Snap-on: Nearly a Century of Dividend Growth and Tool Innovation

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In this episode of The Dividend Mailbox, Greg takes an in-depth look at Snap-on (SNA), a company with a rich history of tool innovation and consistent dividend payments since 1939.  He discusses the company's evolution from automotive tools to specialized equipment for various industries, its unique franchise model, and its financing arm. By examining Snap-on's business model, financial performance, valuation, management discipline, and potential risks, he makes the case that this seemingly "boring" business checks almost all the boxes and is a compelling investment idea for dividend growth investors.  

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Transcript

Greg 00:11 

This is Greg Denewiler, and you are listening to another episode of The Dividend Mailbox, a monthly podcast about dividend growth. Our goal is to stuff your mailbox full of dividend checks. When they grow over time, a funny thing happens, you create wealth. 

Welcome to episode 37 of The Dividend Mailbox. In this episode, we're going to go back to looking at an individual company as a candidate for our decade of dividend growth. But I hope you got something out of the last episode with Daniel Peris and just the whole mindset and thought process that goes into executing and maintaining a strategy of investing for income. Long term success, even in something as simple as just buying a dividend-yielding stock, is not an easy process. But this episode we're back to trying to find ways to implement the strategy to try and make money. And we're going to pretty much spend the entire episode on one investment that we are considering. Hopefully, at the very minimum, you'll at least realize some of the components of what it takes to get long-term dividend growth. 

Well, without beating around the bush too long, we're going to look at Snap-on. It's a company that has come up on my radar before. I never really spent too much time on it because of two real reasons. Number one, it just seemed like kind of a boring business. The growth of revenue has not been anything stellar, but it has been consistent. And then the other reason is that I had an issue with the fact that we are moving into more of an electric vehicle market where you don't have as many moving parts. So therefore, it just seems logical that you're not going to need as many tools, or on the surface, it seems like there won't be as much to fix because more of it is electrical. But this is another case where it really pays to know the story. Snap-on actually goes way beyond just providing tools that work on cars. 

So, I think one of the best ways to illustrate this, and usually we don't go into much detail on the history of a company, but I'm going to give you a little overview of how Snap-on got into business and why it has been so successful over time. We're going to start in 1920. Two guys developed 10 sockets and five handles. They came up with a saying, “Five do the work of fifty.” So that was kind of the heart and the beginning of the Snap-on story. That's what the whole company is built on, and I hope you see this relatively quick. So anyway, they sold socket sets. When you get to 1924, at that point, Ford was building the Model T, and they came up with a tool kit designed specifically to work on Model T cars. That was really the beginning of starting to come up with individual tools to solve specific problems. They soon went into auto repair. They came up with tool sets to do heavy duty, extra heavy duty, jumbo socket lines, to repair trucks, airplanes, farm equipment, road machinery, and maintenance for mills, mines, and power plants. Even in the 20s, they started to go beyond just working on autos. So then, we get to the 40s. As the railroads switched from steam to diesel, Snap-on created a railroad department that was a highly specialized product line that was just oriented towards working on the diesel engines and the railroad cars. Going into the 50s, car production really exploded, there were a lot of road conditions that were not the best, and alignment became a problem. That was one of the tools that Snap-on came up with. As the aviation industry continued to expand, everything was about trying to save weight, and some of the clearances are extremely narrow. Well, one of the things that Snap-on came up with was tight access and thin wall special application tools. They really started to get into more test stuff in the 1950s, where they got into alternator testers, distributors, volt meters, amp meters, looking at ways to broaden just beyond tools. In 1967, they got into a specific set of tools to repair air conditioning systems. In the 1980s, I found this kind of fascinating, they developed some tools to service the lunar roving vehicle, and they came up with specialty tools for aircraft and for missiles. Major customers were Boeing, Grumman, General Dynamics, and McDonnell Douglas. Well, I think you probably get the point here. They're well beyond just fixing a car. Their whole mantra is basically trying to save mechanics time, which allows them to make more money. They're considered premium tools, and they do a lot of things that basically nobody else does. One of the other things that they did, and we're going to get into this much later in the podcast, is they came up with their time payment system. It allowed mechanics to still work and get paid, but buy their tools over time. They've really been in the credit business for almost a hundred years, and another component, which makes it a little bit of a unique story is they have the franchise model. People will buy territory, and you have probably seen one of their big trucks that drive around, and they actually go to locations, they show the tools, and another key piece, which I hadn't really connected in the past, is that these franchises are direct links to the customer. They can get feedback, they can solve problems, and maybe even as important, they can actually help manage their accounts receivable. 

So now moving on, here's where The Dividend Mailbox comes into the picture. Snap-on has been paying a dividend since 1939. Now they haven't raised it every year since that time, but they've never cut it. So, this company has a tremendous track record of generating an income for their shareholders. So, here you've got a company that appears to be another one of these sort of not real exciting— pretty much on the opposite end of something like an NVIDIA, Apple, or Microsoft— but, lo and behold, in 34 years since 1989 through the end of last year, the total return of Snap-on was slightly ahead of the S& P 500. It was up 2,900% on a total return basis. Now, if you go year to date, the stock has underperformed, down a little over 9% while the S&P 500 is up 17%. So on a total return since 1989, it's actually lagging a little bit, but that's part of what has led us to start looking at it. Lower prices create an opportunity if you have a high-quality company that can continue to perform long-term, which is where we're at. Here's an interesting thing. Their revenue growth from 1989 to 2023, revenue has only grown by 5.3% a year. They've grown from $890 million to $5.1 billion. Just looking at that number you would say, “Hmm, okay, how can they generate S&P like returns, when the top line just isn't growing that fast?” Your first answer is probably going to be, well, back in 1989 prices were much lower, and in the case of Snap-on the P. E. was 13. So, it would be pretty easy to assume now the stock trades at a higher P. E. so it's performed better. Well, if you thought that, that's a great guess, but it's wrong because today the P.E. is 13. That total return growth has not come from P. E. expansion. It's really one of the main messages of our whole podcast, because you don't need high growth to generate great returns, you just need great disciplined management that manages their cash flow well, and that's where we're going next. 

If you've ever read Jim Collins in Good to Great, you are well aware that he is a big fan of CEOs that come out from inside the company. That creates continuity with the culture, and then CEOs that understand the company and continue to help the company evolve, but they don't come in and do major shake-ups. So, the current CEO of Snap-on became the CEO in 2007, and he did come up in the company before that. Just to give you a quick look at what his track record is, in 17 years, earnings have grown by 11.3% a year, and dividends have grown 12% a year. Revenue is only up 3.6% per year. Debt has doubled, but we're going to get into that a little later. The share count has actually declined by 7%, and shareholder equity has grown from $1.2 billion to $5.1 billion, which is about 9% a year. When you're looking at a long-term creation of wealth, you have to have a CEO that's disciplined and can execute the strategy. I have to give the guy a B plus, and the only reason why he doesn't get an A is because it would have been nice if revenue had grown a little bit faster. One of the potential issues coming up is he is currently 77 years old. It is worth exploring, “Okay, what does a succession look like?” But I have to assume we have a reasonable chance that he's going to continue to be able to execute. 

So now we're going to go into the 10-year model. If you've listened to more than one of these podcasts in the past, you know that our goal is to double our portfolio income in 10 years, and this implies that we need at least 7% a year dividend growth. That's our hurdle rate. Well, the dividend currently is 7.44 a share. The stock's trading around 255 today. Currently, the yield is just under 3%. That is really our sweet spot, and if you look at the historical returns of the dividends, in the last 20 years, the dividend has grown by 572%. In 10 years, it's grown by a little over 260%, and this equates to an annualized growth rate of about 15% a year. In five years, it's grown by 97%. So the dividend growth is there in a big way, but this is where the rubber kind of meets the road. Their margins have continued to expand, and that is the whole reason why earnings have grown faster than revenue. They can't grow margins forever. In other words, they're not going to end up making more money than their revenue is. The challenge that you run into is “Okay, the dividend is growing much faster than earnings, it's growing way faster than revenue, so at some point that has to slow down. Maybe in the next decade, I'm sure it probably will, but in our case, what we're looking at is if we want 7% dividend growth, we have to get the dividend up over $14 in 10 years. So basically, that's a double. Well, what does it take for a 14 dividend? Number one, we need earnings to grow. Right now their payout ratio is 35%. So if they continue at that rate, which historically has been roughly where they've lived, then earnings have got to $41. That is 8% per year growth. It's possible, but we're going to get into that a little bit more here soon. The other way is they could raise their payout ratio to 40%, which now earnings only have to go to $36, or they could go up to 45%, which is $32. So at that point, they only have to have a little over 5% a year of earnings growth to still maintain that 7% percent dividend growth over a 10-year period. They could pay out 45% right now, this company generates lots of free cash. But if they do actually grow the dividend to $14 and it trades at a 3% yield in 10 years, without any compounding of the income that you would receive, you've got almost 140% 10-year return. So that just gives you a pretty good margin of error, even if they don't get the earnings growth, or the dividend slows down a little bit. 

There's a couple of other scenarios in here that can help get you to the $14. Current earnings estimates for this year are $19. So they already cover it, and they cover it by a fair amount. The 2025 estimates are a little over $20. So theoretically, the company doesn't even have to grow earnings to still potentially be able to pay a $14 dividend. Also, these diagnostic tools are not cheap. This is kind of the good-news, bad-news because cars continue to become more complex. They're harder to diagnose. As mechanical systems and technology becomes more and more embedded in ordinary life and things that get fixed, those are higher-margin products. So it is possible that you could continue to see some margin expansion, but here I'm going to call this the margin of safety and I'm not going to put too much weight into that. But if you get it, it's all just a big bonus. 

So then, let's just move on now to valuation. You know, is the company cheap? Is it expensive? Well, the short answer there is it's sort of in its average trading range. It's somewhat cheap right now. Right now, as I mentioned, the P. E. is 14 and its 10 year average is 16. The price-to-sales ratio is slightly above its 10-year average. It's 2. , the 10 year average is 2.5. For price to book, the 10-year average is 3, right now it's at 2.7. So, the stock is moving a little bit into the cheap zone. 

But the other reasons why we're really interested in looking at this now is, one, they've paid down debt. Their debt-to-equity ratio is down to around 25%, in 2014 it was at 41%. 

You've got goodwill and intangibles that total about 1.3 billion while shareholder equity is 5.1 billion. They've done a good job of managing the balance sheet and not putting too many acquisitions on that potentially dilute shareholder return. 

Long-term receivables are $1. 7 billion. That's where they provide their customers with credit. That is up to 30%. I will tell you that was something that we were initially nervous about because when you have 30% of your sales being financed, it can make you a little nervous, and that number has been trending a little higher. Probably partly because the tools get more specialized and the diagnostic equipment continues to get more expensive. Plus, the average mechanic just can't afford to lay out thousands of dollars for something. We're going to get into that in more detail in a little bit, but we pretty much have that resolved. 

Operating income, in 2013 it was 18%, in 2023 it was up to 25%. So the company has become more efficient and more profitable. 

Return on invested capital, since 2014, it's averaged roughly 15%. A little bit below it, but not much occasionally. 

Here's a great number that you really like to see. Since 2007, the incremental return on capital is up at 25%. And basically what that means is they've taken their earnings that they earn each year, they reinvested it in the company and they're actually at the minimum earning the same returns or higher. 

They've averaged about 1.5% CapEx over the last more than a decade. That number is down slightly, but they do continue to spend on new product development. 

When you look at cashflow and then you look at net income, you really like to see the numbers relatively close because, there's never a guarantee in the accounting world, but it tends to tell you that the accounting is somewhat conservative and what they're depreciating, how they're treating assets and liabilities, they're roughly in line. Cash from operations is $1.5 billion. And last year, their net income was $1 billion. So it's pretty close. 

This is why we're, we're spending time on this company right now and we're looking at it. They generate great excess free cash flow. The free cash flow yield to market cap is around 9%. So if you own the entire company, and you're getting a 9% return on it, over time, things are going to go well for you. That is part of the reason why this company has kept up with the S& P 500 over the last 30 plus years. 

Here's another great number— I tell ya, I really think this company ticks almost all the boxes. They have about $1.2 billion in debt. They actually have $1.1 billion in cash, so this company is extremely liquid. Debt can be a beautiful thing, or debt can basically put you at the bottom of the ocean. In this case, they have $300 million that matures in 2027. It's at a rate of 3.25%. So they still have 3 more years on that, but they have the cash to pay it off if they choose to. These next two numbers, I think, are significant and I really view this as a huge asset for them. They have $400 million that's out in 2048, and that's at a 4.1% interest rate. They have $500 million that's at 3.1% that matures in 2050. They've got cheap financing costs locked in for a long time. That also simply implies that they have very little rollover risk as far as either being able to come to the markets for financing when maybe they're distressed, when the market itself is distressed and it's hard to raise money, or if the cost of money goes up considerably. 

So now we're going to move to management discipline and here, as I mentioned earlier, in the last 17 years, they've only bought back 7% of their equity, which you could say maybe it would help them if they were a little bit more aggressive there. But the other piece to look at is, “Okay, when they have bought it back, you know, did they just pay any price for it?” Well, at the end of 12/21, in the fourth quarter, they bought back $234 million worth of stock, and just kind of back of the envelope, they roughly paid $160 dollars for it, which the stock would have been trading around 10 to 11 times. The fourth quarter of 2022, they bought back $107 million. Again, this is just kind of a, an eyeball estimate, they paid roughly 220, but the stock was trading up at 13 times last year. They bought back $98 million and the stock was probably around $275 so they paid about 14 times. So they do seem to have some discipline as far as when they're going to spend money. They're not overpaying for stock at high multiples. 

The second thing is debt. We've already really looked at that. They took their debt out long term when debt was cheap. So you really have to give them almost an A. In fact, I got to give them an A because when you look at their interest expense for last year, it was only $10 million because they're earning basically the same amount on cash as they earn in debt. So, for all intents and purposes, it costs them nothing right now. Then you look at the debt is rated A and probably the only reason why it's not higher than that is because it's not a mega cap company. 

They've done some acquisitions, but they've been fairly disciplined there. The real simple tell there is you've got a little over $1 billion of goodwill, a little over $5 billion in stockholders equity. So goodwill and intangibles is very manageable. And then the real proof of management discipline comes in return on invested capital. And as I mentioned earlier, they have been very consistent investing their capital. They've actually produced better returns, so management discipline is definitely there. 

And then finally, now we're going to spend a little time looking at risk and growth. We can start with accounts receivable and how they finance that. Again, I will say that initially it was a little concerning when you go back to 2007 and they were basically financing 15% of their revenue, and now they have doubled it. There are a couple of pieces to that puzzle. The first big one is, they had a joint venture with CIT, the finance company. They were only responsible for 50% of those accounts receivable and CIT took the other 50%. They ended that relationship in 2009 and transferred all of their financing over to themselves. Companies that issue credit to their customers— that's always something that you need to pay attention to because what you have to be nervous about is are they starting to issue credit to lower quality customers so they can increase sales? Or is there a risk there where you can have a one-off event where they have to take a big charge if they have some defaults? Well, I can tell you this, in the 2007 10K, they show that they had total accounts outstanding of 188,000. It's not too hard to connect those dots because you've got a lot of individual mechanics out there, but you've got accounts receivable that are spread over a huge base. Well, the next piece is, okay, you got a lot of mechanics, the age of cars on the road continues to get older. That means there's more of them getting fixed. Even in a weaker economy, you still need your car fixed. Or, if something breaks, if your air conditioning goes out, you still need it fixed. So, there is some security there, however, going back to 2010, this is coming out of the last severe recession, 7. 4% of their accounts receivable were non-performing, and they had an allowance for bad debt of 10% of their accounts receivable. Their financing arm was still profitable, even in an extremely depressed economy at that point. We feel comfortable that the financing of their accounts receivable is not a problem. In fact, it's a part of their brand that helps keep mechanics loyal to Snap-on. 

Another risk is Snap-on in a recession, as you can probably guess, it's not what you would consider a defensive position because it's perceived to be somewhat tied to the economy. If you look at past recessions, going back to 1991, the company actually performed worse than the S& P 500. In March of 2001 to November of 2001, it did a little bit better. It was down 5%, the S&P was down 17%. In 2007 to 09, it basically tracked the market. It was down roughly 40% versus 42% for the S& P 500. These are total returns, so this includes the dividend. And then in 2020, from February to April 1st, it was down 35% and the S& P was down 23%. You know, there is some volatility there. However, that can create some opportunities. In the end, you want to be able to buy a quality company at a very reasonable price. The overall market actually is not doing that well versus the headline numbers of the S&P 500 where you see we're up 17%. You've heard this over and over, it's really due to just a handful of companies. With a recession potentially out there, people are seeing some of these economic numbers slowing down a little bit, so it causes some concern. If you look at things that are a little bit more cyclical, I think that's probably the single reason of why Snap-on is down for the year, but we're looking at that as an opportunity to start buying it. Ultimately, we will get a recession, but you have to be very careful waiting, trying to time, especially something that is trading reasonably priced and has great cash flow. I mean, that's what you need to focus on long term. 

To me, The biggest risk of this stock and one of the reasons why we're not ready to commit totally to it yet, although I will say that it is highly probable by the time you listen to this episode, we are going to start a small position in it. I think this is a high-quality company, a tremendous brand, great execution. It really checks all the boxes except for one, and that's clarity of revenue growth that'll help make the dividend growth a little easier to attain. One of the issues that I want to try to get a little bit more clarity on is when you have a CEO that at some point is going to retire, I mean, as I've mentioned earlier, he's 77 years old, who his replacements going to be is a significant factor. Also, do they expect to get more margin expansion? Are they going to get a little bit more aggressive buying back stock? I mean, the company is not going to tell you, “Oh yeah, we're going to start buying back 20% of our stock next year.” But you can talk to them and get some indication of are they looking at more overseas expansion? Are there new areas where they think they can go into? How are they going to continue to grow this company? Can then we say, “Okay, we agree with that.” Or it's possible that the dividend may only grow 5% for the next 10 years. We very well could still get the total return, but when you build a business around doubling your income at 7%, you need to do the best you can to try to achieve that. And that's part of what our whole podcasts are about, trying to have the mindset of not worrying about what the stock does in the next three months, but are you going to build that cashflow over the next decade? For us, the biggest risk is really down to that. And I do hope to actually talk to IR (investor relations) here after their earnings call, which will be at, or after this podcast is already out. So hopefully I'll give you a little bit of an update on that on the next episode. I will tell you whether we've made a bigger commitment to it or not, just to try to have full disclosure on this. 

So, as we wrap up this episode, the great thing about this company, and why we will probably at least take a small position in it is you can see a path forward on how they continue to create more specialized tools. They're just a great brand, and no matter where technology goes, things are going to need to be fixed. If anything, you're probably going to need more specialized tools. They've shown the ability to manage the company through a century where they create value for their customers and they continue to try to make their work more efficient. With basically their no net debt exposure, great cash flow, great cash flow after the dividend, well above what they have to spend for CapEx, — it's not dirt cheap, but it's reasonably priced. You can actually say that there's a pretty good margin of safety here. It's pretty hard to see how this is not a great dividend proposition if you want dividend growth. 

If you enjoyed today’s podcast, please leave a review and subscribe. If you would like more information regarding dividend growth or our investment, strategy please visit growmydollar. com. There you will find previous episodes and also our monthly newsletter. If you have any questions or anything to add to today's episode, please email ethan@growmydollar.com. 

Past performance does not guarantee future results. Every investor should consider whether an investment strategy is right for them and all the risk involved. Stocks, including dividend stocks, are volatile and can lose money. Deneweiler Capital Management may or may not have positions in the publicly traded companies mentioned herein.