Business Breakdowns
· Matt Fleming
[00:00:00] S1: I think if we frame out the three segments, the margins in RS&I are going to be the highest. That's higher price point, higher technical sale and RS&I, which is the Repair Service and Information. In 2010 those were a little over 19%. They're 19.4% margins. Fast forward 14 years later, at the end of 2024 they increased those about 600 basis points, to 25.3%. They think those margins can certainly go up, but I think they're mindful that they're pretty high already. C&I, which is the commercial industrial margins, pretty nice improvement as well. 11% in 2010, again 600 basis points in 2024. That's going to continue to go up. But they do sell about 50% of that segment primarily in Europe through distribution. So they are going to track lower margins than their tools counterpart. But here's the real shining star. In 2010, the tools segment had a margin of 10%, and at the end of last year they finished at almost 23%. 1200 basis points in 14 years, and that averages out to be about 85% of annual improvement. Some of that is for sure mix, some of that's new product and pricing. But that really gets back to the rapid continuous improvement, really under the stewardship of Nick Pinchuk. And this one keeps surprising me. I've owned this company for a long time, and every once in a while I get hesitant and say, well, I just don't know that margins can continue to go up. And I was looking at my notes, and I think I said that when they were at 15%, at 18%, at 20%. So I'm trying to be open-minded that they can continue to improve.
· Matt Reustle, Matt Fleming
[00:00:00] S0: You see plenty of revenue growth stories that explain stocks. It's always interesting to find these efficiency, where you're getting some top line, but the margin improvement, that is quite incredible across the board, across all three divisions. Just in terms of pressures upward or downward on those margins, are there major things that you see as tailwinds or headwinds that you point to? [00:00:00] S1: Well, you can have some mix, again in that tool business. So you're going to have a reference when they went through this tool storage business. High ticket item. Those are pretty high margin. The diagnostics tend to be. So you do have that replacement cycle that can roll through. Those can be challenges. They do buy a lot of steel. It's unclear what impact of tariffs, but just general commodity costs can certainly be a headwind for them, they obviously forge and manufacture a lot out of metals. [00:00:00] S0: When you take the margins, you move it down through the income statement into the cash flow statement. What does that look like in terms of free cash flow conversion and the general free cash flow profile of the business?
· Matt Reustle, Matt Fleming
[00:00:00] S0: When you take the margins, you move it down through the income statement into the cash flow statement. What does that look like in terms of free cash flow conversion and the general free cash flow profile of the business? [00:00:00] S1: Free cash flow can be a little bit more lumpy. And the reason it's lumpy, Matt, is that we do have, as we talked about, this financial services business. And so what happens is when you're investing in finance receivables, that can drain some of your cash flow. So you kind of do have lumpiness over time. In good years, cash flow can certainly exceed earnings, and then probably on average, it may bottom out somewhere like 60% of net income. And it varies in between, but certainly a lot of cash flow at the operating company. No net debt at the operating company. They have a nice dividend. They do some small tuck-in acquisitions. I think the biggest one they've done is maybe $200 million over the last 10 years or so. And so, good allocators of capital. [00:00:00] S0: How does the risk sit in terms of in the system? If a sale is made, it's financed, is that risk sitting at the parent level? Is it at the franchisee level? I know there's a lot of intermingling there, but what are the mechanics there?
· Matt Reustle, Matt Fleming
[00:00:00] S0: How does the risk sit in terms of in the system? If a sale is made, it's financed, is that risk sitting at the parent level? Is it at the franchisee level? I know there's a lot of intermingling there, but what are the mechanics there? [00:00:00] S1: So about 30% of the tools that are sold off the van are financed by Snap-on Credit. I don't know that the technicians are financing this with outside credit. So again, 30% roll through, and then if they do that 30%, that becomes a finance receivable for Snap-on Credit. So that goes up to the parent company. The risk is held with them. The good news is the bad debt is a little under 3%, and the days delinquent are between 1.7 and 2%. And I was looking at banks and other credit companies, that's probably just a touch higher, but not meaningfully worse. And then if you look at what I’d probably call subprime lenders, this is much better than that. So I think that really gets back to that frequent collection, that weekly collection that they do. It really keeps bad debt down. And then they're earning an average yield of almost 18% on these receivables. So it's certainly expensive. And that also behooves their borrowers to pay it back pretty quickly. They also issue receivables to the franchisees. That initial $100,000, $150,000 capital, that's going to sit with the parent but is obviously securitized by the van and the inventory.
· Matt Fleming, Matt Reustle
[00:00:00] S1: So about 30% of the tools that are sold off the van are financed by Snap-on Credit. I don't know that the technicians are financing this with outside credit. So again, 30% roll through, and then if they do that 30%, that becomes a finance receivable for Snap-on Credit. So that goes up to the parent company. The risk is held with them. The good news is the bad debt is a little under 3%, and the days delinquent are between 1.7 and 2%. And I was looking at banks and other credit companies, that's probably just a touch higher, but not meaningfully worse. And then if you look at what I’d probably call subprime lenders, this is much better than that. So I think that really gets back to that frequent collection, that weekly collection that they do. It really keeps bad debt down. And then they're earning an average yield of almost 18% on these receivables. So it's certainly expensive. And that also behooves their borrowers to pay it back pretty quickly. They also issue receivables to the franchisees. That initial $100,000, $150,000 capital, that's going to sit with the parent but is obviously securitized by the van and the inventory. [00:00:00] S0: Have they ever faced issues with the underwriting, the financing arm, just in terms of pockets of weakness and seeing some stress on that portfolio? Has that ever arisen over the history? It's a long history of financing.
· Matt Reustle, Matt Fleming
[00:00:00] S0: Have they ever faced issues with the underwriting, the financing arm, just in terms of pockets of weakness and seeing some stress on that portfolio? Has that ever arisen over the history? It's a long history of financing. [00:00:00] S1: To my knowledge, not at all. And so if we go back in time, in 2009, we bought the stock when they unwound their partnership with CIT. In 1999, they had set up this partnership with CIT who went through various iterations, and in '09, they brought these receivables onto the balance sheet. And there was a lot of hand-wringing, of “this company makes tools, what do they know about finance, etc. etc.” And it's just been smooth sailing ever since. For the most part. I can't think of a period where they've had any stress or issues with the credit. So it's been a pretty nice track record for now. Every once in a while you get what I call the doubters. Really talk about how they're juicing the market. That can be the bear case, they're pushing credit to basically get technicians to buy tools they don't need. It's very much the other way around. The receivables go up when sales of tools go up. They will lead with some promotions. But again, at 18%, it's certainly not what I call incentive financing for the customer. [00:00:00] S0: On the capital allocation side, you mentioned there can be lumpiness in free cash flow. What is their general strategy in terms of allocating capital? It feels like, because of the franchise model, there's unique dynamics here. What does that look like?