Genuine Parts Company (GPC) Earnings Call Transcript & Summary

Good morning. This is Bret Jordan with Jefferies. And I'd like to take the opportunity to introduce Genuine Parts. And Genuine Parts today we'll be sort of viewing from the industrial motion industries side of the story. And there will be audience Q&A available [Audio Gap]

Thank you for joining us today [Audio Gap] We'd much rather be in front of our investors and shareholders in person. But with times like this, we're glad we can participate in these virtual conferences. So GPC is a global service organization and primarily engaged in the distribution of automotive replacement parts and industrial parts. We'd be about 65% automotive and 35% industrial. We're operating in about 14 countries right now primarily north [Audio Gap] earnings, which a couple of the highlights from our Q2 earnings. We were pleased to have the sale of our business product [Audio Gap] simplify our business model and really go to market with core global automotive and global industrial. Some highlights in the quarter. Improving sales trends, primarily driven by automotive. Our industrial business, and we'll talk about it later, was pressured. But we did see improving trends in some of the indices we follow, improving numbers in June and also continuing in July. We definitely made a lot of strides in strengthening our balance sheet, improving our working capital and strong cash flow. So we have a continued focus on our long-term capital allocation. And as always, we're going to always reinforce our commitment to our dividend. So with that, I'll turn it over to Randy for a quick Motion overview.

Thank you, Carol, and good morning, Bret. Good to be here again. It's been about a year since our last time together. So time flies. Just a quick [Audio Gap] of the industries. We are the industrial parts group of Genuine Parts Company. And the majority of our $6 billion is here in North America with about $500 million or so in the Australasia business, which we acquired a few years ago by the name of Inenco. They will be rebranding themselves to Mi Asia Pac going forward. So we do look forward to that happening in the second half of this year. Just to give you a little perspective on our business. We are distributors of mechanical power transmission products, bearings, industrial and safety supplies, material handling, electrical and automation, pneumatics and a number of other product categories that we sell. Our customer base is very broad. We serve over 250,000 customers today globally. And those customers would be most all of your large manufacturing companies and manufacturing sites around the globe, again, predominantly in North America. We've had, of course, our troubles through this pandemic like everybody else. And I was looking at a list of other companies attending the conference today, and many of those are customers of ours. So the story that you will hear from them is pretty much what we have been seeing being their largest distributor for the products that we sell. When you look at the opportunities in front of us, we do have some new opportunities as we've expanded our business into the platform automation space, the conveyance solutions space as well as continued expansion in process pumps and some other categories. So we do have quite a bit of opportunity there. And this pandemic has actually brought about some opportunities for us with some nontraditional customers, particularly as we sell more PPE and whatnot. So we'll get into that in a little bit as well. But it's great to be part of the Genuine Parts team. We do have some opportunities and synergies that exist between us and the automotive group, particularly when it comes to some talent sharing, some systems approaches and shared services. So we're looking forward to a much better second half of 2020.

Thanks, Randy. And I guess, obviously, the most obvious question is really what did you see, the timing -- what were the primary impacts of the pandemic? How have you adjusted the business? I think it would be interesting to sort of take a perspective of how you've seen the impact in North America versus Australasia. But really, sort of what was the timing of the impact? What was the magnitude? And what approach did you have to take internally to address those volume shifts?

Yes. So one thing about this pandemic compared to other downturns in business over the past couple of decades is this is a global situation. So it's not specific to any one country, as we all know. So we've all seen it. But it's been a challenge, I will say. When we started the year, it looked like the year was going to be a pretty nice year, January and February, then the pandemic hit. And that required us to make some pretty significant and quick changes to navigate through this pandemic. So we really focused on what products we were going to be able to sell, most of that being safety and PPE, and that product category has increased nicely. But there was a real primary focus on keeping our people say, and that was #1 concern. So we kicked into a mode of what do we need to do to protect our people. And I'm happy to say that out of our 7,400 employees, we've only had 90 people impacted with COVID to date. And more than half of those people impacted came in July. So July was really the month that ramped up the number of contracted cases within our business. That being said, it certainly has impacted our growth over the last few months, but we have done a number of things to really position ourselves well, so when we come out of this pandemic we're going to be in good shape. On the growth side, we have done some things here recently to really augment the way we do business. We fortuitously launched a new digital site last month that had been in the works for some time, and a lot of our business is now converted to that digital site. And we're seeing a nice improvement in the activity and the sales going through our digital site. We had also launched in January a telemarketing group and they are reaching out to many of our nontraditional customers like schools and universities, and we're selling quite a bit of PPE to those customers. And when you look at our business overall, the U.S. is certainly our largest part of the business and it's been impacted greatly. Canada has been impacted just a little bit worse than the U.S. But our Mexico business continues to perform very well. And in Mexico, we service a lot of the plants and a lot of the customers that we have in the U.S. that have operations in Mexico, and they've been able to sustain the business quite well in Mexico. Now COVID has ramped up in Mexico and we're not sure where that's going to lead. But right now, Mexico is the shining star for us. With regards to products, our automation business that we stood up a few years back has really done well through this pandemic. And it continues to lead in business segment growth, if you will, as we've gone through this.

From a supply chain standpoint, obviously, you sell in to a number of geographic markets, you also source from a number of geographic markets. I mean how has the supply chain held up through the pandemic? Have you had to make changes on the supplier base? And I guess also, you talked about product category shifts. Managing working capital as some of the more manufacturing-related products might have softened and PPE demand strengthened, how have you managed around the demand for a mixed inventory in this situation?

Yes. So our supply chain has actually held up surprisingly well. We don't buy a lot of product directly from China. So what we saw in the supply chain with some of our manufacturing partners that have components of their final products that come from China, they've had to either shift production to other countries, say, Japan, Korea, Taiwan. But Mexico has been a big recipient of some of that product that's been shifted away from China. So overall, our supply chain has been holding the integrity very well through this pandemic. We've not had any outages of product that I can put a finger on to date. The only product category that has been stressed has been PPE initially. So we did see a run on PPE and backfilling the orders that went out of the door was a bit challenging to begin with. All we're really seeing a challenge with right now is nitrile gloves because a lot of those gloves are produced in China. And it's hard to get a good supply of nitrile gloves. But other than that, the supply chain has been solid. We've not really made any changes from our core supplier group to other suppliers as a result of not being able to get products. So our core supplier group, what we would refer to as our strategic supplier group, is certainly intact. And as their largest customer, in most cases, they do respond when we ask. So we're very fortunate in that regard.

Have you considered, I guess, as a result of the different national responses to COVID and the different regional severity, changing your supply chain at all, either diversifying or centralizing your supply network going forward?

Not necessarily changing our supply chain. We have sold quite a bit more PPE over the last few months than we traditionally do. We are starting to see that start to level off a bit. So we're getting back to some normalcy in the rate of product moving through the warehouses and whatnot with regard to PPE. So I can't say that we're looking to change our supply chain. Are we looking to adjust the mix of inventory we carry? Yes. We have been really putting a very focused effort on our inventory mix, making sure we're not too heavy in certain products that are not moving and we've got the right amount of products that are moving. One of the concerns was we didn't want to get overweighted with PPE and then see a leveling off. So we've been able to manage that extremely well. So we don't have an abundance of PPE that's not moving anymore sitting on the shelf. So we've done a great job in that regard, and I'm really proud of the team of what they've been able to do. So no major changes in our supply chain or our supplier partners going forward that I can see.

Bret, I would just add that from an industrial standpoint, they're really not heavily weighted towards China. And as we went through the whole tariff situation and looking at sourcing and all that, industrial really hasn't been impacted. That's also helping them as we think about what could be further supply chain disruptions. Having said that, though, on the automotive side, we've been very careful to make sure that we have aligned ourselves to prepare for what could come or has come, again, be it tariff-driven or trade-driven or some other kind of disruption, Mexico-driven supply chain. So having the benefit of our scale and size has given us opportunities to spread that volume, dual source, do global tenders, things like that. So we've definitely been doing more of that from a global standpoint to kind of protect ourselves.

Okay. Great. And you called out PPE. Obviously, it's a strong category. Are there any other sectors or pieces of your customer base that have been particularly strong during the pandemic?

Yes. So PPE is obviously the strongest category -- product category right now. It's up through the first half of the year double digits. So I don't expect that to continue throughout the balance of the year at those rates, but we're happy to have it. All the other product categories are either flat or down for the year. So that's just indicative of the type of products that we sell to the customers that we sell to. When we look at the industry sectors, our 2 largest categories are equipment and machinery and food and bev. And what's interesting is, is they're at the opposite into the spectrum. So food and bev is hanging in there pretty well and we're about flat year-to-date in the food and bev category. So they've been the most resilient industry, if you will, working through this pandemic. Equipment and machinery through the first half of the year was down roughly 20%. So it's on the opposite end of the spectrum. Really, it's tough because about a year ago, we had every industry category that we track up for the year -- year-over-year. This year, we have just about every industry category we track down, food and bev being the one shining star in the bunch there. But we have some tough roads ahead with regards to automotive, for example. Iron and steel, pulp and paper. Those are going to be industries that we are not going to see rebound quickly. But hopefully, we will see incremental improvement month-over-month through the balance of the year.

And you guys have done a good job protecting margin despite the softness across-the-board. Maybe you could talk about -- and maybe both of you could talk a bit sort of how you've done that structurally, both gross margin and operating expenses. So Randy maybe within Motion, and then, Carol, maybe sort of within the broader organization, how you see levers hold to protect margin?

Yes. So I'll start out from a GPC standpoint and Randy can definitely comment on both gross margin industrial initiatives. And be it our global procurement, global tenders, level sourcing to pricing initiatives have been really impactful in our gross margin. The kind of big headwind for us and as much for automotive as it is for industrial is the loss of volume rebates that weigh on your margins. So we've been able to maintain that gross margin with a lot of internal initiatives. And Randy can speak to yesterday for our quarterly board meeting and just great things coming out of their pricing group. On the cost side, and again, we had started this long before the pandemic is we started our $100 million cost saving restructuring plan last year, Q4, that was going to lead to permanent cost savings of $100 million. We're going to definitely on track ahead of plan on that and are going to be in a great position to deliver on that for this year, largely related to payroll, a few of underperforming operations. Our accelerated actions that we took as a result of the pandemic, we had about $150 million in the quarter. We talked about 60% to 65% of that was payroll. We had government subsidies and rent subsidies, obviously, that were temporary. And then we have some freight initiatives and some other closures in there. I would say a lot of those, we -- they're temporary. They will change a bit in the second half. But having said that, it has also caused us to think about what could be permanent in that other bucket. So as we've looked at voluntary, involuntary layoffs. We've looked at how we made different restructures, whether it's the sales organization, management organization and think about how we can move those to permanent. The real fact is that we're going to find ourselves better positioned as we look ahead on the cost side. As you know, we've had a hard time making progress on the SG&A side. And now we're finally starting to see the benefits of not only permanent, but some temporary ones we've put in place and really getting some momentum as we move forward. So as we come out of this, we're going to be better set up from a cost standpoint. So Randy, maybe you have some stuff to add what's Motion's done.

Yes. So on the industrial side, there's 2 things. I'll address the gross margin first. Several years ago, we began looking at our pricing structure and strategy and making some adjustments in our pricing structure and strategy. About half of our business is under contract with large industrial companies. So very difficult to affect the pricing strategy with those that are under contract. But the noncontract customers we've been able to, I'll say, surgically go in and adjust our margins on those customers. And that has continued to prove to be the right move. So those things have been ongoing for some time, and they certainly did pay us dividends here through the pandemic. And we will continue to surgically or strategically adjust gross margins when and where possible on these noncontract customers. So that's how we've been able to affect the gross margin side. On the operating cost side, as we hit the pandemic, we did make some immediate adjustments. We put many of our locations on 4- day work weeks as opposed to 5-day work weeks. We did furlough about 300 people. We -- also, all of our management team took a 10% reduction in compensation for several months. But we also did some things that were sustainable. And that is we looked at nonperforming operations and we made the tough decision to go ahead and close or merge those nonperforming operations. So that will affect us long term on the cost savings. But not everything is about closing. There are some other investments we've made. For example, in our distribution center in Birmingham, Alabama, which is one of our largest, we invested in a goods-to-person system that provided us a 540% productivity improvement. That's ongoing, and that will be a long-term cost savings improvement for our that operations. So not everything is about cut, cut, cut. There is some opportunity to invest to achieve cost savings for the long term as well. So it's been pulling multiple levers to achieve the results that we're getting, Bret.

And I guess you've shifted some of your hours down. And Carol in the beginning mentioned, I think, some of the economic indices or maybe PMI, some of the data that's been inflecting somewhat positively lately. What do you see, I guess, sort of in the weeds as far as the sequential trend of improvement? And if we are starting to see some improving industrial metrics, what's the timing of that flowing through to your business?

Well, 2 months of improved PMI, if we can call that a trend then I'm happy to -- I hope it is.

More than one.

If that is sustainable, then I would expect that to begin trickling into our business over the next few months. One thing I can share with you is that some of the CapEx orders that were on hold with our customers for the last 3 to 4 months are starting to be released. And the quote activity that we're seeing for new CapEx orders has been picking up over the last 4 to 6 weeks. So both are good signs that the manufacturing economy believes that there will be strength in the second half of the year. And if they turn that belief into actions, then we should start to see some improvement in the coming months.

Okay. And then on the other -- on a bigger labor cost cut topic, you've talked in the past about automation and expanding your investment in the space, including M&A. I guess what is it about the category that appeals to you? And sort of how do you see the growth rate in your automation business versus the broader Motion Industries portfolio?

Yes. So my background is over 25 years on the manufacturing side prior to distribution. And way back then, we were looking at ways to automate factories and eliminate the nonvalue-added jobs within a manufacturing plant. So this is nothing new. But for Motion, we really began to pursue the automation side of the business from a distribution standpoint several years ago. So we've made a number of bolt-on acquisitions to start to bolster our automation plan and business over the last few years. Every manufacturer out there is looking for ways to improve productivity. And the one thing about automating a piece of equipment is, is it doesn't call in sick. It doesn't catch COVID. It doesn't take any time off. And it's also repeatable. You put a piece of equipment in and you fine-tune it and it's not going to make errors that humans make. So there's a productivity improvement that comes along with automation. And that's what all of our customers are looking for, which is why we've made the decision to go ahead and go all-in on the automation side. So we will continue to invest in automation companies. And we did acquire small bolt-on here August 1 that will supplement our current automation business. It's located in California and it makes some of the enclosures that cobots and robots would be housed inside of -- on plant 4. So a nice little tuck-in for us there. We are also looking at other areas, though, not just automation, but also like hydraulic repair services and whatnot to also give us a little bit more stickiness with our customers. And if we can do those things, we become even a more valued solution provider for our customers from top to bottom. So that's where we will continue to evaluate what works for us, what makes sense for our customers, how can we create more value for our customers through the services and continue to bolt on small acquisitions in the coming years.

In the broader M&A topic and I guess you could both probably hit this both, Carol, from an enterprise M&A thought, and Randy, within the Motion business. Has this pandemic shaken anybody lose or changed expectations on valuation or interest in selling?

Yes. Well, we -- it's a great question. And we've obviously have taken a bit of a different approach with our M&A budget this year and have done everything we can to create liquidity and preserve cash. Having said that, we have also said we're going to continue to look for some small bolt-ons. We think second half of this year. Randy mentioned the two that he just did August 1, both in our automotive group globally as well as the North American group and our Australasia Motion group have some just little tuck-ins that we think will come available, either second half or into 2021 that will complement our M&A structure. Look, we're not out looking for any big, strategic, transformational acquisition. As you know, we've been quite busy in the last couple of years. And so you'll see us do some of these tuck-in, bolt-ons and -- specifically in the growth areas. And I think Randy has got a couple categories and areas that he's looking at as well. I think we haven't necessarily seen the activity that may be coming later. Some of these businesses may have had PPP help or maybe there's a bit of wait and see. But I think doors could definitely be open in these large fragmented markets later.

Yes. So Bret, our acquisition funnel is pretty full with regards to prospects that we are engaged with right now. What I am seeing is that some of these smaller companies are maybe looking to take a few chips off the table. So the timing might be good for them. And we are engaged with a number of companies. Carol mentioned some of the areas that we are looking. Of course, we're going to continue to expand our automation footprint until we get a coast-to-coast border-to-border footprint. And hydraulics has been an important part for us as well as what we call Conveyance Solutions. And Conveyance Solutions is everything from moving air liquid or gas through either a rubber hose or on a conveyor belt, and we have a couple of more acquisitions that we're looking at there that might possibly come to fruition in the next year or 2. And then we keep our focus out for other businesses that fit our customer base and one that we've yet to really exploit is the process pump industry. And we've got some ongoing discussions in the process pump area. So look for more from us in the future. But it will be very, very focused acquisitions that truly create more value for our current customers.

And I guess thinking geographically, you've obviously -- you talked about Mexico being a bright spot in North America. You're dominant in the U.S. and you've got the Australasia footprint. GPC is the second largest mechanical auto parts distributor in Europe with Alliance. Are you thinking about taking Motion to Europe? Is there any thoughts of expanding globally?

Yes. Look, I mean, we obviously -- we will always evaluate all opportunities. Right now we can't say that we're looking at, again, any big step out for the industrial business in Europe. I think the opportunities we have within Southeast Asia and our Inenco business and also with North American industrial would be more of our focus right now versus a big step out, say, into Europe.

I'll just add that while I have relationships with some folks in Europe from years past and whatnot, there is plenty of market opportunity for Motion Industries right here in North America. And until we see ourselves really take a dominant position in any specific market here, we're going to focus most of our attention right here, particularly with the scenario globally that we have with regard to the pandemic, and who knows where this fire spreads in the future. So North America is our focus.

Okay. And I guess as you're rebranding the Asia Pac business Motion as well, is that something that you see the brand of Motion being a significant asset in an industrial distribution business? Or is it to save money on letterhead? I guess how do you see the use of the brand?

Well, there a lot of brand equity in the name, Motion Industries, both in North America and Asia Pacific and around the world. We have a very good reputation with our customer base. They know the solutions and the value we provide. And in fact, the guys in Asia Pac, they were very excited that we were going to allow them to move to the Motion brand because they saw value in it as well as their customers. So we're very excited about it. It does position us very nicely with the brand globally. There is value in it. And it stands for something and we're very proud of that. We've got a great reputation and they know it and their customers know it. And don't forget, many of the customers that the Australian groups serve also are customers that we have here in North America, particularly in the mining industry. So it's just continuity of the brand throughout the world and I think it's a great thing, and we're looking forward to supporting them. Not to mention, they will get to piggyback on some of the things that we do here in North America like our digital site, our website and some of the resources and assets that we have here. That's a real easy transition for them now, now that they're also flying under the Mi brand.

Okay. Well, I think we're getting the hook from the moderator here given we've used the full 30 minutes. And I really do want to thank you guys for participating in this, and obviously, for those watching. They're doing meetings throughout the day as well. So look forward to hearing more. But thank you very much, guys.

Thank you. We appreciate your interest and support. Thanks, Bret.

Thank you, Bret. It's always good to see you.

Good to see you. Wish it was in person.

Me too.

Yes, I agree.