Sure, homebuilders, mortgage lenders and supply distributors will likely be winners as a result of the uptick in home prices and sales. However, there are some out-of-the-ordinary housing plays like Deere & Co. (DE), Toro Company (TTC) and Snap-on (SNA) that could outpace the housing sector because they have broader exposure to more economic sectors. Of the three, we like SNA the best.
While its $5.3 billion market cap puts it at a far second from Deere’s $33.3 billion market cap, Snap-on is one of the largest manufacturer and distributors of hand tools, storage units and diagnostic equipment for professional mechanics and builders.
The Housing Connection
The company makes a wide array of hand and power tools that are used in construction. So that makes home builders major clients. For those who don’t buy their tools outright, Snap-on also offers various financing programs, and derives income from this too.
Then there is the automobile industry, which is also affected by how the housing market is faring. Ford reports that its F-series of pick-up trucks have enjoyed record sales over the last few quarters, partly reflecting demand from builders and others in the housing industry that need the sturdy vehicles to haul the materials to build homes. Snap-on benefits from this through its exposure to the automotive repair and maintenance business.
Also, it just made a key acquisition in Challenger Lifts, a company that makes vehicle lifts. This will further improve its market share within the automotive maintenance business.
So far this year, Snap-on’s stock price is up 14.41%. Its earnings growth last year was 10.4% and it is expected to be 10.31% this year. Over the next five years, analysts expect earnings growth to tick up to 11.5%.
Of the peers we mentioned, Snap-on has the strongest margins. Its gross margin is about 48%, its operating margin is 18.11% and its profit margin is 11.05%. Those important metrics have all shown considerable growth over the past five quarters. Its total return to investors is the highest of those three: over 59% over last year, compared to Toro at 32.25% and Deere at 26.4%. Snap-on was well above the S&P 500’s total return of 30.81%.
Snap-on has steadily increased its dividend, too. It is now $1.52, yielding 1.7%. While that is lower than Deere’s $2.04 dividend yielding 2.3%, it is higher than Toro’s $.56 yielding just 1.2%. SNA’s middling dividend performance may actually work to its benefit this year as the highest dividend payers are raided for capital to invest in riskier sectors.
In April, Snap-on reported first quarter earnings – it missed on the top line, but beat on the bottom line. Revenues totaled about $742 million, which was just 0.9% higher than they were for the same quarter in 2012. The groups responsible for much of that growth were its tools, repair systems and financial services.
Combined, these groups raked in about $287 million in the first quarter. The repair systems group accounted for the bulk of those sales. The laggard group was the commercial and industrial group whose sales declined 7% to roughly $266 million. Snap-on blamed lower sales on the military and a soft European hand tools business as a result of ongoing economic weakness in that region for the decline.
Missing the top line was not unusual this year. This issue needs to be watched but doesn’t represent weakness in SNA that isn’t a wider problem across the market. Nonetheless, given that this group accounts for a significant portion of the company’s sales, you should keep an eye on any signs that the company’s margins are eroding.
What the Future Holds
Standard & Poor’s has a 12-month price target of $104 for Snap-on. To get this estimate, it applied a multiple of 17.9, which it noted as the high-end of Snap-on’s range over the past five years, to the 2013 EPS estimate.
In their May 25 report, Standard & Poor’s noted the following:
“We think that multiple is appropriate, given our view of the company’s impressive operating history and our outlook for ongoing earnings gains. Our valuation also incorporates our outlook for an improvement in global economic conditions over the coming year.”
Click to Enlarge As long as the company continues to make the necessary cost adjustments to deal with global economic conditions that could hinder its revenues, we see the stock continuing to trend upward. The improving housing market and the sales it is able to reap from this domestic catalyst should aid Snap-on’s top and bottom lines, making this stock a buy
Recommendation: We recommend a long entry on a breakout above the current pennant formation above $93.50. Currently, we are targeting $103 per share as a near-term price target based on the length of the run prior to the current consolidation.
Options Alternative: Buy a call on the same technical breakout. We like the SNA September $95 calls, which should provide enough room for the expected move to complete. SNA releases earnings in the middle of July, which may be a make-or-break point for the trade. If the stock has not risen above $95 at that point, an early exit would be a good idea.
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