Buying Companies with Great Products – Snap-On (SNA) – Part I

Summary

• Looking at companies that produce high quality products their customers love can be an interesting way to get stock ideas
• We look at 4 companies, Snap-On, Fox, Cummins, and Garrett Motion
• We quickly screen out two companies, then look at Snap-On in depth and find an attractively valued company
• We’ll look more in-depth at Cummins in the next post.

I was back where I grew up in Vermont over Memorial Day weekend. My best friend from high school recently moved back there, so I hung out with him a bit.

He opened his own high-end bike sales and service shop, with his main business being building super high-end custom wheels. He also enjoys rebuilding old cars, especially Toyota 4Runners with the removable top.

Suffice it to say, he spends his time working with pretty different products on a daily basis than I do. I asked him about the products he buys and loves to see if there might be any interesting opportunities in companies I don’t usually think too much about. He mentioned 4:

• Snap-On (SNA)
• Cummins, Inc. (CMI)
• Fox Factory Holdings (FOXF)
• Garrett Motion (GTX)

So, I figured we could do a quick look at each of these to see if there’s anything worth looking at in more detail.

Quickly Screen Out Bad Stocks

It’s important to be able to quickly narrow down your ideas so you can spend your time looking at high potential prospects.

For my first stop, I’m going to look at the OSV Action Score ratings for each of these stocks. I start by entering all 4 into the Stock Screener:

The first thing we can see is that we have two B’s and two D’s.

GTX is pretty much worrying across the board — low quality, value, and growth scores, with a pretty low Piotroski score.

FOXF is similarly bad, but some possible redemption in its growth that may be worth looking at. With a Piotroski of only 2, though, we’re going to rule it out.

These are both so bad, it’s not even worth digging into what’s going on to see if there’s a potential “diamond in the rough.”

SNA and CMI both look pretty good, though, so we’ll look at them more in-depth.

Snap-On (SNA)

Overview

Snap-On makes tools and related equipment. I’m sure most of you have seen Snap-On trucks driving around to visit and sell their wares to your local mechanics.

Key Stats, Metrics, and Financials

From a valuation perspective, it’s trading at the lower end of its recent range across every important value ratio:

Its ROIC is solid and has been improving:

It’s also a dividend payer! Its current dividend yield is about 2.28%. Dividends per share have gone from $1.20 in 2009 to $3.53 in the trailing 12 months. That’s a solid track record of dividend growth.

Meanwhile, it has also been repurchasing shares since 2017, reducing its shares outstanding by more than 5%.

Its debt levels are good and even improving. Its Altman Z score is good. From a quality perspective, it mostly looks good.

Its asset and inventory turnovers have been getting a little worse, while its inventory as % of revenue has been growing. This isn’t ideal and would be something to investigate further.

In the last 6 months, insiders have been increasing their holdings

The big issue here is that its revenue growth has slowed quite a bit. (This likely accounts for the recent inventory bloat, because presumably the slowing was unexpected.)

You can see that annual revenue growth has hovered between 3-8%, but in the last year slipped to 1.8% and has deteriorated even further in 2019, with TTM growth at -0.3%.

Earnings and free cash flow growth has remained quite solid, a sign of good management, but this can’t keep up if the revenue growth isn’t there.

It’s a little troubling that sales growth has slowed so much at this point. It’s possible its industrial customers pulled back on buying during the latter part of 2018 and early 2019 as worldwide economic concerns moved to the fore. But the fears have largely not materialized, at least in the US, so we’d hope that revenue contraction would reverse itself.

That said, this is a strong reminder that this will be a cyclical stock, and since we’re in the late innings of this cycle, it may be a tough time to jump on board, even if things do bounce back in the short term.

Snap-On DCF Valuation

So, with that, let’s look at a quick DCF Valuation of SNA:

I used a starting value of $570M, which is the TTM Owner Earnings. I projected growth at 4.66%, which is the median revenue growth it’s had over 3 year periods since 2013. Snap-On’s a fairly slow & steady company in a slow & steady industry, so I used a discount rate of 8%.

This does put the current price pretty close to the buy price, with a 19% margin of safety vs. the fair value.

You can see when you look at SNA’s price in the above chart, it bounced around the $155 range for 5 years — since May 2014 — despite increasing EPS, dividends per share, and owner earnings. Growth of each of those metrics has been solidly double-digit for almost every year, sometimes into the 20-30% range!

This is obviously what’s implied by P/E, EV/EBIT, and EV/EBITDA falling by so much in the last few years. It’s clearly dropped from the “somewhat expensive” to “almost a bargain” category.

Conclusion

Snap-On could be a good to great buy. It could also be worth waiting until revenue growth turns around, or if a recession happens, waiting till then. It’ll have a lot of runway on the upside.

Add to all this the initial impetus for looking at the company — that it makes great products that its customers love — and this may well be worth your time and money, especially if you’re patient enough to look beyond the cycle.

Since this post got so long, we’ll look at Cummins, Inc. in the next post.

Disclosure: I do not own any stocks discussed in this article.