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.

Sinnerschrader Offers High Yield Plus Growth

Sinnerschrader is a micro-cap German listed company with huge potential to see a substantial stock price appreciation in the next few years. The transition from high street retail towards e-commerce is still ongoing and represents a key secular growth area in the economy and, interactive agencies like Sinnerschrader look set to benefit. Ebay $EBAY buying interactive agency GSI Commerce can be seen as an affirmation of how good prospects look for this industry. It is an interesting stock to do an equity research report on because it offers a blend of strong growth plus high cash generation, with a very strong balance sheet. There is even a high dividend yield too!

Sinnerschrader is an Exciting Growth Stock

The company is one of the top 10 interactive agencies in Germany and currently receives 89% of its revenues from ‘interactive marketing’. This involves developing and marketing internet based activities for a range of companies. In the past, Sinnerschrader has been highly dependent on a few large customers, however this risk is being reduced following the strategy of pursuing growth in new customers. I will discuss this again later. The other two segments are ‘interactive media’ which involves buying online ads for their clients and ‘interactive commerce’ whereby Sinnerschrader develops online shops for its clients.

The important thing to understand with this type of business is that it is relationship based. This carries risks- the staff could walk away with some clients- but also offers great reward as once a client is onboard the opportunity for a recurring ‘annuity’ type income stream is very strong. Indeed, the good news is that Sinnerschrader is aggressively pursuing new customer acquisitions which should lead to increased cash flows in time.

Growth Strategy

Not only are existing markets looking strong, but I believe the opportunity for future growth from areas like mobile applications is very good. Increasingly, the convergence between telecommunications and internet usage is being manifest in the growth of smart phone usage. Email and social networking are the ‘killer app’ for the internet and smart phones are capable of supplanting computers in this aspect. All of which, will mean increased demand for agencies that can integrate clients online offerings towards mobile. In addition, if mobiles are going to be the next payment device than there is an obvious synergy in companies marketing themselves to the customer via mobiles.

Sinnerschrader Results Statement and Stock Evaluation

The company gave its Q3 results on the 14th of July and they can be read here. I was pleased to see that Sinnerschrader is chasing growth, albeit at the detriment of reducing initial margins. With the new emphasis on growth, analyst estimates for revenue growth for this year are 25% to E30m with further revenue growth of 17% for next year. Ebitda for the next three years is forecast at E3.5m, E4.6m and E5.5m respectively. Now considering that the Enterprise Value of Sinnerschrader (stock price of E2.35) is E20.1m than on an EV/Ebitda basis this stock is far too cheap. Similarly, despite the working capital requirements necessary to fund the growth in the business, analysts have Sinnerschrader generating nearly 7% of its Enterprise Value in Free Cash Flow. Again, this is far too cheap for a company set to grow EPS by around 30% pa for the next two years.

Sinnerschrader trades on a forecast forward (Aug 2012) PE ratio of 10.7x and forecast dividend yields of  4.2% and 7.5% for 2011 and 2012 respectively.  I think this is too cheap.

Is McDonalds a Low Price Offering?

McDonald's But Not as You Know it!

McDonald’s $MCD is a fantastic business that is firing on all cylinders. The recent results sailed ahead of estimates and the company is clearly grabbing market share from Yum Brands $YUM and other competition. However, is all of this fully priced in?

As a potential investment McDonald’s has a strong appeal due to a number of factors which I’ve listed below

• From a macro-economic perspective it offers a play on austerity in developed markets as unemployment remains high and McDonalds offers a value meal proposition
• Within Emerging Markets, McDonald’s has a ‘Western aspiration’ brand that benefits from rising disposable incomes and urbanization
• McDonald’s has successful repositioned itself away from fast food junkies and leveraged its brand into launching newer healthier alternatives
• Customers are-thus far-tolerating price increases but price pressures are increasing

Around a decade ago, McDonald’s made a master stroke in taking a strategic stake in Prêt-A-Manger (in order to ‘learn’ how to service a different market) which has partly been behind the successful re-branding. Back then, it would almost have appeared inconceivable that McDonalds would be discussing the kind of product offerings and innovations that peppered the recent conference call. For example, beverage sales were up 29% and McCafe has seen far better than expected growth in sales per store. Premium chicken sandwiches, smoothies, oatmeal breakfasts and wraps are now alongside the traditional burgers, fries and milkshakes in the product mix.

Not only has McDonald’s successfully rebranding but they have managed to diversify and tailor the product offering to differing regions. Delving deeper into the Q2 numbers for regional sales reveals how this plays out

Region	Q2 Comp Sales Increase	Q2 Op Inc Increase
Global	5.6%	11%
Europe	5.2 %	10%
USA	4.5%	6%
APMEA	5.9%	19%

Clearly, the US is the laggard in terms of both metrics, however, it is the most developed region for the company and it has been grabbing market share from Yum as its rival focuses on Emerging Market growth. Moreover, Europe is actually the biggest market for the company and these results represent strong execution.

Commodity Costs Coming

On a less positive side, commodity costs are on the increase and although customers absorbed them well, margins fell in all three regions for McDonald’s. This is an obvious concern-not least for the demographics of a typical customer- but also for future margin expansion. No one likes to be a business with challenged margins. However, I think that with slower growth, going forward, within emerging markets, we could see a moderation in things like beef prices, which could help out McDonald’s margins.

In this report, the company saw cost increases of around 4-5% generally but that figure could come down going into next year. In addition, I think that the value proposition of McDonald’s means that demand should still grow even if the Asian economies start to slow.

International expansion

Turning to expansion plans for this year, here is a break down of where new store openings will be

Region	New Restaurants for 2011
Global	1115
Europe	225
USA	150
APMEA	650
Latin America	90

APMEA is how the company bundles Asia Pacific with the Middle East. Within the APMEA numbers, new stores for China are 200 and 100 and 30 for Japan and South Korea respectively. It is a misnomer to suggest that only Yum are expanding in emerging markets!

McDonald’s Stock Evaluation

Frankly, I think it is fairly priced and would struggle to see much upside from here. I know most commentators are saying this, but that doesn’t mean I should force myself into thinking something different for the sake of novelty!  The opportunity for margin expansion does exist via lower food prices and the growth strategy looks assured but at a current price of $88.56 the stock trades on 17.3x forward estimates. This drops to 15.8x for 2012 but should investors pay this evaluation for two years out earnings, given that earnings growth ($5.6 from $5.12) is likely to be less than double digits?

I think the answer has to be negative. The yield at 2.9% is decent and it’s a decent stock to tuck away long term, but this evaluation doesn’t look cheap enough to me. I will monitor and hope for a dip.

Check Point Raises Estimates

Check Point $CHKP gave results and both revenues and earnings were above consensus. Furthermore, Check Point raised revenue and earnings estimates for the full year, and the stock responded by crashing through a 52 week high. So is everything looking positive for the stock? I think it is.

Check Point was covered in an EarningsView research report linked here and this should provide some good background for the current results. Turning to these results a few key takeaways are

• Q3 Revenues forecast at  $300-308m
• Full Year Revenues Forecast raised to $1.23-1.25bn vs. a previous estimate of $1.19-1.23bn in January
• Full Year EPS forecasts raised to 277-284c vs. a previous forecast of 265-275c

Check Point Sequential Revenues

To put these numbers into context I’ve broken down the sequential revenues here.

 

(m)	Q4 08	Q1 09	Q2 09	Q3 09	Q4 09	Q1 10	Q2 10	Q3 10	Q4 10	Q1 11	Q2 11
Revenue	217.6	195.0	223.6	233.6	272.1	245.1	261.1	273.2	318.5	281.3	300.6
Seq growth %		-10.4%	14.7%	4.5%	16.5%	-9.9%	6.5%	4.6%	16.6%	-11.7%	6.9%
Cur Defer Rev	290.0	283.1	330.0	322.8	384.3	380.9	377.0	362.9	424.2	421.9	413.4
Seq growth %		-2.4%	16.6%	-2.2%	19.1%	-0.9%	-1.0%	-3.7%	16.9%	-0.5%	-2.0%
LT Defer Rev	40.8	41.9	32.1	37.4	41.0	38.9	37.7	33.4	40.4	38.6	43.5
Seq growth %		2.8%	-23.4%	16.4%	9.8%	-5.1%	-3.0%	-11.4%	20.8%	-4.5%	12.9%
Tot Defer Rev	330.8	325.0	362.1	360.1	425.3	419.8	414.8	396.3	464.6	460.4	457.0
Seq growth %		-1.7%	11.4%	-0.5%	18.1%	-1.3%	-1.2%	-4.4%	17.2%	-0.9%	-0.7%

Clearly, these results are good on a historically sequential basis and, it is no surprise that revenues and earnings forecasts were upgraded. Check Point is a relatively mature business that generates high amounts of cash flow conversion and provides investors with a compelling mix of value and growth. It is often compared with the likes of Fortinet $FTNT but Check Points end markets tend to be the larger enterprises who are in need of a comprehensive Network Security solution. In addition, the company is capable of scaling up margins and cash flow when markets are good because they offer a number of ‘blades’ with different functionality. In other words, once a company buys the platform from Check Point than they immediately become a potential customer for more blades.

Frankly, Check Point is the best in class in the sector and given continued global economic growth there is no reason why the company cannot continue to generate margin expansion. The main competition for Check Point comes from Juniper $JNPR and Cisco Systems $CSCO and with the latter in a stage of restructuring, for now, Check Point looks capable of growing market share. The question is whether the stock is correctly priced or not?

Check Point Evaluation

Turning to analyst estimates of EPS of $2.78 and $3.08 it seems that Check Point is set for low double digit growth in the next couple of years. At the current price of $59.3 (an EV of $11.43bn) Check Point trades on 21x and 19.2x earnings. Although, this seems rich, the high free cash flow conversion (around $684m) means that the share presents a compelling value proposition and I think there is a 15% upside potential to the price. A target price of $67.5 seems better value and I will wait for a dip before buying back in with that target in mind.