Genuine Parts Company (GPC) announced a bolt-on deal in order to expand its operations in Australia. The deal, once fully completed, could add some 2% to overall sales. The real problem is that GPC has been unable to post organic growth for quite a while now, and despite the long term stagnation in the share price, shares are not necessarily cheap at around 20 times earnings.
If we factor in the underperformance versus some competitors, and the potential fierce competition from Amazon.com (NASDAQ:AMZN) down the road, I think it is very easy to shun the shares at this point in time.
A Stake, Leading Up to A Bolt-On Deal
GPC announced that it has reached an agreement to buy a 35% stake in Australia´s Inenco. The company will pay $70 million for the stake and has the opportunity to acquire all of the company in the future.
Inenco is an industrial distributor of bearings, power transmission and seals that operates both in Australia and New Zealand. Sales run at a rate of $325 million a year. The effective purchase price of $200 million for the entire firm implies that GPC pays a 0.6 times sales multiple. Once all of Inenco is acquired, the deal will add roughly 2% to pro-forma sales.
Reducing Reliance On Automative
GPC is a distributor of genuine parts as its name suggests. The company is essentially a distributor that operates in 4 segments, generating $15.3 billion in sales in 2016. The company is mostly a play on the US - where 5/6 of total sales are generated - and the remainder of sales is split pretty evenly between Canada and Australia.
Most of the sales are generated from the automotive business. This segment generates $8.1 billion in sales, accompanied by margins of 8.9%. The industrial segment is the second most important segment and will be bolstered by the purchase of Inenco. The industrial segment contributed $3.6 billion in sales in 2016, with segment margins coming in at 7.2% of sales.
The two smaller segments include a still sizable $2.0 billion office product segment. Despite secular challenges this business is still posting margins of 6.0%. The electrical/electronic materials business generates merely $715 million in sales, accompanied by solid margins equivalent to 8.4% of sales.
A Great Track Record Of Growth And Dividends
I would encourage you to read page 1 of the 2016 annual report, which details the company's growth from merely $75k in sales in 1928, to +$15 billion last year. This shows the incredible impact of compounding growth over time and shows the stability of the business. GPC has never posted a loss with exception of a modest $2k loss in the year of its founding.
Since going public in 1948 the company has paid out dividends on an interrupted basis to investors, and this dividend has been growing at the same time as well. Payout ratios have been reasonably high around 50% over the past decade.
The remainder of the money has been used to engage in some modest buybacks and engage in bolt-on dealmaking alongside organic growth. The company has grown sales by +40% over the past decade, equivalent to growth of 3-4% per year. The company furthermore managed to retire a tenth of its shares over the past decade, and the margin profile is incredible stable. Gross margins averaged at 30% of sales, while operating margins ranged at 7-8% of sales.
Despite these solid achievements, it should be said that sales have been flat at $15.3 billion in 2014, 2015 and 2016. The impact of a stronger dollar, turmoil in energy and weaker US industrial production trends were to blame for that. This resulted in flattish to slightly negative organic growth, offset by occasional bolt-on deals. While the company is guiding for 3-4% growth into 2017, this is mainly the result of dealmaking. The flattish sales trends in recent years should be a bit of a worrying sign as the US automotive market might be leveling off.
GPC has an amazing track record in terms of growth, stability of margins, rising earnings and dividend hikes. The company actually saw a modest decline in 2016 earnings on the back of flattish sales trends and slightly narrowing margins. Earnings fell to $687 million as share buybacks allowed earnings per share to be rather flattish at $4.59 per share.
Shares now trade at $92 which is equivalent to 20 times trailing earnings - not a very cheap multiple. Even if we use the 2017 outlook, which calls for earnings of $4.70-$4.90 per share, the forward multiple only drops to 19 times earnings.
The good news is that the balance sheet remains relatively solid. Holding $243 million in cash, net debt stands at $632 million, a number that increases to $973 million if pension related liabilities are included. That remains a very modest leverage position EBITDA coming in at $1.38 billion a year.
Too Much Of A Premium For Quality?
Investors have long liked distributors given the relative stable margins and low capital intensity of the business. Capital spending is very low at just 1% of sales, actually equivalent to just 20% of net earnings. Of course investors like the 90 year history of growth and dividend increases. The 2.9% dividend yield looks particularly juicy.
The trouble is however that organic growth is slowing down quite a bit, and essentially has been negative in recent times. Sales have only been holding up as a result of bolt-on dealmaking. This is a serious worry for investors, as shares have been flattish for quite a while now. The lack of recent capital gains has actually resulted in a slow compression of valuation multiples. That said, shares can hardly be called cheap, as they still trade at a modest premium to the overall market.
Having breached the $100 mark by the end of 2014, shares have been range bound in a $80-$100 range ever since, and are currently trading towards the middle of the range.
It is not just GPC that has been struggling. Other automotive parts distributors such as Advance Auto Parts (NYSE:AAP), Autozone (NYSE:AZO) as well as industrial distributors have been lagging as well. Despite the underperformance of the sector at large over the past two years, multiples remain elevated at 20 times in the case of GPC, although it has financial room to leverage up a bit.
Final Thoughts, A Word Of Caution
The real elephant in the room remains online competition and the potential real growth that Amazon.com might pursue in this segment. Distributors of auto and industrial parts, just like grocery chains typically report gross margins of up to 30% for their services as the middle man.
While it is very true that they offer valuable advise (in the case of GCP) to end customers, and offer direct availability, one could envision that some parts could be easily ordered directly from Amazon.com as well. While advice is necessary for complicated parts, many consumers might opt to shop directly for ¨easier¨ components and accessories such as tires, fluids, covers, lights, etc.
This could seriously impact the organic growth profile of the GPC and possibly reverse it, while pressuring margins in the meantime. In that case the current 20 times multiple would be far too expensive, resulting in painful losses/underperformance for long term investors. If growth can be rejuvenated, upside is probably in sight, yet given the full valuation, I would not expect investors to hit a home run from current valuations. This came as valuations have and continue to be fairly full for automotive suppliers.
GPC has an advantage in terms of a loyal dividend investor base which probably continues to provide support for the shares. The near 3% yield remains appealing for investors and while payout ratios are high, leverage remains very low, thereby adding to the security of that dividend.
All in all, the latest bolt-on deal has the potential to add 2% in sales once it is fully completed. The deal terms (0.6 times sales) looks relatively appealing given that GPC trades at 1 times sales. The real issue is that the external environment remains challenging while the company and entire (automotive) distribution industry still have to fear Amazon.com in the long run as well. For now, I am staying cautious.
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.