Despite a 73% Gain, This Stock is Still Undervalued

It all started back in 2008. Oil and gas prices were soaring. Credit was getting tight, people were losing jobs and the Great Recession was in full force. As these trends took shape, auto sales plummeted. These historical changes forced consumers to take a hard look at their options when car troubles arose. With high unemployment and cash-strapped consumers, many chose to simply fix their cars rather than buying new ones.

#-ad_banner-#Four years later, and we still have a tough economy. Oil and gas prices are back on the rise. Consumers, as a whole, are still opting for used vehicles and driving them more miles before replacing them. As I drive the highways across the country, I notice more and more older vehicles on the road. 

In 1995, the average age of a vehicle on the road was 8.4 years for a passenger vehicle and 8.3 years for light trucks. Today, the average passenger vehicle stays on the road for about 11.1 years, while the average age for light trucks is 10.4 years. When I hear about older vehicles, the first thing I think is replacement parts. 

In fact, this major shift in owning older vehicles has led to a boom for parts retailers and service companies that focus on automobiles seven years-old or older. The do-it-yourself (DIY) auto-repair market has proven to be a very strong sector in these uncertain times. Big-name stocks  O’Reilly Automotive (Nasdaq: ORLY) (up 32% since last year), AutoZone (NYSE: AZO) (up 18%) and Genuine Parts Co. (NYSE: GPC) (up 16%) have seen impressive gains in the past 12 months. 

But you may have never heard of this one company, which is profiting from the booming business of all three of these companies. And its stock price has delivered a 73% gain in the past year. 

In fact, Dorman Products Inc. (Nasdaq: DORM)  is already up more than 50% this year alone:

Dorman supplies automotive replacement parts, fasteners and service-line products primarily for the automotive aftermarket — you’ll find some of the company’s 128,000-plus products in O’Reilly’s, AutoZone’s, and other auto-parts stores across the country. 

Margins at this firm have been impressive, and when looking at a stock, margins matter. The more a company keeps of each buck it earns in revenue, the more it has to invest in growth, fund new strategic plans, or distribute via dividends to its shareholders. Dorman’s gross, operating and net margins for the past 12 months are all at or near all-time highs. As a result, its share price has soared.  

Looking at Dorman’s current P/E of 13.3, this looks favorable compared to other auto-parts distributors, such as BorgWarner (NYSE: BWA) at 15.7, Denso Corp.(OTC: DNZOY) at 14.3, and Gentex Corp. (Nasdaq: GNTX) at 14.7.  

Dorman has strongly positioned itself within the auto-parts supplier industry. It has used innovation to develop products at a record-setting pace. This innovation has led to strong financial results during the past 15 years.

Dorman’s recent second-quarter report gave investors even more good news. For instance, revenue from continuing operations in 2012 increased 14% compared with the prior year to $144.2 million. Revenue growth was driven primarily by strong overall demand for our products and higher revenue from recently-introduced products.

Net income from continuing operations in 2012 increased 25% to $16.1 million from last year. Diluted earnings per share from continuing operations in the period rose 26% to 44 cents. Gross profit margin was 36.9% in 2012 compared with 35.9% in 2011. The increase is primarily the result of lower transportation costs and a favorable change in sales mix.

Selling, general and administrative expenses increased 9% in 2012 to $27.4 million, but were down as a percentage of sales to 19.1% in 2012 from 19.7% in 2011. Cost increases were primarily the result of higher variable costs and additional product development spending.

Dorman’s stock should continue to thrive during the next few years.  There are five factors working in its favor: 

1. As consumers continue to keep their vehicles longer, the demand for replacement parts will increase. 

2. As the auto-parts market continues its push for new products, this provides a strong competitive advantage for Dorman.  

3. With each new part Dorman creates, it gets a two-year window free of competition. 

4. It has no competitors in many of its product lines. Consumers would have to go to a junk yard to find used products not at the same quality as Dorman’s products.

5. Dorman has displayed consistent and stable growth. Earnings trends show the company is growing solidly year-over-year. Its revenues have increased for 10 consecutive years.

With its sustained and accelerated growth during the past 15 years along with its new-product competitive advantage, I think shares are at least 15% undervalued. This stock should be trading in the $30s.  

Risks to Consider:  As oil and gas prices continue to rise, most consumers will drive less, which often reduces the need for maintenance and failure parts. Additionally, if the economy picks back up, then consumer preferences could shift back to new auto sales, reducing the demand for replacement auto parts.

Action to Take –> Dorman Products is a buy under $30 a share. The stock has been growing at an annual rate in excess of 20% for the past 15 years and could easily hit $40 within the next year.