Generac Is the One to Watch Out For

July 15 -- Power outages are getting more common in US and Canada.

The energy crisis has taken over the whole world and its adverse effects are encompassing the residential and commercial sectors alike. According to the estimates of U.S. Department of Energy, power cuts cost businesses an average $80 billion loss per year. This has opened the gates for standby energy source providers in the market to take advantage of this opportunity. The use of standby power generators are growing more popular each day. Companies providing such machinery are expected to experience exponential growth on the basis of growing demand. The companies are expanding their operations outside the U.S. so that they can cater a larger market. One company working on this principle is Generac Holdings.  Let’s see if investors can trust the company’s growth expectations or not.

Generac’s business outlook

Generac is a manufacturer and marketer of generators and other engine-powered machinery for residential, commercial and industrial markets. The company has a huge market share in the residential sector holding a 70% share of the domestic home standby market in the US. It has a huge distribution network of over 4800 dealers which acts as a competitive advantage and a barrier to entry for the new players in the market. The company’s sales rocketed up to the $1 billion mark for the first time in 2012, which was a 48% growth in sales from 2011. Along with this, the company’s 3 year average income growth stands at a huge 29.4% compared to the industry average of just 3.5%. The cash flows of the company increased from $105 in 2010 to $213 million in 2012.

Though it is performing better than the industry, the company has a lower return on equity and return on assets compared to rival Cummins.  But it may not be too worrisome for Generac, as Cummins has gone down with its revenues last year and its performance might deteriorate more in coming future due to the strict regulations recently introduced by the government on diesel engines. Briggs and Stratton on the other hand is a large cap stable company with little or no growth expected in near future. Thus it is unable to excite you with its margins or returns.

The company’s main focus these days is the optional standby power supply for markets, restaurants, healthcare institutions and telecom companies. This is because of the huge losses these places incur when power is cut and there is no secondary power source.  Hospitals cannot risk the life of patients by not keeping power generators. They are bound to keep power generators for emergency purposes. Moreover, the company is also considering working on a line of generators that use natural gas as the power source. This decision might be fruitful as natural gas prices have declined and demand for such products would be high.

Competitive situation

As mentioned above some of its peers are Briggs and Stratton and Cummins. Cummins gives Generac a tough time in the residential market whereas Briggs is present as a dominant force in the commercial sector. Moreover Cummins is not just confined to power generation; it has a number of other operations. Currently its diesel engine business is in a funk as the government has conducted some serious changes in the regulations for diesel engine vehicles. Cummins is currently working on Natural gas engines to take advantage from the low natural gas prices in the country.

Briggs on the other hand also has two segments i.e. engines and products. Most of its sales and profits are attributed to the engines segment whereas its product line of generators and power washers have reported losses since the past 3 years. Both these other companies have their primary focus on engines, but Generac is focused on the production of power generators only. This gives the company an advantage over its peers to increase its market share of the power generators market. Furthermore, both Cummins and Briggs provide a decent yield to their investors which Generac does not, but Generac does give out hefty special dividends to its investors. In June 2012 the company paid a $6 per share dividend which is huge compared to what you have to pay for the company’s stock.

Recent acquisition

In the last quarter of 2012 the company made a strong move to enter international markets by acquiring Ottomotores. Through this acquisition, the company would take over the operations of Ottomotores Mexico and Ottomotores Brazil in Curitiba. This would enable Generac to combine both companies which are involved in the manufacturing and selling of diesel generators from 15 kW to 2.5 MW. Ottomotores is a leading company in Latin American standby power industry. This would help the company to strengthen its grasp on the Latin American market where its competitor Briggs & Stratton is already present.

Conclusion

Power generators are an essential component for both residential and commercial users alike. With the energy shortage in different countries increasing, the market for these power generators is growing. Growing companies like Generac can make full use of this opportunity due to its exceptional presence in the market over more than 50 years and its strong profitability and cash flows indicating that the company can take a few leaps of faith. Furthermore, its acquisition of Ottomotores will help it to focus on its sales outside the US market and take advantage of synergies.

www.fool.com  

Made In America: Generators

January 9 -- When the lights go out, most businesses idle their production until the electricity is restored by the power company.  However, a periodic disruption in utility service is exactly the time when the power generation industry’s products spring into service.

Generators provide backup power to homes and businesses, generally delivering between 800 watts and 9 megawatts of power through diesel, propane, natural gas, or bio-fuel sources. The industry has attracted notable attention in recent years as increasingly frequent storms make generators an important infrastructure asset for a wide range of businesses.  Best of all, many of the leading products are made right here in America.

The #1 manufacturer of home generators is Wisconsin-based Generac.  Founded in 1959, the company makes a variety of standby and portable generators through four manufacturing plants located in Wisconsin and Georgia.

While its products have historically been powered by diesel and propane fuels, Generac has been developing products that utilize cleaner-burning natural gas or bio-fuel in order to comply with government emissions rules.  In addition, the company has been diversifying into related markets through the acquisition channel, including the 2011 purchase of Magnum Products, a leading provider of light towers and mobile generators.

In its latest fiscal year, Generac reported revenues and adjusted EBITDA of $792.0 million and $188.5 million, increases of 33.6% and 20.6%, respectively, versus the prior year.  The company's strong sales were aided by a greater level of purchases by U.S. customers who were affected by recent storm activity, as well as its limited exposure to weakening international economies.

While operating margins slipped compared to the prior year level, the major cause of the decline was a shift to lower priced portable generators, rather than inefficiencies in its operations.  Gross margins have also been affected somewhat by rising commodity prices, but the company has been able to hedge their significant raw material needs and has found domestic sources for over half of its products’ components.

In FY2012, Generac has continued to generate solid results, with increases in revenues and adjusted EBITDA of 59.0% and 102.0%, respectively, compared to the prior year period.  All of the company’s segments have enjoyed double digits gains in sales, led by the commercial unit’s 81.9% increase.

While healthcare organizations have long recognized the need for generators, a wider range of businesses are adding power-related products to their mission-critical infrastructure.  Generac’s profits have also benefited from more favorable commodity prices, due to slower economic growth in emerging markets.  The higher profitability has led to strong operating cash flows, with $129.2 million generated in the first nine months of the year, which has allowed the company to return money to shareholders.

Generac estimates that only 2.5% of U.S. residential homes have emergency generators, which represents a significant growth opportunity for the company.  Given the company’s narrow focus on the generator market, though, where can investors find industry investments with greater product diversity?  One avenue would be to look at the manufacturers of engines for power generation products.  Two of the leading companies in this area are Briggs & Stratton and Cummins.

Founded in 1908, Briggs & Stratton is the largest producer of air-cooled gas engines for outdoor power equipment, with leading positions in the portable generator and power washing product lines.  While the company continues to derive the majority of its business from engine sales, it moved into the generator business through the acquisition of Generac’s portable generator unit in 2000.

Like Generac, Briggs & Stratton manufactures products in U.S. based facilities, although it has moved some production overseas.  In its latest fiscal year, the company reported declines in revenues and operating income of 2.1% and 14.5%, respectively, compared to the prior year period.  While sales of power generation products rose during the period, engine sales declined 13% due to Briggs & Stratton’s significant exposure to contracting European markets.  Despite weak current profit margins, Briggs & Stratton's restructuring activities should provide solid operating leverage for an eventual rebound in international economies.

Founded in 1919, Cummins is a global manufacturer of commercial engines and related components, as well a developer of power generation products and systems.  The company has built a $13 billion business around the sale of diesel and natural gas engines, which generates over 60% of total sales, and Cummins has been a beneficiary of rising demand for construction equipment in the fast-growing economies of China, Brazil, and India.

In FY2012, though, the company has been affected by the same global financial pressures and negative factors that have hurt Briggs & Stratton.  In the first six month of the year, Cummins reported declines in revenues and operating profit of 0.6% and 7.6%, respectively, versus the prior year period.  

Robert Hanley      www.beta.fool.com

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinions of our bloggers and are not formally edited.

Generac May be a Little Short on Power Here

January 2 -- I love modestly-sized niche industrial companies, but I tend to like them a lot better when they're not especially popular or well known yet. That's the problem with Generac (GNRC) - although I really like Generac's power generator business (and the prospects for taking it global), there is ample analyst coverage today and the valuation is not all that compelling.

Generac has built itself into a billion dollar-plus business by manufacturing a broad range of standby and portable electric power generators. Generac's systems range from 0.8kW to 9MW and cover the waterfront from small portable generators to fixed residential standby units to larger industrial generators.

Unlike competitors like Briggs & Stratton (BGG), Kohler, Cummins (CMI), and Caterpillar (CAT), Generac is solely focused on generators, and that focus shows. The company has the broadest array of products available to the market, many of which offer meaningful performance/cost advantages (like lower cost of ownership and higher reliability). Generac also uses a lean manufacturing process that includes outsourcing, and the company has reaped good margins and returns as a result.

Generac has also differentiated itself with the fuel sources - while it's commonplace for residential standby generators to run on natural gas or LP, industrial generators have historically used diesel. By offering natural gas and LP options (as well as diesel and bi-fuel), Generac has created genset options with lower cost of ownership and operation, but without sacrificing performance.

While Generac is certainly working on building its commercial and industrial (C&I) business (more on this later), the residential business generates more than 60% of revenue at present. The real question is just how big Generac's addressable market could get.

Generac believes it has about 70% of the residential standby market, with Briggs & Stratton and Kohler claiming about 10% each and Cummins holding 5%. Unfortunately, the residential standby market is only about 2.5% penetrated today (with another 12% or so of homeowners owning a portable system). With each 1% of residential standby market penetration worth about $2 billion in addressable market size, it's well worth asking if this market can grow.

The biggest obstacle to growth is that the purchase of a standby system is at the very least a highly discretionary purchase, if not a luxury item. Generac (and others in the market) have made great strides in lowering the cost (down about 50% over the last 14 years), and the company has worked with builders to increasingly design standby units into the basic design of new homes. Accordingly, it's not unreasonable to think that the growth of this market is tied at least in part to the growth in residential housing (particularly on the higher end where an incremental $2,000 to $5,000 may not be problematic).

Perception of need is another issue, but the U.S. utility infrastructure is taking care of that one for Generac. While major weather events like Hurricane Sandy and 2012's "super derecho" certainly bring more attention to the need for and advantages of standby power supplies, the ongoing erosion of the power system is arguably a bigger factor. There were over 60 power outages affecting more than 50,000 people in 2010, versus just five such outages in 1993. Given that it seems unlikely that the U.S. government is going to find enough spare change in the couch cushions to fund a major transmission/distribution system improvement initiative, more and more homeowners may turn to fixed standby systems as a means of guaranteeing that their power stays on all the time.

When it comes time to buy, Generac is usually well-positioned. Not only does Generac have over 4,000 dealers across the country, but its products figure prominently at Home Depot (HD) and Lowe's (LOW), even with Briggs & Stratton selling systems under the General Electric (GE) brand name.

Though clearly smaller than the residential business, I wouldn't sleep on Generac's C&I business, as the company has ramped up its investments into these operations. Right now, Generac has about 15% share in the C&I market, with much of that concentrated in the standby market. That leaves them well behind the likes of Caterpillar (which has about 30%) share, Cummins (25%), Kohler (20%), and Germany's Tognum.

Generac has done relatively well in places where you'd expect solid interest in standby power - healthcare facilities, educational facilities, telecom installations and so on. Part of the question now is how successfully the company can expand its addressable market. Given the cost of spoilage, businesses like supermarkets, convenience stores, and restaurants are all likely candidates, but I suspect there's a larger market in customer service-sensitive applications. Consider that in the recent Hurricane Sandy it would seem that more Verizon (VZ) towers stayed operational compared with AT&T (T), as Verizon made greater use of mobile gensets.

Generac is also looking to compete more directly in markets like construction, where rivals like Caterpillar and Cummins have been pretty successful. In acquiring Magnum, Generac bought a business that has about 10% share in mobile trailer-mounted generators, as well as 35% share in the light towers that construction crews use to light up work areas at night.

Perhaps just as important are the overseas growth opportunities. Caterpillar, Cummins, and Tognum are global genset businesses, but Generac really hasn't been up until recently. The company is moving to change that, though, with a recent distribution arrangement for Australia and the acquisition of Ottomotores from TT Electronics. Ottomotores has solid C&I market positions in Mexico and Brazil, and I believe entry into Australia could be a launching pad into markets like Indonesia and India - markets where power reliability is a major issue even in large cities.

Will Risks Zap Investors?

Like any company, Generac has multiple operating risks for investors to consider. While Generac has benefited from its focused approach to the generator market, the company has begun to spread its wings a bit, re-entering markets like pressure washers. At the same time, there's always the risk that competitors will check any moves the company makes to gain share in the C&I market and/or look to grab some of that sizable share in the residential standby market.

Investors should also note that private equity group CCMP Capital Advisors owns more than half of the shares and three of the seven board seats. While the company recently announced (and then canceled) a secondary offering that would have seen about one-third of that stake go into the float, investors need to realize the potential for conflicts of interest here.

Likewise, I can't say I'm ecstatic about the company's decision earlier in 2012 to recapitalize and pay a $6 per share special dividend. The recapitalization added about $400 million in net debt, and I believe the capital could have been better used to grow the business.

Last and maybe least, there's a small matter with Briggs & Stratton that means little today, but could become an issue in the future. Generac exited the portable generator business years ago, and in so doing Briggs & Stratton came to own the trademark to "Generac Portable Products." Generac reentered the business in 2007 and while Briggs & Stratton doesn't presently use that trademark, I suppose it could and create some market confusion in the process.

The Bottom Line

I like the Generac business quite a lot, and I think there are good prospects for both domestic market penetration and overseas growth. What I don't like so much, though, are the expectations already built into the stock.

Generac has recently been delivering free cash flow margins in the high teens, but I think the company is likely to see those fall into the mid-teens as the company invests in growth. Even still, investors should note that the company spends quite little on Capex (relative to sales) compared with most industrial companies. Consequently, while I can see this company growing revenue at a nearly 10% compound rate out past 2000, the free cash flow growth rate is more likely to be in the high single digits.

If Generac grows at an 8%-9% clip, fair value (net of the debt) would seem to be in the high $20s. That said, I would note that the company earns very good returns on capital, enjoys healthy market shares, and has a manufacturing system that should scale well with relatively modest incremental investments. That would lead me to give it some benefit of the doubt in terms of its future growth prospects (and/or the appropriate discount rate), but even an "enhanced" fair value analysis suggests a fair value in the mid-$30s today. To me, then, that makes it a great watch list candidate, but a riskier idea for new money.

Stephen Simpson         www.seekingalpha.com