EUR 850.00 For Business Accounts Only

Morningstar | Initiating Coverage of Graco With Wide Moat Rating and $47 FVE

We are launching coverage of industrial firm Graco with a wide moat rating and a $47 fair value estimate. We also assign the company Standard stewardship, medium uncertainty, and stable moat trend ratings. Our fair value implies a multiple of approximately 23 times our 2019 EPS estimate, and we view the stock as fairly valued at current levels.

Graco has consistently generated lucrative returns on invested capital, averaging 25% over the last decade. We believe the company has established a wide economic moat based primarily on customer switching costs and secondarily on intangible assets. Graco is a leading manufacturer of equipment used for managing fluids, specializing in hard-to-move liquids. Many of its products perform mission-critical functions and are integrated into a customer’s production process, but often account for only a fraction of a customer’s production costs. As such, customers are less likely to switch to a cheaper but less proven alternative, since the cost of unscheduled downtime could far exceed cost savings. For example, an auto assembly plant is unlikely to skimp on a paint system. Graco’s large installed base also generates a stable stream of recurring revenue, as aftermarket parts account for roughly 40% of sales.

The main concern for Graco remains growth. We view Graco as a GDP-plus business and expect that the firm’s commitment to innovation and healthy research and development spending will continue to drive additional sales from new products and adjacent markets, as well as market share gains. We project organic revenue to grow at a mid-single-digit rate on average, which implies that management will have to rely on acquisitions to reach its targeted 9%-10% growth rate. Historically, acquisitions have not depressed the firm’s operating margins or ROICs, which gives us comfort that management will remain patient and avoid overpaying for acquisitions. Still, relying on M&A carries acquisition risk.