When You've Got to Change Your Tune

 | Apr 12, 2012 | 11:30 AM EDT
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Snap-On (SNA) is another name off the list I referenced earlier in the week -- companies that are near and dear to my heart because I've covered them for so long. This is a fantastic name with durable competitive advantages and, for that reason, I imagine it someday being owned by a larger company.

Through the years, Snap-On has wowed me with its diagnostic tool innovation for auto repair shop technicians. It's generated oodles of sales basically from a franchised mobile-van-distribution model, and it's turned out continuous productivity gains that yield strong cost savings. Snap-On's portfolio of businesses has long held pricing power due to the leading-edge nature of the product offerings, and its profit growth has tended to surprise strongly to the upside from a combination of pricing and cost containment. Knowing all this full well, I opted to pen an upbeat note to clients at the start of February.

Much to my dismay, though, the stock has been stuck basically in neutral. This is despite a favorable fourth-quarter overall operating margin performance (reported at the start of February) and not many new concerns on demand in international end markets, such as Spain, that have been slower than molasses. In fact, for some time now Snap-On has been calling out market sluggishness and setting very low expectations for a recovery. So what is the deal with the stock?

Top Line Considerations: First, revenue growth is solid, if not strong, compared with rivals and historical seasonal patterns. Second, we already know end markets in Southern Europe will be challenging for Snap-On for the foreseeable future.

Costs: Productivity gains have generally been a full offset to inflation, as seen in the gross margin.

Overall: Increasing exposure to China market is a good thing -- Snap-On is an end-cycle play, meaning its products have been needed to help fix cars sold in the country the past five years. Also, the name sports a 2.3% dividend yield and a below-market price-to-earnings multiple.

What's Really Going On

Since the above considerations aren't of much assistance as to the big picture with Snap-On, here's a bit more extrapolation.

• Given the restructuring changes by quarter, there is a sense that productivity gains are on the verge of slowing.

• Inventory days are ticking higher, and this is highly unwelcome for a tool company trying to sell premium priced product. Slower moving inventory could hint there is increased competition -- possibly from Stanley Black & Decker's (SWK) auto and commercial tool business -- or the value equation is not being sold correctly to consumers.

• Its fourth-quarter margin showed a downtrend in its highest operating-margin business as other segments have experienced a more positive trend.

• There has been a shift in sales mix to lower-margin essential tool and facilitation products. This means more sales to auto manufacturers and dealers that could use their scale to negotiate advantageous prices, as opposed to sales at full price to a local repair shop.

Given all this, I now found myself being less bullish on Snap-On in the near term.


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