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SMP - Standard for the Portfolio?
Posted by: Henry Tan (IP Logged)
Date: March 1, 2013 10:17AM
Unbridled passion for automobiles prevailed long before popular franchises such as The Fast and The Furious took it mainstream. After this box office hit, the desire to modify cars impacted the wallets of young adults worldwide, as they hungrily sought after-market parts for their personal vehicles. This niche market is quite lucrative, with sales of after-market parts totaling $285.7 billion in 2010, and estimated to exceed $336 billion by 2015. Standard Motor Products (SMP) has a storied history, with over 94 years in operation since its inception in 1919. Based upon current conditions, an investment is SMP is recommended due to potential for long term growth, and margin of safety is derived from its deviation from intrinsic value.
SMP caters to both the after-market enthusiasts and those seeking OEM parts for their vehicles. Original equipment manufacturers produce parts that are originally in a vehicle, but sold as part of a major brand such as Nissan and Toyota.Their customers of focus are primarily large retail chains such as AutoZone, other OEMs, and large distributors.
Standard Motor Products believes that in times of economic distress, people are more likely to repair rather than replace, and as such, forecast sales to remain strong for the foreseeable future. Furthermore, as cars get older, they are more likely to be in need of service or repair, which benefits the business model of SMP. In terms of business structure, Standard Motor Products has two major operational segments:
1. Engine Management Segment: This segment focuses upon the production of ignition and emission wires, cables and fuel systems.
2. Temperature Control Segment: This segment focuses upon the production of air conditioning, heating, engine cooling, window and windshield parts.
"Our goal is to grow revenues and earnings and deliver in excess of our cost of capital..."
SMP quarterly earnings were quite positive when compared against third earnings in 2011. Net sales increased by 16.8% year over year, even with the loss of a major business account. In turn, this drove the profit margin from 5.5% to 6.1%, with bottom line earnings increasing by 29%. Free cash flow increased from $50 million to $54 million. Operating margin has continuously improved since the fourth quarter of 2011. This was attributed to “product cost savings from our recent acquisitions, as we relocate additional manufacturing hours to low-cost areas.” More specifically, in order to compete with Eastern manufacturing capabilities, SMP has outsourced some of their production to facilities in Poland and Mexico to keep overhead low.
Based on SMP’s recent acquisition activities, it seems likely that SMP will continue to grow while reducing overhead via future acquisitions. On the same note, since the first quarter of 2012, ROE, ROA and profit margins have experienced similar positive trends. Overall earnings per share were reported at $0.74 per share, versus $0.59 year over year.
"We are pleased to announce that, for the third consecutive year, we have been able to increase our dividend rate as a result of our continued financial performance improvements. Our Board's decision to increase the dividend reflects our commitment to delivering returns to our investors."
Dividends increased by 28% from $.07 to $.09 between 2011 and 2012.At current prices, this renders a yield of approximately 1.8%. SMP’s board of directors recently announced their intention to increase this dividend to $0.13 per share, driving the yield to 2.1% at current prices. It should be noted that in 2008 and 2009, the firm experienced rather lean years, and as such, lowered its dividend to $0.05 in the former, and outright eliminated it in the latter. However, as one can tell from the chart, in terms of free cash flow payout, the firm is currently paying out slightly more than 10% of its free cash flow, signifying a rather large potential for growth. As history demonstrates, in any sector, dividend growth is often linked to the firm's performance, and no dividend can be guaranteed to continue forever, let alone continuously grow.
When compared against the basket, SMP is quite favorable on several fronts. It is more profitable and less debt-laden when compared against the average. It is more efficient in terms of return on assets and when liquidity is considered in terms of the current ratio, SMP is more liquid then the basket. On the multiples front, SMP trades at lower multiples on several metrics, ranging from the P/B ratio to the EV / FCF measure, which implies SMP is undervalued.
Utilizing the multiple valuation methodology, several prices are rendered. The average price derived from all of the different measures prices SMP at $37.99. However, looking at the data, there are two clear outliers: P/B and EV/FCF. As such, when these two multiples are eliminated, the firm is valued at $29.49, which presents upside potential of 20.8%.
Like all equities, there are several risks associated with SMP. First, over the last few quarters, upper-echelon staff has been selling, rather than buying equity. This in itself is rarely a positive sign for shareholders. Furthermore, SMP is essentially a small-cap firm, with products in a rather narrow scope, rendering a diversification risk, or lack thereof. Finally, the firm has over $60 million in notes payable, with its credit facilities expiring in 2015.
With that mind, based upon current conditions, an investment into SMP is recommended due to three primary reasons:
A. There is a 20.8% upside from current trading prices when utilizing the multiple valuation methodology, with adjustments made for outliers.
B. The firm is only paying out near 10% of its free cash flow in dividends, which is positive for the dividend conscientious investor.
C. Margins are expected to continue to improve as acquisitions continue and become integrated into SMP’s operational model.
As such, based upon the aforementioned reasons, an investment into SMP may prove to be beneficial to both the dividend investor and the value-oriented investor.
1. Mario Gabelli currently owns 694,000 shares of SMP.
Stocks Discussed: SMP, TEN, DLPH, BWA,