Business

Founded in 1997, XPEL is a distributor and marketer of automotive Paint Protective Films (PPF). These films protect vehicles against scratches, rock chips, or other road debris and keep a new car looking newer for longer. By protecting against these damages, it also helps maintain the cars value for trade in or resale on a secondary market.

XPEL began as software company that sold designs used to cut protective film for painted vehicle surfaces. Essentially, XPEL maintained and sold access to a database of thousands of individual car parts dimensions, used for cutting patterns for PPF shapes. This means that rather than maintaining individually cut pieces for specific cars parts, installers could hold generic film and cut it to a customer’s need depending on what make and model of car they drove. This had the added benefit of allowing installers to begin work on a car almost immediately since they would not need to wait on delivery for a specifically cut piece of PPF or play a guessing game of trying to anticipate which types of cars would compose their clientele. This software was widespread within the PPF industry and meant that XPEL had existing relationships with most installers. In 2009 a new management team was installed who began to transition away from a purely software role and, in 2011, XPEL unveiled their ULTIMATE film product line. Today, XPEL operates a network of authorised independent installers, company owned installation centres and operates company owned installation centers within select new car dealerships. Since then, XPEL has expanded to their product line to offer window protection or homes and offices, window tinting on vehicles and recently bicycle orientated PPF.

XPEL reports revenue in two segments, Product revenue, which is made of PPF, Window film, and Other, and Service revenue, which is composed of software, installation labour, training and cutbank credits.

 All of XPELs revenue product categories have seen impressive growth, in particular the Window Film business.

I am particularly optimistic about bicycle PPF. High end road bikes are an expensive, discretionary product that consumers have an interest in protecting, similar to a car. When a person purchases a high-end bicycle, it becomes and object of attention in their local bike club. Bicycle frames also suffer from regular scratches, either from crashes or during transportation.

In 2000, the UCI, cycling governing body, announced that any bicycling that is used in a UCI sanctioned event must be in excess of 6.8kg. With advancements in material technology, getting a bike to the 6.8kg weight limit is becoming easier and easier. For certain professionals, weights need to be added to make the bikes UCI complaint.

Recent years have seen mass adoption of disc brakes over rim brakes, which come with a weight penalty but offer better breaking in wet conditions. Some riders have begun using deep section wheels in place of lightweight wheels, which offer better aerodynamics but come with an associated weight penalty. Some riders have elected to have custom paint jobs applied to their bike for no performance reason, simply because they liked the design in spite of the associated weight penalty.

The bike industry distribution model is remarkably similar to how cars are distributed. Bike shops are often operated independently and are usually licensed to sell only one or two brands of bicycle, similar to how a car dealership may only sell Ford or Volkswagen cars. There is currently only one major bike brand that has a DTC business model (Canyon). A local bike shop mechanic would not have the skills or equipment to wrap a frame. In the event that XPEL signs a deal with a bicycle frame manufacturer, I would regard this as thesis confirming that the bicycle segment will create significant value for XPEL.

Directors of XPEL own a significant share of the company and, bar one, none have conducted significant insider selling despite the substantial increase in stock price. Despite the overall decrease in ownership by Executive and Directors since 2020, this is mostly due to one executive’s insider selling (Richard Crumly) and a director with high insider ownership no longer serving on the board of directors, his shares no longer counting towards insider ownership.

Competitive Advantages

XPEL has numerous competitive advantages over its competitors.

First, it is recognised as a premium brand within the PPF industry. XPEL is by far the most highly regarded product within the PPF industry. I would encourage anyone interested in XPEL to read through message boards and forums related to car detailing. It pioneered the PPF industry by offering a product that would not become discoloured over time, could consistently be applied without trapping air bubbles within the film and was ‘self-healing’. As evidence of this, consider the fact that XPEL installers are required to both pay for classes on installing XPEL films and sign exclusivity deals with XPEL, requiring them to only use XPEL products. If XPEL were a run-of-the-mill, generic product, would any installer agree to these terms?

XPEL has significant switching costs associated with leaving the company. For an independent installer to become an authorised installer, a dealership must pay XPEL for training and certification. XPEL insists that its authorised installer exclusively sell XPEL products. If a rival PPF company wishes to lure away an XPEL dealership, the value proposition must be more than enough to overcome these training costs and be worth losing their ability to sell XPEL products. A slight price cut would not be enough to attract dealerships to their company. For an XPEL installer to leave the XPEL network, what is offered to them must be a substantial improvement over what XPEL offers.

XPEL operates a ‘installer locator’ service on their website. This allows prospective customers to find an authorised XPEL installer that is geographically closest to them. This allows potential customers to find the installer that is most convenient for them to use. It also serves a second purpose in that it directs customer to specific installers and can represent a large proportion of their sales generation. An installer who leaves the XPEL dealer network would be removed from the installer locator list and would see this sales generation disappear. This further ‘locks in’ installers to XPEL.

Prior to selling Paint Protection Film, XPEL was a software company selling access to a database detailing the dimensions of thousands of individual car parts. A rival PPF company who enters the scene would need to replicate this database to allow their installer to hold generic film, not pre-cut individual pieces. While it would be possible for a company to do this, it would be prohibitively expensive, take years to fully complete the database and there is no guarantee that customers would switch to this new competitors’ products over the established, known XPEL. This is a significant barrier to entry for any company wishing to enter the PPF-sector.

Valuation

I estimate a 36.21% IRR if shares are purchased at their current price and held for five years using conservative assumptions. These assumptions are expanded upon below.

A link to the DCF and DCF notes in excel form can be found by clicking this link

First, I am estimating a Gross margin expansion to 40% by 2027. XPEL has already seen its Gross margins expand from 24.8% in 2017 to 38.57% in its most recent quarterly filing and is currently in negotiations with its main supplier. Over time, this Gross margin figure may end up being far too conservative, especially if XPEL can diversify its supplier base, obtain favourable terms with the supplier it is in negotiations with, and begin upselling its products on supercars and flex its potential pricing power due to its reputation as a premium product in Auto-Detailing circles.

We then assume that Operating Expenses will grow roughly in line with revenue in the future. For XPEL, Operating Expenses has consistently hovered around 20% of Revenue. The furthest Operating Expenses have deviated from the 20%-of-Revenue rule was 2020, when they were a mere 19.29% of revenue. In the model, Operating Expenses are directly linked to revenue where they are 20% of Revenue.

Similar to using revenue as a proxy for calculating operating expenses, amortisation is consistently approximately 5% of operating expenses. There is a greater variation in this rule than in the above (Amortisation was 4.09% of Operating expenses in 2019 and 6.23% of operating expenses in 2021), but since amortisation is a much smaller figure than operating expenses and a small percentage of the value of XPEL overall, this variation is acceptable as it will not have a meaningful impact on the overall value of the firm.

Usually, I like to add back depreciation and try and independently estimate Maintenance CapEx. In this instance, deprecation serves as a reasonably accurate estimation of Maintenance CapEx due to the short economic life of the assets used in the calculation of depreciation. In addition, due to the fact that these new quantities of these assets will need to be purchased to finance future growth, I expect that these quantities will grow roughly in line with revenue. I modelled depreciation and Maintenance CapEx growing in line with Revenue on a YoY basis.

Because XPEL is an extremely asset light business, the majority of Growth CapEx comes in the form of acquisitions. Acquisitions are irregular and XPEL can experience acquisition opportunity droughts when markets are richly valued and a deluge of acquisition opportunities when market multiples contract. I do not have a high degree of confidence in my Growth CapEx and would not be surprised if, in the coming years, my figure was vastly different from the actual results for XPEL. The majority of XPEL’s value is related to its terminal value. If my estimate of Growth CapEx does turn out to be different from the actual results, this figure will not substantially be affected.

I assume no change in shares outstanding due to the fact that this figure has not changed since 2018 and XPEL can still reinvest excess cash in the business at high rates of return. I assume a change in net debt that is roughly in line with cumulative FCFF produced.

Finally, we use a NOPAT multiple of 25. Despite this being a relatively high multiple, I believe it is more than conservative given the high-quality nature of this business.

Risks

XPEL’s primary revenue source is closely tied to the auto industry which is highly cyclical. In an economic downturn, people either delay getting a new car or, if that cannot be avoided, opt for a cheaper model of car than they would have chosen had a macroeconomic downturn not occurred. Even if the total number of new cars sold stayed flat in a recession (highly unlikely), XPEL’s revenues are also tied to the type of cars sold. It makes far more sense for a customer of XPEL to purchase paint protection for new and expensive supercar than a moderately priced, budget car. A recession would, without question, negatively affect XPEL, but one mitigant of this is that for car aficionados, paint protection is downstream of a new car purchase. A hypothetical customer might, with their personal finances weakened, choose to forgo purchasing a new car but, still wishing to make some discretionary car-related purchase, choose to paint protect one of their already owned cars.

A significant proportion of XPEL’s purchases were conducted through a single supplier, entrotech, Inc. For FY 2021, over 75% of XPEL’s inventory purchases were through entrotech. In the event that entrotech’s business were disrupted, its relationship with XPEL became adversarial, or it signed an exclusivity contract with one of XPEL’s competitors, it would represent a significant interruption to XPEL’s ordinary operations. In January 2022, XPEL announced that it would not extend its existing agreement with entrotech and that it intended to enter into a new long-term supply contract with entrotech. If XPEL cannot negotiate a satisfactory long term suppliers’ agreement with entrotech, it could face inventory supply issues and gross margin compression.

A material portion of XPEL’s revenue comes from China. In addition, to having a material portion of their revenue coming from an, at times, business hostile country, XPEL only has one distributor in China. Should the CCP or this distributor take a hostile position towards XPEL’s business, there is a real possibility that XPEL’s China market could disappear overnight.

XPEL’s current CEO, Ryan Pape, has been instrumental into making the company into what it is today. Since being brought on as CEO, he has brought XPEL from a company on the brink of bankruptcy (in one case, he paid off a company debt with a personal credit card) to a rapidly growing, high-quality company deserving of a significantly above market multiple. If he were no longer associated with XPEL, I cannot say XPEL would continue to have the same success it has had in the past in the future.