Investment thesis
Our current investment thesis is:
– FOXF is positioned for long-term success, owing to the fundamental structure of its industry (niche characteristics) and the competitive position it has developed.We struggle to see how it can be challenged on equal footing, with superior expertise and relationships with the industry.
– Its runway for growth is still attractive, as inorganic growth is working and its organic trajectory is supported by industry growth.
– Quarterly results are showing a softening of growth but we do not consider this a concern relative to the wider economy.Despite this, the company’s valuation has slipped, suggesting value in our view (~5% NTM FCF yield).
Company description
Fox Factory Holding Corp.(NASDAQ:
FOXF) is a leading designer, manufacturer, and marketer of performance-defining ride dynamics products used primarily on bicycles, side-by-sides, on-road and off-road vehicles, snowmobiles, and motorcycles.
Share price
FOXF’s share price performance has been exceptional, returning over 400% to shareholders during the last decade.This significantly exceeds the wider market, illustrating its impressive trajectory.This is a reflection of the company’s consistent growth story, although the share price performance occurred in the latter part of the period.
Financial analysis
Presented above are FOXF’s financial results.
Revenue & Commercial Factors
FOXF’s revenue has grown incredibly well, with a CAGR of +19% during the last decade.
Growth has been supremely consistent, with an acceleration during the post-pandemic period.EBITDA has maintained pace, with an equal +20% rate.
Business Model
FOXF specializes in high-performance shock absorbers and suspension products, catering to niche markets such as off-road vehicles, mountain bikes, motorcycles, and snowmobiles.
Its focus on specialized, top-quality components has created a loyal customer base within these industries, allowing for recurring sales and strong marketing.
The business is split into 3 parts, Specialty Sports Group (“SSG”) (Biking segment), Powered Vehicles Group (”PVG”), and Aftermarket Applications Group (”AAG”).
FOXF invests heavily in R&D to create innovative, cutting-edge suspension technologies.Its expertise in developing advanced damping systems and shock absorbers is unrivaled within the industry, creating relationships with global businesses.This positions the company perfectly to attract enthusiasts and professional athletes seeking superior performance.
FOXF supplies original equipment manufacturers (OEMs) in various industries (~57% of revenue), which broadly ensures consistent revenue, particularly given the number of relationships the company has.Additionally, its strong presence in the aftermarket sector (~43% of revenue) allows consumers to upgrade their existing vehicles or equipment, tapping into a market of enthusiasts and professionals aiming to enhance performance.
These factors have allowed FOXF to build a strong brand reputation over the years, known for its high-quality, durable products.Positive word-of-mouth, coupled with endorsements from professional athletes, OEMs, and racing teams, has solidified its position as a trusted choice for enthusiasts seeking superior suspension components.When coupling this with its deep expertise in production, we consider the company to have a wide moat and strong competitive positioning.
FOXF has expanded its global footprint, reaching new markets around the world.Its products are available internationally, capitalizing on the growing interest in off-road sports and recreational vehicles in various regions.This importance here is that the friction associated with going global is minimal barring any nuances in production, making this a very cost-effective strategy.
Scope for growth
We believe the following factors, in conjunction with its existing organic growth trajectory (further market penetration and industry growth), will allow the business to achieve healthy revenue growth in the coming years:
– M&A – FOXF has consistently acquired businesses throughout the last decade, strategically expanding its existing offering and deepening its exposure to particular segments.
Management is confident that the pipeline remains strong for further acquisitions.
– Targeted Marketing and Sponsorships – With scale, FOXF is positioned to invest more greatly in targeted marketing campaigns and sponsorships within its niche markets.This approach ensures they reach the right audience and improves conversion.
– Diverse Product Portfolio – FOXF is positioned to expand its existing product offering, particularly in response to changing trends.
– Rising Demand for Outdoor Recreation – Increasing interest in outdoor activities like off-roading and cycling should support the demand for performance-enhancing vehicle components.This trend appears to be accelerated by the pandemic.
– E-Mobility – Developing suspension systems tailored for electric vehicles has the potential to future-proof the company and position it early for the inevitable trend toward this.
– Digital Integration – Integrating digital technologies into its products has the potential to create the appearance (and reality) of a superior product.This can come from such things as data analysis, predictive maintenance, and enhanced user experience.
Margins
FOXF’s margins have trended up during the last decade, although what is more impressive is its resilience.
The improvement is a reflection of scale benefits, with GPM improving by 4ppts, offset partially by an increase S&A investment to drive sales (+5ppts to revenue).
Given EBITDA-M has been broadly within the 17-18% range, it is likely this level is the maximum the company can operate at on a normalized basis.
We see limited downside risk due to its strong business model and competitive positioning.
Quarterly results
FOXF’s recent performance has slowed relative to its 3Y trajectory, with top-line revenue growth of +19.4%, +5.8%, (1.5)%, and (19.1)%.In conjunction with this, margins have slightly softened, although it remains uncertain if this will tick down in the coming quarter due to seasonality.
The slowdown the company has faced is attributable to the wider macroeconomic environment in our view.With heightened interest rates and inflation, consumers are experiencing an attack on finances with living costs soaring.
This has contributed to reduced discretionary spending where possible.This is also impacting retailers, who are now more careful with the level of inventory they are holding.
Looking ahead, we expect conditions to remain difficult in the coming year, with improvement likely once expansionary policy returns.This likely means headwinds ahead for FOXF, although its strong trajectory implies the company could offset much of this pressure.
The key takeaways from its most recent quarter are:
– The (1.5)% decline in revenue is a reflection of a (58.6)% decrease in its Specialty Sports Group (“SSG”) segment, offset by a 12.4% and 8.2% increase in PVG and AAG net sales, respectively.
– The company has announced an agreement has been reached to acquire Marucci Sports.
– This decrease is attributable to higher levels of inventory across various channels, suggesting Management has been caught materially unaware of evolving inventory trends.
– The increase in Powered Vehicles Group (”PVG”) is principally due to strong demand in the OEM channel, illustrating its continued strong organic growth.
– The increase in Aftermarket Applications Group (”AAG”) is primarily due to M&A, with the inclusion of Custom Wheel House (acquired in Mar23), and healthy organic growth in the upfitting product lines.
– The decline in GPM was primarily driven by inventory, as well as a shift in product mix, offset by increased efficiencies.
– Despite the wider market conditions, Management will continue to evaluate acquisition targets in its pipeline.
Balance sheet & Cash Flows
FOXF’s balance sheet is incredibly clean.The company utilizes minimal debt, with a ND/EBITDA ratio of 0.6x.This has been achieved due to its strong and consistent FCFs.
Distributions to shareholders have been minimal, owing to the company’s reinvestment in growth.During the last decade, >$600m has been spent on acquisitions.
We are broadly supportive of this assuming acquisitions are accretive.
As the following illustrates, ROE has trended down, which is not a positive development.A portion of this is due to greater cash on hand, with ~6% of revenue in cash at Sep23 vs.<2% prior to FY15.This said, it is clear that some compromises have been made.These acquisitions have clearly been margin and business model accretive, although when accounting for consideration paid (and thus goodwill acquired), it is dilutive for shareholders. Given there have been acquisitions during the LTM period, this will step up following a full year of profitability, contributing to a highly attractive level. Outlook Presented above is Wall Street’s consensus view on the coming years. Analysts are forecasting a step-down in its growth, with a CAGR of 4% into FY24F.In conjunction with this, margins are expected to remain broadly flat. We consider these assumptions reasonable, although likely lean toward conservatism.Organic revenue growth of ~4%, when considering economic weakness for all of FY23F and most of FY24F, appears logical and in line with Q1 (assuming Q2/Q3 was in fact a one-off due to inventory).Conservatism comes from the fact an acquisition has been made and there is further scope for additional.As previously mentioned, we expect margins to remain flat. Industry analysis Presented above is a comparison of FOXF’s growth and profitability to the average of its industry, as defined by Seeking Alpha (26 companies). FOXF performs extremely well relative to its peers (which are assessed as auto parts makers).FOXF’s revenue growth is substantially higher than its peers on a 3Y and 5Y basis, as well as across profitability metrics.We attribute this to a combination of strong business model, allowing for above-average organic growth, as well as supplementary inorganic growth through M&A. Further, FOXF operates with substantially better margins, allowing for a superior LFCF and ROE. We attribute this to its unrivaled competitive positioning, with innovation and relationships allowing the company to successfully differentiate itself. Valuation FOXF is currently trading at 15x LTM EBITDA and 12x NTM EBITDA.This is a discount to its historical average. A discount to its historical average appears unreasonable in our view, owing to the company’s strong financial and commercial development during this period. FOXF still has a good runway for further acquisitions and will transition its capital allocation toward buybacks/dividends at some point.This said, the size of the discount above is misleading, owing to the post-pandemic period of elevated multiples.We would estimate that FOXF is trading at a normalized discount of ~10%, with our target premium being ~25%, suggesting upside of ~15%. Further, FOXF is trading at a ~41% premium to its peers on an LTM EBITDA basis and ~12% on a NTM P/E basis.Given the company’s strong financial performance and highly competitive business model, we consider a premium to be justifiable. This said, we are not wholly convinced by the NTM delta, particularly because we consider FOXF better positioned to navigate a decline in macroeconomic conditions once its inventory build-up normalizes. Finally, FOXF’s NTM valuation has consistently trended up during the last decade, as investors have incrementally turned more bullish on its development.The company has fallen below its linear trajectory, with NTM FCF yield remaining elevated.This to us represents attractive value. Key risks with our thesis The risks to our current thesis are: – Significant economic downturn affecting consumer spending. – Increased price competition leading to decreased market share. Final thoughts FOXF is a high-quality business in our view.The company has a wide moat, owing to its deep expertise, global brand, and relationships with OEMs. This is a position that is difficult to rival, as illustrated by its lack of margin dilution and consistently strong growth. The company is being impacted by the macroeconomic environment but we believe its focus on a niche and broader trajectory will ensure its relative performance is still attractive. We believe FOXF is trading below its fair value, with a NTM FCF yield of ~5%..
