Cooper-Standard - Potential Multi-Bagger
And a Great Learning Stock
Introduction
In my last post, I argued that a retail investor like me should avoid turnarounds, deep value stocks, momentum plays, and generally complex situations in favour of simple to understand, easy to own, long-term compounders.
Today’s post is the opposite. I’m feeling more optimistic, I guess.
People can learn skills. Skills just usually take longer to learn and require more commitment than most expect, so we tend to think of those who are good at stuff as “naturals,” though this is rarely the case. Multilingual people, for example, are perceived as “having a knack for languages” when they likely practiced deliberately for thousands of hours. A person who sees others’ capabilities as innate probably has just never learned how to learn.
Relating this to stocks, I think Cooper-Standard (CPS) is a great way to grow an investor’s skill. I own it in decent size (12% of my portfolio measured by market value) and am really appreciating how it is growing my intellectual and psychological investing skills.
Much thanks to Tom Hayes at hedgefundtips.com for the idea and modelling of these skills every week on his videocast.
Cooper-Standard – Thesis and Intellectual Skills
Cooper-Standard’s thesis is as follows:
Cooper-Standard is a small-cap that supplies sealing and cooling systems for almost all major automakers, but especially Ford, GM, and Stellantis. The pandemic almost made them close the doors, but they survived, albeit with a ton of debt. The share price fell 96% from its peak of ~$145 to as low as ~$4.
They got their debt refinanced, reducing bankruptcy risk drastically, and have had two quarters in a row with positive free cash flow, even turning GAAP profitable in the latest quarter. As a result, the stock is up significantly from the lows. But if we look at the chart, we can see that if the business may have a lot more to go.
Because the car business is cyclical, some macro factors need to be considered. Here are the important ones:
Firstly, light vehicle production, for which CPS makes most of its systems, is trending up towards historical means:
Secondly, new car inventories in the USA are extremely low, meaning production volume is likely to continue to increase until inventories are back to normal:
Thirdly, people are going to be replacing their existing vehicle because the average age of a car in the USA is higher than it has ever been:
And lastly, new cars are going to appear more affordable relative to used cars because interest rates have caused used car loans to get very expensive while OEMs are offering very low financing on new cars. Payments at 0-1% APR are a lot better on the wallet that 8-10%.
Almost 9% financing on this used car. 
0% financing on all these new cars. Additionally, car sales have demographic tailwinds. Millennials now being the largest population segment and entering their 30s, the age when people start having babies, work a lot, and spend the most (especially on things like housing, staples, and transportation):
With this macro set-up there could be many ways to benefit. However, Cooper-Standard is one of the better bets, in my opinion. Here’s why I think that:
Firstly, CPS makes money with increases in gross production volume, so investors are insulated from margin compression at the OEMs and have relative diversification of revenue compared to customer-facing automotive stocks.
Secondly, CPS has huge operating leverage, meaning that if sales increase a little, profits increase a lot.
Thirdly, management is incentivized by return on invested capital (ROIC), meaning they are trying to grow profitably and efficiently, leading to cost-cutting and divestitures of loss-making divisions.
Fourth, the company doesn’t dilute shareholders, probably because of their unique compensation structure that prioritizes business quality instead of growth-at-any-cost.
In sum, CPS appears to be led capably, owner-friendly, and has the potential to become very profitable provided production volume continues to increase.
Just like any thesis, it’s time to quantify all these facts and stats. Below is that calculation:
Trading at ~3x forward P/E, CPS could be a three to seven bagger from current prices. This opportunity only exists because there is risk involved, however. The most obvious is the debt, which stands at a whopping ~$1B; being so indebted means investors must weigh the probability of default and bankruptcy.
Because of the recent refinancing, most of the debt matures in 2027, so there are no impending debt cliffs – a good thing.
They also have plenty of liquidity should something happen in the near-term.
The refinancing appears to be on terms that haven’t prevented them from being free cash flow positive for the last two quarters. Given more production, we can expect this to continue
Recessions hurt cyclical stocks like CPS. They are also very difficult to predict with any accuracy, whether that be the timing and severity of them.
In sum, barring a 2009-style recession, the probability of default and bankruptcy is not high, and certainly not imminent.
How wrong can we be and not lose money? What’s our margin of safety? Bankruptcy risk may not be high or imminent, but the balance sheet is far from a fortress – it is hairy. The company would not survive a sustained downturn in the way Microsoft would. Are we being compensated for this risk at current prices? In my opinion, we are, but not by a lot. Here’s why I think that:
The auto industry is vulnerable to recessions, but inventories are low enough, cars old enough, OEM financing cheap enough, and demand secular enough that production should have some resiliency in the face of a light recession.
At current low-ish auto production volumes CPS is free cash flow positive and therefore safe from bankruptcy risk until at least 2027, when most of their debt matures. Auto production could go back to levels where CPS isn’t FCF positive, but that would likely take another pandemic or deep recession.
Even if the stock were only able to earn $3.50/share in a couple years (half of the base case) and traded at a low multiple (around 10x), the stock would be worth ~$35 – still 75% up from today’s prices. I would take that.
In sum, priced into CPS is room for missed expectations and unexpected events. We can be wrong and not lose money at current prices, but not much higher.
It is also possible to be wrong and make a lot more than expected. CPS could beat expectations and have unexpected events occur that benefit the company. Here are a few:
A strong economy fuels a raging bull market in stocks, giving CPS unexpectedly strong earnings and a high multiple.
CPS cost-cutting is better than expected resulting in margin expansion beyond what they’ve achieved historically, boosting EPS.
Electric/hybrid vehicle production increases quickly, from which CPS makes more money than internal combustion engines and has stronger IP.
CPS takes market share from competitors.
New products – For example, “Liveline Technologies,” a proprietary AI software that reduces manufacturing waste by up to 50%. CPS just got its first external contract for the software.
In sum, Cooper-Standard’s well-incentivized management is going to translate normalized auto production into ~$7 per share earnings for the company, and eventually that will be reflected in a share price much higher than it is now, like has been the case in the past.
That’s the thesis – there’s more going on than with a compounder stock, so I find I’ve learned a lot more in terms of intellectual investing skills from it. Skills include:
Assessing management
Valuation
Industry analysis
Accounting knowledge
Business understanding
Doing lots of detailed reading
Famous investors talk about temperament being more important than brains, and Wall Street already being full of intelligent people -- intellectual skills are useless without their counterpart psychological skills.
Next are some psychological skills owning CPS is helping me to hone.
Cooper-Standard – Psychological Skills
The first psychological skill owning CPS is teaching is holding through volatility. For example, the Big 3 automakers recently wrapped up negotiations with the autoworker’s union in Detroit. During the 6 weeks that the strike lasted, the headlines were terrifying. Here’s an example:
CPS dropped from a high of $22/share to under $12/share, a steep 40% decline. Did this reflect a change in industry fundamentals? No:
CPS management estimates north American production to fall 1.9% from 15.5M light vehicles to 15.2M and upped their estimates for the rest of the world -- hardly a difference worth writing home about. You wouldn’t know by the price of the stock though.
The point: In the short term, price is nothing more than what you pay. Put another way, if volatility in a stock’s price is reflective of fundamentals, then it’s very likely coincidence.
A second psychological investing skill I’m learning is probabilistic thinking. Earlier I offered brief lists of positive and negative surprises that could happen to CPS, which is useful, but not complete. An investor must ask themselves, “how likely is each potential surprise?” Humans tend to think extremely unlikely events are more likely to happen than they actually are, which is why lottery and life insurance exists. In reality, things are rarely as good or as bad as they seem, and a lot more nuanced.
For example, with the amount of debt and cyclicality CPS has, a deep recession or second pandemic could make CPS a goose-egg. That’s scary and makes me want to avoid the stock. However, what is the actual likelihood that happens? Not high. Meanwhile the positive surprises include much more likely events like margins improving, and other business lines finding success. Using probabilistic thinking, I’d say the chances of a catastrophic event are diminishingly small, while there are a host of much more likely positive surprises that could occur.
In sum, it is tempting to overweight the negative possibilities, but the probability that something unexpectedly good happens to CPS is at least as high as something bad happening. Assuming you’re not betting the farm on it, that’s a risk a rational person takes each time.
A last skill I’m learning is holding to intrinsic value – not selling early. At the current price of around $21/share, I’m approaching a double on my earlier purchases, and have a cost basis of around $14/share, putting my gains at around 50% in less than 6 months. The temptation to take a 50% gain in such a short period is strong. But the stock is worth far more than that – it currently trades at a 3x forward P/E ratio.
The stock is worth at least $50/share today, and probably a lot more. Nonetheless, it is tempting to sell. Why? I wouldn’t sell my house for 1/3rd of its intrinsic value just because I bought it for even cheaper. I’d want full price. For some reason, this intuition doesn’t extend to stocks (for me). But that’s changing as I learn stocks are businesses, assets like any other. You don’t just sell because there’s an offer.
In sum, I’m learning to hold through volatility because CPS trades far from its fundamentals, think probabilistically because the negative possibilities feel worse than their likelihood, and avoid selling before reching intrinsic value because I know what I own and what its worth.
Conclusion:
Cooper-Standard is an interesting business with an even more interesting stock. I’m excited for the future, but already thankful for what it’s taught me intellectually and psychologically.
Thanks for reading!