Genuine Parts: Wait For The Next Buying Opportunity On This Dividend King (NYSE:GPC)

In recent years, I have added a twist of secular growth to my investing strategy. This can be observed with my purchases of the likes of Amazon (AMZN) and Alphabet (GOOGL) in the last couple of years.

At my core, however, I remain a dividend growth investor focused on buying qualitative businesses at favorable valuations. This is precisely why my portfolio is loaded with dozens of Dividend Kings and/or Dividend Aristocrats.

Over time, Dividend Aristocrats and Dividend Kings do fall from grace. However, I believe that a well-diversified portfolio and occasional monitoring of such businesses (e.g., selling as fundamentals deteriorate) allows for outperformance over the long run.

From 1973 to 2022, dividend growers and initiators, as a class delivered 10.2% annual total returns. That’s substantially better than the 7.7% annual total returns that an equal-weighted S&P 500 (SP500) index generated. Put another way, an investment amount in the dividend growers and initiators would have become 3.5X more valuable than the same investment in the S&P 500 by the end of the period.

Genuine Parts Company (NYSE:GPC) is a Dividend King, with 67 consecutive years of dividend growth to its credit. The last time that I covered the Dividend King was in June 2021, when I rated it a hold. At that time, I liked Genuine Parts’ fundamentals. However, I didn’t like the valuation. As my discussion of fundamentals will bear out, I still believe that it is still a fundamentally sound business. But the valuation remains a bit too much for my liking to justify an upgrade to a buy rating.

Genuine Parts’ 2.7% dividend yield is reasonably attractive when stacked up against the 1.4% yield of the S&P 500. This is especially true when considering that it should have ample room to extend its dividend growth streak for the foreseeable future.

That is because, for one, the 41% EPS payout ratio is well below the 60% EPS payout ratio that rating agencies desire for Genuine Parts’ industry. The 46% debt-to-capital ratio is also barely elevated beyond the 40% that rating agencies desire. Thus, Genuine Parts’ debt is rated BBB by S&P on a stable outlook.

The company’s 0.5% risk of a dividend cut in the next average recession is the lowest allowed value in the Dividend Kings Zen Research Terminal. Even in a severe recession, this risk rises to just 2% – – higher than the 1% floor, but not substantially so. For some insight into how these dividend cut risk estimates are calculated, they are based on a variety of metrics. These include a company’s payout ratio and debt-to-capital ratio versus the industry-safe ratios set forth by rating agencies.

The biggest drawback to Genuine Parts may be its valuation. Using the historical dividend yield and P/E ratios as a proxy (i.e., an average of 10-year and 25-year valuation metrics), its shares could be worth $138 each. In the case of Genuine Parts, I believe these metrics to be fair since fundamentals (e.g., growth) are about the same versus those periods per a look at FAST Graphs. Relative to the current $142 share price (as of January 23, 2024), that suggests Genuine Parts is 3% overvalued.

If the company grows as anticipated and reverts to its fair value, here are the total returns that it could deliver over the coming 10 years:

• 2.7% yield + 9% FactSet Research annual growth consensus (reasonable in my opinion given Genuine Parts’ low- to mid-single-digit net sales growth, margin expansion, and share repurchases) – 0.3% annual valuation multiple contraction = 11.4% annual total return potential or a 194% 10-year cumulative total return versus the 9.8% annual total return potential of the S&P or a 155% 10-year cumulative total return

A Mixed Quarter But Strong Results Nevertheless

Falling $90 million short of the analyst consensus for net sales, Genuine Parts wasn’t able to pull off a double beat in the third quarter. Even so, the company’s $5.8 billion in net sales represented 2.6% growth over the year-ago period.

Genuine Parts’ revenue growth was driven by a few components. First, comparable sales grew by 0.5% during the third quarter (0.6% for the automotive segment and 0.3% for the industrial segment). Next, bolt-on acquisitions made within each segment contributed to 1.7% of net sales growth for the quarter (2.4% in automotive and 0.6% in industrial). Third, favorable foreign currency translation in the automotive segment (1.1%) offset unfavorable foreign currency translation in the industrial segment (-0.3%). That chipped in 0.5% net sales growth in the quarter. Finally, a 0.2% negative impact from other factors in the automotive segment partially countered net sales growth to the tune of 0.1% during the quarter.

Genuine Parts’ adjusted diluted EPS climbed 11.7% year-over-year to $2.49 for the third quarter. That was $0.07 higher than the analyst consensus. Improved operating efficiency helped the company’s non-GAAP net profit margin to expand by 40 basis points to 6% in the quarter. Combined with the greater net sales base and lower share count, that is how Genuine Parts’ adjusted diluted EPS growth outpaced net sales growth during the quarter (details in the previous three paragraphs sourced from Genuine Parts’ Q3 2023 Earnings Press Release).

Looking ahead to the fourth quarter (earnings are expected to be announced on Feb. 16), analysts anticipate $5.66 billion in net sales. That would imply 2.5% growth over the $5.52 billion in Q4 2022 net sales. From my view, I am inclined to agree with the analyst consensus. Genuine Parts’ modest comparable sales growth and bolt-on acquisitions should help the company to meet these forecasts.

Additionally, the analyst consensus is that Genuine Parts will put up $2.20 in adjusted diluted EPS. That would equate to a 7.3% growth rate over the year-ago period. Again, this is sensible in my view. That’s because I also believe that net sales growth, margin expansion, and share repurchases can drive such level of growth.

The momentum is also clearly on the company’s side, with 8 out of 10 EPS revisions being upward in the last 90 days. Lastly, the $9.89 in adjusted diluted EPS projected for 2024 would be a healthy 6.7% growth rate over the $9.27 consensus for 2023 (info in the paragraph according to Seeking Alpha).

Moving to the balance sheet, the company’s debt to adjusted EBITDA was 1.6X as of September 30. That’s well below the targeted leverage ratio of between 2X and 2.5X per CFO Bert Nappier’s opening remarks during the Q3 2023 earnings call. Also, the company had $2.2 billion in available liquidity on its balance sheet at the end of the quarter.

Ample Free Cash Flow Can Support Dividend Growth

In the last five years, Genuine Parts’ quarterly dividend per share has grown by 31.9% cumulatively to the current rate of $0.95 – – a 5.7% compound annual growth rate. I would expect dividend growth to remain at least as vigorous in the years to come.

That’s because, through the first three quarters of 2023, Genuine Parts posted $732.6 million in free cash flow. Against the $393.4 million in dividends paid, that is a 53.7% free cash flow payout ratio (info from page 8 of 31 of Genuine Parts’ Q3 2023 10-Q Filing). That leaves the company with sufficient capital to pay growing dividends, repurchase shares, and keep up with debt obligations.

Risks To Consider

Genuine Parts is a quality business, but it still faces risks that could hurt the investment thesis.

The automotive and industrial parts industries are competitive. If the company wants to maintain and build its market share, it will need to keep delivering value to its customers. Otherwise, the company’s market share and growth prospects could diminish over time.

Another risk to Genuine Parts is the potential for a cybersecurity breach. Even with its spending dedicated to updating its IT systems, there is no guarantee that a breach won’t ever happen. If such an event were to occur on a big enough scale, it could compromise sensitive customer, employee, and supplier data. That could result in a loss of trust in the company’s brands and litigation that could damage its growth story.

Finally, Genuine Parts’ automotive store brands are primarily independently-owned stores (6,679 of 9,801 as of the end of 2022). If these franchisees were to be in conflict with the company, that could weigh on sales since Genuine Parts sells inventory from its company-owned distribution centers to these franchisees (page 5 of 93 of Genuine Parts’ 10-K filing).

Summary: Waiting For A Better Long-Term Risk/Reward Proposition

Based solely on its 15.4 blended P/E ratio, Genuine Parts could have some upside ahead in the next couple of years. This is below its normal P/E ratio of 18. If it returns to this valuation multiple and grows as expected, 41% cumulative total returns could be generated through 2025. That’s far better than the 5% cumulative total returns predicted for the SPDR S&P 500 ETF Trust (SPY) over that time.

However, I buy companies as much for the next 10 years and beyond. At the current valuation, I’m not interested in adding to my position. This is because I want to build a margin of safety to dramatically improve my odds of earning 10% annual total returns. If Genuine Parts ups its dividend as is expected next month and there is a pullback to the low- $130s, I would think about upping my rating to a buy. For one, the starting yield would be closer to 3%. Also, this valuation would provide a cushion for modest misses of the analyst growth consensus in my view. Together, this would make Genuine Parts a compelling buy in my opinion.