Graco Inc. (GGG) Earnings Call Transcript & Summary

Okay. Well, with that, kicking off our conference is Graco. Based in Minneapolis, Minnesota, Graco supplies technology and expertise for the management of fluids and coatings in both industrial and commercial applications. It designs, manufactures and markets systems and equipment to move, measure, control, dispense and spray fluid and powder materials, serves customers around the world in the manufacturing, processing, construction and maintenance industries. In addition to its Minneapolis headquarters, Graco has regional headquarters in Belgium and China with production and distribution centers located worldwide. Graco has 169.5 million shares outstanding. Stock is at $86 for $14.6 billion market cap, $650 million of net cash and a $14.2 billion total enterprise. Joining us from Graco are David Lowe, CFO and Treasurer; and John Bower, Director of IR Finance and FP&A. So before we get right into questions, I know that David would like to get up and just say a few words, framing the business for those who are maybe a little less familiar with Graco.

Thank you, Kevin. And I want to thank our friends at Gabelli for the invitation to participate in this 35th Annual Pump Valve and Water Systems Symposium. It's been our pleasure to participate in this program over the years on several occasions, and it's one of our favorites. Mercifully, I won't give you a prepared presentation. Q&A is far more interesting, but I did think I would just give you a 90-second thumbnail of Graco if you're not familiar with us. Graco Inc. was founded 99 years ago in Minneapolis, Minnesota, and its original business was designing and manufacturing lubrication equipment for the automobile industry. We extended our industrial exposure in many niche markets usually by leveraging technology we've developed in one industry, one application group in our technology and stretching it over other businesses. If you're looking for a quick way to think about the company, maybe it's -- we handle difficult to handle fluids and maybe you could think of expensive materials. Our growth over this century has been mostly organic. And as you will see, if you look at our financials, we report in 3 segments, but that's really deceiving. Our business is in 15 to 18 niche markets. That's how we think about our business on a daily basis. And it's sometimes why you'll find me, I ham and ha when you ask me to generalize about what's going on because we're balancing a lot of businesses. The businesses that we're in, I'm going to try to generalize when I say, we like business-to-business. We like businesses that are global. We like recurring revenue. We like in our terminology, critical applications because business-to-business people will pay you well, if you offer them durable, high-quality solutions. Our customers are return-on-investment driven as in fact, we are. It's part of our culture. And I think, quite frankly, it's reflected in our operating returns and our cash flows over many, many years. We have an interesting manufacturing footprint. While we are a global country company, more than 80% of our manufacturing is here the U.S. Last year, we did just a little bit over $2 billion in revenue, and we've been public since 1969.

I mean it's much better than watching paint dry. So we'll take that. Exactly. So thank you for that, and welcome again. And I add, we do want this to be interactive. So if anyone has a question, raise your hand, we're happy to get a mic to you. And those on the webcast as well, there should be a mechanism for you to submit a question. We'll find a way to get that up here to me as well. So that was a great overview. I thought we'd start by exciting and delighting everyone and pointing out that Graco, you've got these 15, 18 businesses. One hallmark is you generate a lot of cash flow. With that cash flow, you now have a lot of cash on your balance sheet, as we said, $650 million or so and minimal internal capital needs. Just in November, you acquired COROB for EUR 230 million plus an earn-out, and that adds to your strong position in the global paint and coating machinery manufacturing category. So first, maybe we could start -- talk a little bit about that deal. What makes you excited about it? What was interesting about it in terms of technology, expertise, end markets. But then more broadly, clearly, M&A had dipped down for a while. We've seen it perk back up last year. A lot of people are excited about the deal-making environment. M&A has been an important way for you to grow your top and bottom line over the years. Maybe you could talk about what you're looking at now from your strategic position internally?

Okay. That's a good question. Is this on? The transaction that Kevin is referring to is the COROB manufacturing products business out of Northern Italy. It manufactures a variety of machines that are used in the mixing, shaking, tinting activities in the colorant marketplace, in other words, making paint, the right color to match existing or desired color shades. This business, I think, characterizes a lot of things that we like about these niche markets that we're in as well as with respect to deal strategy, the way we like to think about opportunities in this space. As far as businesses that we're in, these niche markets, most of them are not particularly large markets. They're sub 1-billion-dollar markets. In some cases, they're just a few hundred million dollars. And they're not -- they may grow at GDP and they may grow with technology and good pricing a little bit above GDP in this business-to-business environment. But they're not huge and they're not exceptional growers. So you're saying you're thinking, well, what's not to like? What we like about that is it means the industry is relatively -- these industries are relatively stable. You know who the competitors are. New competitors typically don't come into these specialized markets and especially corporate industrial behemoths that they could own the whole market, and it wouldn't mean anything to them. We like that. I mean, I joined the company 30 years ago. The competitors we were talking about in those days are the same competitors we're talking about today. That's the way the COROB market is. There's 2 large global players, COROB is one, a business called Fluid Management that's part of a company you may have heard of. IDEX is another one. And then there's a few regional and local players. What we liked about this business -- and then I'll try to talk more broadly, what we like about this business is that we know the channel and the end users. Think home centers, think paint stores, people that are doing transactions involving paints and coatings. That's our world anyway. And we think we have opportunities to capitalize on where they're strong and where we're strong. COROB's operational footprint is very interesting. Their very much state-of-the-art manufacturing location in Northern Italy is highly mechanized, very competitive on a global basis and absolutely first rate, and we would consider the quality of a Graco factory. They also have a very interesting footprint in India, where we really have other than a warehouse and a sales arm, we really have no activity. There, they have a long time and experienced manufacturing operation, and they have a local sales and service network of a couple of hundred people across the country that give them very, very interesting coverage. Flip it around, here in North America, which is our core, core business for most of our contractor products, we have a very well-developed sales and technical organization, not to mention tremendous coverage with channel partners like the largest home centers and the largest paint chains, and we think we can do some things for them there. Lastly, this was not a program -- this was not an initiative that was done with an auction process. This was a business that was privately held. In this case, it was held by private equity. Through contacts in the industry, we established a working relationship with the owner and over a period of 9 months, got to see the operations, got to know management, got to understand the dynamics better than we think we would have in the auction process, and we're very comfortable when it came time to close the sale. And I would say more broadly, we have a responsibility, we know to be good stewards of capital. And when we talk about our capital deployment process, in our case, number one is we like the businesses that we're in, and we're always going to be, I would say, big on the organic side. We are committed year in and year out to product development. We invest about 4% a year in that line -- in that level of activity. And we think it's important because in business-to-business environments where people are looking for ways to improve their productivity and their ROIs, in this particular case, the best mousetrap wins. If you can get it into people's hands, the high enough quality and you can support it afterwards at a reasonable price. And after that, our factories, we really believe in state-of-the-art manufacturing facilities. When you visit one of our factories, we have 4 in the Greater Minneapolis area, not exactly the place you would think of as a major hub of manufacturing. They're state-of-the-art machine tools, robotics, how have we stayed competitive by competing or by manufacturing in the United States, lots of automation, lots and lots and lots of tools that are surprising in a business that is relatively low-volume compared to consumer products businesses. And you say, well, how do you get away with that? We get away with that because we source all of our global demand out of dedicated factories in one place. And then finally, yes, I would say that the other 2 areas, the other 2 important buckets are development activities. And we look at our business opportunities to see if we think we can add value and if we're going to have a return on investment, and that's where we could get into a lot -- I'll spare you, a long conversation on pricing and multiples and so forth. By the way, the COROB deal, which I said kind of fits within our special sphere, that was -- not as cheap as I'd like it to be, but it was between 11 and 12x. So we're not -- try to avoid those deals in the elevated levels that we've seen in some markets over the last few years. And then shareholder return and returning money to shareholders. I don't think of Graco as a classic cyclical company. But because of the industries that we serve, construction markets, automotive, semiconductor, farm, et cetera, you do, Wall Street does. And so what that means is as a cyclical -- this is your world, this isn't my world. But as a cyclical, once every 3 or 4 years, we go on sale, right? 30%, 35% down. And I know this because I've seen it over my time frame with the company. And when that happens, we like to be in a position to move quickly and move aggressively. And I think if you look at the long swath of our history, we track our purchases over the last 20 years. We've brought in a little bit more than $2 billion worth of stock. Our return on investment on that is about 15.5%. And if you look at when we bought, maybe we could have done -- we could have been more aggressive in '08, '09. but we were in the market in '15 when it was quite soft for industrial companies. Some people have forgotten that. We were buying aggressively when COVID hit. And even a couple of years ago, in 2022, when our stock was down nearly 30%, we were in the market. We always like to have the financial flexibility to do all of those things when the time is right. The drivers on number two, development; and number three, buying stock does depend on what the price of the merchandise is.

Love to hear that. We'll get to your question in just a moment, maybe somebody can give you a mic. But I could follow up with probably 15 questions from what you just said. But maybe I'll just start with, you did a resegmentation that you just announced at the end of the year that's going to be coming -- this coming year on how you report. I'm curious, how much is that of that is internal versus external? In other words, have you actually reorganized the way these businesses are managed, operated, run? Is this part of cost reduction? And obviously, one of the new divisions or the new division is called expansion markets, which is obviously pretty positive and highlighting both the growth potential in those markets as well as it sounds like that's where a lot of your M&A opportunities are going to be. Could you just kind of discuss that reorganization and new segment reporting?

Yes. So I'll start, and I'm sure David might jump in and fill in some details as well. But the principal driver behind the restructuring, which we announced last Q4 and it's in place today is principally around growth. David mentioned in his opening remarks and again in his follow-up commentary around organic. We very much are heavily reliant on organic. And over the last 20 years, organic growth has been about 6.5% compounded over the last 20 years. And when you look at these niche businesses, David mentioned we report in 3 segments, but we operate in sort of 18 or so niche markets. And I would say, historically, we still reported in 3 segments, but we also had what I would call lots of little businesses within -- underneath those segments that really were also driving investment decisions, driving new product strategy and also a lot of new products that were going into these markets. But when you look across those verticals, the same core markets and customers really traverse a lot of them. It's going to be contractor. It's going to be industrial customers, large OEMs. And I think over the years, there's been a level of, I wouldn't say complexity, but we've introduced a lot of businesses that were going into these large channel customers representing different segments of the business. And when we stepped back and really looked at the organization and really thought through how do we drive higher organic growth in the next cycle. We recognize that there was a growing opportunity to sort of reorganize to really focus on those customers and really be customer focused. And we've got some experience with this. About 4 years ago, we took our high-performance protective coatings and foam, which are large, almost industrial type products that were in our Industrial segment, and we moved them into the Contractor segment. And we did it principally because the customers that are buying those products are contractor customers, and we've seen some really good success. So really, the reorganization is all around organic growth. There is some synergies that we've realized as well through sales and marketing and engineer. But really the principal driver is all around organic growth and improving that.

Great. Let's go to the crowd for a question.

You mentioned you have state-of-the-art factories and you have been using tools and automation. Well, I've been reading a number of academic articles and books recently, all making the point that the U.S. is manifestly not a global leader in what's called advanced manufacturing, mostly because it requires such heavy expense and long-term-oriented capital expense. And the question is, how do you see that from your point of view? For example, are the tools and the instruments that you're automating with mostly from Germany, Japan, South Korea or wherever, not the United States? And particularly for these niche businesses, only doing a few hundred million a year, it's really expensive. I don't know how you do it to really get into what's called advanced manufacturing. So that's my first question. And I have one more after that.

All right. Well, it's a good question. And I would say that our model -- what helps us on our model is that we consolidate all of our volume in single locations. As you said, we are not a high -- I mean, what's a high-volume business. If you're making power drills or something you're measuring your output in the millions. In our contractor business, which would be a high-volume business for us, we measure our output in the tens of thousands of units a year. In our industrial business, that's where I spent about 25 years, we measure our output of high-volume units, a few hundred a year. And so you look at this and you're thinking, well, gee, that's not a lot. But first thing, you can see it builds the case for -- well, for goodness sakes, do it in one place. And while the volumes are not high for individual SKUs, we share lots and lots and lots of common platforms, technologies and parts. And so we may have individual parts that go into dozens of different pumps, dozens of different spray guns and such, and we are able to build it on a cost-effective basis. Maybe we are lucky in the particular choice of the competitors that we have in our marketplaces. I talk about these niche markets. They are a few hundred million in revenue normally. I mean a big one for us might be the -- maybe the pro paint side of the contractor business, sorry, for the jargon. Maybe that's $1 billion worldwide. That would be a big guy for us. So -- in those spaces, there's companies that we compete with, including some public companies you're familiar with. We compete with IDEX in 2 or 3, but the places, great company. We compete with Nordson in a couple of 3 places, great company, Dover and IR and such. But we really aren't competing with global behemoths. By that, I mean, we're not in these $5 billion and $10 billion and $20 billion markets, and we don't find ourselves competing with Siemens or American -- Emerson Electric or Honeywell or Rolls-Royce or people that could overwhelm us. We're competing with a handful of, I'll call it, sophisticated corporate players that are competent competitors and they compete in the right way, and they want to make money as we do. And so far, it's been a recipe for success.

And just to put a number on that, 8% of cost of goods sold is labor. So the labor component is quite small. And then you're really talking about the raw inputs, which there's global markets that we're buying those off of, so.

Okay. That is very much appreciated. My second question, totally unrelated topic. Given your great cash flow characteristics, what are the advantages of any today of being public?

That's a hard one. Do you want to do it? Pro and cons. There's pros and cons. Obviously, as -- from the company side as opposed to your side, the -- we'll call it the quarterly reporting drill is -- it's an ongoing drumbeat. The annual reporting requirements, the filing of the 10-Ks and all that. I mean it's an expensive process. And how smaller companies do it, smaller companies than Graco, I have no idea. What I would say, as I think about your question, we do strive to take at least to take advantages of some aspects of being a public company. Employees around the world, except in places where it gets complicated by taxes and local law, but most of our employees are here in the U.S. So these things work. We have a couple, 3, what I would call, participation programs with our employees that they can take advantage of the financial success of the company over many years. Unlike a lot of companies, there's no great secret here, we have an employee stock purchase plan, where you can buy in at a discount every year and once a year, you get shares at an attractive price that as an employee, you can retain and we hope that most of them do, or you can sell right away as a way of participating in the organization and making people owners and having skin in the game is part of it. We also have, I would say, maybe a little more unusually, a rather generous all employee stock grant program, where every so -- typically, it's on a 3-year drum beat, we grant stock options to all of our employees, as I said, except in places where it doesn't work or it's too clunky, but I think the U.S., it works well here. And those stock options vest over time. And it's another way with leverage of giving employees some additional skin in the game. And when we look, the heart of our business are our factories. We're an operating company. We're not a portfolio company. We probably aren't a classic industrial marketing company either. The heart of our business is our factories. And in our factories, if you visit them, you will see they're warm in the winter and they're cool in the summer. And there aren't a lot of sharp objects and there aren't pools of water lying around. And it's not dusty and it's not noisy. And when you go and start talking to our employees in the factory, you'll find us not just machinists, but assemblers and packers that have worked there for 20, 30 and 40 years. We pay a competitive wage. We have a suite of benefits, and we offer them a way of sharing in our success with these kinds of programs. And I would argue it's that stability and the buy-in that the employees have for us that has contributed very substantially to our success over a long period of time. They can raise families in a metropolitan area. They can save money for college and for cabins. And we do all of this, and I hope not to offend anybody on the East Coast, these are -- this is a nonunion operation, and we're in Minnesota for God's sakes. So I think it says something about the way we try to make our relationship and our employees -- we have a shared set of objectives and interests. And in some small way, being a public company helps us.

Maybe I could just follow up to that first question about manufacturing. Obviously, been an advantage having all your manufacturing or most of it in Minnesota. Can you talk us through tariffs? Obviously, that helps you for your sales in the United States, but both for some of your inputs coming into those factories, whether it's raw inputs or the machinery itself. And then conversely, for your sales outside the United States, just walk us through how you're thinking about potential tariff impacts.

Okay. So -- it's also a timely question, right, and a good one. And of course, the answer is we don't know, right? I mean we don't know what -- how this is going to play out. As a manufacturer with most of our operations in the U.S., we -- I would say, the vast majority of our key vendors are domestic companies are located nearby. It's just the nature of how logistics work in manufacturing, except in some cases, with some materials and some electronics that come in overseas. So as we've tried to get our hand around -- a handle around that part of the equation, I mean, it's not nothing, but I'm talking about adding to our -- you're our expert here. I mean, if we added to our purchase cost of 1% or 2%, that would highly surprise me. That's not really where, I guess, I lose sleep. Where I do lose sleep is we don't have complete visibility, and I don't think anybody does, as to where do our vendors get all of their parts, where do our vendors do their buying and such? And we probably have a degree of dependency there that we don't understand today. And I'd be exaggerating if I said, well, I'm not worried about it. But I don't know if that's $1 million or $10 million. It's probably not [ multiples of that, but it could be something. ] But then lastly, I mean, the real question, and I'm -- this is the Harvard Club, and I didn't go to Harvard. But the complications, the risks and maybe the opportunities of changing the relationship that global trade has been based on and has been developing during the whole post war period. We don't know. It could represent an opportunity in terms of when the countries look at these really niche-y products that are used to help make their countries and their markets more productive and meet the needs that you folks were talking about at the beginning of the presentation today, need for infrastructure, need for more housing, need for more water, need for more things. Maybe we could get a pass, but there's no guarantee that we will, and we'll have to see.

Yes. We're coming close to time, so I'm going to sneak in a couple of final questions. So first of all, a lot of positives in the business, but there were some negatives. You called out your semiconductor business and China as headwinds in 2024. How do you see those businesses turning around to seeing your positive outlook into '25? And then I'm also just curious from your perch, what's your view of the homebuilding industry, both new construction and repair and remodel?

Yes. So I see we're at time. But I would say if you look at our results in 2024 on the industrial side, it's really a story of both China and semiconductors. And I would say certainly a very strong negative impact on both. But if you were to just kind of look at the underlying order activity throughout the year, I would say there was a steadiness to both where as we exited the end of the year, I would say it appears that there's been some stabilizing kind of at these lower levels. And so as we come into 2025, hopefully, we're reaching a point where the headwinds are behind us and perhaps we can start improving off of a lower base.

And as far as housing goes, I mean, Northeast people know about the affordability crisis, and we keep our eye on interest rates. And I'd say those are the broad negatives, and that's probably going to resolve, but not this quarter, not this year. On the other hand, the factoids we take some comfort in is age -- the median age of U.S. housing is now 42 years. That represents a big opportunity 20 years -- back in 2000, it was 28 years. So as housing ages, it needs to be either remodeled or rebuilt, and we think that represents an opportunity. And at some point, some of those homes owned by 60% of the homeowners who have mortgages at 4% or less are going to have to make a move. And when more existing homes come to market, that's very good for us in the remodel and repaint sector because people spend most money on their homes just before they sell it or just after they move in.

Great. David and John, thank you. Thank you to Graco. Let's give them a hand.