Ben Axler
August 16, 2017
"Hedge fund manager specializing in forensic financial research"

A Forensic Review of Dorman Products Suggests Financial Strains: 30%-50% Downside Risk

Following our recent successful short calls in the automotive and transportation sector, notably Gentex (GNTX – article ) and Echo Global Logistics (ECHO – article ), Spruce Point Capital Management is pleased to announce it has released the contents of a unique short idea involving Dorman Products Inc. (Nasdaq: DORM or "the Company"), an aftermarket automotive part supplier primarily to the Do-It-Yourself (DIY) market (e.g. Advance Auto Parts (AAP) AutoZone ( AZO ), O'Reilly ( ORLY ) and Genuine Parts ( GPC )). We have conducted an extensive fundamental and forensic accounting review, and believe DORM's financial presentation, accounting, and limited disclosures obscure the pressures it is facing to grow amidst a slowing and rapidly changing environment.


As a result, we have a "Strong Sell" opinion and a long-term price target of approximately $35 - $50 per share, or approximately 35% to 50% downside


The full report is available on our website www.sprucepointcap.com


Executive Summary


Dorman Products (Nasdaq: DORM) is an aftermarket auto parts distributor stuck between a rock and a hard place as it sells both through Amazon, which is seeking to grow further into online auto parts distribution, and through the biggest brick and mortar retailers (Adv. Auto Parts / O’Reilly / AutoZone), which account for a majority of its sales, and are struggling with slower growth and margin pressure. Spruce Point has conducted a deep fundamental and forensic accounting review of DORM and believe its opaque disclosures, aggressive accounting, and precarious industry positioning do not warrant its significant share price outperformance and premium valuation relative to peers. As a result, we see above average risk of continued earnings disappointment and meaningful share price correction


Revenue Growth Slowing and Overstated : Revenue growth has slowed from a 13% CAGR (2009 to 2015) to less then 6% in 2016 (adjusted for extra week). Furthermore, if you look under the hood, DORM’s net revenues are an estimate and therefore subject to significant manipulation. Our adjusted gross sales estimate (we define as total product places on the shelves of customers) slowed to an abysmal 1.5% in 2016. Analysts expect DORM to continue growing top-line sales at 7% which we believe to be difficult given its largest customers are growing low single digits


Product Innovation Slowing, Prices Deflating : Unique products introduced declined 13% in 2016, the first contraction in years. Piecing together clues from DORM’s various disclosures, we estimate average revenue from new part introductions has been in a multiyear decline, while its annual R&D spend increases. DORM has no patent protection for its products, making it easy for competitors to copy key parts. Furthermore, its own product copies are increasingly being challenged by recent undisclosed litigation (eg. General Motors)


Hidden Margin Benefits From Aggressive Capitalization and FX Tailwinds Coming To An End : We believe DORM’s earnings leverage is waning. Revenue and gross profit from active accounts slowed to low single digits in 2016. The weakening of the Chinese Yuan has been a hidden tailwind to gross margins in the last three years since DORM sources products heavily from China/Taiwan. We estimate that DORM’s gross margins benefited by ~350bps cumulatively from 2014-2016. DORM doesn’t discuss any of these FX benefits in its MD&A, and now the Yuan is on a strengthening cycle. DORM also embarked on an ERP implementation which was 163% over budget, and allowed it to capitalize $38m of costs from 2011-14. DORM has not amortized any of these costs, thereby inflating its earnings per share by $0.07c by our estimate


Balance Sheet Strain Becoming More Evident : DORM portrays itself as debt-free, but is heavily dependent on factoring receivables, which we believe should be evaluated as debt. The % of revenues that are factored annually has risen from 21% in 2009 to 65% in 2016 and exposes DORM to the increasing interest rate env’t. DORM’s working capital to sales ratio is at a multi-year high, while operating cash flow in 2016 abnormally increased from inventory declining - suggesting it liquidated or deferred new purchases to generate cash. DORM is also shifting its business strategy to invest in many undisclosed JV/minority investments, while opaque related-party purchases are increasing


Valuation Premium Unwarranted, 25%-50% Downside Risk: The Berman family, DORM’s controlling shareholder, has been selling heavily in recent years along with DORM’s top long-term fundamental owners, using company cash to repurchase shares. Just two analysts see 18% upside, while the market ascribes a premium multiple of 2.5x, 11x, and 20x 2017E Sales, EBITDA and EPS. We normalize DORM’s financials for aggressive cost capitalization and adjust its enterprise value for minority investments and factored receivables as debt. If DORM traded in-line with its aftermarket auto part peers at 1.1x-1.5x 17E sales, 2x-3x book value, or 13x-15x 17E P/E we justify 30%- 50% downside risk potential


About Spruce Point Capital Management

Spruce Point Capital Management, LLC is a New York based investment manager founded in 2009. The firm focuses on short-selling and special situations opportunities. The firm conducts in depth forensic fundamental research and takes an activist approach to investing. Our research challenges conventional thinking with deep fundamental analysis, analytical rigor, and conclusions rooted with our unique viewpoints. For more information visit our website (http://www.sprucepointcap.com/), and follow us on Twitter @Sprucepointcap (https://twitter.com/sprucepointcap


Disclaimer

This research expresses our investment opinions, which we have based upon interpretation of certain facts and observations, all of which are based upon publicly available information, and all of which are set out in our complete research presentation report on our website. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained herein may include forward looking statements, expectations, pro forma analyses, estimates, and projections. You should assume these types of statements, expectations, pro forma analyses, estimates, and projections may turn out to be incorrect for reasons beyond Spruce Point Capital Management LLC’s control. This is not investment or accounting advice nor should it be construed as such. Use of Spruce Point Capital Management LLC’s research is at your own risk. Any historical performance achieved from any idea or opinion from Spruce Point Capital Management should not be considered an indicator of future performance. You should do your own research and due diligence before making any investment decision with respect to any of the securities covered herein. Spruce Point Capital Management, subscribers and/or consultants shall have no obligation to inform any investor or viewer of this report about their historical, current, and future trading activities

You should assume that as of the publication date of any presentation, report or letter, Spruce Point Capital Management LLC (possibly along with or through our members, partners, affiliates, employees, and/or consultants) along with our subscribers and clients has a short position in all stocks (and are long/short combinations of puts and call options of the stock) covered herein, including without limitation Dorman Products, Inc. "Dorman" or "DORM" or  "the Company"), and therefore stand to realize significant gains in the event that the price of its stock declines. Following publication of any presentation, report or letter, we intend to continue transacting in the securities covered therein, and we may be long, short, or neutral at any time hereafter regardless of our initial recommendation.

This is not an offer to sell or a solicitation of an offer to buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction. Spruce Point Capital Management LLC is not registered as an investment advisor, broker/dealer, or accounting firm.

To the best of our ability and belief, as of the date hereof, all information contained herein is accurate and reliable and does not omit to state material facts necessary to make the statements herein not misleading, and all information has been obtained from public sources we believe to be accurate and reliable, and who are not insiders or connected persons of the stock covered herein or who may otherwise owe any fiduciary duty or duty of confidentiality to the issuer, or to any other person or entity that was breached by the transmission of information to Spruce Point Capital Management LLC. However, Spruce Point Capital Management LLC recognizes that there may be non-public information in the possession of DORM or other insiders of DORM that has not been publicly disclosed by DORM. Therefore, such information contained herein is presented “as is,” without warranty of any kind – whether express or implied. Spruce Point Capital Management LLC makes no other representations, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. All rights reserved. This document may not be reproduced or disseminated in whole or in part without the prior written consent of Spruce Point Capital Management LLC.

More from Ben Axler
The most important insight of the day
Get the Harvest Daily Digest newsletter.