times that of Genuine Parts and thirty-five times the growth rate of Federal Mogul (see chart below). Free cash flow growth for Dorman Products is 944% versus 59% for Genuine Parts. Federal Mogul’s free cash flow growth has been negative over the past five years (see chart below).

<img src="http://media.ycharts.com/charts/f430b2e7dd1c2154528207c7e1fa338c.png" />

DORM Revenue TTM data by YCharts

 

<img src="http://media.ycharts.com/charts/67e3c20390f6d3069667a3b169545c15.png" />

DORM Free Cash Flow TTM data by YCharts

Dorman Products not only has a higher rate of growth in terms of revenue and free cash flow, they also keep more of what they earn (see chart below). Dorman Products’ operating margin stands at 17% versus 8% for Genuine Parts and 4% for Federal Mogul. Dorman Products’ profit margin is more than double that of Genuine Parts.

<img src="http://media.ycharts.com/charts/1bf6c6511c05f685b2eef7b9a9a303c8.png" />

DORM Operating Margin TTM data by YCharts

<img src="http://media.ycharts.com/charts/4cc70fbe9df578271b2e6cbe6af242d3.png" />

DORM Profit Margin data by YCharts

The debt ratios of Dorman Products are excellent (see chart below). The long-term debt to equity ratio of Dorman Products is zero as of the most recent quarter. Federal Mogul by contrast is 272%. The total debt to equity ratio of Dorman Products is only 20%. Genuine Parts Company has a debt to equity ratio of 17%.

<img src="http://media.ycharts.com/charts/0f7fd2dba8c935b38c1817938eb67858.png" />

DORM Debt to Equity Ratio data by YCharts

Another thing to like about Dorman Products is that the largest shareholder, Chairman, CEO and Treasurer Steven L. Berman, owns 19% of the company. I believe management that hold a large interest in the company they run are going to be good stewards and that their interests are going to be aligned with shareholder’s interest as a whole. It also lessens management turnover which can be detrimental to a company.

There are fundamental risks with this company despite the excellent metrics described above. The company has expressed concerns about pressure from customers to extend their payment terms and lower prices. Retailers that Dorman deals with are feeling the financial heat from the final consumer who is contending with lower take home pay. Dorman may be selling more products because of tighter times but margins are under constant pressure. Dorman occasionally sells their accounts receivable to increase liquidity and lower risk. However, Dorman Products is also trying to develop new products that can fit into cars better and save the final consumer time. This should keep continued customer interest.

Political risk for Dorman Products from a selling standpoint is low because they sell primarily in North America. However, they buy a lot of parts from places such as China. The Yuan has increased in value relative to the U.S. dollar making it more expensive to buy from there. If this trend continues margins may come under pressure from this front as well.

Market risk for Dorman Products is moderate with a P/E ratio of around 18. The stock market has been over exuberant in my opinion. I am going to wait for a correction before buying.

With continued unemployment rates above recent historical norms the American consumer is going to stay frugal. Future product development should aid in Dorman Products future prosperity. It would be wise to keep an eye on Dorman Products’ margins because customers are going to continue to exert pressure on them. The moderate P/E ratio compels me to wait before buying or making a Motley Fool Caps call. Dorman Products, given the right price, should provide superior returns.


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