University of Minnesota Duluth - CFA Institute€¦ · Company, Inc. Jack W. Eugster Retired...

University of Minnesota Duluth

CFA Research ChallengeMatt Murphy, Colt Wolfram, Mike Pochucha, Phil d’Entremont, Appo Agbamu

Investment Recommendation

$70One-Year Price

Target

-5%

$73.94February 10, 2015HOLD

RECOMMENDATION

Foreign Currency Effects

Domestic Acquisition Challenges

Lower Demand from the Mining Industry

Slowing Economic Growth in Key Foreign

Markets

Business Description

INDUSTRIAL

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

CONTRACTOR LUBRICATION

Industrial Segment

59%

% of Net Sales

Source: Company Filings

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

0

50

100

150

200

250

2009 2010 2011 2012 2013 3Q14

$ In

Millions

Operating Earnings

Contractor Segment

31%% of Net Sales

Source: Company Filings

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

0

10

20

30

40

50

60

70

80

2009 2010 2011 2012 2013 3Q14

$ In

Millions

Operating Earnings

Lubrication Segment

% of Net Sales

Source: Company Filings

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

-5

0

5

10

15

20

25

Operating Earnings

$ In

Millions

Corporate Governance

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Board of Directors

Audit Committee Compensation Committee Governance CommitteeManagement Organization

Source: FactSet

Ownership Summary

Institutional Free Float

Management

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Patrick J.

McHale

Chief Executive Officer

Joined Graco in 1989

James A.

Graner

Chief Financial Officer

Joined Graco in 1974

Retiring this year

Charles L.

Rescorla

VP of Corporate

Manufacturing, Distribution

Operations & Corporate

Development

Joined Graco in 2003

$-

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

$3,500,000

$4,000,000

$4,500,000

Patrick J.

McHale

James A.

Graner

Charles L.

Rescorla

Base Pay Bonus Option Award Value Other

Source: Company Filings

Industry Overview

0

20000

40000

60000

80000

100000

120000

50

100

150

200

250

300

350

400

450

GD

P p

er C

apit

a in

Do

llar

s

Pri

ce p

er S

har

e in

Do

llar

s

S&P-400 Diversified Industrial Machinery Index

VS. GDP per Capita

S&P-400 Diversified Industrial MachineryEU GDPEast Asia & Pacific GDPU.S. GDP

U.S. GDP

per Capita Asia Pacific GDP

per Capita

EU GDP

per Capita

0.94 0.81 0.86

Correlations

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Competitive Analysis

Porter’s Five Forces

Source: Bloomberg

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Market ShareINDUSTRIAL

LUBRICATION

Graco

25%

Competitors

75%

Graco

58%

CONTRACTOR

Competitors

42%

Graco

9%

Competitors

91%

Source: Company Filings

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Expansion into New Markets

23 person sales team

in South America

Blue Stars indicates

where staff are

located

New Market

Expansion

Source: Company Presentations

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Comparison Companies

Source: FactSet

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Investment Summary

Japanese GDP Expected to Decline 0.5%

for FY14 (ends in March)

Chinese GDP Expected to Grow at

7.4%, Which is the Slowest in 24 years

Eurozone PMI Rose in January to 52.6

from 51.4 in December

Slowing

Economic

Growth in Key

Foreign

Markets

Foreign

Currency

Effects

Domestic

Acquisition

Challenges

Lower Demand

From Mining

Industry

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

GDP Growth Year-to-Year

East Asia & Pacific European Union United States

Source: The World Bank

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Investment Summary

A Strong Dollar

Will Hurt Graco

Through:

As Central Banks Introduce

New Stimulus Plans We

Expect the Trend to Continue.

Slowing

Economic

Growth in Key

Foreign

Markets

Foreign

Currency

Effects

Domestic

Acquisition

Challenges

Lower Demand

From Mining

Industry

77

79

81

83

85

87

89

91

US Dollar Index Spot Price 1-Year

TranslationSlowing

Exports

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Investment Summary

2005 2008 2012

Slowing

Economic

Growth in Key

Foreign

Markets

Foreign

Currency

Effects

Domestic

Acquisition

Challenges

Lower Demand

From Mining

Industry

Gusmer GlasCraftITW/Liquid

Finishing

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Investment SummarySlowing

Economic

Growth in Key

Foreign

Markets

Foreign

Currency

Effects

Domestic

Acquisition

Challenges

Lower Demand

From Mining

Industry

200

250

300

350

400

450

Sep-10 Sep-11 Sep-12 Sep-13 Sep-14

Copper COMEX Spot Price

0

20

40

60

80

100

120

140

160

Sep-10 Sep-11 Sep-12 Sep-13 Sep-14

Newcastle Coal Spot Price

Source: Bloomberg

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Financial Analysis

$-

$50.00

$100.00

$150.00

$200.00

$250.00

$300.00

$350.00

$400.00

2013 2014 2015 2016 2017 2018 2019 2020

Mil

lions

Net Income Available to Common Shareholders

8.2% CAGR

Income Statement

Source: Company Filings, Team Estimates

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Financial Analysis

0.0%

5.0%

10.0%

15.0%

2013 2014 2015 2016 2017 2018 2019 2020

Return on Assets

Balance Sheet

Source: Company Filings, Team Estimates

Key Points

Strong Cash Flow

Short-Term Asset Buildups

Finishing Brand Holdings, Inc.

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Financial Analysis

Cash Flow Use

Share

Repurchases

Debt

Reduction

Growth

Through

Acquisitions

Dividend

Increases to

Shareholders

Statement of Cash

Flows

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Financial Analysis

Statement of Cash

Flows

$-

$20.00

$40.00

$60.00

$80.00

2013 2014 2015 2016 2017 2018 2019 2020

Mil

lions

Capital Expenditures

Source: Company Filings, Team Estimates

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Strong Cash FlowsMaturing Revenue

Streams

Primary Valuation

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

First Stage

Growth of 10.3%

Strength in America

Lag in Asia-Pacific and

EMEA

RevenueMargins

Gross Margin: 53%

Operating Margin: 25.9%

Net Margin: 18.5%

Net Margin: 17.5%

Source: Company Filings, Team Estimates

$70

Primary Valuation

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Second StageMargins

Gross Margin: 55%

Operating Margin: 27.9%

Net Margin: 17.5%

Net Margin: 19.5%

Growth of 9.8%

Normalized Growth in

Americas

Increased Growth in

EMEA and Asia-Pacific

Region

Revenue

Source: Company Filings, Team Estimates

$(0.25)

$0.25

$0.75

$1.25

$1.75

$2.25

2013 2014 2015 2016 2017 2018 2019 2020

In M

illi

ons

Revenue by Region

Americas EMEA Asia Pacific

Primary Valuation

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Perpetual Growth Rate Components

Global Economic Conditions

Organic Growth

Strong Cash Flow Generation

Currency Fluctuations

Required Rate of Return

Artificially Low Cost of

Debt

Artificially High Cost of

Equity

WACC Breakdown

Cost of Equity 7.4%Cost of Debt 1.9%

Risk Premium 1.7%

11%Total

Secondary Valuation

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

Monte Carlo Analysis

SimulationIntrinsic Value Sensitivity AnalysisLimited Upside

EV/EBITDA P/E Monte Carlo Analysis

10.7

$6.5 X

$70

21

$3.8 X

$80

1000 Observations

Over 252 Trading

Days

$81

Investment Risks

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

U.S.

Housing

Market

Rise in

Interest

Rates

End User

Conversion

Price

Sensitivity

Business

Description

Corporate

Governance

&

Management

Investment

Summary

ValuationFinancial

Analysis

Investment

RisksConclusion

Industry

Overview

&

Competition

$73.94February 10, 2015

-5% $70One-Year Price Target

HOLDRECOMMENDATION

Foreign Currency Effects

Domestic Acquisition Challenges

Lower Demand from the Mining Industry

Slowing Economic Growth in Key Foreign Markets

Conclusion

Valuation

Correlations Since 2009

Income Statement

Balance Sheet

Statement of Cash Flows

Pension Fund

Use of Cash

Business Segments

Ratio Analysis

Questions?Historical Valuation

DuPont Analysis

Corporate Governance

Management Team

Ownership Summary

M&A History

Geographic Breakdown

Channel Checks

Current Environment

Product Breakdown

Index Valuation

Index Leverage

Index Profitability

Index Cash Flow

S&P 500

Top Institutional Holdings

Top Institution Types

Perpetuity Growth Method- Sensitivity Analysis

Perpetuity Growth

2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5%

Discount 10.0% $ 66.41 $ 69.82 $ 73.75 $ 78.34 $ 83.46 $ 90.27 $ 98.22

Rate 10.5% $ 62.19 $ 65.10 $ 68.44 $ 72.28 $ 76.77 $ 82.07 $ 88.43

(WACC) 11.0% $ 58.47 $ 60.98 $ 63.83 $ 67.09 $ 70.85 $ 75.24 $ 80.42

11.5% $ 55.16 $ 57.35 $ 59.81 $ 62.60 $ 65.78 $ 69.46 $ 73.75

12.0% $ 52.21 $ 54.12 $ 56.26 $ 58.66 $ 61.39 $ 64.51 $ 68.10

12.5% $ 49.55 $ 51.24 $ 53.11 $ 55.20 $ 57.55 $ 60.21 $ 63.26

Valuation

Correlations Since 2009

U.S. GDP

per

Capita

Asia Pacific GDP

per Capita

EU GDP

per Capita

.99 0.98 .56

Industrial Machinery

Index Correlations

Source: The World Bank

U.S. GDP

per Capita

Asia Pacific

GDP per

Capita

EU GDP

per

Capita

0.90 0.98 0.72

Graco Correlations

Income Statement

Source: FactSet

Balance Sheet

Source: FactSet

Statement of Cash Flows

Source: FactSet

Pension Fund

Source: FactSet

Use of Cash

Source: FactSet

Business Segments

Source: FactSet

Ratio Analysis

Source: FactSet

Graco Valuation

Source: FactSet

DuPont Analysis Graco

Source: FactSet

Corporate GovernanceWilliam J. Carroll

Former CEO, Limo-Reid, Inc. d/b/a NRG Dynamix

Eric P. EtchartSenior Vice President, The Manitowoc

Company, Inc.

Jack W. EugsterRetired Chairman, President and CEO,

Musicland Stores Corporation

J. Kevin GilliganChairmance and CEO, Capella Education

Company

Patrick J. McHale President and CEO, Graco Inc.

Lee R. MitauRetired Executive Vice President and General

Counsel, U.S. Bancorp

Martha A. Morfitt President and CEO, River Rock Partners, Inc.

R. William Van SantSenior Operating Partner, Tenex Capital

Management, L.P.

Corporate Governance

Source: FactSet

Management TeamPatrick J. McHale President and CEO

David M. Ahlers VP, Human Resources and Corporate Communications

Caroline M. Chambers VP, Corporate Controller and Information Systems

Mark D. Eberlein VP and GM, Process Division

Karen Park Gallivan VP, General Counsel and Secretary

James A. Graner CFO

Dale D. Johnson VP and GM, Contractor Equipment Division

Jeffrey P. Johnson VP and GM, EMEA

David M. Lowe Executive VP, Industrial Products Division

Bernard J. Moreau VP and GM, South Central America

Charles L. RescorlaVP, Corp. Manufacturing, Distribution Operations and Corp.

Development

Christian E. Rothe VP and Treasurer

Peter J. O’Shea VP and GM, Asia Pacific

Mark W. Sheahan VP and GM

Brian J. Zumbolo VP and GM, Lubrication Equipment Division

Management Team

Ownership Summary

Source: FactSet

M&A History

Source: FactSet

Geographic Breakdown

Source: Company Presentation

Current Environment

Source: Company Presentation

Product Breakdown

Industrial

Products Applied Fluid Tech.

Petroleum

Management

Process Pump

Equipment

Finishing Equipment

Finishing Equipment Finishing Equipment

In-Plant Polyurethane

Equipment

High Performance

Coatings & FoamSealants & Adhesives

Composites

Contractor

Contractor Accesories

Field Marking Equipment

Fine Finish Equipment

Line Striping Eqiupment

Paint Spraying Equipment

Pressure Washing

Equipment

Roof Coating Equipment

Spray Guns

Texture Spray Equipment

Lubrication

Centralized Equipment

Controllers & Monitors

Centralized Equipment

Single Series Single

Point

Mobile On-road

Equipment

Compressor Lubrication

Industrial Lubrication

Mobile Off-Road

Equpment

Index Valuation

Source: Bloomberg

Index Leverage

Source: Bloomberg

Index Profitability

Source: Bloomberg

Average

Gross

Margin

Average

Operating

Margin

Average

Profit

Margin

31.05 9.83 6.51

Index Cash Flow

Source: Bloomberg

S&P 500

Source: FreeStockCharts

Top Institutional Holdings

Source: FactSet

Top Institution Types

Source: FactSet

Channel Checks

Source: FactSet