Snap-on：专业工具的生意 - [Business Breakdowns，第213期]

This is business breakdowns. Business breakdowns is a series of conversations with investors and operators diving deep into a single business. For each business, we explore its history, its business model, its competitive advantages, and what makes it tick. We believe every business has lessons and secrets that investors and operators can learn from and we are here to bring them to you. To find more episodes of breakdowns, check out join colossus.com. All opinions expressed by hosts and podcast guests are solely their own opinions. Hosts, podcast guests, their employers or affiliates may maintain positions in the securities discussed in this podcast. This podcast is forformational purposes only and should not be relied upon as a basis for investment decisions. This is Matt Russell and today we explore the world of tools to break down Snap-On. My guest is Matt Fleming, portfolio manager at William Blair. For all of the publicity that the other Snap gets, Snap-On has been around for over 100 years. Today, it operates with over a $17 billion market cap. And it has continuously evolved the straightforward model of selling tools to specialists like mechanics into this durable business model where it has carved out a leadership position in the professional tools market. Matt gets into what makes Snap-on different, the early days of tool innovation, the relationship focused sales team built around a franchise model, and a financing program that dates back to the very early days of Snap-on. If you've only lived in the world of DeWalt tools, you'll have some fun learning about the professional world through Snap-On. So, please enjoy this breakdown. Snap-on. All right, Matt. I am excited to break down Snap-on today. This has been a fun one for me to research myself and get into some of the history here of this business, one that I was not particularly familiar with.

I thought the best place to start is with the simplest overview. They operate in an interesting niche and an interesting segment of the economy, so maybe you could just kick us off there.

Of course. Well, Matt, I think they do probably the best job of describing their business. They self-describe as a designer and manufacturer of innovative and high-quality tools that “make work easier for serious professionals performing critical tasks where the cost of failure is high.”

They are a tool company, but it is very different from the tools that maybe you have in your garage or I use in my basement from time to time. These are professional-grade tools—very, very high quality. They have to be durable. The socket wrenches cannot snap, and the screwdrivers cannot bend.

Their technicians and users, which I will get into, are using these all day, every day for their livelihood. Things like comfort and ergonomics really matter. Then again, dependability matters. One of the great things about Snap-on is that they are constantly innovating and creating tools for their customers to do the job more quickly and efficiently. So, there is very high uptime and productivity improvement.

You mentioned it there: it is a little more targeted at the professional rather than me with my set of DeWalt tools or, pick your consumer brand. Do they have a particular market that they go after in terms of tool usage? Is there concentration in certain portions of that?

Yes, there certainly is. Again, these are professional technicians, and 77% of their customers are vehicle-service professionals. Think about automotive technicians and mechanics working at dealerships, but also, for the most part, at smaller collision-repair or auto-repair shops.

The other 23% of their customer base are also professionals, but usually in what they describe as critical industries. Think aviation, aerospace, military, government, natural resources, and trade schools. It is a pretty well-defined professional segment that they are targeting.

How do you think about the market that they operate in? We could look at it as the broader tool market, or separate it between consumer and professional. How do you frame it? Do you have any sense of the size of that market, just in terms of what it represents?

Take these numbers with a grain of salt because they are a little bit squishy. What I have come up with is probably the total tool market in the United States. I will reference the United States because that is about 75% of Snap-on’s tools in North America, and predominantly in the United States.

That market is about $6 billion, but again, that is going to include Stanley Black & Decker, DeWalt, the stuff that I may use, and big-box retailers. I estimate about half of that—about $3 billion—is probably the total addressable market for their customer base.

The way to think about that, though, is that there are 800,000 auto-repair technicians in the United States. That is their primary customer base. There is about 8% turnover annually in that industry, so about 68,000 professionals are coming into that business every year. It is pretty fluid.

Specifically, the way they measure market share—and I am sure we will talk more about this—is through a specialized distribution network that they call mobile tool distribution, probably more commonly known as the van market. They have about 60% share within the van market for mobile tools.

Within their 2 other segments, which are adjacent, think non-auto technicians—auto-repair equipment and critical industries—market shares are a little bit harder to frame out. Auto-repair equipment is very decentralized, and Snap-on has by far the leading share, but it is hard to put a number on that. The same is true within critical industries: it is a little more concentrated, but again, they have the majority of that share.

It is an interesting business model in terms of how they have evolved with the mobile-van dynamics, and there is a bit more that we will get into there. But let us just go all the way back to the start. It has a rich history. Can you bring us to the origin story and some type of timeline to where we are today? It is a long time, so any major points that you think are worth highlighting?

I think it is really fun because when you look at the business today, you can look back and really see the evolution of this company. There were no major pivots. There were just what I would say are evolutions and enhancements.

In 1920, there was an automotive engineer named Joseph Johnson who recognized the burgeoning automotive industry in the United States—the Model T, Ford, and all the other car companies that were coming out. He recognized that you could increase productivity through tools.

He essentially invented what we consider to be the modern-day socket wrench. He came up with a system with 5 different handles and 10 different sockets that you could interchange and interconnect. His mantra was that 5 does the work of 50. He created this multipurpose tool back in the day when you had single-use tools, so it was a much more effective model.

Fast-forward to 1930. The company he founded, which was then known as the Snap-on Wrench Company, merged with another high-quality tool company called Blue-Point. Those 2 companies merged and renamed the company Snap-on Tools.

In the 1930s, you had some interesting evolution because we were unfortunately in the Depression, and not a lot of tools were being bought. What Snap-on came up with was what they called “dream orders.” They would go to their customers and say, “Hey, I know you are not in a position to buy any tools right now, but what would be the magic wish list? If you were to get any tool you want, what would it look like?”

They would really listen to their customers describe what they needed in the tools. That became the precursor to what we now talk about as the voice of the customer.

The other thing that they pioneered during the 1930s was extended payments. They called them time payments. We will fast-forward to the model today, where technicians are able to buy tools off the van, finance them, and make regular payments. That really originated in the 1930s.

In the 1940s, post-World War II, we saw the development of direct distribution, which was the precursor to today’s mobile-tool-distribution or van model. In 1990, they converted that business to a franchise model, which it is today and is a very important part of the story.

In the 2000s, like a lot of other companies, Snap-on really embraced continuous improvement and developed what they call the RCI, or Rapid Continuous Improvement system, based on the Toyota Production System. Certainly, there are other very well-known brands and systems: the Danaher Business System, 80/20, Kaizen, Lean, and so forth. Snap-on’s is called RCI.

The last really important milestone, I would say, is Nick Pinchuk, who is the president, CEO, and chairman today. He became president and CEO in 2007 and has been really integral to their implementation of this business system. When we talk about the margins and the sales growth, he has really been a key part of that.

Such a rich history, and a lot that I want to get into there. I think the idea of the wish list, particularly at a time when the economy was stressed, is something where you could easily just look internally at your business and think about ways that you can improve it, but to go externally is powerful.

On your point about the financing model and giving technicians the ability to do this, which is a unique way of providing credit and almost creating a new business line, it is interesting to me to hear that. When I think of tools, again, I am coming from the consumer perspective, so I am thinking of things that might not be super expensive.

When you think about the cost and the average sale, are they higher than I am imagining? What drives that financing need, which is not immediately obvious to me?

I think you have hit the nail on the head. Typically, their products are 20% to 30% higher than their competitors, which I think speaks to their brand loyalty and the quality, and so forth.

What's really interesting—and when I first got into Snap-on, this was really the hook for me—is a couple of dynamics I think we should explore. The first is that, in the United States, it's a very different model in that the technicians have to supply their own tools.

If I go to work at an auto repair shop, I'm essentially using the bay and whatever car comes in. If it's my turn, I can go work on that car and get paid for it. But because there's such a high turnover in the industry, the tools are basically required to be owned by the individual. And so, there's not a lot of working capital for the shop. Therefore, what ends up happening is that the tools you have as a technician really enable you to do more work.

What's amazing to me, Matt, is that not only does, say, a BMW require different tools than a Toyota, but even within the same brand, different makes and models all require different tools. So what you end up having is a vast collection of tools that you need as a technician.

Some of the work I did suggests that an entry-level technician—if you or I were to get started in this business—would probably need 25 to 50 tools, and that might be $11,000 collectively. If you're an experienced technician and you've been doing this for maybe 15 or 20 years, you might have $40,000 worth of tools.

For the most part, the financing does tend to be for higher-ticket items, such as tool storage. That might be a $10,000, really sophisticated rolling toolbox. Increasingly, power tools are more expensive. Then there are diagnostic tools, which are essentially laptops that you can plug into the car and get a whole diagnostic setup. Those are pretty high-ticket items. For the most part, you tend to finance those, but over time, there's quite a collection of tools that the technician will finance.

I'm sure there's some combination of both, but quality seems like a big piece of this. Is that what they really lean on relative to the competition? What is their brand value when you think of quality, convenience, and even the status that it might signal as a brand?

Their competitors, specifically Matco, have adopted a van model as well. So I think where Snap-on really differentiates itself is just in a tight geography: the vans are stopping by at least weekly, if not more, for the technicians.

Technicians really prefer to buy from the van for a couple of reasons. One is that it's pretty convenient; they don't have to leave their place of work to get a tool. The second is that the vans are really doing value-added selling.

You might be the van operator and I'm the technician, and I'd say, "Matt, I've got this issue that I really need to solve." And you might say, "Oh, well, you should really be using this tool and not that tool." And you happen to have it in stock. So I think it's really the differentiation of the value-added sale.

It's the SKUs. Snap-on has 40,000 SKUs just in the tool segment, and 65,000 SKUs companywide. But again, just for that automotive technician, there are 40,000 different SKUs. They're constantly innovating.

One number I came up with—it's a little hard to pin down—but CEO Nick Pinchuk referenced their Snap-on franchise conference, which is their big annual event. Last year, they showcased 4,500 new tools to the van technicians and operators so they could really understand them.

I would say to your listeners and to you that one real highlight of Snap-on is listening to its quarterly calls, when Nick Pinchuk picks a tool to describe and is quite passionate about it. So I picked 2.

An example they talked about is this new special hex driver with an extra-long 5¾-inch shaft that allows technicians on newer cars to adjust the radar sensors without having to take the bumpers and the grilles off. Historically, they'd have to take these parts off. Now they've got this extra-long piece that goes in there.

Their new handheld is called the Apollo diagnostic system. It uses their software system called Mitchell 1. There are over 3 billion repair records and 500 billion data points in this system. It's just unmatched.

One of the new things they were talking about, which I think is really cool, is that you can actually set your tool crib up so that if you take a tool out and, at the end of the day, you don't put it back in and shut it, it will let you know that you're missing a tool.

They're taking that technology and applying it to folks who work on aircraft engines, just making sure that all the wrenches you brought out came home with you. And they're thinking about adding those types of innovations to things like medical as well.

It's painting a very nice picture. The next time the mechanic tells me it's going to be $2,000 because they have to take apart the steering wheel, I'll make sure that they check with Snap-on first.

I think that's a great idea.

Yeah. On the van model, for me, it's easy to look at this and say, "Ah, it feels like it might be outdated with everything happening online these days." Can you walk through what that looks like? They have a weekly meeting. You mentioned that they're trying to buy things off the van. I can't imagine they're carrying 40,000 SKUs.

So what does that look like in terms of whether there are conversations about what they might need and then they're bringing them the next week, or a little bit more that gets into the sales process? I know it's going to look different each time.

Setting the stage: There are 4,700 vans worldwide. The majority of those, about 3,400, are in the United States. 5% of those are company-owned. The rest are this franchise model.

When you get into a franchise as a franchisee, there's going to be an initial outlay of capital, and then you do have franchise costs. That's probably, I think, around $20 million a year in total for Snap-on that they get from these franchises.

And then there's a capital commitment that the van has to buy somewhere around $140,000 of inventory. So, to your point, they really want to make sure that their customers are being supplied with the inventory. They don't want a van to be under-inventoried.

A franchise van probably has up to $200,000 in inventory. So they're going to carry, obviously, not 40,000 SKUs, but they're probably going to carry the 80/20—the 80% that are the fastest-turning products. Certainly, if there's a product they don't have, they can order it and bring it back.

The beauty of the franchise model, as I said, is not only the value-added sale, but it also works very well when they sell on credit because there's a natural governor: every week, you're coming and collecting. If I'm not paying you back and I say, "Well, hey, Matt, I need a new tool," you might say, "Well, you get paid for the first tool before that." So I think there's a natural balance on both sides of that.

Certainly makes a lot of sense, the enforcement of that credit. I want to tap into that evolution from van into franchise and the franchise model. There are obvious benefits when it comes to capital intensity and what you can do, but can you tap a little bit more into that? Was it unique when they did it, and what would you say are the major benefits of operating this way versus the traditional in-house sales force?

First of all, I think you can control your margins, and so they will sell at a certain price to the franchisee. They have probably what I call MSRP, or list pricing, that they set out, but ultimately, it's up to you as a franchisee to price appropriately. Therefore, there's very little discounting that they're doing, as opposed to, say, Stanley Black & Decker, who has to partner with a big-box retailer with a lot of pricing power. They're going to share in that margin.

The vans do a pretty good job, and they typically earn about a 30 to 35% gross margin, but they are bearing the risk. They are also absorbing the capital cost as well and, frankly, the operating cost as well. So they're driving a van around pretty regularly.

The risk to that, of course, is Snap-on's got to really make sure that their customers are getting serviced and make sure the brand is intact. It was sort of a natural evolution: once they had that geography and footprint in place, to really outsource the model to a more capital-light model.

Do you see pockets of pressure on that system? Because, as you mentioned, you're putting a lot of the business decisions in their hands. It removes some of the risk from you, but ultimately, you're dependent on them to remain in business and thoughtfully efficient. How much volatility have you seen with that over time?

I don't have a great number in terms of turnover, but it's pretty low. I wouldn't go so far as to say that the Snap-on franchise is like a Budweiser dealer or Caterpillar dealer or anything, but it's a pretty loyal group.

They bring all these franchisees out to this franchise conference every year, and it's a 10-day event. People really love it, and they look forward to it. The initial capital costs are not insignificant, so I think what you get is folks who are pretty committed to being in the business and then figure out pretty quickly that they like it.

One thing I didn't mention is that the company also has a number of other trucks that they use as well, and they will supplement the vans. These are pretty funny. They've got the Rock & Roll Cab and the Techno, which is T-E-C-H-N-O.

These are specialized vans that they will bring around and really help the franchises sell the product and market it, but, for example, they don't have to carry 100 units of $10,000 tool cribs. I think Snap-on's done a very good job partnering with the franchises and making sure they know that they're supported.

One of the other things I wanted to tap into was the idea of advice. This is something that I'm always surprised by, but I need to adjust my thinking around it: how these reps can really instruct and help out the actual people performing the jobs. Would you say that that is a big piece of what they're doing?

How would you measure the value in just the knowledge and the ability to suggest a different tool that's going to make whatever operation a little bit easier on a BMW?

Candidly, the van operators are not necessarily automotive technicians themselves.

They’re probably not going to suggest a new way of auto repair. Where I think they’re value-added, though, is really understanding from the company what the new product line is. And this is, again, really refreshing: 4,500 new tools a year. The company itself does a great job of really going to visit customers, watching technicians take cars apart, taking notes, and saying, “Wow, we could come up with this new product.” So, again, I think the new tools are really being designed in partnership with the customer, but it’s the van operator who is just really distributing and promoting. That’s probably a better way to think about it.

That makes sense. On the idea of the advantage that they have built over time, it’s a historic business. There have been a ton of tool businesses around. Maybe this gets into what you were mentioning with KCI, but what can you point to that has allowed them to differentiate from competitors, but also just maintain that advantage over time? If you were to isolate or think about different variables, what really stands out there?

First of all, they have a lifetime warranty. I can’t speak to Matco’s warranty or some of its competitors, but that’s a pretty big differentiation because, getting back to this capital cost, if you’re going to pay a 20% to 30% premium, you want it to be durable, and then if it breaks, you want to obviously have it taken back. I think that’s a key piece of their brand.

It really probably goes back to the innovation and breadth of product. They’re really controlling how far and wide they can go. For example, Matco supplies Milwaukee-brand power tools on their van, but it’s a third party. Snap-on really takes pride in the fact that they control 85% to 90%, meaning soup-to-nuts manufacturing, design, and distribution of their products. They really feel good that they’re continually giving folks what they want.

There are upgrade cycles, which they’re currently working on. Tools are probably farther and fewer between in terms of replacement, but you’re probably going to replace your diagnostic equipment every 3 to 5 years, and you might replace your tool storage every 5 to 7 years. I think there’s a pretty loyal customer base. I don’t want to suggest it’s Ford versus GM, but I think folks who really know the product have a strong brand loyalty there.

If we start to consolidate everything we’ve mentioned into the financial model a bit here, when you think about top-line growth and the drivers, you have the new SKUs. It’s unique because of the franchise model, but can you break down how you approach top-line growth? How does the business frame it as well?

They talk about 4% to 6% organic top-line growth, and that’s company-wide. Obviously, that goes in waves. If I break down those components, it’s going to be the new entrants to the technician market—68,000 a year. It’s going to be the existing base that is growing with, again, those new tools that they’re buying. There does tend to be some cyclicality, and I don’t know if that’s the right term. It’s probably better described as a product refresh.

A couple of years ago, they really revamped their tool-storage line. That was a pretty big driver as well, so you do get those spikes. The business tends to track overall economic growth, but I would say there’s certainly a component of consumer confidence slash small-business optimism. When the technicians are concerned about the economy, they might pull back on their purchases, just as a consumer might. There does tend to be a little bit of that as well, but it’s certainly not the boom-bust of other industrial companies.

Coming into this, my impression was maybe that there was a little bit more of the natural replacement cycle that was keeping a floor on revenue, which may be the case, but I’m getting the sense that a lot of the revenue base—revenue growth—is driven by either net-new mechanics coming into the industry or net-new SKUs being introduced to the market. Is that the case, where it is a lot of new business rather than the recurring maintenance state?

I think that makes a lot of sense. If we break it down another way, Matt, tools are about 54%, diagnostic equipment and management systems 22%, and equipment 24%.

Equipment is going to be big-ticket items such as a car lift or a wheel aligner. That’s going to be purchased not by the technician, but by the auto shop itself. For sure, there’s a replacement cycle there. There is some innovation. They were just talking about a new wheel aligner that’s modular, so you can move it around your shop if you don’t have the dedicated space. There’s certainly innovation there, but for the most part, I think you’ve got some more replacement cycles that go with that.

Diagnostics and management systems, I would say, fall more into the new-growth category. If you think about the complexity of new cars, a 2025 Tesla is really different from your 2012 Honda Civic or what have you. It’s much more computerized. You have to be really plugging in. I think in that segment, those are higher-ticket prices, going to be a little more cyclical, but you’re having technological innovation for sure. That big piece, 54%, I think you really got that right, where there is going to be some replacement, but the majority of that’s probably going to be new SKUs and new entrants to the market.

On that point, just in terms of the evolution of cars and what they have become, where they’re increasingly computer-like, you often hear anecdotes from mechanics about how challenging it is to work on a car. It feels like there’s not a lot of standardization from one car to the next. How much of a reality is that, and how does it impact the business? Is it just a matter of evolving to create tools that support that new look and feel of a vehicle, or is there anything else to it?

On the margin, you’ve actually seen dealerships gain share from the independent repair shops. That’s because they have access to this sophisticated equipment. Therefore, folks like Snap-on are going to design and create tools for small independent shops to compete effectively.

My sense is that, in the old days, you might have had a big computer in your office and you had to do your work there. Now, obviously, we’ve all got mobile and handhelds and iPads. I think increasingly that’s the way technology is going to go, in addition to just being able to plug your machine into the car and have the machine tell you what’s going on with it.

If you just think about the number of manuals you have to have for a car that’s been in production for 30 years, you don’t want to have your bookshelf filled with those manuals. You want to have it all on your laptop and flip it up really quickly. It’s as much data as it is interaction with the machines.

What’s really interesting is that Snap-on, I think, is developing a pretty interesting subscription business. Every year, as a technician, you might just download all your manuals for 100 different cars or what have you, and then somebody brings in something you don’t have. You might actually purchase that and be able to work on it.

Yeah, it’s an interesting way to add a new revenue line. It makes a lot of sense in a value-added way. On that point, just in terms of the independent repair shops versus car-associated dealerships and their maintenance services, does Snap-on have any relationships with the auto OEMs, the car dealers? Do they sell into that market at all?

Yes, they do. You can kind of cut this business a number of different ways, but the way they actually break down their segments is into 3. They call it Snap-on Tools, which is about 39% of the business. That’s primarily focused on the automotive technician that we talked about, primarily the independent channel.

Then they have C&I, which is Commercial & Industrial. That’s the Commercial & Industrial segment we talked about. That’s going to be about 23%. The remainder, 30%, is what they call Repair Systems & Information. About a third of that is going to be tools that they sell to technicians at the OEM dealers. Another third is going to be undercar equipment—think the big, heavy-capex lifting systems—and a third is probably going to be the information systems that we talked about.

Thank you. I think I’ve asked you to break down the revenue base every possible way, and you come away armed with the numbers. The last point, just on the top line and revenue: you mentioned cyclicality, for lack of a better term, but there’s exposure to the general economy. How has the business performed when we have seen recessionary periods? Whether you take the financial crisis—I know that was a very unique time—something like the industrial recession, which I’m not sure would have had an impact in that 2015–2016 timeframe, are there any historical precedents that you can point to that really project what type of sensitivity they would have to downturns?

The first quarter of 2009, which I’d say is probably the worst period in recent economic history, ex-COVID, which we can talk about, organic sales were down 11% in the Snap-on Tools business. It recovered pretty quickly to finish the year down 3%, and then ramped pretty quickly thereafter. The following year was plus 5%, plus 8%, plus 10%, plus 13%—really, for the 3 years afterward, 2010 through 2013, high-single-digit organic growth.

There was a similar pattern in 2020, where you had Q2, when the whole world was shut down, down 20%. Sales were down 8% in the first quarter and down 20% in Q2 2020, but then there were 17% and 20% rebounds, followed by 27% and 50% organic sales growth in Q1 and Q2 of 2021.

The reason I mention that is what the data would say is that you certainly can have drawdowns in organic growth, but it tends to get made up in the recovery period. That could be pent-up demand, that could be delayed replacement, that could, again, be new entrants, and some combination of all the above. It’s a trend line that moves upwards with some shocks when you have macroeconomic periods.

I think that’s right. If we transition down into the margin line, and you mentioned they’re able to control the margin now with this franchise model...

Can you talk a bit about what that has looked like historically and where they tend to operate from a margin perspective?

I think if we frame out the 3 segments, the margins in RS&I are going to be the highest. That's a higher price point, higher technical sale, and RS&I is the Repair Systems & Information segment. In 2010, those were a little over 19%—they were 19.4% margins. Fast-forward 14 years, to the end of 2024, and they increased those by about 600 basis points to 25.3%.

They think those margins can certainly go up, but I think they're mindful that they're pretty high already. C&I, which is the Commercial & Industrial segment, showed a pretty nice improvement as well: 11% in 2010, up 600 basis points in 2024. That's going to continue to go up, but they do sell about 50% of that segment, primarily in Europe, through distribution. So they are going to track lower margins than their tools counterpart.

But here's the real shining star. In 2010, the tools segment had a margin of 10%. At the end of last year, they finished at almost 23%. That's 1,200 basis points in 14 years, which averages out to about 85% of annual improvement. Some of that is, for sure, mix. Some of that's new product and pricing, but that really gets back to the rapid continuous improvement, really under the stewardship of Nick Pinchuk.

And this one keeps surprising me. I've owned this company for a long time, and every once in a while I get hesitant and say, “Well, I just don't know that margins can continue to go.” I was looking at my notes, and I think I said that when they were at 15%, at 18%, and at 20%, so I'm trying to be open-minded about whether they could continue to improve. You see plenty of revenue growth stories that explain stocks. It's always interesting to find these efficiencies where you're getting some topline, but the margin improvement is quite incredible across the board, across all 3 divisions.

Just in terms of pressures upward or downward on those margins, are there major things that you see as tailwinds or headwinds that you point to?

Well, you can have some mix again in that tool business. So, you're going to have a reference when they went through this tool-storage business—a high-ticket item. The diagnostics tend to be high-margin, so you do have that replacement cycle that can roll through. Those can be challenges.

They do buy a lot of steel. It's unclear what the impact of tariffs will be, but general commodity costs can certainly be a headwind for them. They obviously forge and manufacture a lot out of metals.

When you take the margins and move them down through the income statement into the cash flow statement, what does that look like in terms of free cash flow conversion and the general free cash flow profile of the business?

Free cash flow could be a little bit more lumpy. And the reason it's lumpy, Matt, is that we do have, as we talked about, this financial services business. So what happens is, when you're investing in finance receivables, that can drain some of your cash flow. So you do have lumpiness over time.

In good years, cash flow can certainly exceed earnings. Then, probably on average, it may bottom out somewhere like 60% of net income. It can vary in between, but there's certainly a lot of cash flow at the operating company and no net debt at the operating company. They have a nice dividend, and they do some small tuck-in acquisitions. I think the biggest one they've done is maybe $200 billion over the last 10 years or so. So they're good allocators of capital.

How does the risk sit in terms of the system? If a sale is made, it's financed. Is that risk sitting at the parent level? Is it at the franchisee level? I know there's a lot of intermingling there, but what are the mechanics there?

About 30% of the tools that are sold off the van are financed by Snap-on Credit. I don't know that the technicians are financing this with outside credit. So, again, 30% roll through, and then if they do that, that 30% becomes a finance receivable for Snap-on Credit. So that goes up to the parent company. The risk is held with them.

The good news is the bad debt is a little under 3%, and delinquencies are between 1.7% and 2%. I was looking at banks and other credit companies; that's probably just a touch higher, but not meaningfully worse. And then if you look at what I'd probably call subprime lenders, this is much better than that.

So I think that really gets back to that frequent collection, that weekly collection that they do. It really keeps bad debt down. And then they're earning an average yield of almost 88% on these receivables. So it's certainly expensive, and that also behooves their borrowers to pay it back pretty quickly.

They also issue receivables to the franchisees. That initial $100,000 to $150,000 of capital is going to sit with the parent, but is obviously securitized by the van and the inventory.

Have they ever faced issues with the underwriting in the financing arm, just in terms of pockets of weakness and seeing some stress on that portfolio? Has that ever arisen over the history? And it's a long history of financing.

To my knowledge, not at all. So if we go back in time to 2009, we bought the stock when they unwound their partnership with CIT. In 1999, they had set up this partnership with CIT, which went through various iterations, and in 2009 they brought these receivables onto the balance sheet.

There was a lot of hand-wringing: this company makes tools—what do they know about finance? And it's just been smooth sailing ever since, for the most part. I can't think of a period where they've had any stress or issues with the credit, so it's been a pretty nice track record.

Every once in a while, you get what I call the doubters really talking about how they're juicing the market. That can be the bear case: they're pushing credit to basically get technicians to buy tools they don't need. It's very much the other way around. The receivables go up when sales of tools go up.

They will lead with some promotions, but again, at 18%, it's certainly not what I call incentive financing for the customer.

On the capital-allocation side, you mentioned there can be lumpiness in free cash flow. What is their general strategy in terms of allocating capital? It feels like, because again of the franchise model, there are unique dynamics here. What does that look like?

They're buying back some stock. They've got a dividend. They are looking for opportunistic acquisitions. They're actually redeploying their capital in this finance company, which has been a pretty good use of their equity when they're getting those returns.

They're spending probably 2% a year on R&D, so they are very efficient with their capital. They don't have a ton of capital expenditures. Probably the biggest source of redeployment is putting it back into that finance company.

And on the M&A front, I know way back when it was a tool manufacturer. Is that still what it looks like? Is there anything else that falls into the potential crosshairs?

No, this would primarily be tools. And so they bought a brand fairly recently that gets them into the specialty torque business, which is a niche for them. I would say the others are pretty similar.

That was called Mounts. That was a $40 million acquisition. AutoCrib was another tool-storage business, about $36 million. So what I would say is it's just going to be getting into smaller adjacencies where they can acquire a brand that's going to be attractive for them.

Thinking about potential headwinds, again, I know we've bounced around and addressed a ton. If you just think about the overall auto market, whether it's a reduction in the number of vehicles owned per household, whether or not that's actually playing out, but it's a commonly discussed theme, are there themes like that that you can point to as potential headwinds or structural market dynamics that you see or worry about?

Well, I wouldn't say it's the auto headwinds themselves that I worry about. My personal view is you are going to see a lower number of OEM-manufactured cars. And the reason you're going to see that, Matt, in my opinion, is the auto OEMs really want to manufacture higher-price-point cars.

So, 15 years ago, there might have been an entry-level, call it, $20,000 automobile. Those are really hard to find right now. And obviously the OEMs want to manufacture plus,000 SUVs. On the margin, I think you're going to have fewer new builds, but the positive is that you are going to have a very robust used market and you're going to see people hang on to their cars a lot longer.

Right now, the average age of the car parc or fleet is over 12 years. That used to be in the single digits, call it, 10 years ago. So people are certainly keeping their cars a lot longer. And then over time, that's going to mean increased repairs. In the old days, if you bought a car every 3 or 4 years, or if you leased and you turned it in, you might not want to repair as frequently. Now you are going to do that, so I think that's actually a structural tailwind for Snap-on.

I think where you could see some challenges, though, is ultimately this is a people business. And if you look at the number of new entrants over time, it's unclear to me how many people are getting into the auto-repair market. You certainly look at other industrial markets, like long-haul trucking, for example, and it's just very hard to find people to enter that industry.

So over time, if younger folks don't want to get into automotive repair as a career, that might just put pressure on the number of participants in it.

It's something I was thinking about as well, because when I covered the trucking sector, those 2 roles were frequently mentioned as massive shortages that were perpetual. It was auto-repair mechanics and then long-haul truckers.

In trucking, there's an obvious impact that that can have when you see capacity come out of the system, but you see it recover quite quickly. In auto repair, it's a little less clear to me what that impact looks like—whether it just drives the price of auto repair higher. What do you think it actually means if you do see a shortage of labor in that market that persists?

I think in the short term that's going to give pricing power to the mechanics who are really saying, “All right, I've only got a certain number of hours in the day.

Hey, if I’m going to work on your car, you’re going to have to pay for it.

The other thing I would just throw into that discussion, Matt, is I don’t know what immigration trends look like and how that impacts the number of participants as well. I think you could see fewer people getting into the business, fewer technicians, higher pricing, probably longer wait times. Maybe on the margin, that discourages you from getting your car repaired if you say, “I can’t wait 3 weeks, and I don’t want to spend this money.” But I think this all takes place over a longer period of time.

When you put it all together, thinking about the framework that you would use here for this type of business, valuation-wise, what type of approach do you take, and how does that differ, if at all, from how the market views the stock?

One of the hallmarks of our process on the William Blair Value team is that we’re big believers in historical valuation. We think that looking at comps is great, but as we like to say, if there’s a cheap company in a universe, you might find that that’s like buying the cheapest house in an overpriced neighborhood. So, it doesn’t tell you what the universe does.

The other thing is that I think you can get false positives and false negatives. Said another way, there are some companies that, frankly, trade in their own valuation orbits. So, it’s really important to understand where you are relative to that.

Fortunately, Snap-on has been around a while. It has a pretty seasoned trading history. And this is pretty unusual, but what we do is we go back and look at the historical valuation metrics averaged over 5-year, 10-year, and 20-year periods. And for Snap-on, they’re very similar, actually, in all 3 periods.

So, if you look at the P/E on a 5-, 10-, and 20-year basis, it’s traded between 13 and 17 times. And so, if you look at next year’s estimates, that would imply a range of something like $270 to $360 for Snap-on. Same thing for EV/EBITDA: 8.5 to 12 times gets you to something like $260 to $364. Personally, I like P/E a little bit better with this company because of the finance company, but I think they actually shake out pretty similarly.

But what I would tell you is, when you do look at the comps, I would say the stock does look undervalued.

Comps are tricky. So, I think what I looked at was Interpac Tool, which is a manufacturer of high-precision hydraulic tools. That stock trades at a P/E of 23 and 15 times EV/EBITDA. But ESAB and Lincoln Electric are both welding companies with a very high consumables business, but sort of industrially tool-y. Those companies trade at very similar valuations: over 20 times P/E and 15 times EV/EBITDA. I do think there is the potential for Snap-on to rerate.

If I were asking you to make an assumption about those other names and why they would trade where they do versus Snap-on, is it the finance business? Is it the growth characteristics of those businesses? Is there something that would be the easy explanation of the valuation gap between them?

If I had to guess, it’s probably the consumable element when I look at those welding companies. I think the finance business is misunderstood for Snap-on. So, I do think that plays a role.

For a very significant company in terms of brand and recognition—for an $18 billion market cap company—there’s surprisingly little sell-side coverage. There are 9 analysts who cover this name. That’s actually as high as it’s ever been. It is a little unusual for a company of its size and stature.

Absolutely. I think it’s not a household name, which is quite interesting. And when I saw the market cap, I was quite surprised. A lot of people know the other Snap that trades in the market, and the 2 couldn’t be more different. There’s not a lot of overlap, I think, in that investor base.

No, I would agree. Well, this has been a fascinating discussion. I have learned so much. Thank you for explaining it in so many different ways. We close these out with the lessons that you can take away from a business and potentially apply elsewhere. What stands out for Snap-on?

Well, I think there’s 5. And so, 1 is that I think it’s a great lesson to identify end markets where there’s a natural demand. In this case, we’re talking about that automotive turnover. We’re talking about the value of the tool to the technician and secular tailwinds.

Number 2, I would say, innovate differentiated products that can command brand loyalty and a price premium. So, we talked a lot about innovation and their loyal customer base.

3, have that value-added, unique distribution. I think you can really see the impact that’s had on the tools margin and really the value to the consumer.

4th, I think continuous improvement speaks for itself and the margin improvement in the tools business. And then, finally, leadership matters. It really starts at the top, and Nick Pinchuk, I think, is an iconic CEO. There are some obviously well-known other CEOs out there, and I think Nick’s name is not always mentioned with them, but it probably should be. I would say those are my 5 lessons.

Excellent. An excellent way to close it out. Thank you very much, Matt, for sharing the knowledge. To find more episodes of breakdowns ranging from Costco to Visa to Madna, or to sign up for our weekly summary, check out join colossus.com. That's jolsus.com.