Value Investors Club / SNAP-ON INC (SNA) (SNA)

Description

Snap-On Inc. (SNA)

Snap-On (SNA) is a designer, manufacturer, and marketer of auto and industrial tools and

equipment. Products SNA sells range from wrenches, screwdrivers, and tool storage boxes to

vehicle lifts, tire changers, and software based auto diagnostic equipment. SNA’s primary end

customers are auto mechanics, auto repair shops, auto OEM dealerships, and non-auto industrial

companies.

SNA stock is currently trading for $160/share and is up over 250% in the past 5 years. Given the

Company’s current valuation of c. 20x LTM P/E, we believe the market is overlooking both SNA’s

increasing reliance on its financing business to drive sales growth and the potential slowing of

SNA’s core end markets. Fair value for SNA is likely sub $100 / share.

For background, SNA has three operating segments and an in-house financing business. SNA’s

Tools segment, which is c. 30% of EBIT, earns revenues through franchise fees the Company

charges its franchisees. These franchisees generate revenue by selling tools and equipment to

independent auto mechanics. SNA’s franchisees do not sell in a typical brick and mortar retail

operation, instead they drive around vans that are effectively mobile stores.

Next, SNA’s Repair Systems & Information (RS&I) segment, which is c. 30% of EBIT, sells

diagnostics repair software, handheld and PC-based diagnostic equipment, inaddition to

undercar equipment and parts catalogs directly to auto repair shops and OEM dealerships. RS&I

also sells diagnostics equipment (handheld tablets) to SNA’s Tool segment franchisees, which

then sell the software and equipment to independent auto mechanics.

Further, SNA’s Commercial and Industrial (C&I) segment, which is c. 20% of EBIT, sells tools

(wrenches, etc.) to industrial customers in the power, oil & gas, mining, military, and aerospace

& defenses sectors as well as the U.S. Government. A majority of C&I sales are earned

internationally. SNA earns the remaining 20% of its EBIT by extending financing. 80% of loans SNA

extends are to mechanics its franchisees sell products to and the remaining 20% of loans are

made to franchisees. When SNA extends financing to mechanics it is for “big ticket” items only

(e.g. a tool storage box that costs $10,000 or diagnostic equipment that can cost a similar amount

as well). Almost all loans are 100% loan-to-value.

SNA has become increasingly reliant on financing sales to the mechanics it sells tools and

diagnostic equipment to, we believe this is inflating growth and unsustainable. Over the past two

years loan originations as a % of total Tool segment sales is up over 1000bps, and is significantly

above prior cycle peak levels. This is notable, because the Tools segment is now driving a majority

of SNA’s organic operating growth. Furthermore, franchisees have recently commented that they

are extending an increasing amount of credit to customers that have become price insensitive as

customers have $0 of initial out-of-pocket costs (given 100% LTVs).

While increasing financing availability will drive short term sales growth, we believe growth

deterioration will be even more pronounced once growth slows, which could be soon. Recent

commentary from franchisees also suggests that they are becoming cautious that growth may

stall as the end customer has no need to continuously purchase “big-ticket” items if they recently

made such a purchase. A number of “big ticket” product introductions were made in 2015,

including SNA’s 95

anniversary tool storage box and new diagnostics product, which also helped

spur big-ticket sales in 2015. As these introductions are lapped in 2016, the Company should face

headwinds in both its Tools segment as well as Financing segment. Furthermore, commentary

from franchisees also suggests that sales growth was relatively muted in early 2016, but then the

Company decided to slightly loosen its credit standards and increase offered promotions.

Consequentially, Q1 2016 origination growth nearly doubled Tools segment growth. Lastly, the

value that the market is ascribing to the financing business is also stretched - simply applying a

sector multiple to SNA’s financing business implies almost $20 of downside to the stock.

In addition to SNA’s financing business likely propping sales there are other signs emerging that

point to a potential slowing of sales for SNA. Repair work directed towards independent

mechanics and repair shops (SNA’s two largest customer groups) benefited from the suppression

of U.S. auto sales following the Great Recession and the consequential increase in vehicles that

are older than five years; repair shops classify their target market as vehicles that are 5 to 13

years old. Typically, cars are 5 years or younger carry dealership warranties.

The amount of new vehicles that are aged 0-5 years is expected to grow over the next several

years as recent U.S. auto sales have been relatively strong and the amount of leased cars returned

to dealerships increases - total vehicles leased increased from 11% in 2009 to 22% in 2015. This

influx of used vehicles aged c. 3 years will likely replace older vehicles on the road. The mix shift

to younger cars is noteworthy as the margins SNA earns from OEM dealers is not only lower than

what SNA earns from independent mechanics and auto repair shops, but also because OEM

dealerships are also less reliant on SNA for tools and equipment. Further, recent survey data of

independent repair shops shows that the amount of independent repair shops that plan on

purchasing new capital and diagnostic equipment has decreased over the past few months.

Lastly, SNA’s C&I segment has already begun to experience headwinds driven by its oil & gas and

U.S. Government exposure. While the Company has historically cautioned investors about its U.S.

Government exposure, the Company significantly missed Q4 organic growth expectations in the

segment (sales growth was negative) and attributed most of the large negative surprise in sales

growth to its oil & gas exposure. Thus, either the Company had historically understated its

exposure to oil & gas or did not understand challenges it faced in the business. Despite the

headwinds in the segment only beginning to notably materialize in Q4 2015, broker estimates for

this segment were slow to change for 2016. While the Company beat consensus expectations in

this segment for Q1, the year over year comparable growth number remain challenging – SNA

should continue to disappoint estimates in this segment until it completely laps its oil & gas

headwind, particularly given the beat in Q1. Further, there could be even more pressure in the

segment if any of its other end markets begin inflect negatively.

Despite the current and potential headwinds SNA is facing across its different segments, sell side

analyst estimates have not been revised downwards. We believe the slowing of organic sales

over the next 12 months should lead to a material de-rating of SNA’s stock price to sub

$120/share as the Company’searnings miss consensus estimates and its multiple subsequently

compresses.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Earnings

Lapping of big-ticket items

Origination growth continues to outpace tools growth

Reduction of average fleet age

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			2016	2017
Price:	163.00	EPS	0	0
Shares Out. (in M):	58	P/E	0	0
Market Cap (in $M):	9,500	P/FCF	0	0
Net Debt (in $M):	780	EBIT	0	0
TEV (in $M):	10,280	TEV/EBIT	0	0
Borrow Cost:	Available 0-15% cost