This marks our 51st consecutive year of dividend increases.
- Jerry Nix, Genuine Parts CFO 4Q06 conference call
Genuine Parts Company's (GPC) conference call has long passed (Tuesday). But the company (mostly known for its NAPA stores) is a company that I think every management team in America should pay attention to, if only for educational purposes.
GPC: Why the Premium?
From a stock perspective, I should probably point out that Genuine Parts has risen beyond what I said the "net present value" of what the stock is (when I last issued my rankings). You can see those details on the Autoretailstocks website and then click on GPC and look at the basic report and notes I have written on GPC (still working on getting all of the articles from last year uploaded, however). Clearly if the current price of the stock remains, I will need to re-visit my ranking and/or 2012 earnings estimates. Once again, let's not get caught up in the quarterly ebbs and flows of a stock price.
But, I have to admit that it is the price of the stock that has never made sense to me in all of my years writing investment research on Genuine Parts. And I am sure a lot of investors even today are scratching their heads. Think about. On Tuesday management said they expected to earn between $2.95 - $3.05 in earnings per share (eps) in 2007. This is roughly 7% - 10% growth from 2006. Yet, investors for some reason (based on the current stock price) are willing to pay some 17x this projected earnings for GPC's stock.
To put this in perspective, a rather controversial "rule of thumb" on wall street is to pay a "multiple" of earnings generally consistent with a company's growth rate. In Genuine Parts case, investors are willing to pay some 2x the company's anticipated earnings in 2007.
And it is not like management is expecting a difficult 2007. It is probably the type of earnings growth you should expect from Genuine Parts (maybe the low end could be adjusted up a bit) when the economy is good. 2006 was a pretty good year (for the company and the US economy), and GPC produced about 10% year-over-year earnings per share growth ($2.76 over $2.50). And when the external environment hasn't been as accommodating, there have been periods like 2001 to 2003 when the company's earnings per share haven't grown at all.
I know, I know, a price/earnings (p/e) to growth mentality is such a "rudimentary" form of determining a company's "true worth" (most of the pros on Wall Street that are reading this are thinking to themselves). I don't think it matters what type of valuation methodology you use. Go ahead and do a discounted cash flow analysis, or an "economic value add" [EVA] approach. In almost every case, I think you tend to come up with the same conclusion, that for some reason or another, investors are willing to pay quite a premium for GPC's stock.
Why is that? Why do investors seem to be in love with this frankly boring investment? I can tell you it is something that has tripped me up for years. Now I am still someone who believes what you pay does matter (just like for used car retailers). So I don't want to give you the wrong impression. But at least I am beginning to understand why investors pay such a premium.
Most astute investors will probably tell you it is the company's consistency. True, there is something reassuring about investing in a company that has been able to increase its dividend for the last 51 years. One that has paid a dividend every year since going public in 1948. A company that has had sales increases in 56 of the last 57 years, and profit increases in 44 of the last 46 years.
And yes, management certainly has been around the block. I think the "young buck" on the senior management team is the company's CFO (Jerry Nix) who has some 30 years with Genuine Parts. I still remember walking out of my first meeting with GPC's senior management team, turning to the head of our consumer team and saying "these guys have forgotten more than I've learned about the industry."
But this is one of the things as an analyst you need to get over real quick. I and many of my peers fall prey far too often of becoming "star struck" so to speak with charismatic management teams. Our responsibility remains to the stakeholders, not management. And experienced management teams can run into more problems than inexperienced management teams. I don't think anyone would say Ford's problems are that they lacked experienced managers. In fact, they finally recognized that maybe they should get someone with a different perspective, and so the new hope lies in a CEO that comes from outside the automotive industry (Alan Mulally from Boeing).
Keep in mind, experience only helps you avoid the pitfalls from mistakes made in the past. But it is just as likely to cause managers to miss changes in the industry environment, to become comfortable. Dare I say complacent? So I hardly think we can chalk up Genuine Parts premium (afforded by investors) to the company's rich history. Companies like Ford and General Motors similarly have that.
So what's the difference? Why has Genuine Parts seemed to successfully navigate through the typical "business life cycle?" You remember, the whole innovation, growth, maturation, and then decline, life cycle that every business and product inevitably goes through? It extends to biology too, although here again, humans are doing a miraculous job of extending said cycle. But I digress.
I think the answer to GPC can be summed up with a Japanese word; Kaizen. When you look up the word kaizen at dictionary.com, you get booted over to wikipedia, where it describes the definition of kaizen as: "to change for the better," or "improvement." It is the notion of "continuous improvement."
In my opinion, kaizen is sadly an incredibly overused jargon in American corporate culture that is something that more often than not generates more money for the training companies and consultants that preach/teach "kaizen," than the actual productivity improvements that occur.
Here's what is so cool about GPC. I have never heard Genuine Parts management team use the term kaizen, or even continuous improvement. I don't even know if they are all that familiar with the "formal" concept as I doubt they feel compelled to hire consultants to teach them about a philosophy that seems embedded in the company's culture.
But the idea of constantly trying to change for the better is what I think really differentiates Genuine Parts. You've heard me compliment Tom Gallagher (Genuine Parts CEO) for being the only executive in the automotive aftermarket industry that emphasized "we take every new entrant seriously," when I asked him about the potential competitive threat of new online entrants. And on the company's conference call you heard him echo that statement again, but also emphasize the company's own NAPA online website and hint that there are improvements coming to the website.
But it extends far beyond Tom Gallagher. I have sensed this same curiosity and never wanting to rest on your laurels type mentality out of almost every level of management at Genuine Parts I have met with over the years. Motion Industries (the company's industrial segment), S.P. Richards (the company's office products group), I think in every one of those meetings I was asked by the division heads what I think and know about the competitors. Even when I have met with district level managers in automotive, the focus was as much on the competition as what sets NAPA apart.
Now I am someone who is less concerned about the preservation of the organization and more on the mission. In other words, focus less on the importance of the organization and more on the importance of the value proposition you are trying to deliver. This is ultimately what I think generates economic returns (focusing on creating something of value not worrying about the organization that provides said value).
At times this could ultimately mean dissolving or splitting apart an organization as the organization no longer is the best to facilitate the mission. For example, helping people communicate the written word was once best facilitated by typewriter companies. Today computers best facilitate this form of communication. In the future, it may very well prove to be a PDA (personal digital assistant). A great example; Apple. They had to change their name to Apple Inc., from Apple computers, because they are no longer a computer company but a consumer products company.
But if you ask me how a company (organization) like Genuine Parts has been able to overcome the pitfall so many successful organizations fall prey to (resting on your laurels), going through the typical "business life cycle," I think it really comes down to this idea of Kaizen (continuous improvement). So if you want a management team to watch, I don't think there is a better example out there than GPC.
Enough, let me regurgitate a few figures for you. . .
Snapshot of Results/Guidance
Since I like to focus on a longer term perspective, let me give you the summary on an annual basis
Revenues: $10.5 billion in 2006, up 6.9%
Gross profit: unchanged in 2006 at 31.3% (although a bit lower in 4Q)
Operating margin: unchanged in 2006 at 8.1% (up in 4Q due to expense leverage in industrial)
Pre-tax profit margin: up 12 basis points (from 2005) to 7.4%.
Earnings per share: (eps) of $2.76. Up 10% from last year.
Guidance: $2.95 to $3.00 in 2007. Assumes 6% - 8% total top line growth.
In the first quarter management is expecting only 4% to 6%, however, so obviously top line growth is a little "back ended." The company expects (1) 2% - 4% top line growth in the automotive segment in the first quarter, (2) 7% - 9% top line growth in Industrial segment in the first quarter, (3) 3% - 5% growth in office products, and (4) 8% to 10% growth in the electrical segment.
Automotive: 49.6% of total revenues in 2006, 47.3% of total operating income in 2006
Revenues were up 3.4% for the year. Hurt by the company's Johnson Industries that it has been reducing exposure to. Core NAPA was up 5% for the year.
Operating profits were 7.7% of total revenues, down from 7.8%. Mostly reflecting Johnson Industries.
Interesting stuff: The company said they increased the number of NAPA auto care service centers (a program I have been a big fan of) by 2% (number of stores participating in the program), and they have seen the volume increase by 5%.
They re-merchandised 700 stores, and look to increase the number of store resets in 2007. When I followed up with management Tuesday afternoon (sadly I am technology challenged so I didn't turn my mute button off and therefore was unable to ask the question during the call), they said that they pay for the company owned store resets, and they will buy a lot of the stuff needed in bulk, and pass along at cost for the independently owned NAPA stores. So it is the independent NAPA store owners that pay for the actual resets on the bulk of these then (and why you don't see it showing up in cap-x).
They added a net of 64 new stores, still not at management's goal of 100 a year, but getting closer. I also heard them say they now have about 1,000 company owned stores. I've been advocating Genuine Parts own more of the stores, as there is just too much that can go wrong (with customer service and efficiency) when you have a distributor servicing an independently owned jobber who services a repair shop who then services someone whose vehicle broke down.
Over the next ten years (as I have discussed in previous notes), I still think you will see company owned jobbers (like O'Reilly (ORLY) and GPC) providing systems and potentially even customers (from "online resource centers") to independent repair shops. This is why I see aftermarket distributors (like GPC) eventually becoming competitors to folks like Midas (versus vendors today). Management has not bought into this vision and still prefers the independent (jobber) owner model. But it is nice to see the number of company owned stores tick up.
Industrial: 29.7% of revenues, 30.4% of profits.
Revenues were up 11.2% in 2006. Operating margins expanded 80 basis points to 7.5%.
Interesting stuff: If you have not been to Motion's headquarters in Alabama (the industrial segment's company), and you own shares of this stock you really are missing the boat. I know the strong economy has helped this segment. And I am not going to deny a downturn in the U.S. economy will cause margins to erode.
But everything you hear me describe about becoming a resource center for your customer in the automotive side of the business is what Motion is delivering. It is the REAL growth story (in my opinion) at Genuine Parts, hidden in all of the other segments results. Motion is not just gaining share, it is actually creating an industry. Instead of companies and their maintenance staffs trying to order parts from hundreds of different distributors, Motion really is becoming a "one stop shop" company owned jobber that can deliver a complete maintenance repair operation (MRO) to manufacturing plants.
So the decision to outsource more of the MRO capabilities (I think) is the biggest competition, not the distributor down the street (like I said, I think they are creating the market not just competing in it). I think Motion picks up more and more of this "share" (the decision to outsource versus doing it internally) through each economic cycle, and this is why you see the segment getting so much leverage and top line growth when the economic backdrop becomes more favorable.
Office Products: (S.P. Richards) 17% of total revenues in 2006, 20% of total profits
Revenues were up 7.1% in 2006, operating margins weakened a bit to 9.4% from 9.5% last year.
Interesting stuff: Management always describes this as a steady business, and admittedly what we continue to observe year in and year out. I'm not going to pretend to be an expert in the office products industry. But it is my general suspicion that over time you will see the company's larger customers like Staples and Office Depot take share from their smaller independent office resellers.
So I think (directionally) operating margins in the segment have likely peaked, and over the next several years you might see a slow erosion in the office products segment operating income as a % of revenues. Having said that, S.P. Richards' considerable size and scale makes a natural partner for these larger players. So if the Big Box retailers do figure out the commercial office market and become a bigger presence in the market, I think GPC's office products group will grow with these customers. And last I checked, you spend dollars, not percentages.
Electrical/electronic: 3.9% of total revenues, 3% of total profits.
Revenues: 19.5% growth in 2006.
Operating margins: climbed 40 basis points to 5.5% in 2006.
Interesting stuff: I think this segment should be rolled into the company's industrial segment.
GPC 1-yr chart: