Strattec Security Co. - Locking up the Industry
Originally Published November 12th, 2022
Welcome my friends to another edition of the Weekly Value Finder where we look at stocks that Mr. Market has seemingly discarded into the trash heap and left without any fanfare.
This week’s highlights include:
Price to Book ~ 0.6
Price to Free Cash Flow ~ 10
Market Cap ~$100 Million
Net Debt of basically zero
What little gem are we going to speak about today?
Strattec Security Corporation (STRT)
If this sounds familiar it is probably more due to it sounding eerily similar to Stratton Oakmont, the Jordan Belfort-run firm from the ever-popular Wolf of Wall Street, than you actually having heard about the company.
It’s nothing like that scam though, so stick with me…
Company Description
Strattec Security Corporation is a simple company to understand, which is part of what intrigues me. They make locks, keys, ignition start systems, door handles, liftgates, steering column locking mechanisms, latches, and some other small components for automobiles.
Strattec calls these “access control products”. I call them a much-needed niche in the automobile industry.
MOAT
Strattec has one distinct moat and one that lives more on the fringe. The actual moat is Switching. This is because the company will sign a contract with a vehicle manufacturer to provide the mechanisms for the life of the model. This typically means 5-6 years per model, where they will be locked into income, albeit one that will most likely decline as the popularity of a model wains.
The next supporting piece of Strattec’s competitive advantage is that there is some barrier to entry when it comes to this type of niche industry. Starting a company in this sector is fairly expensive in comparison to the roughly 12% margin that it entails. There isn’t a lot of incentive here for new companies, and instead, it’s the larger, established companies that pose a threat to Strattec.
PROS
Low/No Debt. Strattec’s balance sheet is impeccable when it comes to managing risk. After cutting the dividend during the pandemic, Strattec has been working feverishly to pay off its remaining long-term debt. Currently, it sits with almost zero net debt and has positioned itself in an advantageous position for M&A. This is something it did in 2009 when it acquired Delphi Corporation’s Power Products Group.
Contract Structure. As I mentioned in the moat section, the structure of Strattec’s contracts locks them into production for a model for a 5-6 year period. With most auto manufacturers continuing to release copycats of popular models, it becomes a safe bet that unless there is a drastic problem in the security of the vehicle due to products made by Strattec, then contracts will be resigned. The 2023 model list contains a significant amount of models for a company with a market cap of $100 million and as you can notice, many of these models are extremely popular.
Semiconductor Shortage Ending? That isn’t a typo. This pro has a question mark behind it for a reason. According to the newest quarterly report, net sales increased year over year by ~20% due to improvements in semiconductor availability. That being said, with China on an ever-changing CoVid policy, the production can be anyone’s guess. If the production is truly getting back to pre-pandemic levels, then Strattec should be well positioned to increase their production, and increased sales are a certainty.
CONS
Long-Term Contracts. “Wait up a second, didn’t you just say that was a PRO?!!!” Yes, I did, but before you rake me over the coals for being a hypocrite let me explain. Long-term contracts are great for companies to lock in constant revenue that can continue to produce free cash flow for investors. That being said, in some environments, these types of contracts can hinder profitability. What types of environments? How about one with high inflation and rising costs? When Strattec signs an agreement, they lock in a long-term price that both sides think is fair. That means that rising costs cannot simply be passed on to a customer as they can in things such as produce, oil, etc. These types of issues are already being seen in the financials of Strattec and are something that could be a liability in the short term.
Recession and the Automotive Industry. Locking in contracts for models is great, but what if the models don’t sell? A reduction in new automobile sales means a reduction in the need for Strattec’s components. Sure people will always need vehicles, but the growth from the past few years is bound to slow with interest rates rising and people pinching pennies. What does a recession do to vehicle sales? Well see for yourself:
High Customer Concentration. This could just be called “high concentration” because there are two potential downfalls wrapped up into one here. First off let’s talk about the customers. Three customers, GM, Ford, and Stellantis (aka Fiat Chrysler) make up just about 65% of Strattec’s revenues. While all three of these companies are safe bets to be around for the long term, any massive change in strategy or a loss of models could lead to disaster very quickly.
The second part of the concentration conundrum (dynamite phrase!) is that Strattec is highly positioned in light trucks and SUVs. This means that they could be very susceptible to loss of revenue due to long periods of high gas prices, something that very well may be on the horizon. Both of these points are incredibly relevant when speaking about the future success of Strattec.
Conclusion
The more I get into Strattec the more I like the company and the management around it. They have put themselves into a great financial position to withstand any possible downturns that could come their way and to take advantage of opportunities for inorganic growth through M&A.
The problem though is that in the near term I am not sure where organic growth is going to come from. While semiconductor production is looking like a promising trajectory back toward the norm and should lead to sales increases, I’m afraid that the margin is going to be sliced thinner and thinner due to inflation and rising costs. Add this to an increasingly higher-rate environment and new car loans are not going to be what they have been.
Due to the cons currently outweighing the pros in my mind and the uncertainty regarding the economy, this is a company that I can’t recommend buying at this time. That being said, it is a must-add to your watchlist. When the economy works out the upcoming kinks, or if Strattec finds another acquisition, then this would be an instant re-evaluate and a possible portfolio addition.
As always, thanks for reading, and happy investing!
The Profit Investigator