Motley Fool analyst Auri Hughes joins the podcast to discuss XPEL (XPEL 0.77%), a rapidly growing business providing paint and window protection films to the automotive industry, among other applications.
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This video was recorded on Dec. 2, 2021.
Nick Sciple: Welcome to Industry Focus. I'm Nick Sciple. This week, Motley Fool analyst, Auri Hughes, joins the show to take a look at XPEL, a market leader in protective films serving the automotive industry, among many others. Auri, thanks for joining me.
Auri Hughes: Thanks for having me, Nick!
Nick Sciple: Great to be here with you. I said in the intro, XPEL, market-leader in protective films, what does that really mean? What services are they offering to their customers?
Auri Hughes: It's an interesting business. Basically, if you have a car, it could be a sports car or just a car you're excited about and you want to protect it from rock chips and debris and those things that naturally happen as you drive the car, you can get this paint protection film that was actually used by the military back in the day that we found out had these applications where you can put it on cars and have it applied and it protects from rock chips, from paint debris, but you can't see it. It's invisible. It looks just like the paint was there. It's not visible to the naked eyes. It's really exciting for car enthusiasts or people that just want to protect their car.
Nick Sciple: When you think about the guy with the sports car that parks across two parking spots to make sure nobody dings up his car, this is really the target market for this guy. Then the cool thing about this too is the paint protection film is self-healing, so you can scratch the film. But then you heat it with some heat and magically, it's good as new, which obviously is very attractive when you're spending tens of thousands of dollars. Historically, they've served with the high-end sports car market. These folks are very particular about their vehicles.
Auri Hughes: Definitely, yeah. You're excited about your car if you're making this investment.
Nick Sciple: Yeah. I think one of the other interesting things with XPEL as well is that they're not just providing this film, but they have a software differentiation that really has helped them grow.
Auri Hughes: Yeah. Definitely the DAP or the DAP software provides the cutout of the cars, and it's just this huge library and database of the different models of cars. Once you go in there, you find your model of car then it'll cut out the film and the shape of the car, so I think it just helps in the application so you don't have to cut it yourself or do all those things that probably makes the labor a lot easier.
Nick Sciple: Yeah, exactly. So really attractive for the installers of this film, less waste, you can produce quicker, that sort of thing. If you look back at the history of the company, they started really focused on the software and it really evolved over time to drive some of this film product. Can you talked about the history of the company, how they got to where they are today?
Auri Hughes: Yes. Basically, when I researched this company, I had to look at the history of paint protection film in general. The history of paint protection film was that it was being used by the military on helicopter blades. When the helicopters takeoff, you'd have rocks and debris and stuff flying up and chipping away at the blades. So they would apply this paint protection film and it would protect the helicopter blades. Eventually, like a lot of things that are discovered, we found out it had commercial uses. Then it naturally transitioned to XPEL and I think 3M was doing it as well. Then you've got the DAP, the DAP system. Then they just thought eventually it will be more profitable just to lean into the paint protection film and establish these relationships with these third-party installers, which they have providing the training and then providing the paint protection film.
Nick Sciple: Yes, so we talked about paint protection film, sounds pretty boring. It sounds like a pretty niche market. Why is this a company that you are excited to own and invest in?
Auri Hughes: I think leadership for me, I don't like the super hard thesis where you have to pull it out. I like to see that it's a good business and I think from day one, when I first put on the XPEL investment, I saw they were growing. They were clean as far as profitability and their balance sheet, which is very rare in the micro-cap space. A lot of micro-cap companies tend to be very messy or have weird financials, but they were growing steadily and getting bigger year-over-year, and then I started reading about the product and seeing what they were doing. Then it's just been a steady compounder from a small base which is usually have good results when you see that in stocks.
Nick Sciple: Yes, so just to maybe put some numbers on that, you look at the past five-years through the end of 2020, 30 percent revenue growth CAGR year-over-year. You looking at the most recent quarter, US organic revenue up 49 percent, year-over-year, Canada organic revenue up 40 percent year-over-year, and this is in a market where has been well-documented, there's not a lot of car inventory out there on the market. We're at a low point, that's the slowest Q3 for new car sales in the US in a decade. Obviously, a lot of this film is being installed when folks buy the car new. They want to make sure it stays as good as new for as long as possible to see this incredible growth even against a macro background that isn't necessarily favorable to the business. Also when you see that the historical track record of growth as well, it's the market that may not sound big when you first hear about it, but actually it's giant and growing when you look at some of the new areas that XPEL is starting to move into with some recent acquisitions
Auri Hughes: Yeah, and I think when you start from a small base, you can grow substantially larger as they have. The acquisitions are really interesting too. They're really starting to show that horizontal integration, I think that makes sense, I like that they're going after companies that really complement what they're already doing.
Nick Sciple: Yeah, so can you talk about some of these acquisitions. Earlier in the show we mentioned the historical market for this is like the type of guy who is driving a Ferrari that's going to go get set certain aftermarket work done on their car. But more recently with some other acquisitions, they're moving down-market into actual buying it straight from the dealership with some of these recent acquisitions.
Auri Hughes: Yes, so you've got the dealership one and then the one I was just looking at now is InvisiFRAME, which is this bike aftermarkets parts where they're doing a similar thing actually where they're creating coverings to protect bikes, so again, paint protection is related, different, not cars, but they're going after that. That was a quick win, added $2.7 million and it's a creative. They also grow and they maintain profitability, which is very interesting to me as well. One of the acquisitions, I think you're referring to is this PermaPlate film, the distributor and installer of automotive window film serving dealerships. Again, it's a business that relates, they install window film, so it's just a nice complement to what they're doing so they can probably, they know that market, they understand that business. It makes a lot of sense, and they are creative. That's one thing I like is that the acquisitions add to the bottom line, or most of them from what I've seen.
Nick Sciple: Just bolt-on acquisitions yeah, and into your points. We mentioned paint protection film so far. With the PermaPlate acquisitions, touching window protecting films, the majority of the business still today is the paint protection film. But XPEL also offers window film for automotive applications. Think about window tinting, things like that. Also window film for building applications, for greening buildings, and preserving heat, and things like that. With this PermaPlate acquisition, what they're doing is acquiring this window film business that is historically, before cars go to the lot or as soon as they roll onto the lot they would attach that window film. Now, XPEL has that part of the business, it's integrated with some of these dealerships and that gives them the opportunity not only to grow the window film side of the business, but potentially to cross-sell some of the paint protection film products and other things. Of course, if you ever into a dealership, they like to add on add-ons that add them profitability, things like a paint stripe for a couple of 100 bucks, so you see both from the perspective of XPEL, growing their market and from the perspective of their customer's ability to add some more add-ons. It makes sense for them and I think there's lots of opportunity to continue to go down market from this high-end car enthusiasts to your everyday person who wants these added features driving up the lot, or that dealerships can convince them they need driving up the lot. One question, I think a lot of folks have and you mentioned earlier 3M also a player in the paint protection film industry. Why isn't this a commodity or how do you think about potential risks from competition facing XPEL, and how do you think they may be able fend those off?
Auri Hughes: Yeah, I think just being the premier. Because they actually got sued by 3M at one point in their history, which was devastating for the stock, but they overcame that, and it makes sense if you are a bigger competitor, you've got more resources and someone's doing something similar, you could probably throw money at it. But I think the way a company like XPEL wins when you're going up against massive company like 3M, that's doing a lot of things in paint protection is just one of them, is be the best. Be the premiere provider. Have the mind-share, serve your customers super well and they will come to you first. I think that's what we've seen because I think no textbook is going to be like, yeah, this small company can compete with 3M, but I think if you're known for that product, you serve that market well then it's possible and I think that's what they they've continued to do and they've won. They've made it a big point to go after those installers and have really great relationships with them. I think that's one of the things that also have helped them to compete, even though you've got two other players.
Nick Sciple: Yeah, when you think about how folks go about buying these products, you may buy a high-end vehicle, but you're going to go to your body shopper, your dealership and that's the type of person who's probably going provide you some advice on the types of things you need to install. I think in these types of markets where the person who is actually buying the car that's getting the film product is taking advice from an expert, that type of middleman situation, really winning the distributor, the person who's making that sale to the customer. The thing is really the key customer to when we talked earlier about the DAP software and how that's really user-friendly for the installers, makes it really easy to reduce waste, install things quickly. Also XPEL is strategically acquired some of its distributors to try to get closer to the installers. When you look here, I think the real key constituency to when, is the installer base, and to the extent you can make those folks happy then they're going to sell through to their customers, and so far, it appears like XPEL has had some success there.
Auri Hughes: Yes, certainly.
Nick Sciple: Okay. One other thing maybe we should talk about with XPEL is there an asset-light business, so they are not the ones manufacturing their paint protection film, they source it from a third party. Some benefits there obviously very asset-light, potential risks as well. How do you think about the supply agreements for XPEL and where that fits into the business?
Auri Hughes: Yeah, I think those supply agreements needs to be like ironclad. It's nice that they're taking on the paint protection film inventory and then reselling it and they are known for it. But it would be nice if they can control the supply, but I've kept those relationships strong for a fair amount of years now. The other thing they've been able to do that is one of their goals is they increase gross margins, so over time they're getting better prices on the paint protection film. That means they have a good relationship where everyone feels taken care of because they could. What if I was supplying XPEL and I wanted to squeeze them or get better prices, so they've maintain those relationships. But it would be nice if they did control that part of the supply chain. But it is a resell business.
Nick Sciple: Yeah, it almost looks like a pharmaceutical agreement. Just a little bit of context, so at 75 percent of their film is sourced from one supplier and XPEL has the exclusive rights to market it or around the world. You see some of these things in pharmaceuticals where we have the manufacturer and they give an exclusive right to maybe somebody like Allergan or somebody like that to go market the product, and that's really what's going on here with XPEL. You could look at the agreements or the agreement renewals every two years and you could say, man, XPEL is selling so well, maybe there is a risk with the supplier and it takes back the supply and disinter-mediates them from the market. For me, it's one of those things that as long as XPEL is throwing up this 50 percent plus revenue growth and building a brand that's incredibly strong, the likelihood that the supplier is going to pull that deal is incredibly low. Because again, you're giving up all these incredible sales. I think you see a lot of this in, again, in pharmaceuticals as well. Allergan I think doesn't technically own the Botox chemical, but it's unlikely it's ever going to get pulled back for them because they've been so successful selling the product. For me, I view the relationship as a strong one for XPEL again, because they've had so much success. To your point on the margins, if you have a supply agreement that keeps what you're buying at a fixed price, and because of your presence in the market you are able to raise prices to your customers and that all ends up falling to the bottom line. That appears to be some of what XPEL has been able to do the past several years as margins have gone up. When you're looking at XPEL moving forward, RSO, we talked earlier looking the past five-years, growing revenue at a 30 percent clip accelerating in the past. Most recent quarter you're looking at over 40 percent. How do you think about metrics to track how the company is performing going forward and the potential opportunity at maturity?
Auri Hughes: Yes. The biggest thing I'm following is, it's still a fairly young company, but it's maturing. I think the biggest concern, the key metric they always tied to or throw out is somewhere around new car sales. Usually they think about the business as you buy a new car, you're at the dealership, and then you get XPEL installed, and that's the key driver. It's still a fairly young company but as the business matures, I'm going to really be paying attention to new car sales because it may get to a point where the business, and I don't think we're there yet because they're still growing consistently, but it could start to be cyclical because it will ultimately be tied to new car sales and that's a very mature cyclical business. That's not something you're going to see in the very nascent early years, but as the business matures, I think it's going to be very correlated with new car sales, which will go up and down with the economy but I don't think we're there yet, but that is something to watch out for.
Nick Sciple: Right now there's secular growth in paint protection film, but at some point we had saturation, at some point there's enough people that want this type of product and we'll see where that happens. So far it hasn't yet shown up but we'll see the extent to which that materializes. One thing we haven't talked about Auri that I think is important, is management leadership of this company. You talk about how they went for micro-cap lands and now this is a $2 billion plus company. That's an execution thing that you had to get there by really executing it in a strong way. What do you make of management and leadership of the company?
Auri Hughes: I think one of the criteria I was starting to look at or consider is how much value has management already created? Have they proved they can allocate capital? I think Ryan Pape, the CEO, he's proven that. He's led and grew a business, took it over from almost going bankrupt, growing from 10 million market cap to 2 billion. That's insane. That's a huge gain. I think there's definitely talent there. He's shown he can allocate capital. I think it'll just be checking to see that he's continuing to execute. One of the things I love about these small companies is there are some great leaders that just no one knows about like growing this business to this size that aren't the Jeff Bezos's of the world or, I forgot the guy that runs Apple.
Nick Sciple: Tim Apple.
Auri Hughes: Yeah, Tim Cook. But someone that's running a small company that's doing well and we're in a part of the market where if you do your homework, you can benefit from that. I think this is a company where if you do your homework, you understand management, you trust them, you're bound to do well. The business is still growing well and it's had a nice little pullback. The valuation looks more reasonable than it has and now they're allocating capital and buying businesses, so it's still interesting to me.
Nick Sciple: The real story that got me excited about XPEL is there's a Texas business journal podcast where he had Ryan Pape on, maybe a year-and-a-half, two years ago. He talked about back in early 2010. He came into the company and became CEO and the company was on the verge of bankruptcy. Maxed-out his credit cards to save the company. Called the creditors and said, listen, we can't pay off everything, but I'll max out my credit cards and we can pay you and that ended up saving the company. Obviously leadership that is willing to max out their personal credit cards to save a business and then after that is able to achieve the growth they have over the past 10 years really instills a lot of confidence in me, both in their investment in the business and in their ability to execute. With him still leading the company, being in-charge of many of these acquisitions we talked about, whether it's PermaPlate or the bike protection film gives me a lot of confidence in the future of the business.
Auri Hughes: I think that's very fascinating. That reminds me Tom Gardner always talks about the story for Middleby with Selim Bassoul and he had taken out a loan and I think he bought some large portion of the company and he was just all in and look what happened there, and you see the power of inside ownership. If you have a board that supports you and that's rewarding you in good leadership, it shows you just what's possible. That interview you shared with me was really great because for companies like this, it's hard to find research on leadership. If you can listen to something like that and he was explaining what it took to grow that organization and sales was a big part of it. There really wasn't a sales system and he put sales in place to grow that business to what it is today. Very fascinating. I think great leadership, someone definitely that's worth maybe investing behind.
Nick Sciple: Sure. When you talk about maybe investing and you mentioned earlier valuation, stock came public 2020, I believe, and it has really performed very strongly, but has come back a little bit. What do you make of the opportunity today?
Auri Hughes: I should have pulled up CapIQ you earlier. I recently looked at it when we were going to do this segment and I have a pretty good amount already, but to me it does look fairly attractive. I think the biggest thing is for stocks, it's continuous compounding and they've been putting up very strong growth rates with profitability, which is something I like, which sometimes I start to think is going out of style where a lot of companies burn cash, maybe I'm a little old school. But their year-to-date over the last 12 months, 58 percent revenue growth, 22 percent in 2020, 18 percent, 63 percent, 18, so really strong revenue growth with profitability. You're getting operating leverage that's going to the bottom line. The bottom line revenue growth has been between 60 and 80 percent. I look at that and then I compare it to the multiple it's trading at now and it's trading at 43 times EBITDA, which is not super expensive, not super cheap and then the next year's EBITDA is 32. Just looking at a lot of companies, I don't think it's egregious not cheap, but it's something I would feel comfortable with. I think it's fairly priced, under 10 times sales. It's had a pullback too compared to the prior years. In past years, it was trading at maybe 50 times forward EBITDA and 47 percent and now it's at 32 times forward. I usually like to see those pullbacks. I think it's fairly attractive where it's at now.
Nick Sciple: If you can write down another five years of 30 percent compounded revenue growth, that type of EBITDA, and again, with the type of operating leverage. You talked about you can really get there on evaluation that maybe optically looks a little high on the traditional valuation metrics. Auri, we've talked about XPEL here for going on 25 minutes or so. For someone who is listening to this podcast, they'd walk away with, say, a couple bullet points on this company to go home with. What would be the things that you'd want them to leave this conversation with?
Auri Hughes: Key things. It's funny there's certain lessons I've learned that have reinforced themselves as I've looked at more businesses, and as I've worked with more experienced people and this is a key lesson, the power of high inside ownership which XPEL had, starting from a small market cap and growing continuously for a long time. Those are like the formula for XPEL. That's what happened with Monster. You see that consistent theme or a lot of those elements and a lot of the big winners. Even if you don't want to buy it, I think it's a good case study. It's what I learned from them. I'm happy to own.
Nick Sciple: Riches in the niches. I think is a perfect example of one of those. Auri, thanks so much for joining me. Always love having you on.
Auri Hughes: Thanks Nick. Thanks for having me. Hopefully, do it again.
Nick Sciple: As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for mixing the show, for Auri Hughes. I am Nick Sciple. Thanks for listening and Fool on!