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Is Snap-On an Ideal Dividend Growth Stock? 3 Pros, 3 Cons

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  • SNA

Snap-On (NYSE:SNA) is a classic dividend growth investment, or “DGI.” DGI names like SNA stock have a few major, common traits. They tend to operate in conservative or under-the-radar industries. They’ve been in business for decades. Their management has proven their ability to adapt with the times. And their dividend is a central part of the investment thesis. Investors who use stocks to generate income rely on these names as the core of their holdings, as they tend to fare better during difficult times than the market as a whole.

I personally own many DGI stocks. And within the industrials space, I just started a long position in Snap-On’s peer, Illinois Tool Works (NYSE:ITW). Why’d I pick ITW and not SNA stock? Let’s first take a look at the cases against and for SNA stock.

SNA Stock Cons

Core Business Struggling: Over the past year, the organic sales of Snap-On’s hand tools business have declined slightly. Snap-On’s management seems somewhat confused about the issue, downplaying fears about competition. The company intends to keep rolling out new products, trying to pique the interest of consumers.

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The sales losses and operating profit margin declines of the tools business have been particularly steep in recent quarters. Snap-On’s other segments have been stronger, and the company has realized significant gains from currency fluctuations. But with hand tools making up nearly half of the company’s revenues, Snap-On needs to fix that business before its long-term outlook can become favorable again.

Earnings Gains Aren’t From Its Businesses: As Snap-On’s earnings recovered over the last several months, SNA stock has rebounded after falling early this year.

However, much of Snap-On’s earnings rebound was generated by items that are unrelated to its core businesses. The tax cut, in particular, is delivering big, cosmetic upside to the company’s net income and earnings per share. Once next year rolls around, however, we’ll lap the effect of the tax cut, and the company will need to find a new lever to raise its earnings. Yes, the company is still buying back SNA stock. But with SNA stock back near new all-time highs, the buyback will provide less of a tailwind than when the stock was trading lower. And currency fluctuations are providing a big boost this year that could reverse at any time.

Tariff Uncertainty: I remain unconvinced that the talk and bluster about a global trade war will amount to much. However, if that view proves to be wrong, SNA stock could fall.

The company is quite exposed to raw commodity prices, with steel in particular being a major determinant of its profit margins. If Trump become totally protectionist, we should expect steel prices to rise, and Snap-On will likely have problems distributing its products in certain foreign markets. While trade uncertainty won’t have a major impact on Snap-On for some time, short sellers are already piling into the stock, likely in large part due to this potential risk.

SNA Stock Pros

Great Brand: Snap-On has a great brand, as its products are known and loved by their primary users in the repair sector. Snap-On has consistently been able to earn high profit margins over the decades due to the trust its users have in Snap-On’s merchandise.

While many brands are having trouble in the internet era, specialized products such as industrial goods are more immune to this pressure. Amazon (NASDAQ:AMZN) is unlikely to launch its own competing products, as it would in more generic categories such as batteries or generic drugs. And given the niche nature of Snap-On’s market, the company has far fewer major competitors than you’d find in other sectors. As a result, the company has a strong and durable moat which insulates it from economic cycles and short-term volatility.

Snap-On Credit: One of the major points that bears on SNA have emphasized is that the company is giving financing to its customers. This practice has caused Snap-On’s accounts receivables to rise significantly in recent years. In theory, during an economic downturn, repair shops might not be able to pay for the goods they purchased on credit from Snap-On, leading to an earnings shortfall for Snap-On and a major decline in SNA stock.

That is a real risk, but the bears could be blowing it out of proportion. Snap-On has been operating in this manner for many years now, and in the past it has been prudent about this program. Also, in general, its customers are not large companies that purchase a huge amount of products, so a few scattered defaults wouldn’t be disastrous. As it is, Snap-On has excellent credit and can thus obtain capital cheaply. It seems logical for Snap-On to use its ability to provide a value-added service to customers and collect some additional interest.

Strong Dividend Performer: Snap-On is not a dividend aristocrat. Unlike Illinois Tool Works or W.W. Grainger (NYSE:GWW), Snap-On hasn’t raised its dividend every single year for at least 25 years. However, Snap-On hasn’t cut its dividend since the 1980s, and the company has raised its dividend in most years except for rare occasions, such as in 2009.

Since the recession, Snap-On has been a high-achieving dividend company. Its quarterly dividend rose from 30 cents in 2009 to 82 cents today. That represents an increase of nearly 300% over the past decade. Anyone who bought the stock in 2009 is now earning a 4.8% yield on his or her cost. It’s tempting to look at the current 1.8% yield and say the dividend of SNA stock isn’t big enough. However, with the dividend growing more than 10% compounded per year, SNA is a perfect dividend growth investment.

The Verdict on SNA Stock

Bears have piled into SNA as it approaches its previous resistance at the $185 level. Incredibly, 13% of the float of SNA has been sold short. That’s a massive figure for a company with such a staid and conservative business. The short sellers are betting on a breakdown in the company’s accounts receivables or an issue with tariffs.

That is a highly risky move on their part. All signs point to SNA breaking through resistance and challenging the $200 level in coming months. Trading at 17 times its trailing earnings and 14 times its forward earnings, SNA is hardly expensive compared to the overall market. Yes, the company is having some operational issues right now. Over the decades, though, it has shown the ability to bounce back quickly. SNA stock seems poised for more gains going forward. That said, I personally bought ITW stock as it is near its 52-week lows, rather than SNA stock which is near its highs. But both stocks should advance further.

At the time of this writing, Ian Bezek owned ITW stock.

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