Friday, 16 September 2011

Company Focus - Snap On Inc. – Seeking to Maintain its Grip on the Auto-Trade.

In contrast to the previous post - viewing the localised macro-economic impetus of 'automotive glamour' -. this post is pointedly directed at the opposite end of the spectrum; one company that operates within a largely 'invisible' sub-sector which nevertheless acts as a cornerstone to the auto-sector across assembly, maintenance and repair arenas.

The subject, that of hand & service tools. The company: Snap-On - USA originated and publicly listed.

Presently at the macro-level the United States of America appears to be essentially re-shaping itself economically. The importance of a deflated US$ and cost base cannot be under-estimated, two fundamental parts of its effort to regain economic and inter-linked cultural global control. Whilst apparently officially on hold (given the extended 0% base rate announcement), the official re-deployment of a QE3 may still be waiting in the wings. Those 'Fed printed' sums used to continue a managed decline of the global reserve currency for the sake of US exports, but also critically to possibly provide the funds for an American-led liquidity injection into the ravaged EU Periphery sovereign debt markets - so as to stave-off or limit China's own 'EU rescue' interests.

From this perspective, the US$ looks to be the ever lengthened 'wrench handle' of international 'monetary leverage', whilst each of the EU's individual over-indebted countries could be seen as requiring precisely sized 'complimentary sockets'. Ironically then under this highly plausible scenario, as US debt is 'ratcheted-up', so the captive pressure applied upon near-default EU states becomes ever more acute.

[NB This, EU and MENA politicians no doubt well understand, an economic grasp on S.Europe to maintain influence, akin to the E.Europe 'missile shield' located to repel Russian influence. In short the re-emergence of US geo-political assertion].

Perhaps much to Athenian dismay then, never has Archimedes' phrase been so apt: “Give me a lever long enough, and a fulcrum on which to place it, and I shall move the world”.

The iconic Snap-On ratchet and socket-set then not only serves as a metaphor for America's mid-term geo-political influence over a fractured Southern Europe (and by virtue over the MENA region), but in its physical self is an industrial essential to the American way of life; a fundamental appliance for the economic rebuild of the nation.

The firm 'Snap-on' was established in 1920, exploiting the inter-changeable socket on single wrench idea first patented in 1863 by a J.J. Richardson.

One founding partner was a Joseph Johnson, whose initials 'serendipitously' reflect Richardson's. Whether the other founding partner William Seidemann purposefully chose Joseph Jackson to lend apparent 'authenticity' by association, whether Jackson himself altered his original name or whether of truly serendipitous nature (rare, given that manipulate is often masked as coincidence), the originator's initials were indeed duly connected. In 1920 the company started commercialisation of the 'wrench & multi-socket' – initially using 10 sockets on 5 wrench sizes.

To simultaneously gain a wider geographic coverage, avoid high production start-up costs and circumnavigate the close relationships between hardware shop owners and the existing tool trade, Snap-On chose to sell its products via a fleet of cars & vans. Using the capabilities of two new partners, Mssrs Stanton & Palmer, this enabled it to deal directly with the end-users within the then burgeoning US motor trade of the time, from car dealers to farm mechanics. This mobile distribution method allowed a fine tuning of production levels to demand levels, so enabling more efficient cash-flow management and avoiding the build-up of typical 'capital trapped' large stock inventory levels.

This lean-run, self-sustaining business model then allowed it to survive the ravages of the 1929-32 Great Depression, to benefit from Roosevelt's 'New Deal' spending and to again benefit from the USA's WW2 militarisation programmes.

It entered international markets in 1931, also in that decade offering credit / hire purchase to customers and was publicly listed as Snap-on Inc in 1939. (ticker NYSE: SNA).

However, it was focus on the automotive sector allowed it ride the ever upward growth of Detroit between 1920 and the late 1970s, the emergence of dominant town dealers, multi-brand dealers, semi-professional and home-garage mechanics spanning servicing, maintenance& repair aswell as automotive hobby segments such as hot-rods and muscle cars. Secondary arenas were other tertiary mechanical utility & hobby items such as ride-on mowers, motorcycles, power-boats and later quad-bikes, buggies etc. In response to the growth of the market, and so to serve immediately, company vans were turned into fully-stocked mobile retailing units. And critically, since the early 1980s it has nurtured a close association to genres of motorsport via sponsorship of both the Penske team in NASCAR and more recently a 'Funny-Car' dragster teams in NHRA.

Because the tools were precision die-cast and machined, comprised of a superior steel content and carried a life-time guarantee their quality became generally proven. This allowed the brand to become viewed as 'tool of choice' and the company to generate and maintain higher margins within an industry typically under constant competitive pricing pressure (strategic & tactical), thus cost-reduction pressure and scale-up pressure; all the hallmarks of a 'commoditized' industry. Thus Snap-On, along with (typically) nation-centric others sought to maintain a marked perceptional difference between itself and competitor-set; intentionally positioning itself from early-on within the top band of 'premium' vs 'middle-ground' vs 'price-sensitive' hand tools.

The renowned Swedish tool manufacturer Bahco was acquired in 1999 to provide greater international market reach, a secondary 'mid-point' brand application and capture operational manufacturing, back-office and presumably distribution synergies between the companies. Additionally the original premium product line '100% USA made' has been supplemented by an 'affordable' series called Blue Point, often manufactured outside the USA, primarily in SE Asia, the items are presented as offering Snap-On quality at a lower price point.

Thus 2 'sister' product lines have been created which not only provide a greater price-point coverage in top and mid tiers, but the use of the Blue brand colouring competes against and defends against other blue-branded automotive tool producers.

Regulatory and consumer forces of course forced the technical sophistication and complexity of vehicles, requiring diagnostic equipment for initially emissions control testing, but becoming critical to the service and repair of vehicles with ever evolving 'intelligent brain' functions. This led Snap On to develop a series of diagnostic equipment which in Europe is branded 'Sun'.

Today the company is led by Nicholas T Pinchuk, holding both posts of Chairman and CEO, and is comprised of 3 division – the following from company website sources showing 2010 income mix:

Snap-On Tools – 35%
Commercial & Industrial - 35%
Repair Systems & Information - 28%
Financial Services - 2%

Its 2010 geographic market share being:
North America - 65%
Europe - 25%
Asia-Pacific - 8%
RoW - 2%

Thus as is evident, there is innate heavy reliance upon N.A. And the EU, together providing 90% of sales, whilst in roads into Asia and beyond have been – by international corporation standards, especially those say of Automotive VMs – very limited.

This is undoubtedly because historically, and especially since WW2, emerging Asian, Chinese, Indian and Latin American countries have sought to formally or informally protect the foundations of their hand tool industries from foreign competition. Such countries recognising that not only was the sector fundamental to the economic growth of the nation itself, but critically inter-twined with affordable DIY mechanics of older car-parc vehicles, the servicing of increasingly capital intensive industrial plant in evolving manufacturing bases and would underpin the expanding auto-dealership numbers and demands from internal and regional growth in car, truck, bus and coach purchase and use. In short, the indigenous hand-tool sector was/is crucial to EM growth, expecting its increasing sophistication to align general GDP growth. In short locally playing Snap-On's own boom experience between 1920 and 1970 in the USA.

Thus unlike say the likes of McDonalds or Starbucks, where EM countries could invite, learn and mimic new sector learning, even though patiently present in-market it seems Asia and RoW markets (excluding anglo-Australia) have essentially repelled Snap-On for mass application – instead seemingly serving targeted business sub-segments.

Thus, such areas have been 'a very hard to crack', a painful but realistic view of business affairs.

This intrinsic, long-time headwind against what is presumed as a natural geographic extension of its core auto-trade support activities has undoubtedly underpinned its efforts to grow and capture business from alternative sources, hence development of income streams such as government, military and others (see below).

As stated, thus beyond core 'front of shop' retail offerings of: Hand Tools, Power Tools, Tool Storage, Basic Diagnostics and Shop Equipment, there has been a concerted effort to climb the value-ladder by also targeting 'packaged service' offerings to capture higher-value later stage technical and commercial developments orientated around automotive. Areas in which though the core product offering may differ little to the garage retail arm, can be sold in a different large scale and support-driven manner so adding 'costing' and 'timing' dimensions to the proven 'quality'. These new arms then designed to generate close relationships which provide typically larger 'single customer' sales orders and long term ties.

The previously mentioned primary 2 divisions created were 'Commercial & Industrial' and 'Repair Systems and Information'. Each now provides similar and near level of income stream to hand-tools. Together they represent 63% of income and includes buyers from:

- Transportation services,
- General industrial,
- Government,
- Education,
- Agricultural,
- (Other [ad hoc] commercial applications).

So garages & dealerships, and now these additional clients, were then sold developed products and services, including:

- Proprietary software
- Vehicle service information
- Equipment repair services
- Training
- Product procurement facilitation,
- Business management systems,
- Tele-diagnostics.

So, in essence, Snap-On reacted to the need to broaden its business net and thus segmental catchment area.

Yet throughout, 'serving in the shadows' (at only 2% of revenue) has been the Financial Services Group, consisting of 'Snap-On Credit' a US based entity which finances domestic and foreign franchisees.

[NB As highlighted at the beginning of this web-log, because of the USA's global 're-creditization drive', investment-auto-motives expected to see disproportionate growth in the firm's Financial Services division from its present low level, so re-energising its other divisions].

Historical financial reporting show the following:

Net Sales in 2008 were: $2,853m, in 2009 were $2,362m (-17%) and 2010 were $2,619m. Q1 & Q2 2011 trending shows an FY2011 expectation of $2,844 (base), which investment-auto-motives will be modified by 5% slow down in H2 2011 giving FY2011 of $2773m, thus posting slight improvement over preceding year.
CoGS in 2008 were $-1,567m, in 2009 were $-1,305m and 2010 were $-1,408m, showing
that consecutive annual 'CoGS absorption rates' of: 54.9%, 55.2% and 53.76% for respective years, thus averaging 54.6%.
Operating Expenses in 2008 were $-933m, in 2009 were $-824m and 2010 were $-894, and as such show themselves to respectively be 33%, 35% and 34% of Net Sales value, averaging 34%.
EBIT in 2008 were $358m, in 2009 were $205m, and in 2010 were $277m, respectively showing 12.5%, 8.7% and 10.6% of Net Sales.
Net Earnings in 2008 were $237m, in 2009 were $134m and in 2010 were $186m, respectively showing 8.3%, 5.7% and 7.1% of Net Sales.
Basic EPS in 2008 was $4.12, in 2009 was $2.33 and in 2010 was 3.22

Whilst the top-line reporting of 'Net Sales' is seen as a creditable 'true reflection' of income, reporting, investors should be concerned with – and seek transparency in - the annual level of discounted, damaged, missing and stolen items. Provided by category would provide even greater confidence given that the retail-like Snap-On business model (with added complexity) is arguably open to abuse by junior management, staff, franchisees etc, operating a black-market in such goods which only goes to undermine the brand itself.

Equally, such 'invisibility' may be used by less consciousness management to manipulate the Net Sales figures.
For FY2010 Snap-On publicised a MarketCap of $3.5bn, revenue of $2.6bn, 130 country coverage, and claims itself to be “one of the few publicly listed companies that has paid a consecutive quarterly cash dividend without interruption or reduction”, offering an annualised average of 2.1% per annum.

The 2011 'Outlook' expectation from it's 2010 SEC filed report mentions “expansion in emerging a range of $55 million to $65 million. Snap-on also expects to incur $11 million of higher year-over-year pension expense in 2011 largely due to the amortization of investment losses incurred in 2008 related to its domestic pension plan assets. Interest expense on the $250 million of senior notes issued in December 2010 will approximate $2.7 million per quarter in 2011. Snap-on anticipates that its full year 2011 effective income tax rate will approximate 33%”.

Three financial reporting quarters on, and today Bloomberg figures indicate that the a mix of less robust S&P and recognition amongst investors of the company's limited exposure to BRIC+ regions, has deflated the MarketCap toward $2.9bn.

However, as seen by very basic trended forecasting, amended for the H2 2011 slow-down, investment-auto-motives expects Snap-On Inc. to post a FY2011 Net Sales figure at about $2,773m, excluding FX effects worth $9.1 in Q1 and $30m in Q2, giving an annual 'run-rate' of about $78.2, which may well be booked into the last Q4 and FY reporting, or earlier if cause to do so.

The turmoil of 2008, the deep 'North Atlantic Recession' and prevalent investor focus on BRIC's and newer second-phase EMs, will have woken Snap-On from any complacency that may have become historically ingrained.

Pinchuk's undertaking of both key senior roles obviously raises corporate governance issues, since a listed company (unlike private) ideally has 2 mutually respected but independently minded seats.

Such a dual role may be consensually agreed amongst stock-holders and the BoD for expediency purposes, typically seen if a company has previously experienced a period of ideological dead-lock between seniors. But typically the dual role format tends to happen in periods of necessary company structural change requiring the clarity and free-hand of single leadership: AT&T. A good example.

However, given Snap-On's generally stable history - 'turning the handle' of its pseudo monopolistic position - the former cause then does not then seem the case. Instead the latter hypothesis of structural change looks to be the case, with management and institutional investors alike very probably recognising that the 'American Century' upon which Snap-On rode has indeed faltered in the face of the 'Risen East'.

As such the company may require structural reformation across the full business, including the Finance division which accounts for only 2% of income.

However, the first division seemingly 'taken to task' looks to be the core of its hand-tools division., given that its self-styled All-American 'business boundaries' incur greater over-head costs: Being largely 'All American', 'American made' and using its own and franchised fleet-based sales force, increasing costs have undoubtedly been baked-in over the years. Yet given the nature of the business and service proposition – and inherent costs therein – there seems few major cost-saving opportunities to be had, instead ongoing efforts at cost constraint in salaries, wages, overhead etc,

However, the one field open to structural change is that of procurement. Snap-On looks to be seeking ongoing change in procurement sourcing and practice to try and secure its profitability, beyond the organic sales boost and positive FX effects of the US$.

It is unknown whether Chairman & CEO Nicholas T Pinchuk is directly connected/related to the Ukranian steel-magnete Viktor Pinchuk, yet it seems probable given the name's geographic and Askenazi origins. Both men work within international supply and demand of metals, with Viktor Pinchuk having official ties to the USA's Peterson Institute and Brookings Institute.

His personal interests are as an influential individual in Ukraine (married to daughter of a former President) and operates the Interpipe (Steel) Group and an investment firm with portfolio assets relating to: the production of pipes and tubes, railway-carriage wheels, speciality steels & alloys, and general associated machinery. Reports indicate that he in turn appears to have business relations with another powerful Ukrainian, Rinat Akhmetov, his broad interests in metals mining, processing and production via System Capital Management group (SCM) which includes the prime subsidiary of Metinvest Holding Co. Metinvest has a number of steelworks including: Azovstal Iron & Steel, Ilyich Steel & Iron, Yenakiieve Iron & Steel, Promet Steel, Spartan (UK), Tremetal (Italy) and American assets.

Thus Snap-On's CEO appears to have reason for and links to 2 of Ukraine's primary power-brokers across the vertically integrated world of Ukranian steel manufacture. The consolidation of which, when added to the sizable 'easy-reach' resources, should provide a price-reduced basis so important for western steel procurement to improved margins.

This, investment-auto-motives believes will play a fundamental role – probably already underway – for the necessary structural change in Snap-On Inc's procurement and production methods at raw material, semi-finished product and possibly contract manufactured levels. These actions greatly enabled by Interpipe. The 'EastOneGroup' investment company's holdings and those of Metinvest Holding Co.

So whilst Snap-On executives and management rhetoric is not at all wrong in highlighting that... “Snap On is positioned for the future with favourable vehicle population trends, increasing vehicle complexity, growing demand in emerging markets and significant opportunities in industries
outside of vehicle repair”...they also no doubt quietly recognise to themselves that the availing opportunity may not be wholly open to themselves given past experience of EM markets.

To compensate for this, they recognised that a significant business re-structuring was inevitable

This initiative theoretically promote profitability and notionally stock-holder quarterly yields. However, it seems that Snap-On instead seeks to re-invest the monies accrued from input-level cost-savings to continue to maintain a hold over US domestic, Canadian, Mexican, European and Australian markets, whilst also continuing to try and 'crack the nut' of EM markets.

The firm says it will....”Enhance the franchise network to reach more vehicle repair technicians....Expand in the garage [sector] with shop owners and managers....Extend to critical industries outside of vehicle repair....Build in emerging markets where vehicle repair and critical industries are in early stages”

The problem Snap-On faces though is arguably a long-held 'saturation' of North America, very challenging competition in its 'intermediate markets' such as Mexico and most European countries and possibly increasing resistance from EM countries as they seek to retain the benefits of their home market vehicle sector growth.

The consequential challenge is that the company must try and be both 'internally dynamic' to conjure ways of meeting the headwinds, whilst appearing 'external stable' so as to maintain its stock-holder persona.

A very brief perusal of web-based company information ascertaining to executive pay packages suggests that the senior management team are 'incentivised' on a long-term basis via deferred rewards. This then fits in with the 'mature and stable' character of the company, yet by its very nature may deter from what are seen as risky strategic and operational changes, changes that may be of true long-term benefit.

Any executive remuneration committee which may exist, or indeed major stock-holders at AGM appointee soundings, would have to weigh-up both elements. Yet it seems that Snap-On largely lives 'under the radar' for ant type of investor activism given its cornerstone entrenchment within institutional investors. Institutional investors may wish to assert the need for some of the C-suite pay-packages to reflect this so as to invigorate the company, if not already the case.

In conclusion then, Snap-On has proved itself to be the historical tool-set of choice amongst the auto-trade professionals, general trades-people and discerning garage based DIY enthusiasts. And for much of its history Snap-On has offered credit lines to many of its customers from young apprentices setting-up the initial stages of their careers to well established firms. But today much of those wholesale bought credit-lines are used to under-pin and expand the coverage of its franchisees, operating single or multiple retail vans.

The 2009-10 stock rally driven by QE boosted America's economic and commercial sentiment, so assisting Snap-On's rebound, yet that has slowed of late and Q2 2011 looks noticeably slower than H1.

The Fed's 2-year held 0% policy looks to boost internal capital expenditure on plant and equipment for many light-engineering firms such as Snap-On, but the company's apparently large property portfolio which underpinned its historical growth and previous non-current asset valuations could well be viewed as requiring re-evaluation, especially so if as is suspected, portions of its manufacturing work could be increasingly contracted-out, thus reducing its production sites down to those of strategic importance and end-phase 'product-finishing' . This then reducing the considerable OpEx costs that absorb around 35% of Net Sales.

This then should boost domestic sales margins considerably, boosted again by the ultimately expected QE3 that may arrive in 2013 or so.

Importantly, there looks an opportunity to re-build the company's presence in 'Periphery Europe', especially so as heavy investments in plant looks to be post-poned so requiring additional expenditure on plant maintenance etc, but specifically the substantial loss of the new car market in the PIIGS countries mean their national car-parcs will age and so provide a fundamental base for trade-professionals, semi-professionals and home garage mechanics.

In this light the combination of a much deflated industrial and service cost-base coupled with American liquidity injections – probably in slow 'abyss-point' phased stages – means the high potential a renewed under-pinning of the economic foundations across 'Peripheral Europe'.

[NB Treasury Secretary Time Geithner's visit to the G7 conference in Marseilles and to Poland focused on Greek debt woes looks to verify this 're-creditization' thesis].

This picture has yet to arrive, but when it does, it will reflect the words of one of the olde worlde's yesteryear industrialists: Gianni Agnelli of FIAT. Commenting upon post WW2 Italy...”we'd had credit in United States, credit from the Bank of America, credit from the Import-Export Bank and the 'start-up' appeared”. History then set to repeat itself.

Snap-On then has an assured future in the US, has ongoing acceptance in Mexico and Latin America and by the above-mentioned action should maintain and possibly grow its hold on a 're-credited' Southern Europe.

But the pan-Asian and especially Chinese & Indian markets look to remain illusive given official & unofficial forms of domestic market protection toward domestic heavy-plant and specialist light tool-making sectors, thus future Eastern EM growth continues to look muted in the near and medium term, all the more so with the Australian economic slow-down.

But below the surface it looks to be radically altering its cost base, prescient for the Tools division, and moreover should be analysing new market opportunities.

One such is ts Blue-Point line, which could be made to expand across new hand-tool markets and perhaps even enter other spheres. Obvious is the bicycle dealer and home repair market - since blue is also the corporate colour of 'Park (bicycle) Tool', a US firm with increasing exposure in the country. Blue-Point could feasibly steal its thunder via direct competition or acquisition. Such a move would fit the recent bicycle trend across specific regions of the US which have witnessed 're-urbanisation' of city centres (eg Seattle, Portland etc), a trend which is set to grow. This would partially off-set the expected loss of sales to home-based car mechanics as such work becomes harder given car/truck sophistication. However, it may also be viewed internally and publicly as a retro-grade step, away from high margin business areas and obviously prone to low-cost competitors.

However, such companies with long histories, apparently deep pockets and typically loose supervision processes in the mid and lower quarters of the organisation are far more prone to 'parasitic losses' both in materials / stock and general labour-productivity. So whilst executives seek restructuring opportunities and managers execute the general operations, much should be done to ensure that portions of this good work are lost via less than scrupulous employee actions. One would assume that the high US and international unemployment rate would deter, but all to often such periods generate low morale and pilfering. Actions to halt such should be introduced, informing staff and investors alike to ensure a tightly run ship is run, and as importantly seen to be run.

This includes reporting of top-line revenues above Net Sales. This then would help to ensure that that a zero-tolerance corporate attitude, and share-owning attitude, is made clear toward lost, damaged and stolen products.

investment-auto-motives thence believes that the company will continue its low-key but stable operating basis, growth levels, operational profitability and share-holder returns. Thus acting very much as the 'defensive', 'utilities-esque' persona it long developed and sustained.

But the business model (as of course with many) is open to abuse, and whilst offering stable returns, could and should be made as transparent as possible. In age age of investor disillusion with old smoke-stack industries of the West and increasing concerns over automotive related investments – eg GM at $21 when listed at $33 – and the still large returns seen in EM regions, the Chairmen and CEOs of even legendary firms must demonstrate their company's worth to even what were previously compliant institutional investors.

Whilst QE provides the short-term boost, as ever corporate fundamentals reflecting industrial foundations ultimately create the future.

Here and now, it looks like Snap-On seeks the benefits of the Southern European commercial 'package deals' where its own Sun brand could shine.