Parsing Genuine Parts' Latest Earnings: Key Quotes From the Earnings Call

| About: Genuine Parts (GPC)
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At the bargaining table, the companies (the Big 3) are expected to try to reduce some retiree obligations. Last year, they spent $11 billion on health care for more than a million retirees and dependents.

(Sean)McAlinden (economist with auto industry think tank) says those costs are a huge disadvantage.

"Last we checked, Toyota had less than 300 retirees in the United States," McAlinden says.

Source: Frank Langfitt, NPR, July 20, 2007

Genuine Parts (NYSE:GPC) 2Q07 stats

genuine\'s stats

2 important quotes from Genuine Parts 2Q07 earnings call
Quote #1: Operating Margin Goal

"Where do you think these margins can go?"

Source: John Murphy, Merrill Lynch

"John, we've said in the past that our goal is to get automotive to 9.0% to 9.5%. For Industrial, to get them to the 8.0% to 8.5% range. Office products to hold them in and around the 9.5% - 10% range. And then the electrical and electronic, we had said we wanted to first get them to 5.5% to 6%.

And of course they're there. And industrial is there.

So I would say the near term objectives are to get the automotive up. Jerry mentioned that if we back out the impact of our 2 new initiatives, the import parts, and truck parts initiatives, they were able to hold their margins in the quarter at 8.3% in quarter, and we think they did a pretty good job with not much revenue to work with. So we would say that we can still think that we can look for 9.0% to 9.5% for them.

And then from an overall corporate standpoint our goal is to get it to 9.0%, and then at that point we'll assess how much further we think we can push it."

Source: Tom Gallagher, CEO, Genuine Parts

Why is this quote important?

As you know, management expects to earn $2.95 to $3.05 in earnings per share (eps) in 2007. But what does a 9% total margin look like? First of all, it won't be in 2007. But what about 2009?

Well, if I assume about $84 million in interest expense and other, a 38% tax rate, and 171.4 million diluted shares outstanding (all expense items below the operating income line), below is what Genuine Parts earnings per share (eps) looks like at various operating margins and sales growth rates in 2009:

GPC earnings

Keep in mind, however, that sales growth often influences operating margins:

"With the auto margins. Do you think you need more sales growth?"

Source: Jonathan Steinmetz

"Well first of all, our objective of getting it to 9% is not one year to the next. It is extended out over a couple of years. We do in fact need to get revenue growth a little bit better than what we have seen thus far this year in order to leverage the cost structure that we have. "

Source: Tom Gallagher, CEO, Genuine Parts

Quote #2: Are there acquisitions that can soak up the cash balance?

"Is there stuff that's larger out there than the $20 million in industrial revenue you mentioned, in other words is there stuff that can add $100 to $200 million in revenue on the industrial side that can soak up some of the growth in the cash balance?"

Source: Jonathan Steinmetz, Morgan Stanley

"Yes there is. And we've got two or three of them. And we're considering those and looking at them. You know in our case Jonathan we'll be more active in that area in the second half of the year. And we'll be more active in the share repurchase in the second half of the year. But you know our issue with these large acquisitions is still a valuation issue. And if we can get that right, we may see one of those large ones in the second half."

Source: Jerry Nix, CFO, Genuine Parts

Why is this quote important?

Clearly the biggest challenge for Genuine Parts is deploying its capital efficiently. They just make too much money to be able to put it to work efficiently. A nice problem to have, but a problem nonetheless.

At this point I think acquisitions are appropriate uses of the cash. But management should also consider a major share tender just so they can get some leverage. Debt is not entirely bad for public companies. You want some of it, and so reducing the more costly (equity) form of financing with debt might not be such a bad idea.

I also followed up with Sid Jones (Genuine Parts Director of Investor Relations) on the topic of acquisitions. He told me that the primary place where the company is looking for acquisitions is in the industrial segment (the question I called to clarify.)

And that prompted another equally important question: what value does Genuine Parts bring to the acquisition?

As analysts, it is a question that needs to be asked repeatedly.

Although my more specific question was what does Genuine Parts get from the acquisition? Sid said that sometimes the acquisition expands their product offering. But most of the time what they are really buying are the customers of these smaller distributors.

And with these added customers, Genuine Parts gets a higher profit margin versus the company they acquired because GPC benefits from greater purchasing power (so lower cost of goods sold). Not to mention lower administrative costs from rolling all of the back office functions (accounting, HR, IT, etc.), into Motion headquarters (Genuine Parts Industrial Group), so the acquired entity essentially becomes a "branch office."

One other quick update I learned from my conversation with Sid Jones Friday. Apparently the 13,200 repair shops participating in the NAPA Auto Care Center program (about $800 million in annualized revenues), buy about 65% of their parts (that are available) from NAPA stores.

GPC 1-yr chart:

GPC 1-yr chart