Over the past few weeks I have been watching the developments of the automotive replacement parts industry. This has provided an excellent opportunity to search for stocks in this sector for investment purposes. One company I think is very interesting to analyse is Genuine Parts Company (GPC). While there are many different factors to look at and consider when investing, in the article below I will look at the debt side of the company. By analysing the company’s total debt, total liabilities, debt ratios and what analyst and other top investors believe about this firm, we should get an accurate idea about the company’s leverage and how much to expect in return from a long-term investment.
The NAPA brand is well known amongst automotive owners, seeking help in times of need. As a middleman service, the brand supplies vehicle-repairs shops with replacement parts, in addition to transportation services. Furthermore, the company’s inventory-monitoring system provides NAPA stores with information about missing repair parts, generating a reliable and massive scaled replacement network. However, apart from its automotive segment, the company also supplies disposable and highly perishable products to the industrial segment. Its vast product portfolio, which outsizes competitors like Applied Industrial Technologies (AIT), allows the firm to sustain profitable operating margins of around 8%.
It is essential to remark that gaining knowledge about the firm’s debt and liabilities is a key component in understanding the risk of investing in this company. In 2008 and 2009 we were able to see some of the repercussions that highly leveraged companies with large amounts of debt succumbed to.
Total Debt to Total Assets Ratio
This metric is used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. It results from adding short-term and long-term debt and then dividing this figure by the company's total assets. If the outcome is higher than 1, it means that a company´s total debt surpasses the value of its total assets. The total debt to total assets ratio (especially when complemented with other measures of financial health) can come in extremely handy when investors want to determine a company's level of risk.
Genuine Parts Company's total debt to total assets ratio has decreased over the past three years, from 0.09 to 0.06, which indicates that the company has added more total asset value than total debt over this time span. It also demonstrates that management is committed to reducing debt. Since the firm’s assets outrank its debt, it’s safe to assume a future low financial risk.
Debt ratio = Total Liabilities / Total Assets
The debt ratio shows the proportion of a company's assets that is financed through debt. When it’s below 0.5, most of the company's assets are financed through equity and on the contrary, most of the company's assets are financed through debt. Companies with high debt/asset ratios are said to be "highly leveraged", exposing them as vulnerable if creditors start to demand repayment of debt.
When looking at Genuine Parts Company's ratio over the past three years, we can see that it has increased from 0.49 to 0.56, marking an unfavourable trend. Given that the company’s 2013 TTM ratio surpasses the 0.50 mark, we can assume that most of the company´s assets are financed through debt. Investors should keep an eye on this metric, because the more it grows, the riskier the investment becomes.
Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity
This measurement is meant to reflect how much suppliers, lenders, creditors and obligators have committed to the company versus what the shareholders have committed.
A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt, which can result in the company reporting volatile earnings. In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations, and therefore is considered a riskier investment.
Genuine Parts Company's debt-to-equity ratio has increased in the past two years from 0.95 to 1.26 (in 2013). As this ratio currently surpasses 1x (1.26), it’s clear that shareholders have invested more in the firm than suppliers, lenders, creditors and obligators, which implies a high risk for the company and its stockholders.
Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity
(LT Debt = Long-Term Debt)
This ratio is very helpful in the assessment of risk, as companies with a high capitalization ratio are considered to be unfavourable investments: if they fail to repay their debt on time, jeopardy of insolvency gets high. Companies with an elevated capitalization ratio may also find it difficult to get more loans in the future.
Between 2011 and 2013, Genuine Parts Company's capitalization ratio has remained unchanged, at 0.07. This means that the company has reduced its equity levels in relation to its long-term debt. The current ratio (0.07) indicates moderate financial risk.
Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt
This coverage ratio compares a company's operating cash flow with its total debt, indicating a firm's ability to cover total debt with its yearly cash flow from operations. The larger the ratio, the better a company can weather rough economic conditions. In Genuine Parts’ case, the ratio currently stands at 1.81, demonstrating that the company has the ability to cover its total debt with its yearly cash flow from operations.
I also evaluate recent institutional activity in the stock and in the past quarter investment gurus Jim Simons (Trades, Portfolio) and Joel Greenblatt (Trades, Portfolio) both bought Genuine Parts’ company shares at an average price of $81.02.
Currently analysts at Yahoo! Finance expect Genuine Parts Company to retrieve EPS of $4.60 for FY 2013 and an EPS of $4.93 for FY 2014, while Bloomberg is estimating the firm’s revenue to be at $14.84B million for FY 2013 and $15.35B million for FY 2014. In addition to this, most estimate an $86.63 price target, which implies significant upside potential from this point.
Although Genuine Parts’ debt levels have grown over the past few years, making it a riskier investment on some levels, I would like to point out the company’s profitable returns on invested capital, which are currently at 37.3%. The returns on equity have also shown strong growth and with 21.6% vastly surpass the industry average of 7.0%. Furthermore, the company’s dominant product portfolio and extensive distribution network will continue to outrun its market competitors O’Reilly Automotive Inc. (ORLY) and Advance Auto Parts Inc. (AAP). Therefore, I feel bullish about this company’s profitability in the long term.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.