Genuine Parts Company (GPC): A Dividend King Trading at an 18-Month Low

Many income investors, especially those focused on the best high dividend stocks, often rely on slow but steadily growing companies to make up the core of their diversified dividend portfolios.

 

And among such companies, certain dividend kings, stocks with 50+ consecutive years of payout growth, represent some of the best time-tested, low risk names you can find on Wall Street.

 

Let’s take a look at Genuine Parts Company (GPC), a business that’s seen sales and profit growth in 84 and 73 of the past 89 years, respectively, and which has rewarded dividend lovers with an impressive 61 straight years of dividend increases.

 

Despite the company’s attractive long-term history, Genuine Parts Company’s stock trades at an 18-month low, driven by disappointing auto industry trends and fears over Amazon’s (AMZN) entry into the automotive aftermarket parts industry.

 

Let’s take a closer look at this dividend king to learn more about the potential headwinds it faces and whether or not the stock’s current weakness could be an opportunity for long-term dividend growth investors.

 

Business Overview

Founded in 1928 in Atlanta, Georgia, Genuine Parts Company is one of the largest (#1 or #2 market share in all segments) replacement part makers in the automotive, industrial, office equipment, and electronics industries.

 

The company markets its products in the US, Canada, Australia, New Zealand, and Puerto Rico through a large network including 103 North American auto and industrial distribution centers, and 6,700 NAPA auto parts stores.

 

GPC’s sales are derived from a diverse group of well-known industry brands including NAPA auto parts, Motion Industries (industrial components), EIS (electrical components), and SP Richards & Company (office products).

 

By far the most important business segments are the automotive and industrial units, which combined made up 83% of 2016 sales.

 

 

Similarly, North America represents the company’s dominant market, generating 92% of last year’s revenue.

 

 

Business Analysis

The key to over half a century of steady dividend growth is a business model that is protected by some sort of moat, meaning some kind of competitive advantage that allows a company to maintain pricing power while growing its market share.

 

In the case of Genuine Parts Company, its moat is courtesy of two main factors: the company’s massive distribution network and its trusted brand names.

 

For example, NAPA auto parts has a total of about 8,300 global stores, serving over 17,000 global service centers.

 

Meanwhile, Motion Industries has a 70-year history of providing quality products to industrial firms like Halliburton (HAL), 3M (MMM), and General Electric (GE).

 

In fact, Motion Industries is closely tied into the entire global industrial base, with its components finding their way into roughly 6.9 million products around the world each year.

 

The second factor in GPC’s moat is its supply chain and large scale inventory ($3.2 billion at the end of 2016). This is because NAPA auto parts works in an industry in which inventory management and just-in-time delivery is paramount.

 

For example, an auto parts store generally doesn’t want to hold a lot of excess inventory because that represents a substantial capital investment. Similarly, auto repair shops generally will order components as needed, in order to service customers that just showed up in a timely manner.

 

GPC’s large network of distribution centers make it possible for its customers to order parts at a moment’s notice and have them generally delivered the same day, maximizing their inventory turnover, and thus sales and profits.

 

As one of the largest players, GPC can afford to hold more inventories and offer better delivery times than many of its competitors.

 

In addition, the auto parts and industrial component sectors are generally price inelastic, meaning that customers care far more about the reliability of products and the convenience of deliveries than they do about getting the absolute lowest price.

 

This allows GPC to maintain above average pricing power for its most important product segments, resulting in steady and even improving (thanks to growing economies of scale) margins and returns on shareholder capital over time.

 

 

Meanwhile, the company’s steady growth, another essential component to its dividend growth thesis, is courtesy of several factors.

 

First, unlike selling to original equipment manufacturers, aftermarket business is relatively stable. Vehicles and equipment breaks down and must be replaced. Therefore, the business is less discretionary.

 

Additionally, the automotive aftermarket has been benefitting from the steadily improving reliability of vehicles over the decades, which allows consumers to own cars for longer, but only if they are properly maintained and repaired.

 

 

The average fleet age for US cars is now 11.6 years and continues climbing. And with the US population slowly but steadily growing, and with it the number of vehicles on the roads, this creates a very large, stable, growing, and highly fragmented industry for GPC to service and expand into.

 

 

In fact, the US automotive aftermarket is a $100+ billion industry, and despite being the largest supplier, GPC’s market share is only about 8.5%.

 

This creates the opportunity for growth through acquisition, both large scale purchases that allow the company to enter new market segments (like Motion Industries), as well as numerous bolt-on acquisitions at its subsidiary level.

 

 

For example, in 2016 GPC acquired 19 small to medium sized businesses that it expects to add $600 million in annual sales, a 3.9% increase over last year’s revenue.

 

In addition, the company has a long-term goal of achieving 6% to 8% annual sales growth and 7% to 10% EPS and free cash flow per share growth thanks to an optimization of its four-pronged growth strategy: acquisitions, organic growth, margin expansion, and steadily reducing its share count through buybacks.

 

 

To boost organic growth (in existing business units) GPC is investing heavily into foreign expansion, particularly into Australia and New Zealand, where it’s growing its store base by about 9% a year.

 

Similarly, Mexico, where NAPA has just 33 stores, represents a market ripe for additional growth opportunities.

 

In fact, GPC appears to be well situated for many years of steady growth because it has a company-wide market share of just 5.5% in four industries with annual global sales of $280+ billion.

 

Finally, GPC has a solid track record of buying back shares, converting its steady free cash flow into a declining share count that results in a long-term boost of about 1.5% a year in EPS and FCF per share.

 

 

In fact, over the past 22 years Genuine Parts Company has bought back 27.2% of its shares, with another 2.1% authorized today.

 

And while it’s true that many companies are terrible when it comes to timing buybacks, often repurchasing shares at market highs, GPC has a good track record of buying back its shares when they trade at fair value or below.

 

This lowers its dividend cost and allows for longer, stronger, more sustainable dividend growth over time.

 

Overall, GPC’s businesses seem to operate in slow-changing industries and maintain dominant market share positions because of their extensive distribution networks (just-in-time delivery), leading range of products, brand recognition, and long-standing customer relationships.

 

Key Risks

While GPC’s impressive growth record points to a highly disciplined and conservative management team, there are nonetheless several risks to keep in mind.

 

First, GPC’s business can be impacted any given quarter by currency rates (roughly 20% of the business is outside of the US), industrial production trends, and the health of the auto market.

 

However, none of these factors seem likely to impair the company’s long-term earnings power.

 

While the aftermarket business is generally much steadier than the broader economy, the company’s industrial business is less predictable because the industries in which it operates can be highly cyclical, resulting in sales and earnings growth that can be a bit lumpy.

 

The weak industrial growth in recent years has largely been due to severe recessions in the mining and energy sectors, (worst oil crash in over 50 years), which has led to declining sales at its Motion Industries subsidiary.

 

 

Fortunately the industrial sector has been recovering in recent quarters, thanks to a doubling of oil prices off their January 2016 lows, as well as stronger economic growth around the world halting the recent crash in commodity prices, which devastated the mining industry.

 

So why has GPC’s stock performed so poorly over the last year? Investors are worrying a lot more about the automotive replacement parts industry, as seen by the dismal performances of O’Reilly Automotive (ORLY), Advance Auto Parts (AAP), and Autozone (AZO).

 

More specifically, the industry was challenged by a second consecutive mild winter, which reduced demand for many of its parts.

 

The big players have also noted that consumer demand has been soft in recent quarters, and perhaps the biggest concern is Amazon’s increased push into the market, which could pressure pricing and margins.

 

 

Fortunately, according to the Reuters article linked to above, the do-it-yourself market targeted by Amazon only accounts for about 15% of Genuine Parts’ sales mix, which is a much lower proportion of total revenue compared to its three larger rivals.

 

Additionally, GPC possesses several advantages that seem to further protect its business from Amazon.

 

NAPA’s extensive distribution network enables it to make rapid deliveries to repair shops (which require very fast turnaround times for customers), the NAPA brand (which accounts for about 90% of GPC’s auto aftermarket products) is trusted by shops and consumers, and having a brick-and-mortar location can help customers ensure they are purchasing the right replacement part (i.e. a hands-on shopping experience is helpful given some of the complexities involved in auto parts).

 

Simply put, I think it would be challenging for even Amazon’s supply chain and logistics network to rival GPC’s given the quick turnaround times demanded by customers and the brand equity GPC has built up over the decades.

 

Meanwhile, another longer-term risk to keep in mind is that NAPA auto parts specializes in components for traditional, internal combustion engine (ICE) vehicles.

 

In the coming decades, electric vehicles (EVs) could account for a large and fast growing segment of the global vehicle market.

 

 

The risk for GPC is that EVs are generally more reliable and less maintenance intensive than ICE cars.

 

That’s because they have far simpler designs. For example, while a traditional engine has thousands of components, EV motors have just one moving part. This means that in the future cars may last longer and require less aftermarket parts.

 

Fortunately this risk doesn’t seem like one that will materially impact the company for many years, if not decades, given the low penetration rate of EVs today.

 

The rise of driverless cars is another long-term risk and means that consumers may be able to subscribe to car sharing services, in which fleets of EV robocars ferry them wherever they need to go, at a much lower overall cost than individual vehicle ownership.

 

That in turn could result in the world’s total vehicle fleet size declining despite a still growing population, which might disrupt GPC’s largest and most important business segment.

 

That’s why management has wisely chosen to diversify its business into other areas such as industrial components, electronic parts, and office furniture, which makes GPC less susceptible than much more focused rivals such as Autozone (AZO), Advanced Auto Parts, and O’Reilly Automotive (ORLY).

 

However, with diversification comes slightly below average profitability because GPC’s office equipment division has far less pricing power, resulting in operating margins of just 0.9%.

 

 

In fairness to the company, while its office business is resulting in slightly below average profitability, its disciplined approach to capital allocation means that its returns on shareholder capital are equal to its peers.

 

However, GPC may struggle to substantially grow its bottom line in the future because the office equipment sector is currently at risk of disruption by Amazon (AMZN) and has far less pricing power with which to defend its margins.

 

Genuine Parts Company’s Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

GPC has a Dividend Safety Score of 97, indicating a highly secure and dependable payout. That’s not surprising given Genuine Parts Company’s impressive record of raising its dividend every year since 1957.

 

 

What explains GPC’s high dividend security and consistent growth? Three main factors.

 

First, despite some cyclicality in its industries, management has proven it can use acquisitions of smaller rivals to keep sales, earnings, and free cash flow relatively stable or growing even in times of economic distress.

 

During the financial crisis, the company’s revenue dropped by just 9% and earnings fell by 16% in 2009. GPC’s stock also performed relatively well, outperforming the S&P 500 by 22% during 2008. Demand for aftermarket replacement parts and services is fairly recession-resistant.

 

It’s also worth noting that distributors’ free cash flow actually increases during recessions because they do not need to replenish as much inventory, converting more of their working capital into cash.

 

Combined with its highly conservative approach to growing the dividend, specifically maintaining a 50% to 55% EPS payout ratio and a similar FCF payout ratio (see below), this means that GPC’s dividend has a strong safety cushion to protect the dividend no matter what the economy may be doing in any given year.

 

 

Finally, Genuine Parts Company has a strong balance sheet, meaning that management likes to keep the company’s debt levels low and its financial flexibility high so that it can continue growing through opportunistic acquisitions while still rewarding dividend investors with the steady payout growth that has become its hallmark.

 

 

GPC’s low debt levels become even more impressive when we consider that this is a highly capital intensive industry and compare its debt metrics to its industry peers.

 

 

For example, GPC’s leverage ratio (Debt/EBITDA) is much lower than the industry average, as is its debt/capital ratio.

 

And while the company doesn’t have a credit rating, its high interest coverage ratio and strong current ratio (short-term assets/short-term liabilities) explain why it’s able to borrow at extremely low interest rates of just 1.9%.

 

Overall, GPC’s dividend is one of the safest in the market. The company maintains healthy payout ratios, sells somewhat recession-resistant products, benefits from a slow pace of change in its markets, has a conservative balance sheet, and reliably generates free cash flow in any environment.

 

Genuine Parts Company’s Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

GPC’s Dividend Growth Score of 70, meaning that investors can likely expect above average (relative to the S&P 500’s 20 year median dividend growth rate of 5.7%) payout growth going forward.

 

This shouldn’t be a surprise given the company’s incredibly consistent record of past dividend increases.

 

 

While past performance is not necessarily a guarantee of future results, given that GPC’s dividend growth rate over the past 30 years has been 6.6% (a similar growth rate to all of its short to medium-term time frames), it seems reasonable to assume that the company should be able to continue growing its payout at around 6% to 8% a year.

 

That’s because the company’s earnings per share seem likely grow between 6% and 8% annually over time, driven by GDP-like growth in its distribution businesses, bolt-on acquisitions, moderate margin expansion, and continued share buybacks.

 

This coincides with the lower end of management’s long-term EPS growth target of 7% to 10%, which means that the company may be able to pleasantly surprise investors.

 

However, it’s generally best to err on the side of caution, which is why I wouldn’t expect more than about 7% annual dividend growth in the next decade.

 

That’s especially true given that the payout ratio is now in management’s goal range, meaning that dividend growth is likely to track closely with the bottom line without room for payout ratio expansion.

 

Valuation

Over the past year GPC has underperformed the S&P 500 by about 30%, making it a potentially attractive investment in an otherwise overheated market.

 

For example, the forward P/E ratio of 17.2 is below both the S&P 500’s forward P/E of 17.8, as well as the industry median of 20.3.

 

In addition, the current yield of 3.3% is both significantly higher than the S&P 500’s 1.9% and the industry median of 2.1%. It’s also much greater than GPC’s own 13-year median yield of 2.9%.

 

Now could be a reasonable time for long-term investors to give the stock closer consideration, particularly if they are optimistic about the company’s ability to continue hold its ground against Amazon and adapt to trends that could (slowly) reshape the auto replacements parts retail industry over time.

 

That’s because at current levels investors can probably expect long-term total annual returns of about 9.3% to 11.3% (3.3% yield + 6% to 8% annual earnings growth), a healthy return for a company with such a safe dividend and a generally low risk profile over time.

 

Conclusion

When it comes to compounding income and wealth, slow and steady usually wins the race. And when it comes to clockwork-like growth, few stocks can compare to Genuine Parts Company, whose long-term focused management team, strong balance sheet, and long growth runway give it a solid foundation to continue creating value for shareholders.

 

With the company’s shares trading at their lowest levels since February 2016 and at somewhat of a discount to their historical valuation multiples, GPC could be one of the few undervalued dividend kings in the market today.