SNAP-ON INC (SNA) SNA S
July 15, 2016 - 9:56am EST by
jbur
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

Sign up for free guest access to view investment idea with a 45 days delay.

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
th
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

    show   sort by    
      Back to top