2023-07-21 12:37:45 ET
Summary
- Shares in leading tool company, Snap-on, declined following the release of Q2 earnings, which showed positive sales growth and significant margin improvement.
- Though the company is experiencing robust demand from customers operating in critical industries, there was some softness noted in their namesake tools division.
- The softness, however, appeared to be related to timing surrounding new product launches. The sales trend, therefore, could very well reverse in Q3.
- Shares, nevertheless, appear fairly valued following a healthy pullback following a strong run-up over the past year.
For Snap-on Incorporated (SNA), margin improvement is commendable, but it doesn't appear to be a substitute for continuing sales strength in their namesake unit.
Snap-on Q2 Results
SNA reported total quarterly revenues of +$1.3B or +$1.2B when excluding revenues from financial services. This represented YOY growth of 4.8% or 5.6% on an organic basis, in-line with expectations .
From a segment perspective, the Repair Systems & Information Group ("RS&I") led the way higher, with YOY organic sales growth of 8.5%. This was trailed by Commercial & Industrial ("C&I"), which grew 3% organically. Lagging behind was their namesake tools group ("SOT"), which still reported growth, but to a lesser extent of just 1.1%.
Q2FY23 SNA Form 10-Q - Summary Of Total Revenues By Segment
Geographically, sales grew in North America, their largest market, representing about three quarters of total external net sales, as well as in South America and Europe. But the company experienced low single-digit declines in Asia-Pacific due primarily to softness in Japan resulting from a weakened Yen.
Overall earnings surprised with an EPS beat of $0.31/share. This was due to significant margin improvement in all three of their major segments. Overall margins before financial services came in at 23.3%, 160 basis points ("bps") improved YOY. Margins improved similarly on a segment basis, with the exception of their SOT unit, which reported an outsized improvement of 240bps.
Market Reaction To SNA Q2 Results
Despite the strong earnings beat, SNA ended the day over 7% lower. This contrasts with the reaction following their Q1 release, in which markets sent shares higher by 8% on dual beats on earnings and revenues.
Even with the giveback, shares are still trading at the upper end of their 52-week range and are up about 19% YTD. In addition to YTD outperformance, the stock is also up over 30% over the past one year.
Seeking Alpha - SNA Basic Trading Data
Key Takeaways Of SNA Q2 Results
Margin Strength: Increased sales volumes and favorable pricing actions, along with lower costs and benefits derived from SNA's Rapid Continuous Improvement ("RCI") initiative contributed to significant margin expansion both at the gross and operating levels.
Overall gross margins grew 200bps to 50.7%, with 220bps of improvement noted in their C&I division. The improvement was even more pronounced in SOT, where margins improved 300bps to 49%.
Margin improvement at the operating level was also significant. C&I, for example, reported an operating margin of 16%, 160bps improved from last year and one of the highest readings for the unit. And in their tools group, margins came in 240bps higher at 26.3%. This is despite payroll costs running at nearly double pre-pandemic levels.
Robust Sales To Critical Industries: One driving factor on the volume and sales front is their C&I group, which is used synonymously with critical industries because sales to this group include customers involved in aerospace, natural resources, government and military, and power generation, to name a few. In other words, mission-critical industries.
In his remarks on the conference call, CEO, Nicholas Pinchuk, noted that they were seeing strong demand in fields such as aerospace and the military. Industrial transportation was also seen as a source of strength due to the continued focus on supply chain resilience.
But Disappointing Topline SOT Performance: Offsetting growth in C&I was a weaker than expected showing by their SOT group. Though organic sales were up, growth was just 1.1%. It should be noted the unit is up against more difficult YOY comps. In the same period last year, the group reported 9.3% organic growth. Still, investors may have been caught off guard, considering the group did grow by 6.3% last quarter.
One of the primary factors holding back sales was capacity constraints that inhibited their ability to meet record demand. In addition, customers also appeared to shun the company's current power tool offerings in favor of waiting for new product launches later in the third quarter. The weaker sales in the unit, therefore, could very well be attributable to timing.
Is SNA Stock A Buy, Sell, Or Hold?
Snap-on has been on a strong streak over the past year. And for good reason. In the bread and butter of their business, the garage, the company is operating on favorable tailwinds that show little sign of abating.
Cars are being held and driven for longer, which is translating to sustained growth for repairs and maintenance. This could be seen in rising technician counts and corresponding wages. Increasingly more complex vehicle configurations are also generating demand for more sophisticated hand and power tools.
SNA is also benefiting from favorable demand drivers outside of the garage from their customers operating in mission-critical industries, namely the military and aerospace. And increased demand here is also positively benefiting their RS&I unit, which continues to exhibit upper-single-digit growth rates.
Across-the-board margin improvement was a highlight of the Q2 earnings report. And a driving factor of this was a 240bps improvement in their tools division. The positive developments on the margin front, however, were offset by weaker sales growth.
And the weaker sales in the unit is likely the reason shares declined following their release. Looking ahead, it's possible the company will make up for this as early as the third quarter, considering sales appeared to be impacted by timing-related factors.
At any rate, I view the pullback in the shares following the release as healthy, given the current run-up. Consensus targets do peg shares with about 3% further downside. Analysts at Roth MKM , on the other hand, view shares fairly valued at just below $300/share. That would indicate upside potential of about 10%.
On my end, I view shares as a "hold". The stock is trading at a reasonable multiple after rising over 30% in the past year. And though margins have expanded, there's a degree of uncertainty on the sales front as it pertains to their namesake unit. It may be best, then, to wait for further updates following the company's new product launches.
For further details see:
Snap-on Q2 Earnings: Margin Strength But A Letdown In The Namesake Unit