SNA - Snap-on: Good Near-Term And Long-Term Growth Prospects

2023-10-31 02:43:33 ET

Summary

• Snap-on Incorporated is well positioned to benefit from favorable trends in the automotive repair industry, driving revenue growth in the near and long term.
• The company's revenue growth prospects remain healthy, supported by the rising average age of vehicles and increasing complexity of vehicles.
• Snap-on's margin should benefit from operating leverage, easing capacity constraints, and its Rapid Continuous Improvement initiatives, leading to improved profitability.

Investment Thesis

Snap-on Incorporated ( SNA ) is well positioned to benefit from healthy demand for its products supported by favorable trends in the automotive repair industry such as rising average vehicle age and increasing complexity of vehicles which should help the company’s revenue growth in the near as well as long term. Further, strength in its Critical Industries business driven by solid demand in Aerospace and Defense end markets and easing capacity constraints in Tools Group business should also drive revenue growth in the coming quarters.

On the margin front, benefits from the company’s Rapid Continuous Improvement ((RCI)) initiatives, production efficiencies and operating leverage from revenue growth should help margins. Coming to valuation, the stock is trading at a discount compared to its historical averages. This , coupled with good growth prospects makes SNA’s stock a buy.

Revenue Analysis and Outlook

Snap-on has seen good growth over the last couple of years helped by strong end-market demand. In the third quarter, the company reported a 5.2% Y/Y growth in net sales to $1.159 billion driven by 4.7% Y/Y organic growth and a 0.5% impact of favorable FX translation. Geographically, the company witnessed Y/Y sales growth in North and South America as well as Europe, while sales in Asia Pacific continued to be negatively impacted by weakness in China and Japan.

In the Commercial and Industrial Segment (C&I) segment, net sales increased 2.7% Y/Y to $366.4 million, due to 3.2% Y/Y organic sales growth, partially offset by the 0.5% negative impact from FX translation. The organic growth was attributed to double-digit growth in sales to customers in critical industries, particularly in the military, and aerospace sectors, which more than offset a double-digit decline in the segment’s Asia Pacific operations.

The Repair Systems & Information Segment (RS&I) segment’s net sales grew 4.3% Y/Y to $431.8 million on organic sales growth of 3.1% Y/Y and a 1.2% positive impact of FX translation. Organic growth was aided by a high single-digit sales growth of undercar equipment, and a low single-digit increase in sales of diagnostic and repair information products to independent repair shop owners and managers which effectively offset a low single-digit decline in activity with OEM dealerships.

In the Snap-on Tools segment, net sales increased 3.8% Y/Y to $515.4 million, with organic sales growth of 3.7% and a 0.1% positive impact of FX translation. A double-digit growth in the segment’s international operations and a low single-digit increase in U.S. franchise operations contribute to organic sales growth.

Looking forward, the company’s revenue growth prospects remain healthy. The company’s vehicle repair business is benefiting from the rising average age of vehicles on the road as older vehicles have more requirements for repairs which helps the company’s tools business. The number of technicians working in the garages as well as their average wages also continues to rise resulting in a good demand for advanced tools.

In the Repair Systems and Information segment, which caters primarily to repair shop owners and managers, the company is benefiting from the increasing complexity of vehicles which is driving the need for sophisticated equipment. The new vehicles are coming with increasing electronic parts to support more features, automotive systems that enhance driver safety, new body material to increase durability and reduce weight, new powertrains, new sensors to anticipate traffic & road conditions, and so on. These add-ons are going to become increasingly complex with continued EV adoption and features like automatic driving vehicles. To make sure that the vehicles with these increasingly complex features are repaired properly, garages need new software to guide repairs or manage shops, calibration protocols and advanced systems for sensor arrays, and advanced under-car equipment to accommodate the precision that supports efficient driving. Snap-on advanced hardware and software offering with a continued focus on innovation helps vehicle shop owners and managers address these emerging needs.

The company’s third segment - Critical Industries - is seeing good momentum in multiple end-markets, like aerospace due to the resumption of air travel post-pandemic, military due to rising geopolitical tensions, etc. Further, as the Chinese economy continues to reopen, the demand there should recover as well, further helping the segment’s sales.

Overall, the demand environment remains good for the company. The company usually holds its annual Snap-on Franchise Conference in the third quarter and it saw a good response this year with orders coming out of the conference up mid-single digits according to management .

Over the last few quarters, the company has seen capacity constraints, especially in the hand tools and tools storage production and the demand there exceeds capacity. The company made some progress with capacity expansions last quarter and is expected to continue adding capacity in the coming quarters as well. As the capacity constraints ease moving forward and the company continues to see good demand, I believe Snap-on can see a healthy revenue growth in the coming quarters.

Margin Analysis and Outlook

In Q3 2023, the company’s gross margin benefited from higher sales volume, pricing actions and lower material costs. Further, the gains from the company's Rapid Continuous Improvement initiatives also added to the gross margin improvement. These positives more than offset the 50 bps of unfavorable FX translation and resulted in a 160 bps Y/Y improvement in gross margin to 49.9%.

The operating margin (before financial services) increased 90 bps Y/Y to 21.2%. Consolidated operating margin (including financial services) expanded by 70 bps Y/Y to 25.1%, driven by higher gross margin, partially offset by a 70 bps Y/Y increase in operating expenses as a percentage of net sales due to increased investment in personnel and other costs.

Looking forward, the company’s margin should benefit from operating leverage from the sales growth in the coming quarters. Further, as discussed in the revenue section, the company also faced capacity constraints in the last few quarters. In addition to impacting revenue growth, these capacity constraints also resulted in production inefficiencies. As the company works on improving capacity over the coming quarters, these inefficiencies should also reduce, helping margins. Further, the company continues to work on its Rapid Continuous Improvement initiatives where it applies a structured set of tools and processes to eliminate waste and improve operations. This should also help margins in the long run.

Valuation and Conclusion

SNA is currently trading at a 13.52x FY23 consensus EPS estimate of $18.66 and a 13.16x FY24 consensus EPS estimate of $19.18 which is lower than its 5-year average forward P/E of 14.36x.

The company has good near as well as long-term revenue growth prospects driven by good demand for its products supported by favorable trends in the automotive repair market such as rising average vehicle age and the increasing complexity of vehicles, and strength in its Critical Industries business due to solid end market demand in Aerospace and Defense. Further, easing capacity constraints in the Snap-on Tools business should help both the revenue and margins in the coming quarters. The margins should also see gains from operating leverage and RCI initiatives in the long term. Given these good growth prospects and a cheap valuation, I have a buy rating on the SNA stock.

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