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Graco: Attractive Entry Point Amid Leverage To Construction

 December 03, 2012 02:49 PM

(By Mani) Graco Inc. (NYSE: GGG) provides meaningful leverage to a sustained housing recovery as it has 45-50 percent exposure to construction/consumer end-markets.

Minneapolis, Minnesota-based Graco is a leading supplier of systems and equipment for the management of fluids in industrial, commercial and vehicle lubrication applications. The company's recent Gema acquisition, which generates $125 million in total sales, has roughly two-thirds of its sales tied to construction/consumer

"While the Contractor segment (29% of '12E total revenue) is GGG's most visible tie to construction markets, its Industrial segment sells equipment that applies paint to appliances, furniture and other consumer products, Oppenheimer analyst Jim Giannakouros wrote in a note to clients.

[Related -Dividend Roundup: GGG, NX, PNY, TY, WERN, WIRE]

Meanwhile, an improving same-store sales in pro-paint and home-center channels, increasing repair/remodel work, and improving mix over time bodes well for Graco.

"We currently model potentially conservative 39% incremental margins in 2013 and 54% in 2014. We anticipate pricing benefits of 2-3% annually to persist, helped near term by pending NPIs across all segments," the analyst said.

Additionally, improved mix as contractors migrate to higher priced/margin products should prove supportive as housing markets recover. Notably, roughly 80 percent of the painting market is driven by repainting (repair, remodel, refresh) as opposed to new construction.

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Specifically, remodeling activity may spike in the coming months as insurance money flows to homeowners who sustained property damage due to Hurricane Sandy.

For the third quarter, Graco earned $37.1 million compared to $36.6 million last year while earnings per share remained flat with last year at 60 cents. Sales increased 13 percent to $256.47 million. Analysts polled by Thomson Reuters expected the company to earn $0.70 per share on revenue of $270.92 million for the third quarter.

Meanwhile, shares of Graco may be on deck for material out-performance in the coming quarters as its leverage to a construction rebound is exhibited. Moreover, its new products, penetrating new niche markets, and pricing should prove supportive to organic growth in the intermediate term.

"Beyond leverage to a construction rebound, we believe As GGG demonstrates $3.00+ earnings power along with continued solid FCF and ROE above 30% in '13/'14, we believe shares could support a multiple in the high-teens, suggesting equity value in the high-$50s at least," Giannakouros noted.

Shares of Graco currently trade at 17 times the consensus 2013 earnings estimate, a discount to its 20 times historical multiple, and not reflective of best-in-class returns profile nor leverage to a housing recovery.

"We believe this provides an attractive entry point to a best-in-class mid-cap industrial," Giannakouros added


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