4. Competitive Advantage
0
1
2
3
4
5
Threat of New Entrants
Degree of Rivalry Between
Firms
Threat of Substitutes
Bargaining Power of
Supplier
Bargaining power of
Customer
Average Number of Units
Sold Per Day
# of
SKU's
2012 Sales ($ in
millions)
0 to 1
37176
(91%) $452 (49%)
2 to 5
2430
(6%) $173 (19%)
6 to 10
307
(1%) $84 (9%)
11 to 15
211
(1%) $40 (4%)
Greater than 15
548
(1%) $170 (19%)
Threat of New Entrants
• Economies of Scale
Degree of Rivalry Between Firms
• R&D Spending, Concentrated Markets
Threat of Substitutes
• Differentiated Products
Bargaining Power of Suppliers
• Moderate Switching Cost from
Manufacturing Equipment
Bargaining Power of Customers
• High switching cost for customers
Source: Graco Investor Presentation Q3 2014
Recommendation | Competitive Advantage | Financials | Valuation | Investment Risks | Conclusion
5. Superior Return on Equity
Driven by:
Profit Margin: 14.4% 5-year
average
Asset Turnover: 1.12 5-year
average
Financial Leverage: 2.52 5-
year average
Recommendation | Competitive Advantage | Financials | Valuation | Investment Risks | Conclusion
Source: Bloomberg
6. Financial Statement Analysis
Strong Liquidity and Solvency
Measure TTM
Average of
Comparable
Firms (TTM)
Current Ratio 5.28 2.29
Quick Ratio 4.16 1.45
Cash Ratio 2.82 0.63
Debt/Equity 0.80 0.56
Debt/Capital 0.44 0.34
LT Debt/Equity 0.64 0.49
LT Debt/Capital 0.44 0.31
Interest Coverage
Ratio 17.28 11.85
Altman's Z 6.46 4.64
Recommendation | Competitive Advantage | Financials | Valuation | Investment Risks | Conclusion
0
50
100
150
200
250
300
2009 2010 2011 2012 2013
EBIT
Data Source: Bloomberg
7. Financial Statement Analysis
High Earnings Quality
Accruals Ratios
Peer
Average
Accruals
Ratio
Graco's
Accruals
Ratio
2010 11.20% 6.45%
2011 14.51% 2.50%
2012 26.62% 147.12%
2013 20.24% -0.17%
Earnings Quality
Restatement of Earnings None in last 2 years
Late Filings None in last 5 years
Dividend Cuts None in last 5 years
Auditor Changes None in last 3 years
Recommendation | Competitive Advantage | Financials | Valuation | Investment Risks | Conclusion
Data Source: Bloomberg
18. Revenue Forecast
5-year CAGR: 6.65%
Macroeconomic
Forecast
End Market
Conditions
New Product
development
New Market
Expansion
Acquisitions
Gross Margin:
54.63% (2014) to 55.83% (2019)
Average Forecasted Tax Rate: 30.67%
Capital Expenditures:
2.5% of sales
WACC: 12.33%
Price Target:
$67.49
Economies of
Scale
Economies of
Scale
DCF Flow Diagram
Operating Margin:
27.92% (2014) to 31.92% (2019)
Depreciation and Amortization:
3.5% of sales
Change in NWC:
2% of sales
H-Model
Recommendation | Competitive Advantage | Financials | Valuation | Investment Risks | Conclusion
19. Multiples Valuation
Peer Comparison:
Trading at relatively high multiples
Driven by superior financial performance
Relative value of $66 per share, range between $50-$80
Multiples Comparison
P/E (TTM) EV/EBITDA (TTM)
Graco 21.41 13.52
Nordson 18.71 12.33
Peer Group Median 18.41 11.44
S&P 500 17.54 11.14
Recommendation | Competitive Advantage | Financials | Valuation | Investment Risks | Conclusion
Data Source: Bloomberg
20. Benjamin Graham Valuation
Original Valuation Formula: Revised Valuation Formula:
These relatively high values show our assumptions seem reasonable given Graham’s
criteria.
Benjamin Graham Formula
EPS 3.65
no-growth P/E 8.5
7-10 year earnings
growth rate 7.862
Value $88.42
Benjamin Graham Revised Formula
EPS 3.65
No-growth P/E 8.5
5 year earnings growth
rate (%) 10.95
Yield on 20 year AAA
Corporate Bonds (%) 3.11
Average yield on Corporate
Bonds in 1962 (%) 4.4
Value $156.99
Recommendation | Competitive Advantage | Financials | Valuation | Investment Risks | Conclusion
29. WACC
Cost of Equity (14.12%)
Fama French Three Factor Model
Adjusted market beta
Weighted average equity risk
premium
Weighting from market cap. and
book value of debt
Parameter Estimates
Variable DF
Parameter Standard
t Value Pr > |t|
Estimate Error
Intercept 1 0.54413 0.45226 1.2 0.2306
Mkt_RF 1 1.03763 0.10104 10.27 <.0001
SMB 1 0.55122 0.13975 3.94 0.0001
HML 1 0.81645 0.14256 5.73 <.0001
Adjusted Market
Beta
1.0094075
Estimated market beta adjusted based on mean reverting property.
.75+.25*raw beta
Data Source: Bloomberg, Kenneth R. French Data Library
Fama French Assumptions
ERP Weight
ERP(US) 0.08298 0.539
ERP(EURO) 0.11207 0.256
ERP(CHINA) 0.08805 0.205
Weighted
Average
Equity Risk
Premium 0.09147
E(RF) 0.01775
E(SMB) 0.02187
E(HML) 0.02334
WACC
Wd 0.144558
Cd 0.023686
Tax Rate 0.278616
We 0.855442
Ce 0.141191
= 12.325%
30. WACC
Cost of Debt (2.369%)
Weighted average yield on the firm’s debt
Bond yields determined by BVAL
WACC
Wd 0.144558
Cd 0.023686
Tax Rate 0.278616
We 0.855442
Ce 0.141191
= 12.325%
current yield of bonds
Yield
Outstanding
Amount (in
Millions)
Series A 1.91% 75
Series B 3.10% 75
Series C 2.51% 75
Series D 3.52% 75
Average Interest Rate on other forms of debt
Average Interest rate
(12/27/2013)
Unsecured
revolving
credit
facility 1.4% 108.37
Notes
payable to
banks 0.8% 9.584
Weighted Average Yield 2.369%
31. H-Model
Short-term growth rate: 6.65%
Average between FCF growth rate in year 5 and 3% mature growth
Mature growth rate: 3%
Average US GDP growth
Years until mature growth: 15
R&D investments should extend the firm’s life.
33. Other DCF Assumptions
Tax Rate:
30% 2014-2017
32% 2018-2019
Depreciation and Amortization:
Forecasted: 3.5% of sales
10-year Average: 3.9%
Capital Expenditures:
Forecasted: 2.5% of sales
10-year Average: 2.9%
Change in Net Working Capital
Forecasted: 2% of sales
10-year average: 3%
34. Divestiture of the Liquid Finishing
Business
Graco announced their agreement to sell the Liquid Finishing business on Oct. 8,
2014
$570 million in net proceeds from the sale
$24 million in dividends collected in first three quarters of 2014
No further dividends after sale
Priorities for redeployment:
Reduce debt
$300 million in private placed debt will remain, offset by an equal amount of cash
Acquisitions
Nearly $800 million in capital capacity
Share repurchases
Reduce outstanding diluted shares to less than 60 million
35. Four Recent Acquisitions
An January 2nd Graco announced their acquisition of High Pressure Equipment
for $160 million, and an additional three acquisitions totaling $25 million.
HiP: manufactures valves, fittings, and other flow control equipment
engineered to perform in ultra-high pressure environments.
HiP tax election is expected to save Graco approximately $1.5 million per
year in cash taxes through 2029.
expected to provide approximately 13 to 15 cents of accretion to the
Company’s earnings per share in 2015.
36. Management and Governance
Management
Average of 15.6 years of experience with Graco
Executive Compensation increased 192% from 2009 to 2013
Board of Directors
8 out 9 members are independent
Average of 14.4 years of experience
Ability to hire external auditor without management’s approval
Established financial statement reporting procedure
38. Board of Directors
Officers Position Affiliate and Description
Chairman
Lee R. Mitau Retired Executive Vice
President and General
Counsel, U.S. Bancorp
Chairman of the Board of Director at Graco Inc. and HB Fuller
Company
Board Member
William Grant Van
Dyke
Retired Chairman,
Donaldson Company
Inc.
Member of the Board of Directors at Graco and Polaris Industries Inc.
Martha A. M.
Morfit
President/CEO at River
Rock Partners Inc. and
CEO at Airborne Health
Inc.
Member of the Board of Directors at Shock Doctor Inc., Lululemon
Athletica Inc., Life Time Fitness Inc., Intrawest Ulc., and Graco
Inc.
William J. Carrol CEO at Hybra-Drive
Systems LLC.
Member of the Board of Directors at Graco Inc.
J. Kevin Gilligan Chairman/CEO at
Capella Education
Company
Chairman of the Board of Directors at Capella Education Company
Member of the Board of Directors at United Subcontractors Inc.,
Capella University, and Graco Inc.
Jack W. Eugster Retired Chairman,
President/CEO at
Musicland Stores
Corporation
Chairman of the Board of Directors at Carleton College
Member of the Board of Directors at Trans-Alarm Inc., Life Time
Fitness Inc. Black Hills Coporation, and Graco Inc.
R. William Van Sant Senior Operating Partner
at Tenex Capital
Management
Chairman of the Board of Director at Quintec SA
Vice Chairman of the Board of Directors at HB Fuller
Member of the Board of Directors at Rush Corporation, Graco Inc.,
and Amcast Industrial Corporation
Patrick J. McHale President/CEO at Graco
Inc
Member of the Board of Directors at North Memorial Health Care
and Graco Inc.
Eric P. Etchart Senior Vice President of
Business Development
at Manitowoc Company
Inc.
Member of the Board of Directors at Graco Inc.
39. Forecasted Income Statement
Graco Inc Income Statement Forecast (GGG US) - Standardized
In Millions of USD except Per Share FY 2014E FY 2015E FY 2016E FY 2017E FY 2018E FY 2019E
12 Months Ending
Revenue 1,219.0 1,346.0 1,501.4 1,351.2 1,507.4 1,681.7
- Cost of Revenue 550.4 601.1 645.5 692.8 743.6 798.0
Gross Profit 668.6 744.9 855.9 658.4 763.8 883.7
+ Other Operating Revenue 0.0 0.0 0.0 0.0 0.0 0.0
- Operating Expenses 324.0 348.3 368.0 388.4 409.7 432.0
R&D Expenses 60.7 66.6 71.9 77.6 83.7 90.3
SG&A Expenses 263.4 281.7 296.1 310.8 326.0 341.6
Operating Income 344.6 396.6 487.9 270.1 354.1 451.7
- Interest Expense 17.5 17.5 17.5 17.5 17.5 17.5
- Foreign Exchange Losses (Gains) 0.0 0.0 0.0 0.0 0.0 0.0
- Net Non-Operating Losses (Gains) 0.0 0.0 0.0 0.0 0.0 0.0
Pretax Income 327.1 379.1 470.4 252.6 336.6 434.2
- Income Tax Expense 98.1 113.7 141.1 75.8 107.7 138.9
Income Before XO Items 229.0 265.3 329.3 176.8 228.9 295.2
- Extraordinary Loss Net of Tax 0.0 0.0 0.0 0.0 0.0 0.0
- Minority Interests 0.0 0.0 0.0 0.0 0.0 0.0
Net Income 229.0 265.3 329.3 176.8 228.9 295.2
- Total Cash Preferred Dividends 0.0 0.0 0.0 0.0 0.0 0.0
- Other Adjustments 0.0 0.0 0.0 0.0 0.0 0.0
Net Inc Avail to Common Shareholders 229.0 265.3 329.3 176.8 228.9 295.2
Basic EPS 3.75 4.35 5.40 2.90 3.75 4.84
Diluted EPS 3.72 4.31 5.35 2.87 3.72 4.80
