Supplying a Hefty Dividend

07/28/2008 12:00 am EST


Josh Peters

Editor, Morningstar DividendInvestor

Josh Peters, editor of Morningstar DividendInvestor, says a venerable auto-parts supplier will continue paying a solid dividend.

The backbone of Genuine Parts’ (NYSE: GPC) competitive moat is its distribution network and customer relationships. By maintaining broad inventories, providing cost-effective products, and delivering faster than rivals, [parts supplier] Genuine Parts excels at what customers value most.

The automotive segment, NAPA, is the largest of Genuine Parts’ businesses. It has had 80 years to grow and establish relationships with vendors and customers. As an aggregator, NAPA buys inventory from parts manufacturers and sells these parts to body shops. NAPA’s intermediary role helps customers and manufacturers avoid transaction costs, allowing them to maximize profits.

Key to NAPA’s strategy is an expansive distribution network across North America that allows NAPA to quickly ship products to a customer, typically within a day. The automotive parts distribution industry is fragmented, and the smaller players are not set up to economically deliver parts on such short notice.

Given that the bottleneck in auto repair is typically the procurement of necessary parts, NAPA’s efficiency helps the repair shops move cars in and out faster. Although a competitor could set up a distribution outlet right next to a NAPA outlet, NAPA has used its technology to help customers keep appropriate inventories, which makes it difficult for customers to switch suppliers.

One significant force that may weaken NAPA’s position is the market share that dealer service centers are capturing at the expense of independent automotive shops. NAPA will probably lose customers as the independent shops go out of business. That said, the distribution network of Genuine Parts is unrivaled in the industry, solidifying its narrow economic moat.

Genuine Parts has leveraged its success in distribution to compete in the industrial parts and office product industries. However, it may be difficult for the firm to sustain economic profits in these markets where the competition is already firmly entrenched.

The industrial segment has experienced recent gains because of the power of its distribution network and the inability of regional firms to compete with it, yielding another alternative for growth.

We see nothing that is likely to interrupt the firm’s run of consecutive annual dividend growth stretching back to 1956. With debt making up less than 20% of the capital structure and strong cash-flow generation, paying about half of earnings as dividends provides plenty of protection against cyclical downturns.

Genuine Parts is unlikely to leave burn marks in the pavement; we anticipate revenue and operating income growth to average a modest 3%–4% [dividend] over the long run. Even so, the bulk of the earnings Genuine Parts retains are usually deployed into share buybacks, boosting the likely per-share growth rate for earnings and dividends to around 7%.

With utility-like consistency and only light cyclicality seen in year-to-year dividend growth, we look for total returns around 11% annually from recent prices. (It closed Friday above $40, with a yield of around 3.8%—Editor)

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