In the amazing movie, "The Founder," you will find the story of how McDonald's (MCD) became what it is today. One of the most impactful moments in the movie is found in the beginning, when Ray Kroc, portrayed by Michael Keaton, is a traveling milkshake mixer salesman running across the McDonald's burger brand and instantly coming to the realization that this was something different and what would revolutionize the traditional dine-in restaurant industry. The key was, most people did not realize it yet.
McDonald's displaced the traditional restaurant business as much as email and computers displaced the need to "Xerox" or fax something. In that same fashion, a number of brands are displacing the traditional "professional" tool market and its ultimate brand, Snap-on (NYSE:SNA).
Over the past few weeks, many of us have spent time putting together gifts for our kids and inevitably used hand tools. My own "aha" moment came over the last few months after having purchased a new "winter beater," an older Mercedes E320. While as the saying goes, "there is nothing more expensive than a "cheap" Mercedes," you can save significant amounts of money if you are handy and can tackle on basic repairs and maintenance yourself.
One of the first places many professionals and DIYers will turn to is the second most widely used search engine, YouTube (GOOG, GOOGL). Whether it is a simple project such as changing your oil on your 2016 Honda Civic, or as complex as doing an engine swap on a 2004 Acura TL, there is a video for it on YouTube from a myriad of DIYers and professional mechanics.
As you build up your list of needed items to complete those repairs, you will most likely find yourself "needing" another wrench, scanner, set of sockets or a power tool. (I do believe many guys such as myself may subconsciously find projects JUST to have an excuse to buy a new tool.) Of course, the thing that is not far behind is discussions of the individual tools and individual "toolbox tours."
So What Does It Have To Do With Snap-on?
Without any doubt, the consensus with the professional and the involved DIY (semi-professional) would be that Snap-on tools are the best. Much like in the gun world, the saying goes, "buy once, cry once."
Snap-on tools are the standard in quality that would withstand the daily use and abuse in either diesel truck shops, airplane hangars or automotive shops. The problem, of course, is that the tools are extremely expensive.
The "value proposition," of course, is that the tools were 100% made in the United States and are 100% guaranteed. If you ever broke it, once a week the Snap-on truck would arrive at your shop and they would replace it for you, either fixing it on the truck in the case of broken ratchets, or giving you a replacement tool if it was not fixable. In the cases where it was not available, the tool would be ordered and you would get it in a week or two.
What was a little surprising for me to learn, and I am sure will be interesting for readers, is that in your employment as a mechanic, the majority of your hand tools and accessories are not provided for by your employer and are purchased. For a new mechanic entering the industry, and much like in any industry where new training is predominantly done through "apprenticeship," it was common for the mechanic to replicate their mentor and buy the same tools for themselves. Thus, many new mechanics entering the industry incurred massive debt buying into the "Snap-on" brand by buying Snap-on tools.
In many shops, like other careers, the "you made it" moment arrives when you have a shiny new $10,000 Snap-on tool box to keep your tools in (or at the very least, you bought into peer pressure and spent $10,000 in cash or debt to buy a metal box to keep your tools in). Browsing YouTube, you will find videos of mechanics showing their tool boxes and tools on which they spent over $100,000, enough to buy a house.
For a new mechanic, it is not uncommon to spend at least $10,000 buying the basic necessary tools just to get started on a job where it will take at least 3 months to repay the debt incurred on the tools they bought.
Of course there are cheaper brands of tools out there, but as it turns out, many workplace environments are no different than elementary and middle schools where kids mocked each other if their parents did not buy them the latest Nike or Reebok sneakers and instead bought them a pair from Wal-Mart or Payless Shoes.
But Now... It's Different
If you spend any time talking to mechanics or watching their YouTube videos, you will quickly realize that times are changing and so is Snap-on - and not for the better.
The Missing "Made In USA"
Many older techs will swear by Snap-on simply because they are "Made In USA." Unfortunately, that is no longer true. Snap-on does both, licenses its brand to companies who can put it on their cheaply made products, and itself now produces its own merchandise with non-US components.
Thanks to YouTube, now more people know.
The question then becomes, if it is no longer 100% made in USA, is it worth paying 10x more?
Not The Only Quality Product
While the country of origin is not a 100% accurate representation of whether a tool is quality made or not, it is no longer Snap-on's competitive advantage.
If there is one company that gets under the company's skin, it is Harbor Freight, which frequently compares its tools to Snap-on's, which are often multiples more expensive.
One recent example of an expensive tool is Snap-on's impact gun, the $525 MG725, competing against Harbor Freight's Impact XT, which sells for $149 before coupons.
(Source: HarborFreight)
While many diehard Snap-on loyalists will quickly dismiss the Harbor Freight tool as junk, thanks to YouTube, there is now proof that Harbor Freight's tools are as good as, if not better than, some Snap-on products. At the very least, a mechanic can buy 3 Earthquake XT tools for the price of 1 Snap-on impact gun.
This YouTuber, in particular, does excellent breakdowns of tools where you can clearly see and compare the base components.
One tool in particular where Harbor Freight got under Snap-on's skin is with its $199 professional floor jack versus the virtually identical $660 Snap-on version.
(Source: Harbor Freight)
In fact, Snap-on sued and lost claiming that Harbor Freight was deceiving customers into believing they were buying a Snap-on. Many speculate that the two floor jacks may be made, or at least have parts made, in the same factory in China. In either case, it is "acceptable" to now use Harbor Freight in a shop environment.
Of course, it is not limited to just larger and more expensive tools. Many "bread and butter" hand tools are virtually identical in how they look and perform.
One example would be Harbor Freight's "Professional" line of tools and tools such as 1/2" breaker bars.
In this video, you have a detailed demonstration comparing some popular tool brands, including Harbor Freight's $20 breaker bar to Snap-on's $157 breaker bar. They both do their job and perform the same task under the same pressures. For the price of 1 Snap-on breaker bar, you can purchase 7 Harbor Freight breaker bars and have leftover money for lunch.
The beautiful thing, of course, is that the Harbor Freight model is also 100% guaranteed for life. If it ever breaks, it will be replaced.
Even the most ardent Snap-on supporters will now concede that many other basic hand tools such as ratchets and sockets, i.e. chunks of steel, are just as good.
Not Just At The Low End
Snap-on's problem now, however, is that it is being hit at all levels and not just at the low level which supporters will quickly dismiss as "junk."
At the very top end, Snap-on is competing with other "professional" tool truck quality names such as MAC, MATCO, PROTO, Cromwell and GearWrench. At this level, beyond pure competition from equally high-quality products, the competing brands are often cheaper.
At the middle level are name brands such as Craftsman, Dewalt, Milwaukee, Makita and Hitachi, which are sold both online and in retail environments. Over the past few decades, you have had the typical names, such as Sears Craftsman, Stanley and DeWalt, joined by the store brands such as Lowe's (LOW) Kobalt and Home Depot's (HD) Husky tools. Amongst these brands, the standard is now for a 100% lifetime guarantee on hand tools and a competitive warranty on power tools. If it breaks, bring it back to the store for a no questions asked replacement.
At the low end you have chains such as Harbor Freight, Wal-Mart (WMT), Tractor Supply (TSCO) and automotive chains such as Pep Boys, NAPA and Advance Auto which have their own branded tools, most of which carry that same 100% lifetime warranty.
Accessibility and Warranty
Snap-on's selling point to professionals was that it would deliver quality, USA-made tools directly to you. Obviously, we now know that it is not the only one who can produce a quality tool, nor are they 100% USA-made either.
The company's argument would be that only with its tool truck distribution model where the driver comes to you, you do not have to take time off and go out to buy or replace tools. Without a doubt, yes... knowing your tool guy/gal would bring you the tool within the next 7 days was an advantage. It was the only way to get a quality tool within a few days, and that is how the company's competitors also operated (tool truck model).
The alternative was if you had the lower-priced/mid-tier Craftsman brand tools from Sears, you could go to a local Sears store and replace a broken tool.
Unfortunately, Snap-on is now competing against modern companies with its hands tied behind its back.
Let's say, for example, you are an independent mechanic and you need to torque some valve covers to spec. Your $500 Snap-on brand torque wrench somehow feels out of spec or broken.
Yes... you will get it repaired or replaced under warranty, but if your customer is coming in 2 hours to pick up the car, what are you to do? In many cases, you cannot wait a week or sometimes two for your Snap-on tool truck to come back your way.
On the other hand, if your $20 Harbor Freight, $60 Lowe's Kobalt, Home Depot Husky, or Sears Craftsman torque wrench broke, you could take it back to the store and get a replacement under warranty and be back at work within the hour.
Beyond that, you have professional brand of tools such as GearWrench, where you take a picture of your broken tool, send it over to the company, and get a replacement in the mail in a day or two. GearWrench is also distributed at stores such as Advance Auto, Sears and Tractor Supply, and can be replaced under warranty in those stores.
For the value-priced, professional-grade tools, you also have companies such as Tekton which sell online at Home Depot and Amazon (AMZN), where you can order and, in many cases, receive them in the next 24 hours.
More importantly, these companies stand behind their tools as much as Snap-on does. I have personally experienced this with both Lowe's and Home Depot. After 5 years of hard use, a ratchet from my Lowe's ratchet set fell on the ground and the adjustment notch cracked. I took the set back to Lowe's, and the manager quickly got me a brand new set, no questions asked as to my responsibility into why it broke. Similarly, after 10 years of abusing and improperly storing my Husky brand torque wrench, I took it to my local Home Depot and had it exchanged for a brand new torque wrench. Once again, no questions asked.
On the availability side, Snap-on is being hindered by its distribution model when it comes to the "right tool at the right time" sale. Oftentimes, you need a specific tool. When you need that tool, you typically need it right there and then and cannot afford to wait 5-7 days to get it by mail or delivered by your driver on the next round. While the Snap-on driver may be 50 miles away covering a different shop, you are likely to be in the 5-mile radius of a Lowe's, Home Depot, Sears, Advance Auto, NAPA Auto Parts, or a Pep Boys, which either sells the tool you need or will let you borrow it for free. Of course, more than likely after the Snap-on driver visits your shop, you will have a visit from a MAC, Matco, or Cromwell dealer shortly after.
Bottom Line
As this is a "big picture" type of article, I wanted to focus on the macro trends occurring in the world and in the industry, as finding those changing winds first will help identify a bigger directional change. Much like in the firearms industry, when over a year ago "gun people" knew that things were fundamentally different while American Outdoor Brands (AOBC), Ruger (RGR) and Vista Outdoor (VSTO) shareholders were still projecting spectacular growth, I believe "tool people" and professionals with influence over younger tool buyers (YouTubers) are turning away from Snap-on's business model.
From Snap-on's side, the company is still distributing through a business model which is now a headwind rather than a competitive advantage. It can neither distribute to as many potential customers as a retail chain, nor does the company have the pricing power or scale to compete with Amazon. Snap-on cannot compete in the long term using a distribution channel which has not been updated since the Internet was created.
Furthermore, Snap-on puts further restrictions on its franchisees (such as tool truck drivers by limiting them to about 200 customers per route), which further stuns its growth prospects. The company is also routinely plagued with disputes with route drivers who often struggle to get by.
Lastly, I believe the company is hurting its business and degrading the "Snap-on" name by both licensing its name to cheap novelties and no longer being 100% USA-made. There is already a growing feeling that the old Snap-on tools which are being replaced are far better in fit and finish versus the new tools they are being replaced with. This will only continue to drive away the only people who care and "need" a Snap-on branded tool.
The above are the three factors which are 100% within Snap-on's control. What is out of its control, however, is further cause for worry.
Today there are more competitors than ever in the crowded tool market, and they are competing with Snap-on at every level.
There have been a number of tool brand transactions recently, and large conglomerates were created. PressureWashr did a study and put together the image below, showing the top tool brands. What it came up with was that 18 companies controlled 91% of the $51 billion hand and power tool market.
(Source: PressureWashr)
Looking at the above picture will surely get you thinking.
At the top of the list, you will find Stanley Black & Decker (SWK). Stanley Black & Decker alone is estimated to control about 14% of the tool market and easily surpasses Snap-on at all levels.
For instance, Stanley Black & Decker competes with Snap-on with its MAC Tools truck brand, its professional Proto, Lista and Vidmar brands, its high-end DeWalt, Lenox, Irwin and recently acquired Craftsman brands, and the mainline Stanley Black & Decker and Porter Cable brands.
With such scale, larger competitors are able to offer similar quality products at far lower prices. With scale and lower prices comes market share.
Beyond that you have the natural turnover in the industry. While decades ago new mechanics bought up additional Craftsman tools because that is what they used as consumers, many new technicians who are now purchasing tools grew up with tools bought on a budget from Home Depot, Lowe's and Harbor Freight - tools that they know come with 100% lifetime warranties.
Those same new mechanics also went through the Great Financial Crisis and know what it is like to be in debt in a flat economy. Combined with influencers who are advising new mechanics not to go into debt buying new Snap-on tools, I believe there is less stigma to buying cheap tools, especially if they come with easy-to-use lifetime warranties.
I believe all of this will continue to be a headwind for Snap-on and a tailwind for larger competitors which have far greater scale, brands and distribution.
The biggest short-term risk, however, I believe, is the economy and the financial grenade that the company is sitting on. While I will dive deeper into the financials in a future article, I do want to highlight this point.
Over the past 10 years, Snap-on has rewarded investors with a 276% stock price return.
The stock price was propelled by substantial increases in profitability (189%), while the revenue grew a mere 26% over the past 10 years.
The "financial grenade," of course, is where those sales came from...
... Credit!
While revenues increased about 26%, Snap-on's credit extended to both franchises (tool truck drivers), and its customers have more than doubled over the past 10 years.
Customers are buying tools - on credit - and those consumers are not exactly "prime credit" borrowers. This point was covered in depth by Stubel Investment Management in the article "Snap-on's Increased Reliance On Credit Sales Is Worrisome." The company is sitting on over $2.6 billion in short-term and long-term receivables.
What was not covered and easily overlooked is that this credit is not the total outstanding. In fact, the traditional financing for the company's tools comes in the form of weekly credit offered by individual Snap-on franchisees to their technician customers. In this manner, the truck drivers buy the tools from Snap-on either in cash or on credit, and then take weekly payments from the customers. The franchisees are, then, not only the salesmen, but are also the bankers, the collection agents and the repossession agents when they do not get paid.
The company's sales are highly dependent on credit and those customers are likely sub-prime credit. Based on my initial look at various articles and Snap-on's recent quarterly financials, the default rate and non-performing loans are continuing to increase as they have done over the last year, and the company is continuing to increase its provisions for loan losses.
When the next recession hits, without a doubt Snap-on's sales and profitability will be negatively affected. The $1 billion question is how this sub-prime credit lender will survive, and how much in writedowns it will have to take.
As a long investment, fundamentally I would stay away.
The company's current market cap is about $10 billion, while its tangible book value is just short of $1.7 billion. This implies a 5.8x tangible book value - quite rich against most peers, especially since that does not account for any future writedowns on loan losses.
Overall, I believe the company is currently priced to perfection and does not present any intermediate upside with significant downside risks.
For Income Idea readers I also highlight a number of ways to implement this article, for both Income focused investors and capital appreciation.
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