Volatile market conditions continue to make life tough for investors, but those willing to look beyond the hype can still unearth hidden gems.
Melville Douglas, the boutique investment management company within the Standard Bank Group says patience, a long-term view and a commitment to fundamental research remain the most astute way to navigate the current market conditions.
The company, which has been delivering superior investment returns and service for more than 30 years and whose Select Global Equity Fund has returned 15% in US dollars for the year ended August 2018, has recently been scouring the investment universe for ideas that cut against the grain of conventional thinking.
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Melville Douglas, which is driven by a team of highly experienced investment professionals based in South Africa and Jersey, notes that the growth of the US auto repair market is largely driven by the size of the vehicle fleet, combined with the average age of vehicles. Over the last decade, Americans have chosen to run their cars longer and opted for additional repairs over purchasing a new vehicle.
The ’Gucci’ of Spanners
Melville Douglas says US-based Snap-On Inc has recently found its way into the Fund as increased technological complexity of newer cars has necessitated more repairs, with specialised equipment required to do it.
“Cyclical stocks usually struggle to make it onto our radar as their return profile is overly dependent on getting the timing of the purchase decision right. In addition, many deeply cyclical businesses don’t generate a return on capital in excess of their cost of capital through a business cycle – an immediate disqualifier for us,” he says.
Snap-on, however, has benefitted from the growing need for more repairs and has expanded its offering to offer diagnostic equipment in addition to tools. The company provides tools, equipment and diagnostic hardware (and software) to the automotive maintenance industry, targeting professional mechanics, service centres and even the auto manufacturers themselves.
“The market is bigger and this company has the industry’s most advanced offering, which leverages the proprietary database of over one billion repair records to offer mechanics the best possible diagnosis and repair decisions,” says Maloney.
The recent economic strength has seen an uptick in new car sales, which one would naturally assume causes a decline in business for independent mechanics.
Snap-on primarily does business in the US, where the automotive mechanic market has some unique characteristics. For instance, roughly 80% of mechanics are independents and as such, have to provide their own tools when approaching a garage to practice their trade. The remaining 20% is split roughly 60/40 between car dealerships and commercial machinery mechanics.
“The trend towards increased complexity in this market is expected to continue. Combined with the strength of the Snap-on brand, the quality of the product (and an extremely robust warranty programme) and the close relationship between mechanics and the franchisee force, there is an attractive case to be made for secular growth over the next few years. In addition, Snap-on enjoys the benefits of substantially lower working capital requirements than most businesses exposed to the industrial cycle due to the franchise sales model. As such, the company also has best-in-class returns on capital, which can be reinvested into the business,” Maloney points out.
From purely being a provider of hand tools in the 1990s, Snap-on has expanded its offering to address the entire automotive service landscape. Its tools are generally considered as the best and a must-have for a professional mechanic. Snap-on is able to charge three or four times more than an equivalent in a retail store, such as Home Depot, given their quality and lifetime warranty. Their products sell at a sizeable (as much as 50%) premium to the professional offering provided by their closest competitors.
“In our opinion, the combination of continued organic revenue growth (with a supportive secular outlook) and further opportunities for margin expansion equate into strong free cash flow generation for the next several years. Snap-on is a unique business in the Industrials sector, and one that has quite some runway for growth left before it,” says Maloney.
“Market conditions may be highly unpredictable, but long-term solutions definitely exist for those who look hard enough, do their homework and are patient. Investors who keep trusted partners close will continue to ride though the market storm,” concludes Maloney.
