I recommend shorting Snap-on (“SNA” or the “Company”).  The Company reported Q2 earnings last week and missed both top-line and bottom-line consensus estimates.  This is the third consecutive earnings disappointment.  My research suggests that recent disappointments in the core Snap-on Tools business are likely ascribed to issues beyond just the “macro” issues which management directs blame towards when explaining the Company’s disappointing results.  During the next twelve months, I think a short of SNA should deliver a 15-20% return as 2025 earnings reset lower and the Company’s equity re-rates accordingly.

A more challenged growth trajectory in the Company’s core Tools business was recently demonstrated and the market initially reacted with some concern but it appears that market participants are now less concerned.  I think otherwise, I think that 2025 consensus earnings will reset lower and possibly to a level below 2024.  In the next twelve months, I believe SNA will push to a new 52 week low and trade at least 15%.  

The core short thesis can be summarized as follows:

·         Degradation in core Tools business is ascribed to more than just macro issues

·         Competition has both improved and intensified

·         Elasticity of demand to premium pricing strategy

·         Industry landscape shifting away from SNA’s core customer

·         Franchisees are not nearly as enthusiastic as the franchisor  

·         Long-dated receivables come with tail risks that could lead to increasing charge-offs

Snap-on is a well-regarded manufacturer and distributor of high-quality tools and diagnostic equipment tailored primarily to automotive mechanics and technicians.  The Company utilizes an extensive network of franchisees, who deliver door-to-door service to its mechanic customers.  The franchisees which operate the mobile van channel are considered by management to be important “partners” although selected franchisees with whom I spoke characterized the relationship as “unsettling”, “hostile”, “abusive”, and “exploitive.”  Many franchisees accuse the Company of trapping them with high-interest debt.  At the end of 2023, the Company’s total mobile van channel count was 4,700 including 3,400 in the U.S. and 5% being Company-owned.  Snap-on also conducts sales through distributors, direct sales, and e-commerce.  The Company’s core business is driven from extending credit to a lower economic demographic.  As of Q2, the Company’s gross finance portfolio exceeded $2.5B of which ~80% was on extended credit with average payment terms of approximately four years. 

A former Snap-on Chairman/CEO once described Snap-on as an upscale retail operation disguised as a tool manufacturer but unlike the affluent shoppers who favor Louis Vuitton, the Company’s clientele is a distinctly blue-collar, lower-to-middle income aggregation with limited access to credit.  Although the Company’s branded tools and diagnostics are well-regarded and command a premium price, the magnitude of premium pricing was questioned by every single primary research interview I conducted.  For example, an oil drain plug remover can be purchased from Snap-on for $60 or at Matco for $25.  As one mechanic said to me, “There ain’t no difference in a plug remover so why is Snap-on charging twice as much.”  The Tools group posted its third consecutive quarterly decline and management blames macro issues as the cause for the decline.  I believe there are other factors including elasticity of demand and an improving competitive landscape that SNA’s management has yet to acknowledge.

Given the average age of a car hit a new record of 12.5 years in the U.S. in 2023, there is a need for more automotive technicians and mechanics.  SNA’s CEO likes to promote the pace of growth in mechanics and their wages but the data fails to validate his assertions.  The median hourly wage was $22.96 in 2023 and $22.48 as of May 2020.  The Company’s primary end customer is earning a wage that has substantially failed to keep up with inflation.  With the average salary of an automotive technician at ~20% lower than the national average, current and potential technicians seem to be eyeing other opportunities to keep up with the cost of living.  Although SNA’s CEO is promotional when highlighting his expectation for technician growth and consequently the growth potential of his critical customer segment, the forecasted growth of automotive technicians and mechanics, at 2% through 2032 according to the Bureau of Labor Statistics, is not expected to be any different than the average growth of all occupations.  Another issue plaguing the automotive repair industry is the lack of completion in postsecondary technician schools.  Data from TechForce Foundation’s Technician Supply and Demand report shows that completions have fallen 34% since 2012.  A research study in 2022 suggested the industry needed 232,000 technicians across the automotive, diesel, and collision sectors but only 42,000 were forecasted to graduate from relevant vocational schools.  As one repair shop owner said, “Older employees retiring are not easily replaced.  The baby boomer generation was among the last to encourage hands-on and blue-collar work.”  There is no argument that there is a need for more automotive technicians and mechanics but my research does not evidence that the prospect for demand for this skillset will be met by labor supply. 

The majority of my research has focused on Snap-on Tools and the Company’s Financial Services in the U.S.  Approximately 72% of the Company’s sales are derived from the U.S.  The Company’s product mix in 2023 was comprised by Tools at ~53%, Equipment at ~26%, and Diagnostics/Info Management Systems at ~21%.  In addition to the signature namesake Snap-on brand, other Company brands include Blue-Point, CDI, Hofmann, John Bean, Lindstrom, Mountz, Norbar, Sioux, Sturtevant Richmont, and Williams.  Through primary research, it is clear that Snap-on’s brands resonate with its end market for being “high-quality” but also at a “questionably high price point” as described to me during more than seventy-five primary research interviews.  The Company’s organizational structure is across four business segments:  Snap-on Tools (~41% of Revenue, ~35% of pre-corporate EBIT); Repair Systems & Information Group (~29%, ~30%); Commercial & Industrial (~22%, ~16%); and Financial Services (~7%, ~19%). 

Management ascribes recent weakness during the past three quarters in its core tools business to macro issues.  I think SNA’s management is being overly cavalier with regards to the elasticity of demand to the Company’s premium pricing strategy and especially in a more difficult macro environment for the Company’s lower credit demographic.  Some primary research comments from automotive mechanics and technicians follow below: 

·         “Snap-on is the Mercedes of tools.  The downside is the outrageous price.  I have been in the business for 40 years and have mostly Snap-on but have purchased much of my bread and butter tools used for usually less than half of the new price on eBay.”

·         “It isn’t 1995 anymore.  Amazon Prime can get you a replacement tool faster than most tool truck drivers.  Many tools from Asia work 80-90% as well as Snap-On for one-third to half of the cost.”

·         “There are a few items that Snap-On does better than anyone else in my opinion but that list is getting shorter every year.  Even then, I would still purchase on the secondary market.”

·         “You can buy the exact same tools cheaper.  Snap-On is pricing themselves out.”

·          “If you can plan ahead and set-up search notifications, eBay, Facebook Marketplace, and pawn shops is the way to go.”

·         “Like everything, with some time and leg work one can assemble a set of quality professional mechanics’ tools at ~40% or less of Snap-On prices.  It’s a trade-off of time versus money.”

·         “Yes, some Snap-On stuff is good to have but less expensive tools will work just as well.”

·         “I bought one of those cheap Amazon TPMS things.  Works fine.  So glad I didn’t buy one from Snap-On.”

·         “I think Snap-on makes the best tools for me but me and some mechanic friends know we can do the job as good with other company tools for lots less money.”

·         “For tools I use daily, Snap-on has worked well for me but I bought those tools in the mid-90s and they now charge triple the price for those same tools.  I would not buy all those tools today.  Back when I started, Snap-on had the best toolbox technology, it was a no-brainer, but that’s not the case today.  I tell the younger guys to consider the Matco and Cornwell guys who visit our shop to save money if they want new stuff.  I know sockets are so much less from ICON that the quality difference just doesn’t make sense to pay up for Snap-on.”  (note:  a 12-piece set of 8 millimeter Snap-on sockets cost $476 versus $45 for the ICON brand; that is not a typo)

The Company was founded over 100 years ago and has built a durable brand but as reinforced by the former SNA CEO, its business is focused on selling tools to a customer segment that is not effectively equipped to pay premium prices.  The median salary for SNA’s core customer was just $48,000 in 2023; this is not an attractive credit and especially for a Company that generates ~20% of its EBIT from its Financial Service business.  Comments from McDonald’s CEO during February that highlighted transaction reductions across its customer segment making $45,000 and less reinforces the challenge to SNA’s core customer.  While MCD pivots towards a “value menu” to address its business challenges, Snap-on is pivoting to lower-priced tool solutions to emphasize shorter paybacks.  However, as SNA’s CEO said, “you’ve got to sell a lot more wrenches to make up for a tool storage box.”  Although the near-term strategic pivot might make sense, I think there is a broader set of challenges confronting the Company which could ultimately require a more promotional strategy to achieve management’s volume expectations or else volume will erode if management is unwilling to accept some margin degradation.  Also, since the gross margin is unusually high in the Tools group relative to the historical average, some reversion to the mean should be expected.

During the past 17 years, SNA has impressively grown its EPS each year other than in both 2009 and 2020.  During the past five calendar years, EPS grew at a CAGR of 9.6%.  Not surprisingly, from the COVID-induced degradation in 2020, EPS has grown more quickly at over 18%.  However, in addition to the catch-up from deferred spending in 2020 as evidenced by the Company’s organic decline of 6.9% and 22.9% during the first two quarters of 2020, there has likely been a pull-forward benefit derived from fiscal stimulus.  From Q3 of 2020 through the end of 2023, SNA’s organic growth averaged 10%.  Growth was closer to 11% for SNA’s Tools group.  However, starting in Q4 of 2023, management acknowledged some weakness which they insist is macro-driven. 

The Company’s growth is decelerating.  While some industrials might be closer to a trough, I do not think that is the case for specifically Snap-on in the near-term.  During the past five quarters, the Company’s organic growth has trended lower and was negative during both Q1 (-0.8%) and Q2 (-1.1%) which had not occurred since Q2 of 2020.  The core Tools group was negative during the past three quarters and worsened as follows: Q4 of 2023 (-5.7%), Q1 of 2024 (-7.0%), and Q2 of 2024 (-7.7%).  Relative to Q4 2023 and Q1 2024, the bar was much lower for SNA’s Q2 results, particularly in Tools, but the Company failed to deliver organic growth.  My short thesis is premised on a short-to-medium term rate of change that continues to moderate or decline. 

At less than 10% below its all-time high, SNA’s equity is not discounting the likelihood that recent performance challenges will persist any longer.  SNA’s P/E averaged ~13x during 2018-2019; its low P/E then was ~11.3x; its high P/E then was ~14.6x which is roughly in-line with SNA’s current 2024E P/E.  I believe SNA is much more likely to revisit the average low from that period, especially if earnings continue to reset lower, than sustain a much higher PE that accorded SNA today.  My research suggests that the Company’s earnings growth will remain muted.  To some extent with consensus 2024 EPS growth at 2.4% and 2025 at 3.9%, this might be understood but perhaps market participants are rationalizing that the worse is over for all cyclicals and therefore SNA’s stock performance will be driven by an indiscriminate rotation with capital flows.  SNA’s CEO characterizes the recent poor Tools group performance as an “unsettled interlude.”  I believe it will prove to be more prolonged; in fact, it wasn’t so much better for Tools pre-COVID.

When considering 2025, I ascribe a much higher probability to the low estimate of 19.48 from Jefferies versus the high of 20.56.  I believe the ~4.2% growth estimated by Jefferies for the Tools group in 2025 will be 2.5% growth at best as management tries to preserve margin as a key priority but top-line continues to be challenged from competition, structural landscape changes, and elasticity of demand.  All else being equal, that’s ~$0.25 less EPS which admittedly is a small change of ~1% to current consensus but once the market realizes that expectations for the core Tools business need to reset lower and not solely because of macro-driven issues, I think the stock will re-rate lower.  If SNA were to trade at its average 2018-2019 PE of 13x on 2024E EPS, the stock would be down over 10%.  At 12x 2025E (a level above the 2018-2019 low PE) consensus EPS, the stock would be down ~15%.

It’s important to highlight that the Tools group averaged a 43.2% gross margin from 2017-2019 and 44.6% from 2020-2022; it was 47% in 2023.  During last year’s Q2 call, the CFO noted some benefit being attributed to cold rolled steel used in SNA’s tool storage products since input costs had come down but the Company was able to hold onto the price that was set before and therefore the benefit of material cost reductions accrued to margin.  While SNA holds their price, the relative premium grows against the competition which is being more aggressive to drive share.  During those respective periods from 2017-2019 and 2020-2022, the Tools group EBIT margin averaged 16.2% and 19.9%; it was 23.6% in 2023. 

Given increased evidence of factors challenging the top-line, I believe the Tools group margin could revert back towards its pre-COVID level.  All else being equal, each 100bps lower to gross margin is ~$0.30 less EPS even if the Tools group were to grow next year at ~4.2%.  I know that management is well-aware of the numerical implications of a lower margin and they want to preserve a premium pricing strategy they believe is appropriate for the durability of SNA’s product and brand.  However, both the macro and micro factors challenge that objective and the fundamental cracks are already evident even if SNA’s stock price has yet to discount it.          

The degradation to growth during the past three reported quarters was a negative surprise to the market and caused SNA’s stock to initially underperform the market although the reaction was much less pronounced last week pursuant to the Q2 print.  The negative reaction was visible from the Q1’24 and Q4’23 results as evidenced by ~8% and ~10% decline in SNA’s equity on the day those results were announced, respectively. 

SNA’s management has characterized the Company’s recent results as “below standard” and ascribed blame to “macro” issues which the CEO recently noted is “a black hole.”  During the Q1 call, the CEO blamed the “below standard” results on “the barrage of bad news, inflation…the Red Sea, the election…the fear of what’s coming around the corner impacts the outlook and paraphrasing the characters of Dune, fear is the outlook killer.”  During the Q2 call, the CEO said, when describing his perception of the automotive technicians mood, “…their confidence in the way forward is still poor.  Everyday there is bad news.  Two wars with no end in sight, the border unsettled, the shipping lanes disrupted, tit-for-tat with China, lingering inflation and the election, the election seems to get unpredictable with every morning news cycle, the hits just keep on coming for bad news for breakfast…And paraphrasing the movie Dune, fear is the outlook killer.” 

It’s interesting to note that the CEO highlighted evidence of some weakness developing during Q4 but this was pursuant to his highly promotional comments from the Q3 call including the following: “…I’m here to tell you the enthusiasm they [franchisees and mechanics] displayed in the industry and the confidence they expressed in their future was something else.  It was contagious…The opportunity we see shines right through political uncertainty or economic turbulence.”

I agree there are macro issues that have been a considerable challenge and could remain so in the near-term but of course there are always some macro challenges.  The purchasing power of an automotive repair mechanic or technician has been marginalized by inflationary pressures relative to the median salary.  “The prosperity of automotive technicians impacts the demand that technicians have for Snap-on tools.”  Although a  mechanic needs tools to perform his or her job, the allure of the bigger tool box and the better diagnostic tool kit has been a recent challenge for SNA as those are more discretionary.   Moreover, the premium price for Snap-on tools is not likely sustainable.  SNA is confronting Company-specific and industry landscape challenges in the near-term that will likely persist in the medium-term as well.  I think management suffers from some hubris at not acknowledging other fundamentally-driven challenges.

Although some investors might have become accustomed to the 10% average organic growth since Q3 of 2020 through the end of 2023, the fact is SNA was not growing top-line very quickly pre-COVID.  The Company generated 1.7% of average organic growth during the three-year period 2017-2019 (in fact, only 1.2% during 2019 and just 0.5% during 2018).  During that same period, organic growth was far worse, at negative 0.2%, in the core Tools segment. 

Among the factors causing the performance at Snap-on’s Tools Group to deteriorate is competition although management has yet to acknowledge it during its recent earnings calls.  As conventional CYA type of language from legal counsel, it is not a surprise to see the Company’s risk factors state, “We face strong competition in all of our market segments.  Price competition in our various industries is intense and pricing pressures from competitors and customers continue to increase.”  However, management remains overly cavalier with regards to acknowledging that competition is improving.  During the most recent earnings call, SNA’s CEO said, “I don’t see any increased presence of the competitors…Usually, the competitors are selling to a different customer base actually.”  During the first quarter call, when asked about market share, the CEO noted none of the 36 franchisees he talked to (which notably is less than 1% of all franchisees) mentioned Snap-on was losing share and although he said “the Matco guys are smart guys,” he also reinforced the same point from the most recent earnings call that “we think that we sell to different people anyway.” 

My research clearly validates to me that competition has increased.  This is notable from my discussions with selected franchisees, automotive mechanics, and competitors.  Even in the absence of any better product from the competition, some elasticity of demand to SNA’s premium pricing strategy has materialized.  Moreover, the fact that Matco Tools, Mac Tools, and Cornwell have been growing their mobile van franchisee count, albeit from a lower base, while Snap-on’s has declined is further evidence of an intensified competitive factor across Snap-on’s most important distribution channel. 

The number of total franchisees at Matco Tools grew by 2.8% last year to a total of 1950 while their U.S. units grew by a CAGR of 1.5% during the past five years to 1858.  The number of total franchisees at Mac Tools, owned by Stanley Black & Decker, increased by 2.5% last year to a total of 1159 while their U.S. units grew by a CAGR of 2.5% during the past five years to 787.  The number of total franchisees at Cornwell, founded one year before Snap-on in 1919, increased by 1% last year to a total of 796.  All of Cornwell’s units are in the U.S. which grew by a CAGR of 2.9% during the past five years.  Matco, Mac, and Cornwell are “real players” that seek to sell to the same customer segment through the mobile van channel even if SNA’s CEO fails to acknowledge such with any degree of humility. 

From my primary research, it is also notable that many mechanics are trying to save money by purchasing some tools through the secondary market either on-line or directly from retiring mechanics.  There are numerous mechanics that visit some of the well-known automotive specialty stores like Advance Auto, AutoZone, NAPA, and O’Reilly for a variety of their needs, and several mechanics told me they have begun to increasingly visit the retailer Harbor Freight which has 1500 stores. 

I had never heard of Harbor Freight previously which sells a broad base of tools across different verticals and buys their automotive tools from some of the same factories that supply both Snap-on’s and Harbor Freight’s tool competitors.  The fact that there was incremental interest among mechanics to visit Harbor Freight which focuses on private label tools at a lower price point is additional evidence to me that elasticity of demand to Snap-on’s premium pricing strategy coupled with enhanced and intensified competition are factors causing the Company to perform “below standard” in their core Tools group business.  I do not agree with management that the cause is solely attributed to “macro issues” although based on the recent price action at SNA, it’s possible that the market does agree with the “macro” excuse and is looking beyond the macro issues towards an improving macro environment.  If the macro environment does improve and yet the below-expectation performance across the core Tools group business continues, then perhaps market participants will then think otherwise.           

Although Snap-on is strongly positioned across its customer landscape based on product appeal, brand strength, innovation, and its pervasive distribution reach.  The competition is improving.  Snap-on’s total franchisee count declined by 0.5% last year and their U.S. units declined by a CAGR of 0.5% during the past five years.  Snap-on’s mobile van count is 75% greater than Matco, more than triple that at Mac in the U.S.  Including the international van channel, the difference is more.  Snap-on’s mobile count is almost 6x larger than the family-controlled Cornwell.  Snap-on’s mobile count is not growing because the Company has saturated the market footprint.  There are no attractive new territories for Snap-on franchisees and primary research highlights numerous franchisees already feeling marginalized by the scope of their territory.  There is much more “white space” growth across the important mobile van channel for SNA’s competition.  As more weekly interaction occurs at the repair shops from Matco, Mac, and Cornwell, I believe that this competitive factor has and will continue to impact Snap-on’s Tools Group performance.

During the Q4 earnings call, when the analyst from Longbow Research asked about any share loss from the competition increasing their number of trucks, SNA’s CEO said, “You could think that, but I don’t think so…you could argue that some locations might be seeing competition where they haven’t but there are a few locations…that don’t have any competition.” 

Snap-on is an innovative manufacturer of tools and its products are durable.  I did not identify much discontent with the Company’s product but there is consensus across the customer landscape with whom I conducted primary research that Snap-on’s prices compel customers to increasingly consider the alternatives.  Some customers have only recently seen vans from Matco, Mac, or Cornwell discuss their product catalog with these mechanics.  I am skeptical that the recent deterioration within Snap-on’s Tools Group is primarily ascribed to macro-related issues.        

The “normalized” environment for SNA is pre-COVID but the competition has improved since then.  For example, Matco has significantly improved its competitive position.  SNA’s Tools segment generated negative 0.3% organic growth during the past five quarters through Q1 of 2024.  This compares to 1.5% growth at Matco.  During the first quarter, SNA’s Tools group declined by 7% while Matco grew by 0.6%. 

There is no argument across the customer and franchisee landscape with whom I conducted primary research that competition from Matco has improved and that is validated by the recent results.  Although Matco’s relative growth is off a lower base, the degradation to SNA’s performance is more than the “macro” which the CEO seeks to direct blame.  Other competitive brands include Carlyle (NAPA), Craftsman, Dowidat, Facom, Felo, Gedore, Hazet, ICON, Koken, KTC, Milwaukee, PB Swiss, Pittsburgh Tools, QUINN, Stahlwille, Tekton, Tone, Vessel, Wiha, and Witte.  Consolidation could occur across the competitive landscape and thereby enhance the combination’s relative strength against Snap-on.

In addition to competitive landscape challenges, SNA will likely continue to confront structural challenges as the Company’s most valuable customer gets displaced by industry consolidation and/or closures.  SNA’s most valuable customer has historically been the independent automotive repair shops but the rationalization of units across the independent automotive repair landscape is a compromising factor to the Company and its franchisee partners.  An advisor to the independent automotive repair shop industry said he expected 0.5-1% of annual attrition.  The decline of independent repair shops is an ongoing industry landscape trend and it’s not favorable to Snap-on.  There are a variety of factors that have driven this decline.

In 2019, nearly half of auto repair shops were owned by individuals who were at least sixty years old and according to an industry survey then, 30% of those owners were thinking of leaving the industry by 2024.  That sentiment was recorded before the onset of COVID which further influenced intentions to leave the industry.  During 2000, more than 6,000 repair outlets were permanently closed.  Most closures were ascribed to COVID-related hardship and economic challenges; independent service and repair shops were disproportionately impacted.  “The traditional auto repair shop is disappearing.  Us independents have declined by double digits since 2018,” said one primary research respondent.  Much of the decline can be ascribed to the aging demographic across independent shop owners, the struggle to find and retain mechanics because of low starting wages, and the increasing vehicle complexity.

In recent years, the auto repair industry has undergone notable changes.  As vehicles evolve to integrate advanced technologies and become more complex, the traditional concepts of repair and maintenance have rapidly changed.  These rapid changes have exacerbated the shortage of skilled technicians and especially because the median salary for an automotive mechanic remains so low.

A repair shop owner said, “It cost too much to acquire the necessary tools and train technicians to repair some car makes these days.”  He described how an alignment on an Audi a decade ago would take 1.5 hours but that is now 3-4 hours because of the advanced driver assistance systems which require that a technician calibrate the sensors and cameras during what historically was a routine realignment exercise. 

A longer-term challenge for independent repair shops is when EVs become a more significant part of the vehicle population but the near-term challenges persist as ICE and Hybrid vehicles come with more “bells and whistles.”  Another shop owner complained that the AC systems are now different on several cars and that requires him to purchase a new machine costing $15,000 to service them. 

There are 40,000 fewer light vehicle service bays versus five years ago largely because of the rationalization of the independent repair shops.  The number of service bays decreased in spite of the 4% increase of vehicles-in-operation.  This partially explains why auto repairs take so much longer.  The declining share of independent repair shops is an industry shift for the aforementioned reasons but also because some dealerships have mobilized a strategy to expand their DIFM market share by repairing all-makes and all-years of vehicles. 

Snap-on’s high margins can largely be ascribed to its strong brand that is reinforced with lots of customer engagement but the allure of the “Snap-on” brand is diluted across dealerships focused on cost efficiencies.  Although Snap-on sells to dealerships, non-independents and to the owners of independents through its Repair Systems & Information Group (“RSI”), the Company is strongest when selling tools through its franchisees to the mechanics.  That business segment—the Snap-on Tools Group--plus Financial Services which primarily serves the Company’s franchisees to enable them to sell to the technicians was almost 60% of total Company EBIT last year.  As more sales get generated through RSI and especially across OEM dealerships and larger auto repair platforms which are gaining share, the balance of power shifts more towards the buyers.  During the past two years, RSI grew CAGR at 8.9%, more than double the 3.8% CAGR at SNA’s Tools Group.

Through much primary research, it is clear that Snap-on’s brand resonates with its customer segment community but it’s also clear to me that there are both structural and competitive dynamics that will likely challenge the Company from maintaining its share unless it compromises margin to do so.  As sales to dealerships and national chains grow, SNA’s direct sales increase accordingly since management believes that larger customer organizations can be serviced more effectively by direct sales people employed by the Company.  However, this comes at the detriment of the Company’s franchisee “partners.”  This was reinforced by franchisees with whom I spoke who commented about some territories shrinking and becoming less viable.  “There are too many garages going out of business,” said one primary research respondent.

Although there are many prosperous franchisees with the top third averaging $1.2M of revenue, there is a broad-based level of discontent across these small business owners.  The bottom third of franchisees generate average revenue of $0.5M, the middle third generates $0.8M.  Franchisees generally view themselves as being trapped in a cycle of debt as dictated by the Company as lender charging its “partners” interest rates with an average yield of 17.7%.  Management has communicated that the high borrowing cost is commensurate with the quality of the borrower. 

One franchisee said, “…I’ve never been more miserable…it’s more about chasing money than it is selling stuff.  It’s exhausting being lied to about hacked cards and forgotten wallets…The tool loan and truck payment eat up most of your profits.  I was lied to by the dealer who I did ride-alongs with as he gets an incentive for referring people…I personally would not recommend this franchise to anyone.”  Another franchisee who is happy with his route said, “It’s not Snap-On’s fault for offering 29.9% financing to people that don’t have good credit nor is it Snap-On’s fault for not having a platinum route driver that can get 9.9% financing.  People should know the cost of credit before they sign.”

One can research multiple historical complaints and lawsuits from the Company’s franchisees to reinforce the unsettling relationship the Company has with its “partners.”  In addition to the discontent and stress across the franchisees because of their personal high borrowing costs in a slowing market, they harbor the additional responsibility, or “burden”, to collect on receivables driven by their sale of tools to a levered customer base earning a median salary below $50,000.

I have not seen any research that focuses on the competitive, structural landscape, and elasticity of demand issues that I researched and described as core components of my short thesis.  That said, I do not have much sell-side access so it’s possible that some of which I described has been highlighted by others. 

The Company’s Financial Services segment is a critical ingredient driving the Tools group.  Financial Services is mentioned 124 times in the Company’s annual report.  The word “tool” is mentioned 173 times.  We know that Snap-on is a tool company but its reliance on driving sales through the Company’s Financial Service segment is a key ingredient to SNA’s success.  However, extending credit to mostly sub-prime credits also comes with significant and lingering risks. 

SNA provides financing programs through Snap-on Credit LLC to facilitate the sale of its products and to support its franchise business.  SNA’s Financial Services customers are franchisees’ customers, principally serving vehicle repair technicians, and franchisees who require financing options for vehicle and business needs.  Finance receivables are extended-term payment contracts to both technicians and independent shop owners with average payment terms of ~4 years.  Contract receivables are extended-term payment contracts with payment terms of up to 10 years.  These receivables include independent shop owners and national chains as well as loans to SNA’s franchisees so the Company’s “partners” can meet their financing needs including the purchase of van leases. 

I know there have been historical short theses premised on credit-related issues.  I think those issues continue to linger as an overhang but since some of that is well-documented and that tail risk has yet to materialize after numerous years, I cannot assert that I have identified the near-term catalyst of a large charge-off that surprises the market.  I do not have access to those historical short recommendations from Grant’s, Off Wall Street, or CFRA which I understand framed deteriorating credit as a long-tail risk.  Those issues might be considered as being more “well-documented” but nevertheless there is a probable case for asserting that SNA’s credit portfolio further deteriorates and drives increasing bad debt expense as a potential catalyst for earnings to erode relative to expectations.  Although I cannot assert that with a high degree of confidence, recent results highlight that credit metrics are deteriorating as described below.    

·         As it relates to extended credit or finance receivables, TTM net losses of $58.6M represented 2.94% of the outstanding at Q2; that’s a large increase of 49bps from the prior year Q2 and close to the 2.93% printed Q2 of 2020 and 3.0% in Q2 of 2019

·         One might deduce from looking at the data that during Q2 of 2021-2023, the 2.33%-2.45% was much more favorable because of the fiscal stimulus benefits and the recently reported net losses will be the norm, at best.

·         The Company’s allowance for credit losses to finance receivables was 3.48% at the end of 2023; since 2015, the peak was 2020 at 4.38% which then trended lower in 2021 (3.9%) and 2022 (3.39%) before the small increase recorded in 2023

·         During 2018-2019, the allowance for credit losses to finance receivables was 3.65-3.71%; it’s likely that SNA’s allowance will increase to at least that level

·         It’s notable to highlight that the auto delinquency rate in the U.S. has recently surged to its highest level since 2010.  I have not conducted the analysis but I suspect there’s some degree of correlation with deteriorating credit metrics at SNA.

·         60-plus day delinquency across SNA’s extended credit is rising:  Q2 2024 was 1.6%, up 30bps from Q2 2023; the year-over-year increase began in Q4 2023

I think it’s relevant to frame SNA’s valuation without applying a multiple to the Company’s financial services earnings but to look at the Book Value of the Financial Services segment when valuing Financial Services.   The Company has grown its Financial Services book value, on a CAGR basis from 2019-2023, at 3.7%.  Its book value was ~$401M, or $7.62, at the end of Q2.  If one were to value it at 2x, or $15.23, the implied valuation for the remainder of SNA on an LTM basis is over 13x EBIT and over 12x EBITDA.  If sentiment were to change to re-rate SNA by one multiple, that’s ~$20 per share of equity.        

On the surface, SNA does not appear expensive trading at 14.6x and 14.1x consensus earnings estimates for 2024 and 2025, respectively.  However, there are a variety of ways to frame valuation and it’s highly questionable that one should ascribe a 14x earnings multiple to SNA’s Financial Services segment.  As noted, if one were to value Financial Services at 2x Book, the implied valuation of SNA on an LTM basis is over 13x EBIT and over 12x EBITDA.  In a slow growth, mature industry where the Company’s premium pricing strategy is increasingly vulnerable and competition has proved to be more effective, I think that is a full valuation.  At 10x EBITDA for the core business and 1.5x book ascribed to the Financial Services segment, that is equivalent to ~$231 or ~18% downside. 

Pursuant to the aforementioned quarterly reports that demonstrated weaker organic growth, consensus estimates for this year were adjusted accordingly such that SNA is forecasted to grow top-line and EPS by just 0.1% and 2.4%, respectively in 2024.  Relative to current expectations for 2025, I think earnings expectations will reset lower which will concurrently cause a re-rating of the multiple to be lowered as well.  Based on my research, I am dubious that the estimated 3.5% in top-line growth will be achieved next year.  Pre-COVID, the Company’s top-line averaged 1.7% organic growth with 3.4% its best top-line during the 2017-2019 period.  Management has noted the need to pivot towards lower priced tools for shorter payback to influence purchasing across the Company’s core mechanic customer segment.  With this stated management strategy coupled with my research pertaining to both the consolidation of the independent repair shop landscape and especially while some competitors are improving their distribution, I believe the landscape is less favorable for SNA and assume top-line growth at 2.5%.  I think that both industry and competitive landscape forces will force management to relinquish part of its premium pricing strategy, albeit they won’t admit to it but such will be apparent across more promotions and margin will compress some accordingly toward.  If the Tools group continues to confront challenges without significant offset from the other business segments, I think some patience of being short will be rewarded as described, or some alpha at the very least.

For those of you who have some training experience from Business Intelligence Advisors (“BIA”), you know what I mean with regards to the identification of deceptive communication red flags.  With commentary like “all those things are better than a poke in the eye with a sharp stick,” SNA’s CEO Nick Pinchuk is animated and passionate with his communication style.  From a review of three years of earnings calls, he is prone to hyperboles and being promotional.  That review provided me with a baseline of some context but my interpretation of recent communication from him that highlights multiple “protesting” is an example BIA red flags that suggests to me that he is being deceptive with regards to the magnitude of challenges at the Company.  I am not suggesting that he is intentionally being deceptive; there is of course a bias for all management teams to speak positively about their business.  My impression of communication from SNA’s CEO is the situation is worse than he is projecting or perhaps willing to acknowledge.  There are undoubtedly some macro-related challenges as management highlights but I believe the magnitude of challenges in the Tools segment are deeper than macro-related and most specifically related to both intensified competitive and elasticity of demand challenges that SNA has yet to acknowledge.

Selected Risk Considerations to Short Thesis

·         Indiscriminate “catch-up” trade:  SNA has underperformed the S&P by ~1600bps during the past year and recent rotation towards both small and mid-caps reinforced by capital flows might be a headwind for the short thesis, at least in the near term, as passive investing and “allocators” overwhelm fundamental analysis. 

o   Mitigating factor:  if this is the case, then one might benefit accordingly more from their long portfolio across selected market caps.

·         Favorable secular growth trends pertaining to the aging car parc and accelerating rates of technological change across vehicles, albeit very well-documented, support the market for vehicle service and repair growth. 

o   Mitigating factor:  indeed this is well-documented and is likely among the factors enhancing the competitive landscape as reinforced by the relative unit growth from the competition across their respective mobile van channels.  SNA’s durable brand and quality tools is not disputed but the magnitude of the Company’s premium pricing strategy is confronting elasticity of demand issues that are likely ascribed to both the macro issues to which SNA management ascribes blame but also definitely competitive factors which SNA management fails to acknowledge.

·         Recent strength at both the Repair Systems & Information Group (“RSI”) and Commercial & Industrial Group (“CI”) could offset the degradation of the core Tools group business.  The majority of my research was focused on the Tools group segment and the Financial Service segment that enables much of the sales within the Tools group.  However, both the RSI and CI segments grew organically this past quarter and could continue to manifest strength.  RSI consists of business operations serving primarily owners and managers of independent repair shops and OEM dealerships through direct and distributor channels.  CI consists of business operations service a broad range of industrial and commercial customers including what SNA characterizes as “critical industries.”  Those “critical” customers are across the aerospace, natural resource, government/military, power generation, transportation, and technical education market verticals.  During Q2, RSI’s 1% organic sales gain was ascribed to high single-digit gain in activity with OEM dealerships but this was partially offset by a mid-single-digit decline in sales of diagnostic and repair information products to independent repair shop owners and managers.  During Q2, CI’s 1.2% organic sales gain was ascribed to a double-digit gain in sales in critical industries but partially offset by a double-digit decline in the segment’s power tools operation and a low single-digit decline in the European hands tool business. 

o   Mitigating factor:  I think some of the RSI strength is likely ascribed to numerous dealerships ramping up their service business to be more diversified towards other vehicle manufacturers and therefore having to purchase the appropriate tools and systems accordingly to address their repair service strategy but ramp-up activity will prove to be a non-recurring benefit to Snap-on.  The weakness across the independents remains notable.  CI business exposure will inherently be lumpier as evidenced by its 2.5% organic decline during Q1 and is not likely to become big enough in the near-term as part of the Company’s overall mix.  For the period 2019-2023, CI’s sales grew at a CAGR of just 2% which was one-third the overall Company’s growth rate.    

·         Buyback authorization remaining at over $270M:  Since the beginning of 2023, the Company has repurchased ~3% of its outstanding shares.

o   Mitigating factor:  when management is asked about their capital allocation priorities, the CEO emphasizes the dividend more than the buyback and the relative underperformance at SNA to the S&P this past year is some evidence that the buyback has not enhanced the Company’s stock performance.  That said, the balance sheet is strong enough as evidenced by the Company’s credit rating with S&P at A- and with Fitch at A to enable the buyback.  The fact that it might not make economic sense for the Company, in my opinion, to repurchase shares at the current level is irrelevant.  During the first half of 2024, the Company repurchased ~$118M of stock at ~$279.

·         Consistency of dividend payments:  Management likes to communicate their consecutive quarterly cash dividends, without interruption or reduction, since 1939.  This is indeed an impressive track record and undoubtedly there will always be longer-term shareholders who might have a low cost basis and/or not motivated to exit nor trim their position through the “turbulence” of short-or-medium term underperformance.

·         Technically the current stock chart might arouse those that solely focus on buying positive MACD coupled with a stock that recently moved above both its 50 and 200 DMA.  I am an investor that focuses almost exclusively on the fundamentals but I have learned to respect the technical issues for tactical purposes.  A risk I recognize for some who primarily focus on the technical issues, they or the “machines” might deem SNA to now be a quality chart despite the fact that the stock would have been providing a negative signal a couple of weeks ago when it was below its 50 and 200 DMA coupled with a negative MACD.

o   Mitigating factor:  risk management, duration of time advantage.

·         Real estate:  The Company operates through facilities and offices totaling 8.7M SF and owns 72%.  I have conducted no research to opine upon the possibility of “higher and better” use to such real estate that might create additional shareholder value.

·         Acquired at a premium control valuation:  this is always a risk across short portfolio other than mega caps.