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Josh Peters and David Manger of
Morningstar DividendInvestor like Genuine Parts for the economies of
scale and a safe payout that should keep growing.
Genuine Parts (NYSE: GPC) is [our] kind of business—durable in the face of economic
stress and devoted to its shareholders’ dividends.
Genuine Parts has developed an extensive distribution network and strong
customer relationships. An ability to maintain wide-ranging inventories and
deliver cost-effective products quickly has allowed the company to carve a
narrow economic moat, in our view.
Genuine Parts’ largest segment, automotive, is a market leader in the
distribution of automotive parts. The company supplies parts primarily to
mechanics at independent repair shops through its highly regarded NAPA brand.
These customers, which require a wide range of products in a timely manner, rely
on NAPA’s middleman services to help move cars in and out of shops as quickly as
possible. The company’s immense store and distribution network combined with its
massive fleet of delivery trucks creates a scale advantage unmatched by smaller
competitors.
Genuine Parts has also created a switching cost among customers by
implementing inventory-monitoring systems in repair shops that notify local NAPA
stores when a shop is running low on a certain part. The recent revamp of dealer
service centers—in attempt to capitalize on the profitability of vehicle
maintenance—has resulted in fewer sales at independent repair shops.
Nevertheless, General Motors and Chrysler have begun reducing their dealership
networks, in turn eliminating numerous service centers.
The company’s industrial segment supplies disposable products such as
industrial belts and pulleys that have short useful life spans. Similar to the
automotive segment, customers demand timely delivery (within 24 hours) and an
array of inventory in order to minimize production downtime. Though sales in
this business tend to track overall industrial production, Genuine Parts’
dominant size advantage—this unit brings in more than 1.5 times the sales of its
closest competitor—and widespread distribution network allow for steady
operating margins in the high single digits.
The office product segment applies the same distribution concepts and
produces the firm’s highest margins, though the expansion of large office supply
retail chains has curtailed growth. Overall, as a market leader with significant
financial resources, Genuine Parts is likely to continue buying smaller rivals
that are unable to compete on a national level.
Though Genuine Parts’ earnings have declined in this recession, raising the
dividend payout ratio from a typical 50% to 67%, we believe this reflects the
large margin of safety the dividend had going in. The firm’s strong balance
sheet (debt is just 17% of total capital) and consistent free cash flows provide
additional support for shareholders’ income.
With more than 50 years of dividend growth under the company’s belt, we
expect more hikes on an annual basis—though near-term growth may be limited by
economic conditions. We project 6% average dividend growth over the long run,
based on 4% sales and operating profit growth and a two-percentage-point boost
from share buybacks with excess cash flow.
A 4.6% yield at our Dividend Buy price of $35 should form the basis for
10%–11% average total returns. [Shares traded near $35.50 Tuesday
morning—Editor.]
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