Genuine Parts Company (GPC) Earnings Call Transcript & Summary

Okay. Hi, everyone. We're going to get right into it. Okay. All right. It's my pleasure to introduce Herbert Nappier, EVP and CFO of Genuine Parts Company. Thank you for joining us today.

Thanks, good to see you.

Good to see you too. Could we launch right into U.S. automotive?

Sure.

I promise I'm going to ask about industrials. I swear. It's not just going to be autos. Can you talk about the recent trends that you're seeing in the U.S.? How DIFM is trending relative to DIY? And how we should think about the market share opportunity in this space?

Yes, sure. A lot to impact there, but look, again, thanks for having us. U.S. Automotive, probably the question of the day. I talked about it a lot this morning in our one-on-ones. I'll start with the kind of broader picture, I guess, industry fundamentals when you think about the U.S. auto space. So we start from a place where good fundamentals across the board for everyone. So age of car has ticked up for 6 consecutive years to 12.5 years. That's a good thing for the aftermarket. You think about the miles driven being up, so a little north of 2% year-to-date, another good thing, more opportunities for repair when we're driving cars more. I think also about inventory of new cars that's been tight. It continues to be tight. The price of a new car is a bit of a deterrent. So again, staying in your own car and fixing your car is probably the most economical way to stay on the road. Think about the acquisition cost of a new car, used cars, with rates pretty high right now to get an auto loan. I was reading a piece a couple of weeks ago. I think 30% up on monthly payment just on the rate alone. And so that's about $100 a month. And that could be a big deterrent as well. And so the backdrop, we think, has stayed consistent and stayed positive as we look ahead. We also operate the U.S. automotive and the global automotive business, for that matter, in a break-fix environment. So there's a need, you have to fix it. You have to get back on the road, so we benefit from that to some degree. One other thing that's shaped the industry, I think, for the last at least 18 months, has been inflation, I'm sure we'll talk about that a little bit more later. But the backdrop for the industry is that everyone and all the players benefited greatly from inflation a year ago. And so with that set up, big price lift a year ago, with inflation cooling off that creates a tougher comp for everyone as we move through 2023. Those backdrops are interesting as you think about what the opportunities are for our U.S. Automotive business. We've had a bit of a choppy year. Started the year with a tough Q1 with some weather impacts that abated as we moved into Q2. Q2, I wouldn't point to any one factor as we looked at Q2 in terms of performance. But again, a choppy kind of look across the sector. Consumer is certainly getting a little bit more cautious as we move through the year. I think the second half will bring a little bit more of that. But when we think about where we're headed, we're really excited despite some of the choppy performance with what we're doing in this space. One of our bright spots is gross margin expansion. So we've got a lot of opportunity to continue to focus there. We had 110 basis point improvement in gross margin in the second quarter. And so the work of our sourcing and pricing team has been exceptional in driving that bright spot. We got a new leader with Randy Breaux, so bringing our motion playbook across to U.S. Automotive. We're excited about that. Randy is a proven leader, 40 years in distribution, commercially focused. And so while we didn't have all the potential we thought we could show in Q2, we've got some really nice things to point to as we look ahead, taking some cost actions as you would when you've had a choppy performance to tighten the belt. And we're making investments, like we talked about at Investor Day in modernizing that business, and we think those are going to pay dividends as well. In terms of strength of DIFM, that is our source of strength. And so the commercial side of our business is where we grew up about 80% of our U.S. Automotive business is on the commercial side. So that's our source of strength, and that's actually where we see the industry in terms of growth moving forward. So we start from a place of strength and we grow into a place of strength with that footprint. So we think that's the place to be. The driver there is complexity of car. I don't know how many of you have newer cars with all the new technology, and we think that's going to push folks away from DIY and back into DIFM as complexity of car and all the technology and sensors and calibration work that needs to be done, and we're right there to serve that need. The last part of your question, give it to me again -- DIFM.

Market share opportunity.

Market share opportunity and we lean into that in terms of market share opportunities. I think as we looked over the last 2 years, we're pleased with what we've done on share growth as we look ahead, because of our positioning in DIFM, we think there's plenty of opportunity. We're a 7% player in a $200 billion market globally, 7% share in the U.S. If you take the big 4 together, 30%, 35% market share. So you can tell it's a highly fragmented space. And with the strength of the NAPA brand, the quality of the parts, we've got a lot of room to grow going, particularly when you think about our footprint with 24,000 locations between our stores and our NAPA AutoCare centers.

And then just kind of wrapping up the conversation on U.S. Automotive is a question that we get a lot is just about pricing. A competitor publicly said how much pricing they were taking in a certain aspect of commercial, and it's been talked about ever since, so could you maybe talk a little bit about what you're seeing with regards to the pricing environment and how you see that playing out?

Sure. Yes. Look, I mean, we have great competitors. We respect our competitors and we all keep each other honest and keep everybody on their toes, which is great. From my perspective, the environment is very rational. I think it's always been competitive. It will remain competitive, but there's no irrational behavior that we're seeing in the marketplace. Everybody is running their own strategy though in their different playbooks. We have different models. We have different concentrations of retail and commercial, and that drives different strategies. For us, we think the place to play, and we talked about this in our Investor Day in March is investment and capability. And so in a world where AI and data analytics, and intelligence is driving a lot more decisions as it should, our investments and capability to look into the pricing spectrum have that data, move away from anecdotal pricing moves and take the rich data set we have from all of the new tools we're building or we can see by geography, we can see by category, we supplement that with the intel from the field, which is still relevant. And then we can take actions to either move up or down, not always about investing in price to move down. It could be investments and capability just to make you smarter and take the opportunities where you see them, but also react in terms of opportunities where a particular category might want to be a little bit more competitive in a particular market or geography. So we love the blend of what we're doing. And that's evident in margin expansion. We've had a nice year in terms of gross margin expansion, particularly in Q2. So I think the investments we're making are really paying some dividends across the long term. But it's a competitive space, it's going to stay that way. But I think everybody is playing well in the space and staying rational as we look at it.

Okay. Great. And we have some questions about some of the investments you're making that we'll get to next, but I wanted to be sure we talked about European Automotive. I think the big initiative there has been rolling out the NAPA-branded products across Europe. And I know it's something that you've been very enthusiastic about. So could you maybe talk to us about why that is so important? Why do you think it's working and what kind of sales and margin lift you see as a result.

Look, we're differentiated. So for those of you that follow the space, we're a little unique in the fact that we are global with the European business, great business there, Australasia, Canada to supplement the U.S. And so we like that diversification of our portfolio and our businesses. Europe is a great business. We have a great team there. They're executing at a very high level, 15% growth in Q2, 11% comp for the quarter and that's coming on the back of a few things: NAPA rollout, which has gone very well, $0 to $300 million in 3 years, we'll do $400 million in sales this year. So the adoption in the market for NAPA-branded product, which probably has some questions on the front end has been very well received. It comes with the same things we think about in the U.S. in terms of quality, availability, that space one of that, and we're seeing that in our sales of the reaction. The margin lift is nice. Gross margin lift is about 500 basis points. And so we're very pleased with the profitability and the execution of our teams across those markets. The other thing that's great about Europe is it's continuing to grow and expand. So we've expanded into Spain and Portugal last year with another addition in Spain over the summer, the fifth largest car parks. And so continue to extend the leadership position across that space. There's a lot of opportunity to continue to roll out that NAPA brand.

Okay. Moving on to industrial. I think you've surprised the market a little bit in terms of your outperformance there. Could you maybe talk to how much of that has been by design and how much you've changed the portfolio there? And how do you see the onshoring of manufacturing impact your outlook for the second...

It's all by design, of course. No. Look, we love that business, too, great leadership team, great execution. The Industrial business has a lot of runway. They've had a good year, 6% comp growth in the second quarter, 12.5% margin. They benefit from a lot of things. First and foremost, a very well-executed diversified portfolio. So they sit in 14 -- they serve 14 verticals, 14 different markets, industries. We're not over-concentrated in any one industry. So we're protected from not being doubled down in a single place where you might move with that industry. So you have a nice buffering within your book of business with those 14 verticals. We've grown thoughtfully, added a vertical around EV. We think about EV often on the auto side as an opportunity. It's a big opportunity for Industrial as manufacturers continue to build new EV plants, the tag along battery facilities and retrofitting ICE facilities, motion. Those are motion customers. So we're excited about that space. When you put that with a really smart acquisition of KDG a year ago, which also brought new capabilities in some growth areas like automation and conveyance. That taken together gives Industrial a nice runway on the top line. Again, fragmented market, $150 billion addressable market, we have a 6% share, and we're the largest player. And so we have a lot of opportunities with size and scale to take more share, but also execution of new strategies. And when you put that together, we're going to have a great year. Nice strong expansion of margin this year as we look ahead. And then we're marching to a 12% 2025 target for that business in terms of operating margin.

And that kind of leads to our next question. I think what we took away from your Analyst Day earlier this year is both for the automotive and the industrial business that you're focused on providing customers with value-added solutions. I think that's always been in your DNA. But it seems like you are doing a lot more here to gain that increased wallet share and win business. So can you help us understand where we are in terms of this initiative and how early on we are? And can you quantify how much of a lift you've seen so far in sales, both on the automotive and the industrial side.

Well, the very early innings, the Investor Day was the debut of a lot of these new initiatives. So I'd say very, very early innings in terms of how we think about where we are. The investments we're making in technology really center around supply chain, modernizing our supply chain. We're able to do that through a new kind of host of ways of looking at the business. That's a lot about efficiency inside of the DC. This is not new technology. It's just new to GPC. So we're not leaning into new concepts that haven't been tried and tested before, but an automation of a DC, when you bring in the robotics and you bring in automated pick and pack is the game changer in terms of efficiency, reducing your reliance upon a workforce that's sometimes hard to find and has high turnover, you get the benefit on the labor side, you get the benefit on the efficiency side. So as we think about adding automation to DCs, that's just one example. When we think about the other investments in technology, it's the ways we work, working with our customers, modernizing payment platforms and technology around payment, just being easier to do business with, and that's a part of our investment on tech. The other side of it will be some of the things we just talked about on pricing, investing in analytics and data. One place we haven't talked about is making those investments and managing our supply chain and our lead times for inventory, so we've got a lot more data now where we can look into the supply chain, look into the inventory lead time, shorten those cycles, particularly as supply chains have gotten healthier, and that's allowed us to be smarter about carrying long-tailed inventory and smarter about having the fast-moving inventory where we need it. It's a working capital benefit as well. So these investments we're making across multiple prisms, early innings. They were factored into our targets for 2025 and a big part of our lift in terms of gross margin and on SG&A as we move ahead to get into double-digit margins overall.

Okay. And you mentioned in supply chain. Can you talk about a little bit with regards to your in-stocks and inventory currently. And we talked a little bit about what you're doing from the data analytics and AI side to better forecast that. But is that something that we could be seeing sooner is helping you now?

We are seeing supply chains being a lot healthier than they were a year ago. And so that's a big help. That's helped in stocking levels in our locations across the board, which has helped in terms of sales. At the same time, we're having an ability to reduce some of those safety stocks that people kept. So there's a working capital benefit to it. We just talked about the lead time, so looking into the cycle. And for example, talk to the motion folks, and they'll say, okay, well, we might have a high-end, slow-moving part that in the old world, we sold it and we'd replace it tomorrow, and it's not going to sell again for 45 weeks. Well, we're being really thoughtful about when we restock that and using this new data to say, well, let's not carry it for 43 weeks, if we're going to sell it in 45, let's be really thoughtful about when we've restocked that. So that's being smarter. But in general, supply chain is much healthier. We're seeing costs come down on ocean freight. We're seeing freight costs come down on DC to store. All of that is factored into how we're thinking about the year in terms of guidance. But I think all -- when you put all of that together, we're really in a much better place for our customers in terms of stocking levels and then how we're managing the inventory on a day-to-day basis.

Okay. And then if we can switch gears to M&A. Just how do you view the current M&A market and in particular, your pipeline of acquisition targets?

So M&A is a big part of our growth algorithm as we gave 2025 targets, 6% to 7% on the top line, we said we'd get a point from M&A. So it's always a part the GPC story. We have a very robust pipeline of opportunities, both on the automotives and industrial side. So we're pretty balanced in that regard of how we look at the 2 businesses. We like the opportunities that are coming. The space is still probably a little inflated in terms of expectations on the seller side. And so that's why we always have to stay disciplined and go back to the things that focus on. We've been very disciplined in this space. We think about really 3 prisms as you look at M&A, strategic fit, cultural fit and the financials. And so in an environment where we still see inflated expectations you have to stick to your principles and really make sure you're looking through a disciplined prism. Strategy will be - does it fit a geography we would you like to expand into, add a capability on the cultural side. Culture is really important, gets lost in some of these conversations. But when 2 cultures don't mesh, it makes an integration sometimes impossible, and you'll never get to the third part of the equation, which is the financials. And we're very disciplined in thinking about accretion ROIC and what it means to the business going forward. We love this acquisition, we just did in Spain over the summer. It hit all the right marks in terms of expansion of geography, cultural fit, financials. And so while the environment has got a lot of activity in it, there's a good pipeline, nothing really actionable here in the near term, particularly as we wait to see inflated seller expectations kind of cool down a bit.

And that leads us to your balance sheet. The leverage ratio we last checked was about 1.8x just below your target range of 2% to 2.5%. How comfortable are you with current debt levels? And how should we think about your willingness to take on more debt, either just in a higher interest rate environment or to fund acquisitions?

Yes. Look, we love where we are. Because it gives us a tremendous amount of dry powder. We can act on this pipeline that we just talked about. So as the opportunity starts to crystallize and come into focus and becomes real, we're not inhibited by trying to figure out how to fund it. So we have that dry powder. We're certainly willing to take on debt to fund a great acquisition. We saw that with KDG. We've made a really smart acquisition. It's gone really well in terms of execution, synergies a year earlier than we thought in terms of 2 years versus 3 years, and the ability to pay that leverage back down. So we were just above 2 after the debt we took on to fund KDG. We're now back to 1.8. We have a stated goal to stay between 2 and 2.5x. That gives us the runway we're looking for, but we're certainly willing to lean in and take on debt to fund the right and smart acquisitions, and we'll continue to do that even with rates a little higher, and we factored that into our business case and how we think about things. And I think there'll be things along the way that with this dry powder, we'll be able to act on, maybe gives us a little bit of an advantage.

Okay. Going back to our automotive discussion before. The question that we keep getting no matter who it is, it's just on EVs. And just I thought you did a good job at your Analyst Day kind of showing us how you can be helpful if things were to pick up with regards to EV demand. So can you talk about how you're thinking about the arc of when we can start to see the EV impact your business? And what are some of the ways you're taking advantage of that.

I think, first you will foresee impact of EV, industrial I talked about that a few minutes ago, you'll see that ripple through on the industrial side first. And I think that gets missed sometimes when you think about GPC about that strength in industrial business is turning back to the automotive side, I think it's important to frame the context, and we can use the U.S. as an example. Right now, there's about 280 million cars on the road in the U.S. depending on who you ask, but we'll just use that number. And then in terms of EV, 2% to 3% on the road. So it's a small space right now. If you fast forward and go to 2030, you'll see 300 million cars on the road, depending on who you talk to, 6% to 8% EV. And so having the right context for how you think about the opportunity is important. It's not a huge one. It's going to grow, but it's still not going to be huge even in 2030. Now having said that, we don't want to be standing around at 2030 and have missed the boat. And so I think what we're doing is being really surgical, really smart, measured investment in the space, and we've been doing it for some time. We think that we are the leader in that space, frankly. And again, I'll go back to this diversified portfolio of businesses that we have, that fact that we're global. And the fact that Europe is actually well ahead of most places in EV and that's where we're actually testing some concepts. Now in many of our stores, we're stocking EV parts. So we're already there in that space and having that availability, which is important, having that solution. But one thing we think about, too, and trying to be innovative, is -- what is the workshop of the future look like? What does that repair opportunity look like in the future? And where you have choice today in terms of your ICE vehicle and you can go to a NAPA AutoCare, you could go back to the dealer, you could go to your local repair shop. We have a lot of choice when we think about our ICE vehicles. How many EVs in the room, how many people have EVs in the room. That measures up to my small sample there of 2% to 3%. You're kind of beholden to your manufacturer in most cases. And that experience, I think, is pretty choppy. And in doing that, you don't have the same choice that you have with ICE. And so the concept that we're rolling out in Europe, which is a great market to test it, is next drive powered by NAPA. So this is taking an existing facility, the CFOs love this because it's capital light and going in and certifying the workshop to work on EVs, adding the technology, the diagnostics, the training, the expertise, there's specialized safety requirements to work on an EV so you keep yourself safe and not electrocuted. And all of those things get added to the equation and then we're able to offer that service. We've got about 150 locations in Europe now, moving to 400. And then we're letting the trend follow our business kind of as the sun moves. So with Canada increasing its prominence with EV, we're moving next drive to Canada. So we've got 2 great markets where we're testing this new concept and then as the U.S. matures, we'll be able to bring it here. So again, measured, thoughtful, surgical investment, not pushing all of my chips in the middle of the table in terms of capital allocation, but also not acting like this has been coming towards us.

Okay. Thank you. We're asking 4 questions to all of the companies presenting. Nothing too to you offbeat. First is just [ related ] to the consumer. And how do you see your consumer going into '24, will they be facing more headwinds or less headwinds versus '23.

That's a tough one to call in terms of more or less. There's a lot out there to digest. When I think about the consumer, we certainly see a more cautious consumer for sure. And that impacts us when you think about automotive, that consumer is the one that's taking a car into a mechanic and the mechanic has been making a choice to use NAPA. So the consumer for us is a little one step removed. But still, we see and feel the pressures. You think about, we talked about auto loans and the cost of an auto loan, you talk about mortgage rates right now and the pressure there, the inflationary impact on everyday purchases, particularly in the grocery store. All of those things are stacking up. I think you've got student loan payments restarting here in the fall. That's another consideration -- and so I don't know that those are more or less than '23 versus '24. From my perspective, we're being very prudent as we're starting to think about '24. So we're entering the business planning cycle for next year right now. And I think we're approaching it with the same eyes-wide-open prudence that we did as we started planning for '23. There's a lot weighing on the consumer. At the same time, we benefit from being in 2 segments that are repair-oriented. And so we have that benefit of on one side, knowing the consumer is a little bit more cautious on the other side, knowing that in many cases, it's not a discretionary fix in terms of how they think about the business. So it gives it a little bit of a floor as we model what's ahead. So more to come, but I think in general, we're probably thinking about it the same way we did entering 2023 with maybe a slight being more to being a little bit more cautious.

And then what about -- its Part B of this question with how does consumers trade up versus trade down. Can you remind us what you've seen with regards to trading up or down in '23 and how you expect it to play out in '24.

Yes. Through the end of the second quarter, we had not seen any real prominent trend to call out. The great thing about both of our businesses as we provide the -- we meet the consumer where they are. So on the automotive side, our assortment includes a good, better, best. So you can match up what you want to choose as your repair part with where your pocketbook is. And that's true for Industrial. We have Tier 1, Tier 2 parts, which allows an industrial to kind of apply that same logic. So regardless of how we think about where we are in terms of trade up, trade down, I would say that we attack it with an assortment in an inventory and a book of business that allows us to meet them wherever they're going to be there in '24.

Okay. Our second question is on share of wallet, which we don't really have to spend much time on since there is a defensiveness to your business. So I'll move on to pricing. Just now that inflation seems to have peaked, how are you thinking about pricing into '24? And how do you think of the traffic and pricing dynamic versus maybe what we saw in '23?

Yes. So I don't want to give too much away to 2024 just yet, but I would just color 2024 in the sense that the industry when you think about automotive through cycles, if you look back at the history book, it hasn't given a lot of price back, so with that as a backdrop, I don't think we would be modeling anything different than what historical patterns and industry trends have been when you think about automotive. On the industrial side, a little less impacted by inflation. The inflationary impact has been very de minimis, low single digits. And so not a lot to factor in there. Certainly, we're coming out of a period, as I talked about earlier, where last year, the automotive side of the business benefited greatly from price, and we're seeing that tick down through the course of the year and cool off a bit right in line with our expectations, quite frankly. And so as you look at where that heads and how you think about the levers, then if price is coming down, then I think we're going to get to a more normalized environment in '24, where we're going to be back to 1 to 2 price benefits. And it's going to put an emphasis on the growth part, which is units and units need to grow. And how do units grow, well units grow because you have great availability and you're meeting the installer market where they need to be, and you've got the right part in the right place at the right time. And so I think it's just going to add an emphasis on growing units, growing units by taking share, and that comes back to part availability.

Okay. And then the last question is about destocking, which again doesn't totally apply, but if you could maybe just level set from an inventory standpoint in stocks if you're satisfied, I think, with the inventory levels at your business.

Well, no CFO is never going to tell you they're satisfied with inventory levels.

Relative, it's a relative question.

Yes, I got you. Look, we -- back to the point I just made about availability. I think for us, that part availability, particularly on the automotive side, but it's also on the industrial and you're getting called and there's a situation with a customer and it's nondiscretionary, and then you need to get whatever is broken fixed, you want that great availability. So the work we're doing that we talked about earlier in terms of managing lead times and supply chain is benefiting us to getting the right part in the right place at the right time. We're being a lot smarter about the fast moving skews and making sure that we've got those in the markets exactly where we need them at the right time, also being smarter about managing the long tail of the slow moving pieces. And so that's an optimization effort that we're pursuing through technology and through brute force to. DIO is always an opportunity for us to manage better, but in general, I would say, continuous focus, continuous improvement really with a bent towards making sure that we've got the right availability as we look at our customer bases on both segments.

Okay. Well, thank you for joining us today. .

Thank you.

Very helpful. Thank you.