Generac Holdings Fundamental Analysis

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Generac Holdings

Generac Holdings

Last Updated: 30 Oct 2022

NYSE: GNRC

GICS Sector: Industrials

Sub-Industry: Specialty Industrial Machinery

https://www.generac.com/

Management

CEO: Aaron Jagdfeld

Tenure: 15.9 years

Generac Holdings Inc.'s management team has an average tenure of 4.8 years. It is considered experienced.

Source of Revenue

Generac is an energy technology solutions company that provides backup and prime power generation systems for residential and commercial & industrial (C&I) applications, solar + battery storage solutions, energy management devices and controls, advanced power grid software platforms & services, and engine- & battery-powered tools and equipment.

The company design, manufacture, and distribute a broad range of energy technology products and solutions. Generac classifies the products into three categories based on a similar range of power output targeted for varying end customer uses: Residential products, Commercial & Industrial (C&I) products and Other products & services.

Residential products

Generac residential automatic standby generators range in output from 7.5kW to 150kW, which predominantly operate on natural gas and liquid propane, and are permanently installed with an automatic transfer switch, which Generac also manufacture. Air-cooled engine residential standby generators range in outputs from 7.5kW to 26kW and serve as an emergency backup for small to medium-sized homes. Liquid-cooled engine generators serve as an emergency backup for larger homes and small businesses and range in output from 22kW to 150kW.

All of them are offered as Smart Grid Ready, which enables customers to connect and enrol their generator as a distributed energy resource in grid services applications.

The deployment of the residential generators in grid services applications where available can improve grid resiliency, while also offering a direct financial incentive for homeowners to participate in these grid services programs, which can help to partially offset the purchase cost of the generator over the product's lifespan.

In 2021, Generac acquired ecobee, a leader in sustainable smart home solutions such as smart thermostats and a suite of home monitoring products.

The company also entered the smart water heater controller market in 2021 via the acquisition of Apricity Code.

Generac also provides a broad product line of portable and inverter generators that range in size from 800W to 17.5kW. These products serve as an emergency home backup source of electricity and are also used for construction and recreational purposes.

In addition, the company provides a broad product line of outdoor power equipment referred to as chore products, which are used in property maintenance applications for larger-acreage residences, commercial properties, municipalities, and farms. These products include trimmers, field and brush mowers, log splitters, stump grinders, chipper shredders, lawn and leaf vacuums, pressure washers and water pumps.

Commercial & Industrial (C&I) products

Generac offers a full line of C&I generators, with power outputs ranging from 10kW up to 3,250kW, that are increasingly being fuelled by cleaner sources of energy.

Generac also offers a full line of industrial transfer switches to meet varying needs from light industrial applications up to the most demanding critical installations.

The company also provide a broad product line of light towers, mobile generators, and mobile energy storage systems, which provide temporary lighting and power for various end markets, such as road and commercial construction, energy, mining, military, and special events.

Other products & services

This category primarily consists of aftermarket service parts and product accessories sold to Generac customers, installation and maintenance services, extended warranty programs, grid services revenue from utilities, remote monitoring subscription revenues, and other service offerings.

Included in this category are revenues from the Generac Grid Services team, which was formed in September 2021 and builds upon the 2020 Enbala acquisition.

The formation of Generac Grid Services accelerates the efforts in the market for grid services by creating a focused team that collaborates across the enterprise to sell turn-key hardware and software solutions used by utilities and energy retailers.

Generac has two reportable segments for financial reporting purposes – Domestic and International.

The Domestic segment includes the legacy Generac business (excluding its traditional Latin American export operations), and the acquisitions that are based in the U.S. and Canada, all of which have revenues substantially derived from the U.S. and Canada.

The International segment includes the legacy Generac business' Latin American export operations, and the Ottomotores, Tower Light, Pramac, Motortech, Selmec, Deep Sea, and Off Grid Energy acquisitions, all of which have revenues substantially derived from outside the U.S and Canada.

Generac distributes its products through a variety of different distribution channels. This omnichannel distribution network includes independent residential dealers, industrial distributors and dealers, national and regional retailers, e-commerce partners, electrical/HVAC/solar wholesalers (including certain private label arrangements), solar installers, catalogues, equipment rental companies, and equipment distributors.

Generac also sells direct to certain national and regional account customers, which include utilities, telecommunications providers and original equipment manufacturers, as well as to individual consumers or businesses who are the end users of the products.

The company offers a broad set of tools, programs, factory support, and sales leads to help distribution partners be successful. No single customer provided more than 6% of the total revenue in 2021.

Generac Holdings Reportable Segment Revenue

Generac Holdings Product Category Revenue

Generac Holdings Economic Moat

Generac Holdings Economic Moat

Economic Moat: Narrow

There are many ways to identify Generac Holdings’s economic moat, but I focus on the above 5 types. The rating is purely subjective and based on my in-depth understanding and analysis of Generac Holdings. Please check my summary to understand more about the economic moat.

Performance Checklist

Is Generac Holdings’s revenue growing YoY for the past 5 years consistently? Yes.

Is the net income growing YoY for the past 5 years consistently? Yes.

Is the cash flow from operating activities growing YoY for the past 5 years consistently? Inconsistent.

Is the free cash flow positive for the past 5 years? Yes.

Is the gross margin % consistent/ growing for the past 5 years? Yes.

Is the EPS growing for the past 5 years? Yes.

Generac Holdings Revenue, Net Income, Operating Cash Flow, and FCF (USD Million)

Is the free cash flow per share growing for the past 5 years? Inconsistent.

Generac Holdings FCF per Share

Management Effectiveness

Is Generac Holdings’s ROE consistently at 12%-15% YoY for the past 5 years? Yes.

Generac Holdings Return on Equity

Is the ROIC consistently at 12%-15% YoY for the past 5 years? Inconsistent.

Generac Holdings Return on Invested Capital vs Weighted Average Cost of Capital

Generac Holdings Shares Outstanding (Million Shares)

The trendline for the number of shares outstanding is increasing, which is something that an investor would not be pleased to see.

Generac Holdings Financial Health

Generac Holdings Financial Health (USD Million)

Current Ratio: 2.13 (pass my requirement of >1.0)

Debt-to-EBITA: 2.04 (pass my requirement of <3.0)

Interest Coverage: 19.88 (pass my requirement of >3.0)

Debt Servicing Ratio: 24.89% (fail my requirement of <30.0%)

Dividend

Current Dividend yield: Generac has stopped paying dividends for the past 5 years.

Have the dividend payments been stable for the past 5 years? Not applicable.

Have the dividend payments been growing for the past 5 years? Not applicable.

Generac Holdings Valuation

Estimated intrinsic value: $53.63

Value is calculated using discounted cash flow method (taking into account their cash and debt) and scenario planning.

Projected growth rate: 5% - 8%

Beta: 1.4

Discount rate: 8.0%

Date of calculation: 30 Oct 2022

Generac Holdings Price-Earnings Ratio vs its peers

Generac Holdings Historical Price-Earnings Ratio

Generac Holdings Stock Performance

The line graph below compares the cumulative total stockholder return on Generac Holdings common stock with the cumulative total return of the Standard & Poor’s S&P 500 Index, the S&P MidCap 400 Index and the Russell 2000 Index for the five-year period ended December 31, 2021. The graph and table assume that $100 was invested on December 31, 2016 in each of Generac Holdings common stock, the S&P 500 Index, the S&P MidCap 400 Index and the Russell 2000 Index, and that all dividends were reinvested. Cumulative total stockholder returns for Generac Holdings common stock, the S&P 500 Index, the S&P MidCap 400 Index and the Russell 2000 Index are based on Generac Holdings fiscal year.

Generac Holdings Stock Performance

My Top Concern

The primary raw materials that Generac used are steel, copper and aluminium as well as batteries and advanced electronic components. The prices of these raw materials and components are susceptible to fluctuations due to trends in supply and demand, commodity prices, currencies, transportation costs, government regulations and tariffs, price controls and economic conditions.

What is worst is that Generac does not have long-term supply contracts in place to ensure the raw materials and components we use are available in necessary amounts or at fixed prices.

Also, Generac’s ability to continue to obtain quality materials and components is subject to the continued reliability and viability of its suppliers.

Any severe price fluctuations or supplies of raw materials may cause Generac to incur additional costs, delay new product introductions or suffer harm to its reputation.

The next risk that I would consider is the dependency on its distributors.

Generac depends on distributors and dealers to sell its products. The distribution agreements are typically not exclusive, and many of the distributors with whom Generac does business offer competitors’ products.

Impairment of relationships with the distributors and dealers, or an increase in distributors' or dealers' sales of Generac competitors' products could materially reduce Generac sales and profits.

Summary for Generac Holdings

Two key factors that give Generac an economic moat are its intangible assets and cost advantages.

Generac possesses a strong brand within a niche area of home standby generators. The company’s market share in this area is and has been consistently above 70% for the past decade, a testament to its moat.

What stood out to me is the systematic approach that Generac established to help its dealers to be successful.

The company plays a critical role in marketing to generate customer leads, which in turn supplies to its dealer network. In addition, Generac has its own distribution system called Power Play. Power Play is a guided sales process for residential dealers, targeted to improve the customer experience and overall close rates. Also, its remote monitoring platform allows Generac residential generator dealers to monitor their installed base of customers through a feature called “Fleet,” enabling the dealers to offer a more proactive experience to service a customer’s generator.

By supplying customer leads and creating a powerful distribution system, it helps to build loyalty among Generac’s dealer network, making them less likely to sell a competing brand.

As Generac has a huge market share in the home generator area, it may lead to a maintainable cost advantage over its competitors. Specifically, in the aspect of buying power, economies of scope (extensive range of products), and in marketing.

However, Generac’s products lack network effect, and it does not cost much, in terms of monetary, psychological, effort or time to switch to a competitor product. As such, I will assign only a narrow economic moat for Generac.

Despite the inconsistency in its operating cash flow, Generac’s performance is considered satisfactory. Its revenue, net income and even its net profit margin are growing steadily over the past 5 years, while its gross profit margin remains flat at around 35%, which is still above the industry average.

Generac had a stellar ROE over the past 5 years, consistently achieving more than 20%. Its current ROE is also way above the industry average of 11%. However, Generac does not have a consistent ROIC of more than at least 12%. In the fiscal year 2016, the company’s ROIC was just slightly above 8%. But after that year, its ROIC gradually rises to above 12% to a current level of 18%, which is almost 3 times its WACC. This may indicate that Generac is getting better at managing its capital allocation.

On the surface, Generac’s balance sheet looks healthy. Its short-term assets exceed its long-term liabilities, and its net debt-to-equity ratio has reduced over the past 5 years to a level that is considered satisfactory. Generac also passes my requirement for current ratio and interest coverage although the ratios are below the industry average. However, its debt servicing ratio is tipping towards a point where Generac’s debt is not well covered by its operating cash flow.

With a narrow moat and inconsistency in Generac performance, capital allocation and debt, I will take a cautious approach by setting a higher margin of safety of 50%. So, with an estimated intrinsic value of $53.63, I will only invest when the stock price is trading in the $27 range.