Sunday, October 23, 2011

Is Genuine Parts Company A Genuine Value Stock?






Genuine Parts Company $GPC is a stock that provides a compelling combination of cyclical growth and defensive stability. The recent results were impressive and it is a stock which is a prospect worthy of equity research reports. What makes GPC attractive is that as, a distributor with diversified end markets, it has the ability to decrease working capital in a downturn.

Furthermore, its largest division (Automotive) has the potential to do well in a recession. Although passenger miles do go down in a slowdown, the average age of a car tends to go up as consumers hold off purchases. And older cars need more spare parts. It is an industry trend that has benefitted the likes of pure automotive stock plays Autozone $AZO and O’Reilly Automotive $ORLY.


Genuine Parts Company

However, Genuine Parts Co is a stock that is about a lot more than automotive parts distribution. They also have a cyclical industrial division and small electronics & electrical division (EIS). In addition there is an office products distribution business which has diminished in importance to the GPC over the years.  To demonstrate the evolving nature of turnover and profitability, here is a breakdown of the last five years for Q3…



Division Profits (k)
Q3 2007
Q3 2008
Q3 2009
Q3 2010
Q3 2011
Automotive
115,023
111,730
107,735
124,059
141,233
Industrial
69,669
77,220
36,495
72,856
97,191
Office
33,183
33,426
26,692
26,657
27,024
EIS
7,685
10,272
6,802
8,393
11,138
Total
225,560
232,648
177,724
231,965
276,766



Now clearly, the automotive division is a lot less cyclical than Industrial whilst the office products division is stuck in a rut due to the ongoing rationalization of employment and ultimately office fit outs. However, the key to understanding this business is how Genuine Parts Company is capable of reducing working capital requirements in the face of a recession. This results in favorable free cash flow generation potential over the course of the cycle…




2007
2008
2009
2010
To Q3 2011
Net Income
506,339
475,417
399,575
475,511
430,159
Depreciation & Amortization
87,702
86,698
90,411
89,332
66,938
Change in op assets & liabilities
47,430
(33,806)
355,312
110,055
(311)
Op Cash Flow
641,471
530,309
845,298
678,663
497,408
Capital Expenditures
(115,648)
(105,026)
(142,259)
(85,379)
(63,932)
Free Cash Flow
525,823
425,283
703,039
593,284
433,476



…and at the Q3 results presentation, the management said this with regards cash flow generation for the full year 2011…

'While our several consecutive years of strong cash flow, we expect to generate strong cash flows for the full year and continue to estimate cash from operations of approximately $700 million for the year. At this level, free cash flow after deducting capital expenditures and dividends should be more than $300 million, which is in line with last year. We are pleased with the continued strength of our cash flows and remain committed to our ongoing priorities for the use of the cash.'
In other words with capex forecast at $105m this means 2011 free cash flow is likely to be at $595m.


Genuine Parts Company Evaluation

Now looking at the current stock price of $57.52 this equates to a market cap of $8,980m and an EV of $8950m. The last five years of free cash flow (across a difficult cycle)  average at around $568m which would GPC on a 5 year FCF/EV margin of 6.3% and this is pretty good value, especially as analysts are predicting 10% EPS growth for 2012. However, there are concerns. Most of the cash flow growth has come from cost savings, inventory reductions and greater working capital management. There is a limit to how far this can go.

Furthermore, net income has not really gone up in the last five years and industrial sales tend to fall off a cliff when the economy gets bad.  For example, in 2008 Industrial sales were growing at yearly rate of near 7% until Q3 then suddenly they fell to 0% in Q4 and then -16.4% in the first quarter of 2009.  It is worth noting how late in the year this drop off occurred. This suggests that the Industrial division tends to be a bit late cycle, so the strength we are seeing now could fall quite sharply if the economy worsens.

Frankly, I think it is better to hold a pure play like Autozone AZO or O’Reilly Automotive ORLY and then balance them with other more cyclical stocks than make an outright purchase of GPC right now.