Description

Generac was written up as a short by AtlanticD in 2014 and subsequently written up as a long by afgtt2008 in 2015. Both of these write-ups offer helpful context on the history of the business. A key point to this thesis is that contrary to what management would have you believe, the business has not changed meaningfully over the past 10 years. Generac is a manufacturer of generators with ~90% of operating profit derived from generator sales.

The short pitch today is fairly simple - similar to circumstances observable in 2011-2013, in which organic sales growth was driven by multiple unprecedented severe weather events, 2021 organic sales growth was +48% and management's targets imply +32% organic sales growth in 2022E. This impressive growth took place as the United States saw a record number of power outages in 2020 and the massive Texas winter storm in February 2021. 

We believe that the 2011-2013 period, referenced in AtlanticD's write-up, is a useful analogue in understanding how generator sales may trend over the next several years. GNRC's 2011 - 2013 organic sales growth of +29%, +38% and +17% was followed by organic sales declines of (8%), (13%) and (3%) in 2014 - 2016. There are other periods in the late 90s and early/mid-2000s which follow the same narrative.

The simple - and intuitive - conclusion is that generator sales are driven by severe weather which causes abnormal power outage events. When the power goes out, consumers go out and buy generators. The surge in demand causes Generac's dealer network to over-estimate their inventory needs. As weather normalizes (events such as Hurricane Sandy or the Texas winter storm are low likelihood and effectively non-recurring by definition), the "bullwhip effect" makes its way through the supply chain and manufacturer sales tend to decline as dealers work their way through bloated inventory positions. Generators are expensive, commoditized products with a 10-15 year lifecycle and little product innovation. 

Reviewing GNRC's organic sales history leads us to conclude that sales are cyclical (not by the typical definition, but in the context of severe weather events and associated boom & bust periods for generator sales). As such, it seems reasonable to conclude that the Company should trade at a below-average multiple if the market believed sales would revert to the long-term base rate of growth (as they did in three separate periods over the past ~25 years). However, GNRC trades meaningfully above historical multiples and consensus estimates suggest sales and earnings will continue to grow from a massively elevated base in 2020/2021. The earnings estimates & multiples at the top of this write up are based on consensus numbers.

What is the bull case?

Bulls seem to believe that this time is different for a few reasons:

-GNRC has spent a cumulative $1.4Bn building a nascent "energy technology" business over the past couple of years. Roughly 3/4 of these expenditures were used to acquire ecobee, a manufacturer of smart home thermostats, for $735mm, and Deep Sea, a manufacturer of generator controls, for $421mm. Equity research analysts point to multiples ascribed to Clean Energy businesses such as ENPH and SEDG to imply GNRC's "energy technology" business - including the two acquisitions referenced above - is worth over $7Bn. Yet when we spoke with two of these analysts to understand how that was possible, they shared a view that GNRC's "energy technology" businesses are likely worth less than the $1.4Bn acquisition cost

-GNRC management likes to point to a number of "mega-trends" driving the business, including increased prevalence of power outages and increasing power outage severity, both of which are accentuated by a notoriously unreliable grid system in the U.S. Our review of power outage data does suggest increased frequency of natural disaster events over time. Our response to the bulls on this point is what level of earnings power are you willing to capitalize? GNRC organic sales and earnings growth have historically averaged somewhere in the LDD over a long time period (15-20 years). Extrapolating that earnings growth from the pre-COVID period through today implies that the business is materially overvalued 

Risks

-The surge in sales & earnings growth, bubble-like market conditions and (what we believe to be unfounded) optimism for GNRC's energy technology business caused the stock to reach $500/share in late 2021. The stock has declined over 50% since peak, which would lead some to suggest "I missed it" - and bulls to argue that the stock is undervalued. Although management commentary on backlog levels suggests that dealer demand is starting to mean revert, recent history suggests it is perfectly possible for the stock to 2x back to peak

-GNRC's through-cycle sales and earnings growth are +LDD as referenced above. GNRC is a market leader with ~80% share of the core home standby generator industry. I don't think I would ever buy this stock, but optically I think the short case would be easier to stomach with a lower base rate of sales/earnings growth

-It is perfectly possible that we see another massive storm or power outage event in 2022/2023. The stock would likely react positively to news of such an event, and this would increase the likelihood that today's elevated levels of generator sales would continue

Catalyst

Normalization in residential generator demand