Genuine Parts Company (GPC) Earnings Call Transcript & Summary

Good afternoon. This is Kate McShane again from Goldman Sachs. And we're very happy to be hosting the management team for Genuine Parts Company for our fireside chat this afternoon. Genuine Parts is a global service organization engaged in the distribution of automotive and industrial replacement parts. The company serves customers from a network of more than 10,000 locations in 14 countries. Today, we have with us, Carol Yancey, EVP and Chief Financial Officer of the company. Carol joined the company in 1991 and has been holding her current title since 2013. And then we also have with us Sid Jones, Senior Vice President, Investor Relations. Sid was appointed to the current role in March 2017 and has been with the company for over 30 years. So thank you for joining us today. Carol, we will turn it over to you for some comments.

Thank you, Kate, and thanks to everyone for joining us today. We really appreciate the opportunity to be with you at the Goldman Sachs Annual Global Retail Conference. So as Kate mentioned, GPC is a global service organization engaged in the distribution of automotive and industrial parts. So we've had a really strong financial performance thus far in 2021 that's been driven by the consistent execution of our strategic priorities and the global market recovery. So we believe our strong sales trends have produced market share gains with 15 consecutive quarters of gross margin improvement, and also improved operational efficiencies that has resulted in operating margin increases over both last year and 2019. In addition, we continue to generate strong cash flows through working capital improvement and our earnings growth. So we also have been effectively allocating our capital across several priorities, and that includes capital expenditures for both growth and productivity investments, bolt-on acquisitions, dividends and share repurchases. So we're actively investing in each of these areas to maximize our growth opportunities while also returning capital to our shareholders. So as we look ahead, GPC is well positioned to deliver above industry growth, enhanced operating productivity and strong cash generation, which we believe will create additional value for all of our stakeholders. So thank you, and I'll now turn it back over to Kate.

Thank you so much for that, Carol. I thought maybe we could just take a step back because even though it's been maybe a year or so since you've transformed your business model, it's relatively still new with the divestment of some of your businesses, combined with the international expansion of your core automotive and your industrial segments. So if you could maybe just tell us how you view the value proposition of your multi-industry model currently. And how are you thinking about -- you mentioned capital allocation in your slides, but how are you thinking about acquisitions in the context of the current environment?

Yes. So our value proposition with having a multi-industry model, with 2 leading businesses, they're both in large fragmented end markets with tremendous growth opportunities. So volume and scale are really huge benefits as we think about the diversity amongst these businesses, and it creates a balance to our performance. So you mentioned the capital allocation, and we've always been a strategic bolt-on acquirer. And we've had a very disciplined approach over the years, and it's always been an important element of our growth strategy. So we're really mainly focused on smaller bolt-on acquisition opportunities, but we're always evaluating the market for additional and the right opportunities. And that would be both domestically and internationally, and it would be commitment to investments in both automotive and industrial. So again, we've had some recent activity. We've had an expansion in the European business with the Ireland market. We've had a couple of digital investments. We've had a number of store acquisitions. So you're going to see us looking at automation opportunities in the industrial space. But again, that's a big part of our growth strategy as we look ahead.

Do you find that the recent pandemic has increased the amount of opportunities there are on the acquisition space? Are you seeing more come available for some of these bolt-on acquisitions than maybe you did prepandemic?

Yes. We would say that pipelines are very healthy, and there are a lot of acquisition opportunities. We've always had opportunities, and again, largely around the smaller bolt-ons. What you have seen is a little more elevated valuations across all the sectors. But again, we remain a very disciplined buyer. And we've got healthy pipelines across all of our businesses. And I think you may see more acquisition activity as we get closer to U.S. tax reform and some other changes here as well.

That's great. And if I could just ask a last question on M&A. You said it's going to be pretty balanced between domestic and international, and then you're also looking towards automation. On the industrial side, how do you think about automotive versus industrial? Is there a nuance there?

Yes. Look, no, I mean what we would say is we have done a couple of large strategic acquisitions on the automotive side. I mean going back several years ago to the Australasian business and then more recently, our European business. And at the same time, a strategic acquisition in 2019 with the further expansion in Australasia for our industrial business. So with the split we have today, roughly 2/3 automotive, 1/3 industrial, would say that it would be equal but a little more of a bias towards the industrial side because we're really excited about that side of the business. We see great acquisition opportunities there. So again, if there is a big strategic step-out, probably more inclined on the industrial side, but we are growing both automotive and industrial inorganically and organically, and again, both bolt-ons and strategics as we look ahead.

And Kate, I might just add to Carol's comments that one interesting element of that balance you mentioned is going to be the timing of these opportunities. We don't always control that per se. And so you may start seeing more activity in one versus another, but then that could switch. So there's an evident flow depending on how long these take to mature, come to fruition, et cetera. And so we battle that historically, that's probably not going to change. But the point is, as Carol said, certainly committed to investments in both businesses.

Great. And I know you're always constantly refining the portfolio, and we just talked about the A side of it. What about the divestiture side of it? Are we pretty much through any kind of divestitures at the company?

Yes. I mean look, you talked about it. We've done some heavy lifting on our portfolio in the last couple of years. And we've gone from 4 segments to 2 segments. We divested a slower growth, lower-margin business. And we really looked hard in our portfolio, did a lot of heavy lifting. And we are very committed to where we are today, which is the global automotive and global industrial businesses. So again, I think we're really past that. And as we look ahead, it's really about growing both those segments in the geographies that we're in today with some possible further expansions. We get excited about further opportunities in Europe. We get excited about digital investments going into adjacencies. I mentioned on the industrial side, there were some really exciting sectors that are adjacencies to the businesses we're in today.

If we could maybe just go into your 2 categories of business starting with the U.S. automotive business. Obviously, that's been more challenged during the pandemic as miles driven pulled back quite a bit as people stayed home. So I wondered if you could maybe walk us through what you've been seeing in that business. Are we to a place where you're seeing levels that were similar to prepandemic either from a miles driven standpoint or from a sales standpoint? And what do you see going forward?

Yes. No, we've been very encouraged by the recovery that we've seen on the automotive side. And really would point to the commercial side, which, as you know, about 80% of our U.S. automotive business is commercial, do-it-for-me. And we knew is with the continued reopening of the economy, the continued improvement in miles driven, that we would see improvement in that business. And that really is what we saw in Q2 and continued into July, and it's really contemplated in our outlook for the rest of the year. So it's been great to see. I mean what we would talk about, and we said it earlier, we have a heavier concentration to the fleet and the government and municipalities, and that was positive high single digits in Q2. And it was great to see that recover. And no reason not to say that whether it's our major accounts, our NAPA AutoCare, our nonprogram accounts or the fleet business continue to improve as we look ahead. So really excited about the fundamentals. And I would say the same thing, the international businesses for automotive have also recovered quite well. And we just have to keep an eye on the periodic lockdowns that we've seen in our international businesses, but the teams have done really quite well despite some really tough times.

Kate, you mentioned that -- I'm sorry. You mentioned that compared to pre-COVID levels, for example, in Q2 in the U.S., our 2-year stack is about an 8% -- excuse me, a 6% comp. And essentially, that's what our outlook implies for the balance of the year. So a fairly steady, solid growth rate relative to that pre-COVID era. Obviously, compared to 2020, much stronger than that. But I think we're all finding ourselves looking back to that 2019 year as a baseline to kind of really assess the progress we're making in those volumes, in our profitability, and very pleased with what we're seeing thus far.

Have you observed any real meaningful changes in the competitive landscape since the pandemic? Is the -- how you're competing today any different really from how things looked in 2019?

Yes. I would tell you really no material changes in the competitive landscape. I think, again, what you're seeing has been pretty rational, consistent and not any drastic changes. I think what is different when you look at different companies, different groups is what the customer mix is, the commercial versus retail and the concentration of customer groups. But again, very consistent in terms of competitive landscape.

Okay. My next question is, I believe the timing of -- right before the pandemic, you had just remodeled a lot of your NAPA stores and were about, I think, to do more of a remodeling for the independents. Could you maybe just remind us, because again, I think it was happening kind of right before the pandemic, what was able to be accomplished at the independent NAPA stores? And where do you see that going in the next year or 2?

Yes. Look, the retail initiatives that we've had, which has been more than just the remodel, say, of the front of the store, the investments that we made in retail and whether it was store refreshes or product assortment or talent or quite honestly, digital initiatives. And the pace of change in what we did, actually, we picked up the pace, if you will. And everybody did and had to in 2020 because that was what was needed. However we could serve the customer, that's what was done. So a lot of the initiatives that we did we were working on continued to roll out, but at the same time, we move faster in some digital areas. So when you think about the buy online, pick up in the store, the curbside pickup, sort of the endless I/O concept, there were a number of things that we did. Same-day delivery to 98% of the U.S. was something we did during the pandemic as well. And those offerings were made available not only to company-owned stores, but also to the independent stores. So again, more than just the retail refresh a number of initiatives in the retail space, which has given us, and we've seen what the results have been. As we look ahead, we continue to feel good about the retail business, albeit a little bit slower growth rates than commercial but still a number of initiatives going on.

And if we could just stay on the automotive business for a second with regards to the supply chain. As you can imagine, it's been quite a focus at the conference the last 1.5 days is just how disrupted the supply chain is. And I know there has been fits and starts since the beginning of the pandemic, but it seems like it's reached a little bit of a fever pitch. So I wondered if you could maybe characterize what your supply chain looks like currently. Are you seeing any kind of bottlenecks as a result of it? What's a slower turning inventory mean when there is supply chain disruption? And have you made any changes or used any levers to help mitigate some of what we're seeing?

Yes. So you're spot on. That's definitely been a huge topic today in all of our meetings, and it's something we -- there's probably not a day or a meeting that doesn't happen that we don't talk about supply chain. Having said that, continue to be challenged by, again, what everybody is seeing in terms of raw material, labor shortages, certainly container issues and port congestion. But what I would point to is that is much more specific, more challenging in our U.S. automotive business. It's a much lesser extent on international audit and an even lesser extent on the industrial side. So our team is doing a number of things in this area to make sure that we have high customer service. And we're ordering well in advance of what we would normally do of normal lead times. And if anything, we're getting inventory sooner or earlier to make sure that we do have it. We work with a broad set of suppliers. We're constantly balancing and looking at that. Quite honestly, our size and scale and leverage plays into this as well. So we're able to look at that. It is something that our sourcing teams work on every day, constant communication. So as you know, it's very much about inventory availability. So it's making sure that we have that. So teams are doing a good job. We're constantly focused on it. And I think one thing I would also mention is we don't have -- we've got diversity in terms of products, in terms of suppliers, in terms of geographies. So we're not overly dependent on one supplier, one country, one product line. So that does give us some benefits. So again, it's something that we think stays with us through the end of the year and probably into next year as well. But we've got a lot of teams focused on it. And again, a number of initiatives going on.

So on the one hand, with regards to the supply chain, you have the disruption on the inventory flow. And then in addition to that, you see inflation as a result, too. So you seem to have some cost inflation, product cost inflation. You have some transportation inflation. And I'm talking in general, not GPC. But then you also have wage inflation as well. Again, sticking to the automotive business because I think we have to kind of approach it in 2 categories. But how do you think you're positioning us from a pricing standpoint to help mitigate all of this inflation? And is there any way that you can tie it back to how you managed inflation during the tariffs period of 2019?

Yes. Look, I think the tariff period was good practice, but it's nothing like with certainly what we're experiencing today. And as you may recall, I mean the automotive business, especially in the U.S., it was 6 or 7 years of no inflation. And then we had tariffs, and we certainly learned a lot. We were able to pass those through. It stayed very rational, and the teams are very focused on that. Where we are today and the inflation that we're seeing, and I think we've talked about this, it's definitely -- again, this price inflation is definitely more pronounced in U.S. automotive. And so what we saw in Q2 of roughly 1.5%, we think it will be more like a 4% for the second half. And we are -- that -- passing that through, staying rational and having a number of initiatives in place, we feel good about that. It is -- on the commercial side, it is much more about the inventory availability and the service aspect of a quality of the parts than the price, the price gets passed through. But it's something we, again, working with our suppliers on how do we pass that through. I think the other thing, and you mentioned it, the inflation on the cost side, I mean, again, that's being experienced again, more pronounced in U.S. automotive, labor inflation, payroll, wages, driver, payroll, store, warehouse workers. We're all seeing that. And then on the freight side, definitely seeing that as well. We mentioned having that headwind in our Q2 SG&A. We expect that, say, in second half. But having said that, as we push through more volume, push through more gross profit dollars, we hope to offset that. And again, we're confident that we're going to be able to deliver operating margin improvement for the full year and improvement over 2019 as well. So we're encouraged by that.

When you have increased prices in the past, what is your anticipation for elasticity? Does it pretty much get passed through? Or do you see some kind of down-trading impact from your customers since it is more commercial than a traditional DIY customer?

Yes. Again, on the commercial side, it is passed through. I mean, generally, the product cost is the smaller line item, if you will, on the repair bill, so the labor side being more important. And so the ability to have the part and to be able to pass it through, we have not really seen that. Again, on the retail side, you might. But that's a much smaller percent to us. And again, I think some of the things that we're doing in the pricing area, making sure that we can offset anything that would come through. I mean I would just point to you, we've had 15 consecutive quarters of gross margin improvement. And our hope is we continue to deliver on our initiatives to offset any pressure that we have in that area. So we want to protect -- with this inflationary environment, we want to protect our gross margin rate, and that is a lot of what our initiatives are doing.

That's helpful. Maybe if we could switch to your industrial business, it has started the last few quarters to see some really good results. I wondered if there was a way to talk about how much is just a change in the macro that's more favorable for the industry versus any kind of company-specific execution you've been successful with.

Yes. So our industrial business, I mean we have been building positive momentum. And obviously, the indicators that you mentioned, industrial production and PMI have been strengthening, and that's driven some of our expansion. We do generally lag these indicators 4 to 6 months. So we are encouraged as we look ahead for improving demand. But having said that, our team has done a great job with their initiatives as well. And some of their investments in omni-channel to help build out and accelerate e-commerce growth, expanding their industrial services and solution capabilities is important as well. So certainly, initiatives would play in there as well, and the team has been doing a great job on delivering on that. So we're encouraged by what we're seeing on the industrial side.

And then, Carol, I wondered if we could zoom out a little bit here and just talk about the overall company P&L because you have been very successful at taking a lot of costs out of your business. Again, initiatives that started more in earnest before the pandemic. But could you maybe talk about what's been achieved and where you think there's more opportunity to go in order to drive the operating margins you mentioned earlier?

Yes. Look, we appreciate the comments that you made. I mean thank goodness, we did start this in 2019 and bringing in and starting the transformation office that we did in 2019 and setting about to really permanently address our cost structure. So we delivered -- we had a target of $100 million of permanent cost savings. We ended up delivering $150 million of permanent cost savings. And then we did a number of things in the temporary cost savings during last year with roughly $300 million of temporary cost savings. But we were able to convert some of those to the more permanent side. And I think the confidence that we got, the momentum we gained, we are not just stopping there. So this transformation team has continued to do work with our businesses. And it's been exciting to see the further momentum that they have. So we think about operating efficiencies in our warehouses. So we see consolidations and automations as an important area. We have an indirect spend, indirect procurement team that's working on a number of areas for us. And then really further back-office integration. And whether it's acquisitions or just some of our existing businesses, really optimizing our back office, if you will. So we think all these initiatives helped offset what we talked about earlier, some of the inflation in our cost. And obviously, I think one of the best things is when we look at our operating margin compared to 2019, and if we're implied that we're up 70 to 80 basis points over 2019, we have permanently lowered our cost structure, which we had not been able to necessarily do as effectively in the past. And you couple that with divesting some of those lower-margin businesses, that has us really excited as we look ahead.

Great. Before I ask you the questions that we're asking every company that's attending our conference, I just want to let the audience know that this would be the time to send across your questions as there is a little bit of a delay. So please send those across, and I'll be happy to read them on your behalf. And in the meantime, Carol and Sid, I'll ask you these questions we've been asking everyone. The first is: consumer demand in the second half. Do you see demand accelerating, decelerating or staying the same through the end of 2021, especially in the context of -- as we move further away from stimulus payments?

Yes. So we would say, overall, it stayed the same to accelerate. What we would say is strengthening demand in the industrial business and the do-it-for-me segment of automotive and probably a slight deceleration in the automotive retail business.

The second question, and again, this applies somewhat to GPC, maybe more of a retail brick-and-mortar specific question, but digital penetration. Could you maybe give us just a brief glance into your digital business? And do you expect it to be a higher percentage of sales in '22 versus '21?

Yes. We definitely expect higher digital penetration in 2022, and that would be both in automotive and industrial. It's building on the momentum that we saw in 2020 and 2021, probably at a slightly lower growth rate than what we saw. But again, we do expect higher penetration looking ahead.

Great. The third question is about the promotional environment. We kind of touched on this before. But we've kind of been in this perfect world of really tight supply and very high demand across most retail categories. How should we think about promotions and just price competition as we enter into 2022 versus what we saw this year?

Yes. So when we think about promotional activity, we would say about the same as 2021, but it may be a lower rate or amount, if you will, in 2019. Our investments in digital in 2021 will allow us to be more targeted and effective with our promotions relative to the past.

Great. And then our last question is 2 parts. One, both relating to the supply chain, which we spoke about before. But if you had to pick one bigger lever that allows you to mitigate some of these supply chain pressures, is it increasing lead times? Is it shifting production? Or something else? And do you expect inventories to grow faster or slower than sales in the second half?

Yes. So I think the biggest lever, we would speak to increasing lead times in the short term, but shifting production in the long term. And then as far as inventories, we do believe they will grow slower than the second half sales.

I'll just ask again if there are any questions. In the meantime, you mentioned shifting production. Carol, are you able to tell us the breakdown of where you have exposure today and where you'd like it to look -- what you'd like it -- excuse me, what you would like it to look like longer term?

Yes. I mean one thing I would say, and again, we've talked a little bit about it, we do have a lot of diversity in our supply base. And when you think about our industrial sector, for example, they are much, much less really insignificant exposure to sourcing from outside the U.S. So less issues there, less exposure there. Our international automotive operations, and whether it's Europe or Australasia, they do have some diversity in supply base, and again, a little bit less risk there. So from the U.S. automotive side, I mean we've said before, from what we source directly to outside the U.S., to also what we source from domestic companies that have plants outside the U.S., it's roughly about 20% of our U.S. automotive business. So again, not a very significant number. So quite honestly, we have diversity across our supply base, but at the same time, we've got significant scale and leverage. So that allows us to move around volumes and to leverage our spend and quite honestly, to get the prioritization that we want from our supplier base.

And Kate, I might add, I don't know that there's a target to necessarily change that 20% ratio, but our teams are definitely working very hard at ensuring there's some diversity, some breadth, multiple supplier or sourcing options across that international base such that it's not just in one region or with one key supplier where through these difficult times, we've learned you can really find yourself in a tough situation from a supply perspective. They're getting really good at it.

Great. I'm sure. There's been a lot of practice, right, because there's been so much disruption. So we don't have any questions. So I think I'll stop there, and thank you again for joining us today. And thank you to the audience for dialing in, and I hope you have a great rest of the day.

Thank you, Kate. And we thank you for your support in Genuine Parts Company. And thanks for your participation today.

Thank you.