Stocks/International

Lyn Alden Schwartzer

Filtering Through the Noise to Find Value

Snap-on is Becoming Attractively Priced

Snap-on Incorporated (ticker: SNA) is starting to look interesting from a valuation standpoint. I’m about to move it from my watch list to my active portfolio to begin dollar-cost averaging into it with a small position.

A Century of High-End Tools

Snap-on was founded nearly a century ago in 1920 at the dawn of the U.S. automobile manufacturing industry. Their name came from their patent for interchangeable ratchets with five handles and ten sockets that could be snapped on to each other, with their motto being “five do the work of fifty”.

Years later, Snap-On sourced the U.S. government with tools during the war effort:

Snap-on makes a variety of high-end tools, and they do more in-house manufacturing than their competitors to ensure quality. They also own some mid-priced brands such as Blue Point.

The company is strongly associated with the auto repair industry, but they have a variety of industrial and aerospace applications as well. One of their principles is that they generally do not sell their products in retail stores. They consider their customers’ time as too valuable to go tool shopping, so they come in vans to customer locations to sell tools to them on-site. Additionally, they have an online platform, which is where I’ve always bought my facility's tools from.

In other words, Snap-On tools are associated with quality and have a century of branding. The company has paid uninterrupted dividends since 1939 without any cuts or decreases. During the global financial crisis, they remained profitable.

Even Thieves Know Snap-on’s Quality

While it’s not always possible due to how limiting it would be, I always prefer investing in companies whose products I have personally used. Wall street analysts know a thing or two about financials, but to have boots-on-the-ground experience with a company is something different. I’ve used Snap-on tools for over a decade now and am an industrial-scale buyer of their tools for an engineering facility. My personal electronics screwdriver, which I used for everything, was always a Snap-on.  

Here’s a funny story. About seven years ago, an engineering facility that I worked at started having tool shortages. Our head mechanical engineer at first thought that some tools were misplaced by technicians, but after a while he started to suspect that someone was stealing them. Specifically, it was the Snap-on tools that were going missing. Only the Snap-ons. We coined this mysterious thief as the “the Snap-on Snaggler."

The mechanical engineer set up a camera with a motion sensor over a table full of tools near a high-traffic walkway, and specifically put a few shiny red Snap-on tools among the pile as a lure. Within a few days, he had video evidence of a night-shift janitor stealing our Snap-ons, and our problem was quickly resolved.  

The Financials

Snap-on has $4 billion in revenue and a market cap of over $8 billion, which puts it in mid-cap territory. Revenue growth has averaged 3% per year over the past five years and 5.5% per year over the past ten years. Earnings have tripled over the past decade. The company grows with a combination of organic increases and small tuck-in acquisitions to expand their product lineup.

The company has a great A- credit rating, with a debt/income ratio of well under 1.5x, meaning the company could pay its debt off with less than a year and a half worth of net income. They have an interest coverage ratio of about 20, meaning their annual operating income covers their annual debt interest expense 20 times over. The company consistently generates returns on invested capital (ROIC) of over 12%, and often over 15%. Their lowest ROIC in the past decade was 8% during the depth of the global financial crisis in 2009. Due to appropriate use of mild leverage, their returns on equity (ROE) are consistently over 15% and often over 20%. This is the mark of an economic moat.

Snap-on started to become overvalued in 2014, and after its price got ahead of its fundamentals, it went into a choppy sideways pattern for about four years. The black line on the following chart is the share price, while the blue line is the price it would be at the stock’s historical average P/E ratio, and the orange line is what the stock would trade at with a P/E ratio of 15.

Chart Source: F.A.S.T. Graphs

I personally love seeing these fundamental patterns. High-quality companies often become overvalued and eventually start trading sideways for a while as their fundamentals continue to increase. Last year I called Starbucks a strong buy when it had that same pattern and it’s up about 80% since then with a breakout:

Chart Source: F.A.S.T. Graphs

I’ve made similar calls for Disney, Walmart, and other high-quality value/quality stocks with that type of pattern in the past few years as well. It’s frankly one of the easiest long-term calls to make and works most of the time. The playbook is simple: a high-quality company with a strong balance sheet and high returns on capital becomes overvalued, it finally encounters some friction, its stock goes sideways for a few years as fundamentals catch up with valuations, the stock becomes fairly-valued or undervalued, and eventually the stock starts moving up again in line with fundamentals as the market catches on.

Snap-on currently has a P/E ratio of 12.6 compared to its five-year average of 18.3, and has a dividend yield of 2.4% compared to its five-year average of 1.6%. In other words, it’s becoming cheap. Their cyclically-adjusted price-to-earnings ratio (price divided by the ten-year average of inflation-adjusted earnings) is getting pretty low after a four-year sideways stock pattern:

At its current price of $154, the stock is at least mildly undervalued according to my StockDelver model for the long term, even with low growth assumptions:

Risks and Final Thoughts

Snap-on is semi-cyclical and sells products to customers in 130 countries, so the timing of its improvement can be disrupted by the global economy. In particular, Snap-on heavily serves the automotive manufacturing and repair industry. They’re not as cyclical as the automobile manufacturers themselves, but their fortunes do ebb and flow with them. Autos are currently in a global cyclical slowing trend, and manufacturing hubs like Germany are under pressure.

Although the Snap-ons fundamentals are solid, its stock price can be quite volatile at times. The stock is currently 18% off all-time highs, but occasionally drops 40% to 60% off highs during severe recessions.

Investors that don’t have stomach for a potential 20% decline shouldn’t invest in Snap-on. For long-term investors that like to enjoy the benefits of dollar-cost averaging, I believe Snap-on has reached the point where it is worth adding to a portfolio. I plan to add a small Snap-on position to my portfolio and begin dollar-cost averaging into it within the coming month or two.

Lyn Alden Schwartzer covers North American stocks and international equity ETFs with a focus on fundamental valuation. Her background is a blend of engineering and finance, and she uses a dispassionate long-term quantitative and qualitative approach to filter through the noise and find value in stocks and markets around the world.
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