Made in America: Generators

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When the lights go out, most businesses idle their production until the electricity is restored by the power company.  However, a periodic disruption in utility service is exactly the time when the power generation industry’s products spring into service.

Generators provide backup power to homes and businesses, generally delivering between 800 watts and 9 megawatts of power through diesel, propane, natural gas, or bio-fuel sources. The industry has attracted notable attention in recent years as increasingly frequent storms make generators an important infrastructure asset for a wide range of businesses.  Best of all, many of the leading products are made right here in America.

When the lights go out

The #1 manufacturer of home generators is Wisconsin-based Generac (NYSE: GNRC).  Founded in 1959, the company makes a variety of standby and portable generators through four manufacturing plants located in Wisconsin and Georgia. 

While its products have historically been powered by diesel and propane fuels, Generac has been developing products that utilize cleaner-burning natural gas or bio-fuel in order to comply with government emissions rules.  In addition, the company has been diversifying into related markets through the acquisition channel, including the 2011 purchase of Magnum Products, a leading provider of light towers and mobile generators.

In its latest fiscal year, Generac reported revenues and adjusted EBITDA of $792.0 million and $188.5 million, increases of 33.6% and 20.6%, respectively, versus the prior year.  The company's strong sales were aided by a greater level of purchases by U.S. customers who were affected by recent storm activity, as well as its limited exposure to weakening international economies. 

While operating margins slipped compared to the prior year level, the major cause of the decline was a shift to lower priced portable generators, rather than inefficiencies in its operations.  Gross margins have also been affected somewhat by rising commodity prices, but the company has been able to hedge their significant raw material needs and has found domestic sources for over half of its products’ components.

In FY2012, Generac has continued to generate solid results, with increases in revenues and adjusted EBITDA of 59.0% and 102.0%, respectively, compared to the prior year period.  All of the company’s segments have enjoyed double digits gains in sales, led by the commercial unit’s 81.9% increase. 

While healthcare organizations have long recognized the need for generators, a wider range of businesses are adding power-related products to their mission-critical infrastructure.  Generac’s profits have also benefited from more favorable commodity prices, due to slower economic growth in emerging markets.  The higher profitability has led to strong operating cash flows, with $129.2 million generated in the first nine months of the year, which has allowed the company to return money to shareholders.

Looking ahead

Generac estimates that only 2.5% of U.S. residential homes have emergency generators, which represents a significant growth opportunity for the company.  Given the company’s narrow focus on the generator market, though, where can investors find industry investments with greater product diversity?  One avenue would be to look at the manufacturers of engines for power generation products.  Two of the leading companies in this area are Briggs & Stratton (NYSE: BGG) and Cummins (NYSE: CMI).

Founded in 1908, Briggs & Stratton is the largest producer of air-cooled gas engines for outdoor power equipment, with leading positions in the portable generator and power washing product lines.  While the company continues to derive the majority of its business from engine sales, it moved into the generator business through the acquisition of Generac’s portable generator unit in 2000. 

Like Generac, Briggs & Stratton manufactures products in U.S. based facilities, although it has moved some production overseas.  In its latest fiscal year, the company reported declines in revenues and operating income of 2.1% and 14.5%, respectively, compared to the prior year period.  While sales of power generation products rose during the period, engine sales declined 13% due to Briggs & Stratton’s significant exposure to contracting European markets.  Despite weak current profit margins, Briggs & Stratton's restructuring activities should provide solid operating leverage for an eventual rebound in international economies.

Founded in 1919, Cummins is a global manufacturer of commercial engines and related components, as well a developer of power generation products and systems.  The company has built a $13 billion business around the sale of diesel and natural gas engines, which generates over 60% of total sales, and Cummins has been a beneficiary of rising demand for construction equipment in the fast-growing economies of China, Brazil, and India. 

In FY2012, though, the company has been affected by the same global financial pressures and negative factors that have hurt Briggs & Stratton.  In the first six month of the year, Cummins reported declines in revenues and operating profit of 0.6% and 7.6%, respectively, versus the prior year period.  Despite the current weakness in financial results, Cummins is valued at a cheap 12 P/E multiple and has similar strong leverage to an eventual rebound in worldwide economies. 

Investors should put both of these engine makers on their long-term watchlist.

rghanley owns shares of Generac. The Motley Fool recommends Cummins. The Motley Fool owns shares of Cummins. 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!

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