GNRC - Generac: Upgrading To Buy As Inventory Issues Improve

2023-11-16 09:11:28 ET

Summary

• Generac has been dealing with excessive inventory of standby generators in the dealer channel.
• However, the company has been making strides fixing this issue, which is close to returning to more normal levels.
• With the inventory issuing improving, GNRC stock looks like a "Buy."

When I last looked at Generac ( GNRC ), I noted that the company was dealing excessive inventory of standby generators in the dealer channel. With the company recently reporting earnings, let’s catch on the name and see how it has been dealing with that problem.

Company Profile

As a quick reminder, GNRC sells generators into the residential and commercial & industrial markets. On the residential side it offers both home standby generators and portable generators. Meanwhile, it sells commercial grade natural gas and diesel powered generators in the C&I space.

The company also offers a number of other energy solution products that its obtained via acquisition over the years, including a system that stores electricity from solar panels and smart home items, such as smart thermostats, smart cameras, and security devices.

Q3 Results and Inventory Issues

In my original article on GNRC, I noted that the company was experiencing two big issues. The biggest issue was that the dealer channel had too much too much standby generator inventory in the dealer channel.

The company was still feeling some lingering impacts of this in Q3, but overall, it appears this issue is getting revolved.

For Q3, sales fell -2% to $1.07 billion, while core sales, which exclude FX and acquisitions, were down -4%. That’s a huge improvement from last quarter when it saw sales decline -23% and core sales down -26%. It also topped analyst estimates call for revenue of $1.04 billion.

Gross margins improved 190 basis points to 52.1%

Adjusted EBITDA rose 3% to $188.6 million, with EBITDA margins increasing to 17.6% from 16.9%. Adjusted EPS came in at $1.64 versus $1.75 a year ago, topping the consensus of 13 cents.

Once again, the Residential side of the business showed weakness, as sales dipped -15% to $565 million versus $664 million a year ago. However, that was an improvement from the –44% decline in sales it saw in Q2.

Discussing channel inventory of its Q3 call, CEO Aaron Jagdfeld said:

“Field inventories continue to come down. And the way we phrased it, they're reaching a more sustainable level because we're definitely seeing areas as we noted, I think, not only at our Investor Day, but maybe even on the last call, where we have certain regions and certain models, certain channels like our dealer channel, in particular, that are feeling like we're kind of at normal. And they're back to the whole question of what is normal, right? I mean we picked a pre-COVID kind of average to say what that is. And so we continue to work towards that and making good progress. We're still undershipping the market in terms of overall end market demand. But it's narrowing up. It's not nearly what it was earlier this year. We were severely undershipping the market earlier this year. That's why the results were what they were. And as we get closer to kind of that, I would call it, in-line shipping to market end market demand, you're seeing the impact of that on the results, both in the gross margin level as well as EBITDA margins. We're able to really focus on improving the efficiency in our factories because we're taking up our production rates to get closer to that end market demand. The really good news is we continue to see end market demand remain quite strong for home standby. And that's in spite [of it] really kind of a light season relative to the third quarter here. Outages in total were above average, the long-term average. And of course, there were a lot of well-publicized articles around potential outages with some of the supply-demand challenges that remain out there. But we feel really good about where the category is at. And we feel like as we've been saying all along, as we finish up the year here and we get into 2024, we're going to be much, much closer to normal at all channels.”

The C&I segment, meanwhile, was strong, with revenue jumping 24% to $385 million. Core C&I growth was 19%. Other Sales rose 7% to $121 million. Ecobee smart home sales have been strong, but the entire solar plus storage market has been weak.

Looking ahead, GNRC maintained most of its full-year expectations. It continues to forecast sales to decline by -10% to -12%. The company expects a standby generator sales to return to growth in Q4. GNRC forecast adjusted EBITDA margins to be between 15.5%-16.5%, while it lowered its net income margin from 6.0-7.0% to 5.0-6.0%.

While Q3 still demonstrated the issues GNRC was experiencing with dealer channel inventory, the company appears to have made great strides in getting back to more normal levels. This is the most important thing the company needed to do this year after the issues surfaced, and it’s done a good job on that front. Meanwhile, the company has seen strong home consultations, which should translate in to some solid sales down the line.

The softness in the solar storage market shouldn’t come as much surprise to anyone following the invertor companies Enphase ( ENPH ) and SolarEdge ( SEDG ). This is an industry problem, and fortunately for GNRC, it is a smaller part of its business. Meanwhile, the company has seen continued strength in its C&I segment, as well as with Ecobee.

Margins have also held up well, and the company free cash flow has also been solid.

Valuation

Based on the 2023 EBITDA consensus of $637.4 million, GNRC trades at an EV/EBITDA multiple of about 13x. Based on the 2024 EBITDA estimate of $801.7 million, it trades at about 10.4x.

Based off of 2023 EPS estimates of $5.31, it trades at 22x, while based on 2024 EPS estimates of $7.23 it trades at 16x.

Revenue is projected to fall -11% this year, and grow over 8% in 2024.

The stock looks reasonably valued versus its electrical equipment peers. Putting a 12.5x peer multiple on 2024 EBITDA get you to $132 stock. Pre-Covid, the stock traded around a 10-16x trailing multiple, so that seem like a fair valuation for the stock.

Conclusion

With GNRC seeing its dealer channel inventory issues dissipate, the company looks in good shape to see a better 2024. There are risks, such as the impact of high financing costs for home improvements, but the strong home consultation numbers should be a good leading indicator for residential sales. At the same time, the C&I segment has been strong.

Right now, GNRC is a borderline “Buy,” with my target around $132-138, which is 12.5-13x 2024 EBITDA multiple. The return is good enough to get an upgrade from me, but I’d prefer a slight pullback. Risks to the downside include a slowdown in sales due to a weakening macro environment and high finance costs, and any sudden change in strength in the C&I segment.

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