Special Dividend, Secondary Offering, & Growth Prospects
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Editor's Note: The original article misspelled Cummins, this article has been corrected.
Generac Holdings (NYSE: GNRC) is doing two financial transactions of interest currently. First, a private equity fund is selling its shares in a secondary offering. The company is also restricting its debt and paying a $5 per share special dividend in the second quarter - a move seen previously in other industries. Generac’s stock has performed well over the past twelve months, and it has delivered positive results and earnings beats.
Capital Structure Changes
Generac announced an underwritten secondary offering of nine million shares. CCMP Capital is the selling stockholder of GNRC and will receive all the proceeds from the offering. The company is not selling any shares in the offering. Interestingly, CCMP Capital has set a price above the current price at $37.17 for the shares; currently the shares trade at $36.95. The deal will reduce the ownership of CCMP from 34.4% to 21.2%. CCMP held 52% of the firm in November 2012.
Generac generates significant free cash flow and, as a result, will pay a special dividend of $5 per share. This is the second year in a row. It has an average FCF yield of 8-10% annually and a $5 dividend is equal to a 13.5% yield. The company is financing the dividend by adding an additional ~$340 million in debt when they refinance. However, a reduced interest rate will offset the increase in outstanding debt. The deal is actually slightly accretive to earnings due to the 200bp reduction in the interest rate.
Generac Holdings Positioned to Benefit from Secular Growth Trends
Generac Holdings is a designer of manufacturer of generators and other engine powered products. Its power equipment serves the residential, light commercial, industrial and construction markets. Generac sells internationally through retailers, wholesalers, equipment rental firms and independent dealers. It holds a 70% market share of US residential generators.
The recovery in the residential market in the US should lead to improving results for Generac. In addition, the residential US market is still developing with a lot of room for further penetration. Management estimates Generac has penetration of 5% on new home construction. Part of the case to own Generac includes the thesis that more homes will add standby power because the aging power grid will be increasingly unreliable and weather patterns will increase the frequency and length of outages. The company also benefits from similar trends in light commercial and industrial, although this market is further along in adopting backup power but still likely relatively early in the process. Additionally, growth will come from international expansion and distribution as well as some new product offerings.
Management gave guidance at the end of last quarter of low-to-mid teen revenue growth and 2Q13 sales to grow by 30-35%. Their guidance does not assume any additional significant storms. Large storms add an additional 200-400bps to sales following the storm. These storms can push estimates higher and occur with somewhat high frequency. There is likely a certain degree of this built into the valuation multiples.
Other companies in the generator market include Cummins (CMI) and Briggs & Stratton (NYSE: BGG). Both of these companies make engines and power generation equipment. Caterpillar (NYSE: CAT) is also a player but contributes a smaller portion of earnings. Cummins is a major international player in power generation but also manufactures diesel engines for use in construction equipment and trucks. Briggs & Stratton also has other businesses, such as manufacturing pressure washers, lawn mowers and snow blowers. Briggs & Stratton has quite small operating margins at 4% and a small ROA of 2.8%. Caterpillar, on the other hand, has operating margins of about 12% and a higher return on assets too. To see a table comparing the competition, click here.
Cummings and Briggs & Stratton are valued close to Generac based on some multiples but the shares of GNRC look like they are at least fairly valued at this time given its FCF generation and growth prospects. The stock is attractive to investors that believe in the secular story of increasing residential and commercial penetration in the US. In this scenario, the profile fits that more of a growth stock versus a cyclical. This deserves a higher multiple; a range of 10x-12x NTM EBITDA seems fair.
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Mike Thiessen has no position in any stocks mentioned. The Motley Fool owns shares of Generac Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!