2023-04-12 06:29:50 ET
Summary
- Genuine Parts Company is a distributor of automotive replacement parts and industrial materials.
- Revenue growth has picked up substantially in the last 2 years but is likely to normalize around 4-6%.
- Profitability has improved on the top line but EBITDA margins are lagging due to rising operational costs.
- Relative to peers, the company performs well but is vastly more expensive.
- The business is very well run and should see good growth in the medium term, however, it is difficult to rate the stock a buy at this price.
Investment thesis
With supply chain issues and general disruptions in the automotive industry, we have seen many parts distributors see their fortunes improve significantly. Genuine Parts Company (GPC) is one of those businesses. Our objective is to assess the quality of GPC from a financial perspective, to conclude if the company still represents value today.
Company description
Genuine Parts is a distributor of automotive replacement parts and industrial materials. The company operates through two segments.
Automotive Parts Group - This segment distributes replacement parts and accessories for various vehicles, including hybrids, electric vehicles, trucks, buses, farm vehicles, and marine equipment.
Industrial Parts Group - This segment distributes replacement parts, supplies, and equipment for customers in a range of industries, including equipment and machinery, food and beverage, mining, oil and gas, and transportation.
Share price
GPC's share price has made impressive gains in the last decade, returning over 100% in the period. The majority of this occurred following the pandemic, with demand supercharged compared to the prior periods.
Financial analysis
GPC Financial performance (TIkr Terminal)
Presented above is GPC's financial performance for the last decade, which we can summarize as displaying consistent attractive returns.
Revenue
Revenue has grown at a CAGR of 5%, with the majority of this occurring in the last 2 years, with successive years of double-digit growth. Revenue has been driven by several factors.
Firstly, GPC has been expanding its footprint. The company acquired KDG at the end of 2021 for $1.3BN. KDG was estimated to contribute $1.1BN in revenue to the new Group in 2022, alongside $50M+ synergies in the coming 3 years. Additionally, 138 net new stores were added globally, further pushing the inorganic growth. Management is forecasting additional expansion through both these channels, supporting the ability to achieve continued outsized growth.
Secondly, it has been difficult to purchase new cars in the last few years, driven by supply chain issues (primarily linked to the chip shortage). As a result of this, consumers have been forced to purchase from the secondary market, alongside keeping their current vehicles on the road for longer. As the following graph illustrates, second-hand vehicles have soured in price.
Autotrader second-hand market price index (Autotrader)
This is beneficial for GPC as second-hand cars are more likely to need remedial work, resulting in a greater demand for parts. This is exponentially beneficial for GPC as the further we see a country's vehicle fleet age, the more parts will be required to keep them on the road. This is not an issue we believe will be righted quickly, as supply chain issues will likely remain to an extent long-term. For this reason, we would expect a gradual increase in the average miles driven per vehicle on the road, representing a long-term tailwind to GPC.
Finally, revenue outperformance has stemmed in part from strong pricing power. During these inflationary times, GPC has been active with price increases, allowing the business to keep pace with changing conditions. This has been possible due to the level of demand in the industry but has nevertheless driven top-line performance.
We do see some headwinds, however, which could mean the sustainability of these recent levels is not achievable.
Firstly, the recent increase in energy prices, due to the economic response to the War in Ukraine, has led to a sharp rise in gasoline prices globally. This has contributed to a softening in miles driven, as consumers seek alternatives as a means of saving money. As the following graph illustrate, the current levels are far above the last few years.
However, this is viewed as a short-term threat that may reduce demand rather than significantly impact the industry's economics.
Additionally, we are seeking a shift toward EV purchases as people seek to be more environmentally friendly and Governments phase out ICE-powered vehicles through legislation. EVs have fewer parts overall and require different types of parts, which further reduces demand for traditional automotive parts. EV's key component is its battery, which in some cases requires OEM support. As the EV market continues to grow, this impact on the traditional automotive parts industry is expected to become more significant. The business may face a risk of losing prominence in the coming decades, and much will depend on how management transitions the business. However, there may be opportunities for development through agreements with OEM suppliers.
Finally, we are seeing economic conditions slow as inflationary pressures take hold. Consumers are seeing their discretionary income decline, as a greater proportion of income is spent on living costs. This could have the impact of reducing parts spending, as consumers defer spending where possible. This being said, many rely on their vehicles and so in most cases, consumers will have to take the loss and spend the money.
In the most recent quarter, we have seen sales remain robust, with a 7.6% increase. Importantly, like-for-like growth remains very strong, suggesting the company is resilient to any changes in economic conditions. Further, it suggests demand remains high, despite 2 years of heightened levels.
Automotive sales (GPC) Industrial sales (GPC)
Costs
Across the historical period, we have seen GP increasing at a higher rate than revenue, contributing to a 6ppt. increase in GPM. This has been driven by operational optimization through technological investment, allowing for better sourcing of products. In the most recent quarter, we have seen GPM increase by 50bps, suggesting gains are still being made. A portion of this will be scale economies, however, it is impressive to see a long track record of operational improvement at the scale of GPC.
S&A growth has been less good, increasing at a rate over revenue. This is partially a result of operational inefficiencies resulting from transactions, as well as investment in growth. In the most recent periods, this has been compounded by inflationary pressures on freight costs. Our view is that this is a clear weak area in the company's financials. Management has acknowledged this, seeing to achieve greater efficiencies in the coming periods.
Margins
These factors have contributed to an EBITDA margin of 9% and a FCF conversion of 4%. Our view is that this is quite attractive, with the company achieving improving metrics across the historical period. It is clear that S&A slippage has eliminated much of the GPM gains, which is why the margin improvement is not much larger. This does represent an opportunity in our view if Management can rein these costs in.
Balance sheet
Moving onto the balance sheet, we see GPC's returns reflected from an efficiency perspective, which suggests improving gains but not at a record level.
Inventory turnover has remained steady, as has CCC, suggesting Management is doing well to manage stock levels. Given that demand remains strong, this is far easier to do but nevertheless is a reflection of efficient operations.
GPC is conservatively financed, with an interest coverage of >20x and a ND/EBITDA ratio of 1.6x. This gives the company substantial flexibility to raise debt if required to finance M&A, as well as aggressively distributed to shareholders.
Speaking of distributions, GPC has consistently grown dividend payments, at a rate of 5%, as well as buying back shares. Given that growth remains strong and Management is willing to participate in M&A where possible, this looks to be a good allocation of resources. We have seen no evidence to suggest distributions are not sustainable.
Overall, we are very impressed with the company's financials. Growth is strong for a mature industry and looks to be sustainable in the medium term. We are not expecting double digits to continue, but 4-6% would be fantastic in our view. The balance sheet is equally as attractive, with scope for expansion. Our only concern is S&A expenses, which we think have slightly slipped in recent years.
Outlook
Presented above is Wall Street's consensus forecast for GPC in the coming 5 years.
Analysts are forecasting a 4% revenue growth rate, expecting softening growth as the industry normalizes. Our view is that this is conservative, given the lack of improvement in the automotive pricing situation.
Moving onto margins, these are expected to improve by around 1ppt., with no significant improvement. This aligns with Management's forecast, potentially suggesting we cannot see S&A return to 20-22% of revenue.
Peer comparison
Presented above is Seeking Alpha's profitability rating for GPC, which considers the company's relative performance against others in its sector.
GPC performs very well, receiving a B+ rating. The key areas of outperformance are efficiency metrics, with a far better return on equity and assets. On a pure margin basis, the company looks slightly better, with a 1ppt. delta in NI-M, 1.5ppt. delta in FCF-M, and a (2)ppt. delta in EBITDA-M. Our view is that the second group of metrics is more important as they direct illustrate the returns which can fund distributions.
Growth (Seeking Alpha)
From a growth perspective, GPC scores lower but still performs well. The key metrics we care about here is of course revenue, which is 7ppts. higher, as well as EPS, which is over 25ppts. higher. This is a reflection of GPC's ability to benefit from the cyclical tailwinds in recent years.
The reason for the weaker score is due to the softer forecast period, with revenue growth only rated a C+. This is a reflection of the consensus view that the next 5 years will be far less fruitful. What is important, however, is that GPC is still expected to outperform, just not at the degree previous.
With these in mind, we would suggest a slight premium on the company's relative valuation.
Valuation
Valuation (Seeking Alpha)
GPC's valuation is rated a D, with the company trading at quite a large premium compared to many of its peers.
On a forward basis, the company is trading at an EBITDA premium of >30% and a >25% earnings premium. ORLY and AZO , 2 leading companies operating in the retail parts segment, are trading at the following levels.
Company | NTM EV/EBITDA | NTM P/E |
GPC | 12.5x | 18x |
ORLY | 17x | 23x |
AZO | 14x | 19x |
Both companies are producing over double the EBITDA margin that GPC is while trading at only a marginal premium. It is difficult to justify GPC's price when investors can buy AZO today. As part of our prior analysis, we rated ORLY a hold and AZO a buy (find linked).
Final thoughts
GPC has done well to capitalize on the tailwinds in the parts industry as a result of supply-chain issues, experiencing impressive growth and being proactive with pricing. The company's financial profile is attractive, with low debt and a moderate EBITDA margin. The commercials are equally enticing, suggesting medium-term scope for 3% growth. Our only issue with the business is its S&A expense growth, which is limiting margin improvement.
The company performs well when compared to peers but its valuation is slightly inflated compared to other options in the automotive parts industry.
For further details see:
Genuine Parts: Attractive Financials But Expensive