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Vanina Egea
Vanina Egea
Articles (218)  | Author's Website |

Wrenching Up: The Tool Industry

September 23, 2013 | About:

I grew up visiting my dad’s combine repair shop. Tools were everywhere and some brands stuck with me. Timken (NYSE:TKR) was one of the brands at the shop. I did not know of Snap-on (NYSE:SNA) until visiting one of its trucks. Now that the economy is picking back up, pushing growth in the automobile and construction industries, its prospects begin to change. Let us see what some of GuruFocus’ tracked investment gurus think of these companies.

Rolling Profits

From its first plant in Johnson City, Tenn., Snap-on grew into a worldwide multinational operation with around 11,500 employees. Among its staple products we can find: hand and power tools, tool storage and diagnostics software. The latest news indicates that overall performance continues to improve. Gurus, however, have mostly stepped out of the business. Robert Olstein, Ken Fisher and Steven Cohen, for example, sold all their shares. Meanwhile, Pioneer Investments, John Keely and Paul Tudor Jones have reduced their holdings in excess of 50%.

At the moment, Snap-on is facing two important difficulties: low consumer confidence in Europe and defense spending cuts in the U.S. However, operating margins remain high, and high customer loyalty coupled with a wide economic moat have helped the firm to stay afloat. For the long run, management wishes to continue penetrating emerging markets and critical industries. Also, the business strategy points to increase its presence in the repair shops segment through improvements in the mobile tool distribution network.

Snap-on holds a leading market position in the U.S., and its most important segment is the service and repair market. Hence, it is expected to be negatively impacted by a decline in the age of the automobile park.

On the up side, the company operates a financial scheme to help customers meet their needs. Furthermore, expansion has focused on professional customers (those which perform critical tasks) and holds half of the market for independent technicians. Lastly, management is looking at the Chinese market to increase international presence.

Financially, Snap-on is a moderate business because most indicators have frozen, while cash flow has declined steadily. Currently trading at 17.9 times its earnings and carrying a 10% discount to the industry average, the stock is overvalued. I share the gurus’ lack of optimism because operating expenses for the company increased during the quarter due to higher volume and other related expenses. Also, as the U.S. car float continues to renew, fewer tools will be required by individuals, especially when OEMs entice customers to visit official dealerships for repairs.

Bearing Down

Headquartered in Canton, Ohio, Timken has spread its operations through joint ventures to more than 30 countries. Its products are divided among four segments – mobile industries, process industries, aerospace and defense, and steel. It is notable that Chuck Royce, Bruce Kovner, Jim Simons and John Keeley have increased their holding considerably.

At the moment, Timken is completing the split of its bearings and steel businesses into two independent, publicly traded companies. The move is a response to dropping sales and higher competition. The company expects to complete the transaction within 12 months, but gurus have already made a positive assessment of the current strategy.

Looking ahead, Timken is not expecting changes to its economic moat, and will focus on increasing the percentage of OEM sales that offer the greatest opportunity for aftermarket sales. It is worth mentioning that the company achieved record sales and profitability during the last recession. And a focus on specialty steels for demanding environments offers a great opportunity to continue increasing margins.

Financially, Timken is stable and expected to continue improving after the split is completed. Currently, the stock is trading at 19.6 times its earnings, just shy of the industry average. I share the gurus’ optimism after the announced restructuring, since the firm has been able to divest non-core and non-profitable segments.

Wrench Down

I prefer Timken mainly because, just like the investment gurus above mentioned, I recognize the potential unleashed by the management’s decision. Additionally, the company holds an important economic moat, and the remaining segments offer a profitable future. Last, its finances will be greatly improved by the recently announced split.

Disclosure: Vanina Egea holds no position in any of the mentioned stocks.

About the author:

Vanina Egea
A fundamental analyst at Lone Tree Analytics

Visit Vanina Egea's Website

Rating: 3.0/5 (2 votes)


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