In a complementary fashion to the already written down studies on other companies as Games Workshop, Mader or Temenos, I am intending to bring first analyses and thoughts behind each of the holdings in portfolio. I originally run into Auto Partner about one year ago, studied its model, other businesses in the sector and finally became shareholder after closely following the company for a few months.
I have ever since continued to read about other businesses in the vehicle spare parts aftermarket like AutoZone, Inter Cars or O’Reilly (where I decided to open a position as well). Although there is still plenty of room for knowledge to be gained, I believe my understanding of the overall industry and Auto Part’s operations is nowadays far more extensive than the first time we crossed paths. I felt that it would be nice to make the most of a recent refreshing look I took on it and write down my thoughts.
As usual, any feedback is much appreciated.
I. Business overview.
Auto Partner is a small Polish group (market capitalisation of c.US$500.0M) involved in the distribution of automotive spare parts and accessories from third parties and its own private label (MaXgear) to small garages and retail customers through its store chain in Poland and the Czech Republic. Aside from its domestic network, Auto Partner also serves customers internationally through its exporting segment.
Even though Auto Partner’s business model is relatively simple, it is worth establishing a clear distinction between the two aforementioned segments in the business operations since, as we shall address later, these fundamental differences pose strong implications for the group’s current and future profitability levels.
While in both cases the group’s role is essentially the same (a facilitator which lowers marketing and operating costs for the original equipment manufacturers -OEMs- and saves time and effort to the end customers by acting as an intermediary between them), the international exporting activities characterise by not having their distribution chain entirely owned by the group.
The key product category for the company is spare parts for European, Japanese and Korean cars, with main contributors to sales being suspension parts (c.17.0%), brakes (c.15.0%) and drivetrain systems (c.12.0%).
Founded in Katowice in 1993 by Aleksander Gorecki (current CEO and owner of c.23.0% of the total pool of shares outstanding or c.50.0% considering the interest in the company held together with his wife -Kataryna Gorecka-), Auto Partner has grown its total revenues and fully diluted earnings per share at an annualised rate of 27.8% and 37.4%, respectively, since FY2015 in a profitable manner without requiring additional equity capital nor a leveraged balance sheet to cover the expansion of its scale and reinvestment opportunities.
Derived from the nature of the sector, the business presents a certain degree of seasonality where Q2-Q3 typically show higher growth rates driven by more demand of its product range and Q4-Q1 characterise by a higher capital intensity.
Since its IPO in 2016, Auto Partner has grown total sales at an annualised pace of 26.1%, going from PLN705.4M to PLN2245.5M by FY2021 end. With data for the full FY2022 not being public yet (expected to be released by April 18th), total revenue for the first three quarters of the year amounts to PLN2097.7M (c.93.0% of the total sales generated the previous year).
Although profitability is arguably not one of the strong points in the automobile spare parts aftermarket, Auto Partner has managed to maintain consistent gross, operating and NPAT margins (around 27.0%, 7.0% and 6.0%, respectively) for the past decade.
Furthermore, the profitability levels of the group have steadily improved in recent years as a consequence of:
The positive impact on profitability derives from (i) the more branches the company opens (in its domestic market), the higher the density of customers it can supply and the lower operating costs that are associated to the transport of merchandise and (ii) the higher the total sales generated by the distribution business, the bigger the discounts the group enjoys from manufacturers due to the increased volume of orders placed with them. When combined with a strict cost-control approach and a relatively robust pricing strategy, this creates a strong operating leverage effect able to increase profitability virtually for as many years as the top-line continues to grow.
Being a shareholder and member of the Global One procurement group also helps Auto Partner enjoying even bigger discounts with key manufacturers, as well as having access to specific ranges of SKUs (stock-keeping-units) otherwise not so easily available to a business of its size.
Sales mix in the poll of total revenues:
In my view, this is one of the most important factors behind understanding the future prospects of the company and, as such, it deserves to be addressed separately. It is therefore covered below (see Chapter ‘Thoughts’).
As a direct consequence of the effects described above, fully diluted earnings per share have increased from PLN0.29 in FY2016 to PLN1.42 in FY2021, this is, a 37.4% CAGR or 11.4 percentage points per year higher than the top line growth rate. It is no coincidence that its market quotation has returned 33.3% CAGR for its shareholders during the same period.
The overall indebtedness levels of the company are healthy, with an interest coverage ratio of 11.4 times towards the end of FY2022 Q3 (18.8 times on average) and a net debt to EBITDA ratio of 1.4 times.
Cash-flows are typically lower compared to income reported following accrual principles, mainly due to the working capital cycle of the business where inventories are increasingly stocked to continue expanding operations and receivables pile up faster than payables -one of the key points that, in my view, should be closely monitored-. Nonetheless, this was also the case for other businesses operating in the aftermarket of automobile spare parts like O’Reilly or AutoZone in the late 1990’s and early 2000’s, when their size was more comparable to that of Auto Partner’s today. As the company gains scale and therefore weight on total orders placed to its suppliers and higher dependence from customers it is likely to start demanding longer payment periods to the former group and shorter times to the latter one. This should create negative changes in working capital, resulting in customers and suppliers effectively funding the expansion of the business while enjoying higher operating cash-flows than reported income.
Despite the relatively small size of Auto Partner, it is one of the main players in the auto spare parts distribution sector within its domestic market and the fact that its international exports segment is growing at faster rates than 40.0% per year provides an indication of the competitiveness degree of the group not only in Poland (where it carries its operations through its wholly owned distribution chain) but also in other European countries.
In my opinion, constant gross margins in recent years (around 28.5%) hide a battery of consequences which make me think of Auto Partner as a guardian of a hidden gem similar to that of Mader and its US and Canadian operations or Temenos and its reduced cash-flows as a consequence of the transition towards a subscription-based pricing scheme. I am talking about its international exports segment which, as of FY2022 Q3, is about to surpass in weight on total sales the domestic distribution segment (accounting for 48.5% of revenues, compared to 45.2% a year before).
While the Polish distribution activities typically grow at a pace close to 15.0% per year, the international segment of the business is delivering consistent top-line growth rates north than 40.0%. This poses some implications on the overall profitability of the business, as these exports characterise by delivering lower gross margins but compensating with substantially reduced operating expenses.
For comparison purposes, let’s take Auto Partner’s revenue mix 3 years ago (FY2019 Q3), when international exports weighted 38.8% on total sales. Gross margins of the group sat around 26.0%, EBIT margins were 5.9% and NPAT margins came at 4.0%. As previously mentioned, with the latest data (FY2022 Q3) international exports account for 48.5% of total sales accompanied by gross, operating and profit margins of 29.2%, 9.7% and 7.2%, respectively. The trend that Auto Partner is experiencing is favourably affecting profitability and, to a significant extent, it is being driven by a stronger presence of exporting SKUs internationally rather than distributing them through the domestic territory.
To put these numbers in context, an increase of c.25.0% (48.5% versus 38.8%) in weight of the international export sales volume is effectively making the group 64.4% more profitable at the operating level and 80.0% at the bottom-line level. Furthermore, as international exports continue to gain share of the total revenues pile, smaller relative increases may suffice to foster similar jumps in profitability over the long term. In my view, nevertheless, short-term profitability is likely to normalise down from the levels reached after the rapid expansion experienced since the start of the pandemic following (i) price increases to deal with inflationary pressures across its entire product range and (ii) more weight of international exports on total revenue mix (higher SG&A costs).
As usual, there are nuances which should be carefully considered in order not to fall in the mistake of assuming that the increase in profitability is solely due to a stronger presence of international exporting activities:
Firstly, Auto Partner’s business model clearly benefits from operating leverage driven by increases in the geographical density of customers, but the international exports segment is certainly amplifying this effect. To understand the degree to which this is happening I have tried to find a peer in the industry which does not have an international exporting segment or whose size relative to the overall sales volume can be considered negligible. Unfortunately, although Inter Cars is likely the best shot I am able to come up with when it comes to finding a comparable business -it is also an aftermarket distributor of auto spare parts in Poland of roughly three times the size of Auto Partner (both in terms of market capitalisation and net income)-, this group also participates in the exporting of goods to other European markets, so its utility for this specific study-case is somewhat limited.
Secondly, as the scale and reach of its operations increase it is reasonable to expect it will continue to receive bigger discounts from its suppliers, driven by (i) bigger order volumes and (ii) being a member and partial owner of the Global One procurement group.
Apart from the increased profitability which should continue to manifest as Auto Partner gains scale there is, in my view, an additional potent growth opportunity for the main players in the industry consisting of (a) an ample room for consolidation of the sector -market share gain- and (b) the industry itself is expected to continue to grow at roughly twice the pace of the national GDP. Auto Partner seems to be well positioned to continue to benefit from these tailwinds.
In a sense, Auto Partner’s business nature reminds me of Mader (an Australian provider of light-work maintenance activities for different resources-based industries): both share a somewhat anti-cyclical component which make them thrive as the macro environment worsens.
One of the key external factors with a strong influence on the distribution business of spare parts for automobiles is the average age of the cars within a given market. Tough economic conditions tend to characterise by rapid increases in the cost of living (inflationary pressures, increasing cost of capital and, as a direct consequence, higher unemployment) and it is under these environments where the average citizen avoids or delays non-essential costs. In my opinion, buying a brand new car (or a second hand one, for that matter) falls in this category. On the contrary, fixing your already owned car when it requires maintenance or some part is broken and needs replacement is a far more urgent expense (even unavoidable in some cases).
The overall effect of this behaviour is a reduction on the amount of new vehicle sales and, consequently, an increase in the average age of the existing vehicle fleet, which in turn leads to an increase in maintenance and repairing activities.
Points to keep an eye on.
There are several topics whose evolution over the coming years should be closely monitored. Most notably:
Auto Partner does not own its storage facilities. The group operates the Bierun’s centre under a leasing contract since 2013, granting them exclusiveness for the usage and exploitation of the premises. Nonetheless, the lessor keeps the right to cancel this contracts with immediate effect shall the lessee incur in one of the following situations:
Late payment of the rent for at least two full payment periods.
Lessee filing for bankruptcy:
Given this scenario, probably one of the last things to worry about would be the cancellation of its leasing contracts.
Use of the leased facilities for other purposes than in accordance with its intended purpose (storage of the group’s operating goods).
The reason why I consider this point one of the most critical ones is linked to bullet (2) below, as the Bierun’s logistics centre is the most important asset for the company’s activities.
As of FY2022, roughly 50.0% of the SKUs inventoried by the company are stored in the distribution and logistics centre located in Bierun, effectively representing the core of Auto Partner’s business with more than 43000 square meters (or c.41.2% of the total storage surface that the group disposes of). Shall any disaster occur (fire, flooding, etc.) on these facilities, it would pose a significant impact on the company’s ability to resume operations.
Auto Partner’s strategy in this regard is to sequentially open new hubs and small distribution centres across the national territory, but even by doing so and successfully executing its current plan the total stock in Bierun’s centre would only be reduced to c.30.0% of total inventories.
Working capital cycle.
At this point you may have already spotted from previous write-ups that I am not a big fan of complex valuations requiring kilometric spreadsheets or models with tens of inputs to come up with an estimation of the intrinsic value of a business. To me, understanding how its unit-economics are at play and what are the risks and drivers of potential future shareholder returns should be the starting point to come up with a simplified, rough estimation of its worth. A valuation work which only requires our minds, some patience and time to think straight and -sometimes- a napkin.
First, let’s address what variables intervene in Auto Partner’s unit-economics and how we can utilize them in this framework.
As one of the main drivers of profitability is the customer density across its distribution chain and since it is largely affected by how many (and how well) Auto Partner’s logistics centres and local branches are located, it seems reasonable to study the trend of (a) the amount of new warehouses opened each year and (b) the sales and profits generation per footage of storage space.
The total warehousing space has increased from c.97500 square meters in FY2018 to c.104500 square meters in FY2022 Q3. This includes both logistics centers and local storage facilities. While the former group generally keeps an ample range of stock (used to supply local branches) consisting of both liquid and less frequent items, the local storage space results more critical to the day-to-day activities of the company (the inventory of these locations consists of the most liquid or most frequently delivered SKUs, from where customers are serviced 3 to 5 times a day). As of FY2022 Q3, the total local storage space in Auto Partner’s branches is estimated to be around 48000 square meters.
While the total amount of storage facilities amounted to 83 at the end of FY2018, the group has kept an average pace of 8 new branches per year, increasing them to 115 by the end of FY2022 Q3.
Revenues per branch in FY2018, FY2021 and the first three quarters of FY2022 have been PLN9.3M, PLN11.6M and PLN9.2M. Assuming a 20.0% growth year-over-year for the remaining quarter of FY2022 (consistent with the overall growth levels experienced in the period Q1-Q3) and a total of 2 new branches opened in the last three months of the year, revenues per branch for the full FY2022 would amount PLN12.2M (domestic annual sales of c.PLN1430.0M with a total of 117 local storage facilities at year end), representing a 4-year CAGR of 7.1%.
Moving forward, if we assume that Auto Partner continues to open an average of 8 new branches per year, the total amount of last-mile premises would increase to 141 by FY2025. With a projected growth rate of per-store sales of 5.0% per year, the domestic distribution segment of the group would contribute to total sales with c.PLN2000.0M by FY2025 (141 stores generating c.PLN14.1M each).
Regarding the international exports segment, a CAGR of 20.0% for the next three years would generate around PLN2500.0M in sales volume (this assumes a 30.0% year-over-year growth rate for FY2022 Q4).
With the two estimations above, total revenues generated by Auto Partner in FY2025 would be close to PLN4500.0M, or a CAGR of 16.5% from FY2022. Additionally, international exports would weight c.54.0% on total sales (compared to 48.5% as of FY2022 Q3).
Although a higher weight of the international exports segment on sales mix can be tempt us to assume higher levels of operating profitability, I believe that in the short and medium term EBIT and bottom-line margins can be impacted or stagnate. Let’s assume that operating margins by FY2025 remain constant around 9.5% and profit margins around 7.0%. Assuming no significant dilution over the forecasted period, EPS in FY2025 would therefore be PLN2.4.
Auto Partner is currently (March 22, 2023) within its historic levels of valuation (around 12.5 times earnings). In my view, a +20.0% compounder business with a simple (but equally effective) and proven business model, with high insider ownership and skin in the game, presenting several growth leverages able to continue to foster growth of the top line and simultaneous increases in profitability for many years without requiring the capital markets nor the use of much debt should get a higher rating than the stock market as a whole.
I believe that if Auto Partner continues to deliver shareholder value and expand its scale we should see higher multiples being applied. Nonetheless, for the sake of conservativeness, we will assume a 12.5 PER by FY2025, so no effect from multiple expansion or compression on total shareholder return.
If the thinking process stated in the paragraphs above materialises -a big if-, the estimated per-share price for Auto Partner by FY2025 should be close to PLN30.1/share which, compared to today’s market quotation of PLN18.7/share, represents a hurdle rate of about 17.0% per year (excluding dividend payments, which at current levels yield 0.8%).
Thanks for reading.