Genuine Parts Company (GPC) Earnings Call Transcript & Summary

Hi, I'm Greg Melich. I cover the retail broadlines and hardlines here at Evercore ISI. It's my pleasure to have with us Genuine Parts, been a long-standing force at our summits and conferences over the years. Representing today will be Will Stengel, who is the President and Chief Operating Officer; and Bert Nappier, who is the Executive Vice President and Chief Financial Officer. So both of you, it's great to have you with us. Welcome.

Thanks, Greg. Greg, thanks for having us. As always, appreciate the hospitality.

Great. So I'll just kick it off with you had a quick -- recently, you had a management change. I think Kevin Herron retiring after a while and Randy Breaux stepping up. I just wanted to see -- give us a little bit of background on why that change, why Randy's role seems to be a bit more expanded than Kevin's was?

Yes. Greg, listen, we're super excited about Randy in his new position. As everybody knows and has seen over the past handful of years, the Motion business has done exceptionally well underneath Randy's leadership. And we're excited to put Randy into a bigger chair so that he can continue to drive a positive impact across Genuine Parts Company. As we've talked about with folks before, the distribution initiatives and the value creation levers that we're pulling are pretty consistent around the globe, whether you're talking automotive or industrial. And so Randy brings to bear really an acceleration and building on the momentum that Kevin and his team have built really nicely over the last couple of years. And obviously, it goes without saying, Kevin, after an amazing 34-year career at Genuine Parts Company, he's had a dramatic influence on the performance of the business over the recent past but certainly over the last 34 years. So congratulations to Randy but also a special thank you to Kevin and all that he's done for NAPA and Genuine Parts Company.

That's great, Will. So I'll start with the questions on the business with [indiscernible]. Could you just level set us on the state of the business right now. What you're seeing was key top line drivers that you can manage yourself internally, but then also the macro situation across your businesses?

Yes, [indiscernible]. So first and foremost, I think we started the year really well last couple of years. We've built a ton of momentum, super pleased with the progress around the world. It is a dynamic environment out there. We've got very discrete defined initiatives that we think position us really well, not just for the near term but for the long term. Those are designed to drive profitable growth, drive margin expansion, drive productivity and drive free cash flow. I alluded to a dynamic environment. There's no surprise, inflation and interest rate environment is creating an environment that is challenging all of us regardless of the industry, and I'm super proud of the team around the world navigating that. I think, the performance over the last couple of years speaks for itself. But we're going to keep our head down and focus on what we can control. We feel good about the balance of the year. We talked about that on our first quarter earnings call. And as I said, that's driven largely by the discrete initiatives that we're executing as a global team around the world.

Could you maybe dig a little deeper there on what in auto and industrial is giving you that confidence? Is it -- we've seen some fears of recession out there and et cetera, so like what makes it different for you guys?

Yes. Look, I think you can think about it really in kind of the secular mega trends that are very favorable on both sides of the business. On the auto side, you talked about miles driven. You talk about a growing and aging car park. You talk about the complexity of the car. And as that evolves, the impact on do-it-for-me, which is an important part, the majority part of our automotive business. We talk a little bit about the EV opportunity that will come over time and what we're doing about that today. So we feel really good about the global secular trends over the medium and long term and short term for automotive. On the industrial side, we have the same optimism for different reasons, whether you're talking about the nearshoring, the impact of robotics and automation and how that plays into our value-add solutions as people try and navigate a challenging labor market, that's in our warehouse in Motion. You talk about all the expertise that the Motion team around the world brings from a technical standpoint. Greg, can you hear us?

I can turn on my own volume, I think it's okay.

Okay. So anyway, we feel really good about the mega trends that we're seeing in both the automotive and industrial side of our business. Obviously, the inflation and the interest rate environment is challenging all of us to navigate and evolve. But that being said, we're cautiously optimistic. And when we talk with our customers, importantly, they're just as bullish on the future as we are. And so we'll take it a quarter at a time and execute our initiatives, but really pleased with where we find ourselves positioned as a business.

Maybe I'll pivot a little bit to Bert, maybe to put some more numbers on that. It remind us of your guidance for both top line this year and the things that you're focused on in terms of driving margins and any sort of macro environment?

Yes. Look, I mean on the macro side, I think we've been pretty prudent about -- Will touched on some of these things, it's certainly a choppy environment on a day-to-day basis. And the broad strokes of things to look at include interest rates, they include inflation. I think there was some progress that's been made there. We also think about -- with our global footprint, we think about geopolitical considerations, obviously, a ground war going on in Europe for the first time since World War II, hasn't had a direct impact on us, but we have to be sensitive to that and what it means for our customers and suppliers and the team members. All of that taken in, I think we're in a good spot as we balance, being prudent against being very bullish on GPC and our execution. We have a lot of nice initiatives underway. And when we think about that, that leads to our guidance for the year of 7% to 9% EPS growth from -- and taking that up in the first quarter. So getting a little bit more confident as we stepped out of Q1. When we think about the things underpinning where we're heading, a lot of those initiatives we highlighted at Investor Day, we think about some of our modernization of supply chain. Those things to modernize, drive an automation and optimize how we're working, will bring productivity benefits, efficiency benefits across the business. And it's not just one particular lever that we're looking at for a business unit. When we talked about that at Investor Day, it really was something underway across the entire portfolio. We also look to sales effectiveness. As we continue to get sharper focus on commercial, being more effective in the field, this is some of what Randy brings across with his very long history of being focused on commercial execution and that's going to translate over into the North American automotive businesses as well. Not that there's already great traction there, we're just going to step it up a notch, continue to drive that growth. Those 2 things will be important. We're going to be more efficient on SG&A. We have made some investments this year, which are baked into our guidance. But at the same time, we're going to leverage in the places that we can. So the great thing about where we're headed is we have so many things that are within our own control and our ability to touch on bases and drive factors that were not relied on what's happening either externally or the wins and how they're blowing externally. We like our gross margin expansion. We have 2 really good quarters here in the fourth quarter and the first quarter, gross margin expansion, and that's at the feet of pricing and category management, which have great, great traction in momentum. Put all of that together, we're lined up for another good fiscal year on the back of 2 very good fiscal years in '21 and '22 and excited about where the business is going.

Great. So maybe, well, to pivot back, I mean there's been a lot of change, it feels like Genuine Parts over the last few years. Where are we now? A positive change and sort of reaccelerate the business and getting the portfolio where you want it to be, what changes do you have in plan to go forward on either a geographic footprint or line of business that we should be on the lookout for?

Yes, Greg, you alluded to it, and I think it's appropriate. There's been a ton of work under Paul's leadership to evolve the business over the last 5 to 10 years. And as you said, the simplification of the portfolio into 2 very attractive long-term businesses where we've got leadership positions with opportunities to grow given the fragmentation of the market. So I would say we feel good about the 2 businesses that we're in. We've got those growth initiatives to capture share and win in the market and invest into the business. So for us, it's all about now executing against these initiatives, staying really disciplined, focus on what we can control. But as Bert alluded to, we've got a very robust road map in terms of controllable execution and we're going to continue to keep our head down and work day after day to just continue to evolve the business and deliver on the commitments that we made at Investor Day.

And so you've got the key places in part and structure. Now it sounds like an execution game, right?

We would agree.

Yes, I would agree with that.

So maybe digging deeper into those areas, I'll start with North American auto. That's an area that -- can you just sort of level set us on the strength we've seen in the last few years? And then more recently, Advance in particular, one of your competitors have some real challenges, I think, from a share standpoint. If you look at your 4-year comps are definitely outpacing theirs. How do you see the competitive makeup there? And is the industry still rational? Or what do we need -- would need to watch out for?

Yes. Look, we don't run those other businesses. So we can comment clearly on what we're doing. I would tell you the industries have always been, for many decades, competitive and intense as it relates to fighting for share, that's no different. It's not changed in the last couple of quarters relative to what it's been over the last handful of years. So that is a question that we've been asked often, and we don't see a fundamental change in the intensity of the market from a competition standpoint. And I would say the same on pricing intensity. In distribution, everybody has been very thoughtful in their own strategic way around pricing strategies and sourcing strategies and the good news for us is all of the work that we've been doing over the last 2 to 3 years on this topic is going to be a major benefactor for our business moving forward. And so you think about investments in tools, people, process around all things strategic pricing, that gives us an opportunity to be very strategic and surgical down to the SKU level in the local markets and win profitable share. I would tell you not off share is equal. And so the discipline around thinking about where we've got good opportunities to profitably grow is something that we spend a lot of time internally thinking about.

Interesting. And between O'Reilly and AutoZone and now Advance, they've all talked about pricing the last few years. You guys really haven't with on sort of big splash thing but it sounds like you're being tailored and strategic about it. Is that -- I don't want to put words in your mouth.

No, that's absolutely right. Look, I mean, a good business is thinking about how to take care of their customers and serve the needs of their customers each and every day. Price is part of that. Importantly, in these industries, it's a much broader value proposition than just price. And so we spend just as much time thinking about inventory availability, making sure that we got the right labor in the markets. We've got the right store footprint to cover strategic markets and grow profitably. As you know, this is a break-fix business model. We're a B2B business in essence and so helping our customers solve the problem quickly with the right part in the right market at the right price is all part of our value prop. So we think about price, but quite frankly, our customers are more focused on making sure that they can be productive in their shops and get back to taking care of more customers as quickly as possible and as productively as possible. And we think we're a pretty good partner to them in doing so.

Got it. Maybe to pivot a little bit to get to the industrial business, M&A is an important part of GPC over time, but it seems like the Kaman's acquisition, I guess, it was early last year, has had a bigger accelerated effect. Could you just help us understand why that is and how you keep that momentum of growing faster than industrial production?

Yes, absolutely. Listen, I think first and foremost, you can do attractive deal and if you don't execute well, your thesis doesn't play out. So credit goes to the very large team over at Motion who have done just a wonderful job bringing to life a lot of the thoughts that we had, quite frankly, on paper as we were analyzing the opportunity. Kaman was a very interesting strategic transaction. If you think about what it did for our relative scale in that profit pool, highly synergistic. And as I said, interesting to say that, but then going to capture it is where the real work is done. And we talked about $50 million of EBITDA synergies through 3 years. We recently shared with everybody that we're pulling that forward inside of 2 years and we're continuing to make really nice momentum. You think about all the work that we're doing about consolidating the footprint, working with our vendors to make sure that we've got the right programs in place, making sure that our cost structure on a pro forma basis is right and then really driving that customer value proposition to big and small customers alike. And we think Motion has the most differentiated value prop in all things, industrial distribution. And I think the results are speaking for themselves, not only just on the top line, but the pull-through on the EBITDA, which is not just a function of good operating but also the synergy capture that we articulated to everybody when we purchased the business.

And so the -- I guess how long -- it's great on the cost synergies, but maybe just to understand the top line synergies a little bit better, I think at your Analyst Day, you guys talked about how it's really become a much more software-oriented business or service business than just selling a bearing that broke. Maybe dig a little deeper on that for us so we can understand it.

Yes. Look, Greg, I would say that the Motion of old and the new Motion are 2 different things. If you look back over time, you'd see a Motion business that probably was labeled as a bearings business. And the great thing about what the team has done to execute is evolve. Kaman brought some of that with capabilities that put us in really growth-oriented segments like automation, like conveyance, that's a new capability and one that Motion pre-KDG acquisition wasn't the biggest player. That's a game changer. And so when you think about that top line and leaning into some of these new spaces, that's a part of the growth there. You also think about -- Will touched on this, the blend of small and medium customer with a large account focus at Motion. That's creating some opportunity as well. The value-add services of going to market is how we're going to continue to drive that top line. It truly is a work -- a team and a group in the field that puts the customer first. It's not about delivering a part to the dock on the back door. It's about taking it into the shop floor and getting the machine up online again and maybe knowing more about it than the person operating it. So there's this great mix of capability there. The diversity of their book of business. And so when I talk about evolution from the old Motion to today, you're talking about 14 verticals and which they're not overly indexed or exposed in any one particular segment, which allows us to be diversified and grow and not be pinned into one place, maybe that's feeling some of this economic malaise more than another one. And so you put all that together, I think it really gives us a strong outlook for the business over the long term. It's certainly a big part of how we think about our targets for 2025 and those that we shared at Investor Day, and we're very bullish on that team and their execution and what they can bring to the table.

Got it. I want to go back to Analyst Day and either one of you can answer this, probably both in some way. You put out some pretty ambitious 3-year EPS growth that we're probably not frankly used to from Genuine Parts but -- and also for new CFOs coming in, so I guess -- I'd love to know what gave you the confidence to sort of go out there with that higher, that 6% to 7% growth, double-digit EBITDA, $11 plus of earnings power right now.

Look, I mean I'll start with the most basic thing and we talk about this a lot, and I talk about this team. I have a ton of confidence in this team. We've got great operators, and we have great talent. And when you look around the table of a leadership team and you all say, let's put our hands on middle of the table and can we go do what we said we're going to do and everybody puts their hand and then says we're all in, that gives you a ton of confidence whether you're the new CFO or if you've been doing this for 30 years. And so it started there. The true one GPC that -- we think there's a lot of potential in this business and let's go get it and execute against it. It's followed by a plan. It can't be a paper tiger. And so I think the confidence comes from that we have a strong plan. We have to go execute it, and there's always execution risk in anything you do, but we really do have a well thought out and strategic way to go drive this business going forward. We benefit from some transformation that quite frankly Will led before I even got here to set the business up in the right place to be successful moving forward. And now we go execute the modernization of supply chain, we go execute the lean on the technology and what technology is going to do as a strategic weapon to transform this business. We're going to lead into commercial and sales effectiveness. And again, that's going to be fueled by talent. And we have opportunities in EV. When I think about EV, I don't just think about EV in the vein of automotive. I also think about what it means for our Motion business. And that's an opportunity that we're just scratching the surface on the commercial side, and that gives me confidence that there's even more opportunities out there when you think about EV, plants being built, and that's an opportunity for Motion. You think about the tag and long battery manufacturing facilities. That's an opportunity for Motion. And you just look at our facilities and the opportunities that we have with supply chain and the things we're already seeing in terms of green shoots of capability, whether it's a fulfillment strategy that's being implemented at Motion or automation that's being put into the facilities, there's a lot of opportunity to get more efficient and more productive. And so you put all that together, and I think it was the right time to have an Investor Day to showcase the strategy of a company that is truly unique and differentiated. We're not just a U.S. automotive business. We're a global business in 2 segments. We play in big markets. We lead in big markets. And so when you have a strategy that's so rich and robust, you're compelled to want to put the financial expression up against that. And we did that. And it took some courage for the 2 of us to convince everyone that we needed to go do that. But we owe it to our stakeholder base and say, okay, where does this go strategically in terms of financial expression with some ambition. And we think we've got the right mix of inhibition in there with stretching ourselves and at the same time being confident about execution. So we're off to a good start, and we had a good start to this fiscal year. And we've got a nice guide for the year, I think, to put us in a position to go get those and be back here in a couple of years talking about how we achieved it. And so I'm excited.

I want to get more into those details on the cash flow. Well, I also love to hear your perspective on that 6% to 7% top line, how much of that is organic growth that you could expect out of the auto business around the world and in industrial? And how much of that is your ability to grow share and expand the TAM.

Yes. Listen, I think the simple way to think about the algorithm, and it's not materially different than what's existed at Genuine Parts Company is we believe our markets grow through over time. We invest in the business and execute to win share. So you add a couple of points there. In a normal inflation environment, there's a couple of points [ for them. ] There's a point of M&A. And when you do that math, there is a very credible path to 6% or 7% on the top line. And so as Bert said, we've got to execute, but we feel like we've got the prioritized investments into the business. We've got a wonderful platform from which to build. And as a relative new person to the organization, I mean, as we said at Investor Day, we've got greater capabilities. We've got great brands. We've got great culture and talent. We've got a great asset footprint. We're a diversified business, not just geographically but also from a business mix perspective. And in my opinion, the team has never worked better together and been more aligned on what we need to do collectively to be successful. And so while it's certainly a step out in terms of being explicit about what we want to do, I have a ton of confidence in the ability for this team globally, collectively to go out and make it to happen.

I'd love to pivot back for a follow up a little deeper on some of those -- the finance numbers. I mean we've got inflations coming off, but it's still a headwind in labor and commodities. I'd love to understand how you're able to offset that to get to those margin goals.

Yes. Well, maybe it helps to give some context for how we look at inflation this year, and we haven't really started to think about '24 and '25. I think that's probably a bridge too far to cross here in June of 2023. But our thoughts about this year is that basically the prevailing thought is that monetary policy will take effect, and I think we're seeing that in some of the readings of late. We modeled our year and baked into our guidance that inflation would tick down and moderate across the quarters. We finished the first quarter at mid-single digits, all of GPC, high single digits for automotive, low single digits for industrial. Our industrial business is more insulated than the rest of the segment from inflation because it's North American centric and because our workforce already started at a pretty high wage base because of really investing in them for their expertise. When I think about Global Automotive, it's more sensitive to some of the import costs, particularly where we've seen over the past 12 months, high ocean freight rates and some of those things and costs being passed through from suppliers. As we got into the first quarter, all of that began to moderate. I wouldn't say it either increased or pulled back. I think we see just moderation but we will see a tick down into the low single digits as we get into the back half and fourth quarter. And really then how do we manage all of that. I think we've done a nice job, as I said earlier, about margin expansion from pricing and category management. We're being able to take everything that Will talked about earlier in terms of investment in pricing and category management and expand gross margin through some of those capabilities, offsetting inflation to the tune of a net benefit in the first quarter and in the fourth quarter. We're being really smart about SG&A. One of the things that has happened to the transformation of this business is spinning out some of the cost structure as we went through COVID, that has stuck. And it's become -- it builds on itself. It creates the spot flywheel of us driving ourselves to be more efficient. So at the same time, we might make an investment in wages like we've had to this year to your point, Greg, we know that we have to offset that somewhere else. We wanted to make an IT investment this year and really be able to lean into technology. That and then a shift in how we modernize our thinking around platforms from a more CapEx-oriented model to a more cloud-based and an OpEx model. And when you do that, then you have to pay for those things. And while we think our investments of 60 basis points of SG&A and wages and IT are the right things, we're only going to delever 30 to 40 basis points this year. That tells you offsetting it in other places. Some of those things are easy to do. You pull back on some of your discretionary spending. You control head count a little bit tighter, you can control your overtime, and I think we're doing a nice job with that. So it's really looking at the business as holistically as possible, investing in team members in the right way but then offsetting it in places where you think it makes sense.

Is it fair to think that over the next 3 years that you could start to leverage a 3 or 4 organic growth rate as opposed to 4 or 5 given that productivity?

Yes, I think so. I mean I think historically, and give me some grace here, I'm trying to study this business as quickly as I can after 14 months. But I think the historical thought process was that we can leverage in the 3% to 4% range, and we're probably living in the 3% range for a long period of time. We're probably floating towards the upper end of that range now but still think we can lever. We would all acknowledge that in parts of the business, the cost of doing business has increased year-over-year. I mean, wages are up. And there's no doubt that, that's got some stickiness to it. But even at those levels, because we see so many opportunities and where we've outlined investment and benefit, we do think we can leverage the business going forward. And that's part of our case as we get to these 2025 targets, we will see SG&A leverage as we get past 2023. We will see continued gross margin expansion over the target period from here to 2025. And those offset some of these things, we think could be more permanent in the level of cost in the business from this, I guess, period of pretty dramatic inflation over the last 12 to 18 months.

Maybe to pivot finally in the last few minutes, just help us understand the CapEx plans and the free cash flow that flow out of that. And I mean, I know you have a dividend streak, so keep to that. But maybe just start on that CapEx running close to $400 million. How much of that is maintenance, how much growth and what's the right leverage ratio for the business?

Yes. Look, there's a lot there to unpack. I'll try to do it in the next couple of minutes. Capital allocation. I'll pull it up a lever and just say, our capital allocation process is very, very disciplined, very, very thoughtful. We're going to focus on the dividend, continue to focus on the dividend and keep it a priority. So no questions there about where we stay focused. To your specific point about CapEx, as we covered in Investor Day, we do think that an uptick of how we think about CapEx from the 1.5% of revenue to 1.7% of revenue over the forecast period is the right thing. We are going to be a little bit more capital intensive over the forecast period. And that's because we have some great things to invest in. We've got supply chain modernization to invest in, technology to invest in. And that's where the vast majority of that increase in our historical intensity has been poured into. I would say that somewhere in the range of 70% to 80% of our CapEx is growth CapEx. And it's focused in these areas because we think they have such nice returns. And then we talk about leverage and we think about our leverage, we love where we are in terms of the flexibility we have. So we're right about 1.7x levered right now. And we love that we have this firepower in this capacity to really take advantage of opportunities as they come as we look ahead. So no pressure there in terms of trying to find something to do with it. We're going to be smart. We're not going to shop without a list, and we're going to stay true to our disciplines around how we invest.

One question we've gotten is given your top line and margin forecast and EPS and CapEx, that the free cash flow looked a little underwhelming. Is there something going on with working capital that we need to worry about? Or was that just conservatism in the way the...

Look, I'll tell you, look I -- you asked me earlier about these targets, and it was something you hadn't heard from GPC. And I think we leaned into EPS, we leaned into a margin target, and we were probably a touch conservative on the cash flow. It's certainly going to take a little bit more working capital to grow the top line at the rate that Will talked about at a 6% to 7% organic. So we'll have to use a little bit of working capital to grow at those levels more than historical. So that was certainly a consideration. We need to be a little smarter on inventory. We've got some opportunity to manage DIO down. I didn't over-index on how much I thought we could do there. We do have a year in that forecast period of uncertainty here with the economy. And so we were probably a touch conservative on DSO and how we thought about that over the next 12 to 18 months. And so Greg, when you add a little conservative here and a little conservative there and a little conservative there on some very specific elements of your cash flow forecast, it might lean slightly more conservative than had I not been nipping and tucking in a couple of other places. But no need to over-index there. As we talked about in the first quarter, we've already raised the bottom of our cash flow guidance for 2023. So we're getting a little bit more confident about this year and look that will continue to be revised as we have all the great opportunities across the quarter to update guidance and our outlook.

Well, given all the volatility we've had in the last few years and global supply chain shortages, can't really call you for want to have a little cushion there. So look, thank you both for -- I think we got through a lot in the time. Any parting thoughts that I didn't ask that you want to make sure that the world knows about?

No, Greg, I think we just want to thank our teammates around the world. It's been a great couple of years, great start to the year, and we just appreciate all their hard work, 58,000 strong around the world, taking care of our customers and each other. So thanks to everybody out there, and thanks to the investment community for the interest in the story and the support. And certainly, thanks to you, Greg, for your hard work and continued interest in our execution.

Yes. Thanks for having us, Greg.

Great. Thank you, both, and good luck, and congrats.

Thanks.

Thanks, Greg.