EUR 850.00 For Business Accounts Only

Morningstar | Sluggish European Results Don't Alter Our Long-Term Outlook for Genuine Parts; Shares Trade Fairly

A large change to our $101 fair value estimate is unlikely after narrow-moat Genuine Parts posted second-quarter results. Although industry conditions in Europe led Alliance Automotive Group to underperform, we see the issues as transitory. While we plan to temper our near-term outlook (the valuation impact of which should be offset by a time value of money-related adjustment), our 10-year forecast still calls for roughly 4% organic annual revenue growth and 7% adjusted operating margins, on average.

Genuine Parts saw $4.9 billion in second-quarter sales (2.3% growth) and a 7.8% operating margin. Management cut its 2019 adjusted diluted EPS target to reflect the soft European automotive environment and a slowing global economy, now calling for $5.65-$5.75 (from $5.75-$5.90), behind our $5.94 preannouncement mark.

The automotive unit (56% of 2018 sales) saw 1% quarterly total and comparable sales growth. As in the first quarter, Europe (nearly 20% of segment sales) was the culprit, with comparable sales down roughly 7%-8%, a steeper slide than the first quarter’s low-single-digit dip. The pullback accounted for most of the segment’s 67-basis-point operating margin decline, to 8.2%. Management still cites a warm winter as the main cause, and with industry fundamentals fairly strong (particularly an aging but increasingly reliable vehicle fleet and a rising number of cars and trucks entering the aftermarket sweet spot), we still anticipate the shortfall will ebb, much as similar weather contributed to an industry slowdown in the U.S. in 2017 that reversed in 2018. A hot summer should aid the recovery, as should the launch of select NAPA-branded items in Britain later in 2019. The U.S. automotive unit continues to perform well, posting 3% comparable sales growth and a flat operating margin despite a damp spring (wet conditions depress do-it-yourself sales as motorists tend to work on their vehicles outdoors), which should offset some of the European weakness.

The industrial unit (34% of 2018 sales) continued to perform well, with sales up 5% and operating margin expanding 30 basis points on the quarter, while business products (10% of 2018 sales) slowed to a 1% total and comparable sales dip, reflecting soft core office supply results.

We are encouraged that management is accelerating cost-reduction efforts in the European automotive subsegment and across the firm. With near-term economic prospects increasingly uncertain amid mixed industrial and manufacturing conditions in the U.S., we believe a proactive approach to costs should be beneficial, and we believe management will continue to prioritize its critical standard of service despite the pressure to boost efficiency.

As expected, management indicated it has been able to pass inflation associated with both the 10% and 25% tariffs on various Chinese goods on to customers through price increases (the hikes mostly affect the automotive segment). Pricing conditions remain rational, which is encouraging as Genuine Parts’ automotive clients are less price-sensitive than they are service-conscious, focusing on having quick access to needed components to return their vehicles to the road.