Put Fox Factory on your watchlist (NASDAQ:FOXF)

Fox Factory Holding Corp. (NASDAQ:FOX) has positioned itself to benefit from the growing demand for high performance suspension products, particularly in the mountain bike and off-road vehicle markets, by building strong relationships with key industry players and produce high quality products. The company has a strong portfolio of new products, including its Live Valve technology for mountain bikes and its electronic suspension systems for off-road vehicles. FOXF has a strong market position, a diversified product portfolio, a history of innovation and a favorable industry environment. The company’s track record of success and growth potential make it an attractive long-term investment opportunity for investors with a high tolerance for risk. However, I currently estimate that the stock is on hold.

What does Fox Factory do?

Fox Factory is a Braselton, Georgia-based company with a market capitalization of $5.2 billion that was established in 1974. FOXF designs and manufactures high performance suspension products. Suspension products play an important role in helping to absorb tire energy to stabilize a vehicle. FOXF’s products are designed for a wide variety of vehicles, including mountain bikes, side-by-side vehicles, on-road and off-road vehicles, snowmobiles and motorcycles. It produces a wide range of suspension products, including forks, shocks and dropper posts for mountain bikes and shock absorbers for all-terrain vehicles, motorcycles and snowmobiles. The company’s products are known for their high performance, durability and quality, and are used by professional and amateur cyclists around the world.

Recent Company Performance

The company’s success can be attributed to its strong brand awareness, diverse product portfolio and history of innovation, all of which have helped it gain market share and expand its customer base. Fox suspensions are popular among off-road enthusiasts. They have competed in major off-road racing series like Baja 1000, Mint 400 and King of Hammers, and now compete in Extreme E. Some of the major brands owned by Fox are FOX, Marzocchi, Zone, RT Pro, JKS, Easton Cycling, BDS Suspension and Ridetech.

In the third quarter of 2022, the company experienced a significant increase in revenue, reaching $409 million, an increase of 18% compared to the same period the previous year. The bicycle and motor vehicle segments also saw notable sales growth, with respective increases of 15.6% and 29.3%. The company’s gross margin fell from 30.8% to 31.7% in the third quarter, and its net income for the quarter rose to $50.8 million, or $1.2 per diluted share. That’s up from $43.8 million, or $1.04 per diluted share, in the same period a year earlier. However, the company currently has a negative leveraged free cash flow (LFCF) of $97.1 million, which is unfavorable to the company as it indicates how much money it has left after have paid all its financial obligations.

Strengths

Fox Factory has a strong distribution network spanning the United States and internationally, with relationships with over 5,000 resellers and distributors and 150 OEM (Original Equipment Manufacturer) partners from which they derive all of their revenue. The company has achieved consistent revenue growth, growing from $403 million in 2016 to $1.53 billion in the past 12 months. This represents a compound annual growth rate (CAGR) of 25%, driven by product demand, strategic acquisitions and partnerships. They were also announced as the official suspension partner of E extreme, an off-road racing series where Fox will supply race-proven off-road suspension to 10 teams. This series will provide exposure to extreme off-road conditions and build brand recognition.

To support continued growth, the built society a “state-of-the-art facility spanning approximately 336,000 square feet in Hall County, Georgia to diversify its manufacturing platform and provide long-term incremental capacity for its motor vehicle group” . As of December 31, 2022, the company had a backlog of approximately $223.5 million, and this new facility will help fill that backlog. The company also has a quick ratio of 1.9, indicating good short-term liquidity.

Weaknesses

Fox Factory’s balance sheet has weakened due to high levels of debt and low cash reserves. As of September 2022, the company had $153 million in cash and cash equivalents and $325 million in long-term debt. This high debt and low cash reserve hampers the company’s financial flexibility to pursue growth opportunities and prepare for potential economic downturns.

Their products are heavily dependent on the off-road vehicle and mountain bike markets, which may be subject to seasonal fluctuations and changing consumer preferences. Their products are often more expensive than their competitors, including Rough Country, Ready Lift, and TeraFlex. If demand for these products declines, the company’s revenues and profitability could be negatively impacted.

In 2019, approximately 11% of Fox Factory sales came from Ford (F), a motor vehicle supplier. Additionally, their top 10 OEM partners accounted for 35% of sales in 2020 and 2021. This heavy reliance on a small number of customers poses a potential risk to the company’s revenue and financial performance.

Looking forward

Intrinsic valuations derived from various methods – including DCF (discounted cash flow), EV/EBITDA (enterprise value over EBITDA) and P/E (price over equity) multiples – indicate an average price of approximately 102 USD, which is lower than the current price of $122. My assumptions for the valuation methods are as follows:

The company has a slightly higher EV/EBITDA of 19x compared to the average multiple (based on peer group) of 14x. This means that FOXF generates a higher EBITDA than its peers, given the value of the company.

The company’s P/E value is 27x, slightly higher than the average multiple (based on the company’s peer group) of 21x, showing that the stock is overvalued based solely on the P/E multiple. E. However, I think some stocks deserve to sell at a higher multiple than their peers because they have better brand recognition and premium products compared to their peers. I believe FOXF is one such stock.

Regarding the DCF, the details are as follows:

• Cost of equity: 11.6%

• Cost of debt: 2.3%

• Tax rate: 20.8%

• WACC (weighted average cost of capital): 8.8%

Note that the values ​​presented above are rounded to the nearest whole number.

The increase in the company’s FCF affected the intrinsic value of the share price and based on the DCF method at $120, which is close to the share price. Seeking Alpha ranks FOXF 207th out of 541 major consumer discretionary stocks, gave it a D- in valuations and an A+ in growth, and gave it an overall quantitative rating of 3.18 out of 5.

Conclusion

Fox Factory has reasonable profits and attractive profit margins. I’m a big fan of the Ford F-150 Raptor and Ford Bronco, which use Fox shocks for their off-road capabilities. And now, with their partnership with Extreme E, I will be watching this stock closely. However, I believe the stock is stalled due to the threat of a negative LFCF on its balance sheet and its heavy dependence on very few OEM partners.