Snap-on Tools (SNA) is a rock solid business which traditionally has delivered on modest organic growth, accompanied by significant margin gains in recent years.
The reported earnings along the way were largely used to strengthen the balance sheet, giving Snap-on quite some firepower at current times to pursue dealmaking, hike its dividend or potentially engage in some buybacks. This firepower in combination with stability of the business and a decent earnings yield, creates quite a compelling story if one buys shares on market dips.
A Rock Solid Business
Snap-on has been in existence for nearly 100 years, providing customers with tools to make professional's lives easier, having paid out interrupted dividends since 1939. Typical products being made include hand tools, diagnostics, power tools and storage systems.
The business is comprised out of three product units. Nearly 40% of revenues are derived from the core Snap-on tools business. Almost 30% is generated from the commercial & industrial group, serving professionals. A roughly similar percentage of sales is derived from the repair systems & vehicle repair shop, as the company has a relatively small financing unit as well.
An increase in the average age of US automotive vehicles, increased usage of technology and more complex designs, create long term demand for Snap-on's solutions. While the external environment is helpful at the moment, Snap-on has made huge internal improvements as well. Operating margins have risen from levels in the high single digits in the period 2006 towards +20% since 2014.
These resulting earnings have been used to expand coverage in existing markets, growth in emerging markets and expand into critical industries. Examples of such ¨critical¨ markets include aviation, railroad, military & defense and oil & gas markets, among others.
Impeccable Growth, What Lies Ahead?
Snap-on has shown steady growth over the past decade although it has not been spectacular. Revenues have grown by roughly 40% over a ten year time window towards $3.5 billion. This translates into growth of +3% on average each year, indicating that volumes gains have been modest along some modest inflation of course.
The real achievement has been made in terms of margin gains. Operating margins have risen 10% in the recessionary years to the low-twenties at the moment.
Despite the strong cash flow generation, on the back of improved margins, Snap-on has refrained form large dealmaking and buybacks, as the outstanding hare base has been flattish. In combination with lack of large acquisitions and a low payout ratio, Snap-on has strengthened its balance sheet in a considerable way.
Putting Money To Work
Days ahead of the third quarter earnings report, Snap-on announced the acquisition of Car-O-Liner, a Swedish manufacturer of collision repair, focused on the heavy duty segment.
The $155 million cash deal will add roughly $95 million in sales, for a 1.6 times sales multiple. Snap-on did not reveal any profitability metrics of Car-O-Liner. One thing is for sure, the multiple looks relatively appealing compared to its own valuation, as Snap-on trades at a sales multiple being roughly 1 times higher than paid for Car-O-Liner.
Solid Third Quarter Results
Snap-on just reported solid third quarter results, as revenues were up by 1.5% to $834.1 million, driven by a 2.6% organic increase in sales.
This revenue number does not include a +17% growth rate in financial service revenues. While they might be relatively small at $71.6 million, these revenue streams are very lucrative. Financial originations totaled $270 million in the quarter, indicating that a third of all clients which to pay for Snap-on's tools by borrowing from the company.
The organic growth marked a modest slowdown from a 2.9% growth number reported in the second quarter of this year and is in line with a 2.5% growth number being reported for the first quarter of this year.
Operating margins from the ¨ordinary¨ business improved by 140 basis points towards 18.9% of sales. Margins from the financial service unit surpass 70% of sales, as operating profits from the financial business make up a quarter of overall operating profits.
Modest sales growth and margin gains, combined with large advancement in terms of the contribution of the financial service business boosted earnings. Net earnings were up by more than 12% to $132 million, as a flattish share base resulted in quarterly earnings of $2.22 per share, putting the company on track to post annual earnings of $9 per share.
The 59 million outstanding shares vale equity at $9.5 billion at $160 per share. The financial business makes the balance sheet a bit harder to read however. Cash stands at $118 million and regular debt amounts to $895 million. Healthcare and retirement liabilities total another $215 million, for a $1.11 billion debt load, or $1 billion net of cash.
Of course part of this debt load is the result of the financial business, offset by large receivables. Contract and finance receivables stood at $1.75 billion on the asset side of the balance sheet. If we factor in these assets, given that they could be sold to factoring companies, Snap-on would operate with a net cash position.
If we assume that the $1 billion net debt load is correct, the entire business is valued at $10.5 billion. Including financial service revenues, total sales are set to surpass $3.6 billion this year, suggesting that the business trades at 2.9 times sales.
Based on a run rate of earnings of $9 per share, equity is now trading at a 17-18 times earnings multiple.
Shares of Snap-on have tripled over the past decade on the back of modest growth, but in particular on the back of margin gains. Shares actually rose from $50 in 2012 to a high of $175 in 2015, before settling around $150 per share for most of 2016.
Given the continued gains made in terms of probability throughout 2016, valuation multiples have compressed a bit since last year. A 17-18 times earnings multiple supports a 5.5% to 6% earnings yield. This is used to pay out a modest 1.6% dividend yield, but note that Snap-on actually does not engage in share buybacks. Roughly a third of this year's earnings were spend on the recently announced acquisition in Sweden, but the company actually has much more firepower.
If we consider the financial receivables as cash, which I am certainly aware they are not, net cash stands at +$750 million at the moment. I note that the company could sell ifs receivables assets to a financial institution, but that would impair the profitability of the business as well.
Note that based on the same metrics, the company was running a net debt load in the past. The much improved balance sheet gives the company plenty of cash to be deployed to pursue deals or share buybacks, possibly to the tune of $1 billion.
So we are left with a rock solid brand, a fair 5.5%-6% earnings yield, modest organic growth and very strong cash balance. While current levels are not a screaming buy, I like the combination of these attributes discussed above, making it a core holding which could be added on dips. If management is able to deploy the excess cash wisely, earnings can growth which combined with valuation multiple inflation does make a $200 level attainable in the medium term.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.