Analyst Report on Graco (GGG)
Analyst Report on Graco (GGG)
Graco makes equipment used to handle all kinds of sticky situations, from spraying pizza sauce in a food-processing plant to paint in an auto factory. This narrow-moat firm fiercely protects its technological advantage.
Users of viscous materials--professional painters, manufacturers, and quick-lube companies--are likely to use Graco equipment. The finishing touch provided by Graco equipment--furniture stain, for example--is highly visible to the end user, yet represents only a small portion of production costs. Graco maintains an impeccable record of precision performance, which facilitates premium pricing in this niche industry.
To maintain its cachet with demanding customers, Graco regularly reinvests 3%-4% of its revenue in research and development. The results speak for themselves. For example, Graco's paint-circulation equipment is used in 80% of worldwide auto production, a dominant position that allows the firm to capture industry growth around the globe. Regular product advancements stave off commodification and drive replacement business from existing customers.
Because of the relatively small size of its markets, new entrants could never achieve sales figures that would justify the investment required to match Graco's capabilities. The larger threat comes from industry players like Illinois Tool Works (ITW), Ingersoll-Rand (IR), and Nordson (NDSN)--all of which run somewhat similar businesses and would like to siphon off share. Graco's position elicits such envy because of its stellar returns: Operating margins continue to march beyond 25%. Aside from dominant market share and the resulting scale benefits, Graco controls costs by stressing lean manufacturing techniques and efficiency gains at the corporate office.
Also, this business quite naturally fits the razor-and-blade business model. Spraying abrasive fluids through a plastic gun creates constant wear and tear. Consumable parts and accessories, which make up 40% of total sales, contribute higher margins and help smooth out cyclical demand for the firm's products. For the customer, diligent maintenance ensures consistent performance and prevents costly waste of material. Though small in the grand scheme, Graco posts giant returns.
Valuation
Our fair value estimate for Graco is $43 per share. We expect 7% compound annual sales growth over the next five years, as Graco capitalizes on rapid growth in overseas markets. The firm is gaining share in Europe and growing on the back of developing economies. Further, we expect operating margins to expand to roughly 30% before retrenching to our 27% midcycle assumption. With Graco's all-equity capital structure, we use a 9.5% cost of capital to discount projected cash flows.
Risk
Graco's high margins and market share will continue to attract competitive advances from industrial powerhouses Illinois Tool Works and Ingersoll-Rand. Both firms compete with portions of Graco's product portfolio.
Stock Price $38.38 (as of 8/15/06)
Fair Value Estimate $43.00
Consider Buying Price $33.20
Consider Selling Price $53.90
Business Risk - Average
Economic Moat - Narrow
Stewardship Grade - B
Graco makes equipment used to handle all kinds of sticky situations, from spraying pizza sauce in a food-processing plant to paint in an auto factory. This narrow-moat firm fiercely protects its technological advantage.
Users of viscous materials--professional painters, manufacturers, and quick-lube companies--are likely to use Graco equipment. The finishing touch provided by Graco equipment--furniture stain, for example--is highly visible to the end user, yet represents only a small portion of production costs. Graco maintains an impeccable record of precision performance, which facilitates premium pricing in this niche industry.
To maintain its cachet with demanding customers, Graco regularly reinvests 3%-4% of its revenue in research and development. The results speak for themselves. For example, Graco's paint-circulation equipment is used in 80% of worldwide auto production, a dominant position that allows the firm to capture industry growth around the globe. Regular product advancements stave off commodification and drive replacement business from existing customers.
Because of the relatively small size of its markets, new entrants could never achieve sales figures that would justify the investment required to match Graco's capabilities. The larger threat comes from industry players like Illinois Tool Works (ITW), Ingersoll-Rand (IR), and Nordson (NDSN)--all of which run somewhat similar businesses and would like to siphon off share. Graco's position elicits such envy because of its stellar returns: Operating margins continue to march beyond 25%. Aside from dominant market share and the resulting scale benefits, Graco controls costs by stressing lean manufacturing techniques and efficiency gains at the corporate office.
Also, this business quite naturally fits the razor-and-blade business model. Spraying abrasive fluids through a plastic gun creates constant wear and tear. Consumable parts and accessories, which make up 40% of total sales, contribute higher margins and help smooth out cyclical demand for the firm's products. For the customer, diligent maintenance ensures consistent performance and prevents costly waste of material. Though small in the grand scheme, Graco posts giant returns.
Valuation
Our fair value estimate for Graco is $43 per share. We expect 7% compound annual sales growth over the next five years, as Graco capitalizes on rapid growth in overseas markets. The firm is gaining share in Europe and growing on the back of developing economies. Further, we expect operating margins to expand to roughly 30% before retrenching to our 27% midcycle assumption. With Graco's all-equity capital structure, we use a 9.5% cost of capital to discount projected cash flows.
Risk
Graco's high margins and market share will continue to attract competitive advances from industrial powerhouses Illinois Tool Works and Ingersoll-Rand. Both firms compete with portions of Graco's product portfolio.
Stock Price $38.38 (as of 8/15/06)
Fair Value Estimate $43.00
Consider Buying Price $33.20
Consider Selling Price $53.90
Business Risk - Average
Economic Moat - Narrow
Stewardship Grade - B
posted by Scott at
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