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Genuine Parts Company: No Longer Undervalued

GuruFocus.com
·7 min read

The last time I wrote about Genuine Parts Company (NYSE:GPC), the stock, along with the rest of the market, was in the midst of free fall. Shares of Genuine Parts suffered a steep decline due to the pandemic. The stock had fallen nearly 53% from the beginning of 2020 through the publication date of my last article on the company.

At that time, Genuine Parts traded with a forward price-earnings multiple of less than 11 and paid a dividend yield of 5.2%. The valuation was well below its 10-year average and the dividend yield was considerably higher than the long-term average. I felt that a reversion towards the mean valuation could offer as much as a 41% return in share price, not including the dividend yield.


Fast forward to today and the stock has outperformed even my very bullish case. The stock has gained nearly 56% in nearly five months.

Shares still provide a 3% dividend yield, but the valuation is now high. Should investors be buying the stock following the gain in share price? In this article, we will look at recent results and current valuation to answer that question.

Quarterly highlights

Genuine Parts reported second quarter earnings results on July 30. Revenue decreased 14.2% year over year to $3.8 billion, missing analysts' estimates by $505 million. Adjusted earnings per share decreased 10.2% year over year to $1.32 but managed to come in 40 cents ahead of what Wall Street was anticipating.

Excluding the company's sale of its EIS Inc. subsidiary, revenue was lower by 10.1%. Acquisitions added 4.2% to growth. Removing a non-cash goodwill impairment charge due to operations in Europe and restructuring charges, Genuine Parts' adjusted net income from continuing operations declined 11.6%. The difference in EPS and net income declines is due to a smaller share count compared to the second quarter of 2019.

Revenue for the Automotive Group, which represented 65% of total sales, decreased 10.1% to $2.5 billion. Total comparable sales fell 10.1%.

North America had few bright spots. U.S. comparable sales were down a mid-teens percentage, but e-commerce sales more than doubled during the quarter. Do-it-yourself sales were strong, but only 20% of Genuine Parts' business comes from this channel.

Sales in Canada were also down double-digits, but profit margins expanded more than 400 basis points due to cost controls. Genuine Parts reported that no independent stores in North America were closed due to Covid-19.

Europe was significantly impacted by shutdowns in the UK and France. Sales were very weak as a result in April and May, but Genuine Parts did see positive growth in June as restrictions eased. Even in a difficult environment, Europe had year-over-year sales growth in May and June.

The Australia and South East Asia region experienced solid do-it-yourself results, though New Zealand was a headwind.

When adjusting for the previously mentioned EIS divestiture, the Industrial Parts Group had a revenue decline of 10.2% to $1.3 billion. Comparable sales fell 16.7%.

North America was especially weak as most industry sectors faced headwinds in the quarter. This includes the auto, equipment and machinery, iron and steel and oil and gas sectors. On the other hand, safety products grew with a high teens rate while food products, chemicals and allied products held up fairly well.

Genuine Parts' purchase of Inenco last year helped the company gain more of a footprint in South East Asia and Australia. Inenco produced positive sales in June, but lockdowns in this region were an overhang on results.

Gross profit margins expanded 76 basis points to 34.1%, the eleventh consecutive quarterly increase. Product mix, acquisitions and pricing helped Genuine Parts to see higher margins. Cost savings helped drive a 13.6% decrease in expenses.

Genuine Parts ended the quarter with $13.3 billion in total assets. The company had $1 billion in cash and cash equivalents at the end of June, which when added to $1.6 billion of unused credit capacity gave Genuine Parts $2.6 billion in total available liquidity.

The company has $3.2 billion of total debt. The average interest rate on all debt is 2.85%.

Like many industrial companies, Genuine Parts' second quarter was as dire as expected. The company did miss on revenue estimates, but greatly outperformed expectations for EPS. One quarter of subpar results due to extenuating circumstances doesn't change my opinion on Genuine Parts. There is still a high demand for its products in a more normal operating environment.

There remain some long-term pluses that I have previously discussed, including an aging fleet of vehicles. For example, in the U.S., more than 70% of vehicles on the road are at least six years old. This is often when vehicles become much more expensive to maintain. The global automotive aftermarket is approximately $200 billion. This industry is highly fragmented and growing at ~2% per year. At last report, Genuine Parts controlled nearly 8% total of this market.

Valuation

According to Yahoo finance, analysts now expect EPS of $4.77 for 2020, down from $5.74 previously. Shares have a forward price-earnings ratio of 19.8 using Friday's closing price of $94.56.

Shares of Genuine Parts have traded with an average price-earnings ratio of 17.7 since 2010. In fact, this would be the second highest EPS multiple since at least 2004 if averaged for an entire year. The only other year where the stock averaged a higher valuation is 2016.

I had previously had a target valuation range of 13 to 15 times EPS due to uncertainty in the economy. While the second quarter may have been the low point, some uncertainty still remains as the virus doesn't appear to be slowing very much, at least in the U.S. Therefore, I am maintaining my valuation range and would become interested in the stock at $72. For those who don't mind paying the average multiple, $84 would be the target price.

Final thoughts

As expected, second quarter results were poor compared to the prior year, but this was due largely to the pandemic. Genuine Parts still sits in a leadership position in its industry with room for future growth.

The stock also offers a 3.3% dividend yield even after more than a 50% rise in share price since the end of March. This yield is still higher than the stock's 10-year average yield of 3% and nearly twice that of the average yield of the S&P 500. At 64 years, Genuine Parts has the fourth longest dividend growth streak according to The Dividend Investing Resource Center.

However, as much as I like Genuine Parts the company, I am now moving to the sidelines on the stock as the valuation is much richer than I am willing to pay at the moment. At the same time, I'm not advocating profit taking, especially for dividend growth investors. The company pays a solid yield and has more than six decades of dividend growth. I believe the stock to be a hold today.

Author disclosure: the author is not long any stocks mentioned in this article.

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This article first appeared on GuruFocus.