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Morningstar | Snap-on Reports a Mixed 4Q as Brexit Worries and Turbulence in China Hit Revenue

Narrow-moat Snap-on reported a mixed fourth quarter due to a variety of factors external to its core U.S. operations. Adjusted EPS of $3.03 beat consensus of $3.01 and exceeded last year’s fourth-quarter EPS of $2.69. Revenue excluding financial services was $953 million versus consensus of $969 million. Commercial and industrial revenue increased 0.6% over the prior year. In contrast, the repair services and information segment and the hand tools segment revenue declined 4.7% and 0.4%, respectively, versus their 2017 levels. Management pinned much of the revenue miss on three factors: currency headwinds, Brexit concerns, and turbulence in China. Despite these unfavorable near-term issues, we view Snap-on’s ability to innovate favorably. A s we incorporate our latest expectations for improved midcycle margins, we expect to increase our fair value estimate by less than 10%.

On a year-over-year basis, revenue excluding financial services was down 2.3% compared with the fourth quarter of 2017. This decline included a $17.1 million unfavorable currency impact. Financial-services revenue rose 3.5% year over year to $82.7 million, continuing a trend of a growing financial-services portfolio, which increased $16.8 million in the quarter. Operating margins before financial services in the fourth quarters of both 2017 and 2018 were each affected by one-time charges involving legal matters. On an adjusted basis, operating margin before financial services declined to 18.7% from 19.4% in the same quarter in 2017.

Snap-on’s mixed fourth-quarter performance was a result of several moving pieces. Notable issues include double-digital declines of product sales in the U.K. as Brexit worries led customer to limit their purchases. China sales were also weak but Snap-on experienced growth in other parts of Asia, including India, Indonesia and Thailand. Products introduced into the Indian market, ideally suited for the small footprints of Indian repair shops, were well-received.

During the earnings call, management was enthusiastic about the trajectory of several of its operations and its ability to introduce new products. Yet, we note that rapidly evolving automobile technology can be a double-edged sword. New automobile design features can be difficult to repair and are rapidly changing. This accelerates the demand for improved tools that makes mechanics’ jobs easier. One example would be the recent introduction of Snap-on’s new flex-head ratcheting wrenches. At the same time, more complex vehicle systems could impede the penetration of third-party diagnostic tools as the OEMs seek to capture more of the market for such tools. Snap-on has countered such initiatives by, for example, adding new tools to diagnose advanced driver-assist systems.

We also note that in 2018 Snap-on added 5,000 new products in its critical industry product lineup, which is sold to industrial customers outside of automobile repair. In 2019, we expect Snap-on to benefit from ongoing productivity trends in a variety of industries, including aerospace, where its customers seek to cut labor costs through improved utilization of feature-rich tools and equipment.