4/21/2011
By Brian Sozzi, Research Analyst

Interesting earnings report from toolmaker Snap-On (SNA), so much so that there are a couple different interpretations.  Consider there were three identifiable external headwinds to Snap-On's business in the quarter: (1) continued economic turmoil in southern Europe, correlating to spiking bond yields; (2) slowing auto sales in the U.S.; (3) Japan earthquake and what that meant to sales of tools and diagnostics to OEMs and the health of the supply chain; and (4) flowing in of pricier commodities on the COGS line.  With these factors as background, Snap-On performed impressively in my view, notching 130 bps of gross margin expansion year on year, ending up in a cash flow positive position, and building on top of the rebound in sales in 1Q09 by posting double-digit percentage gains in two of three business segments.  Moreover, the results came not only against a backdrop of the aforementioned headwinds, but during the seasonally slow first quarter.

Given the strong performance of Snap-On shares from the 4Q10 earnings release in early February (+7%) and history of smashing through consensus forecasts (beat this time only $0.04), I think the market wanted more meat on the 1Q11 bone... 

Negatives include:

1. Light on operating income; $99.8 million including financial services compared to $100.0 mean and $105.0 million high-end.  Investments in the franchise network and in emerging markets appear to be the culprits for the miss.
2. Organic sales growth slowed sharply in all segments on a sequential basis.
3. Capex guidance for FY11 now $65.0 million, tightened from a $55.0 million to $65.0 million range on the prior release.
4. Inventory growth was 2x sales growth (though this may be indicative of inflation instead of a worrisome build in unproductive units).
5. Overall softer commentary behind the Repair & Information Group segment performance, the best operating margin business for Snap-On.  This is where the turbulence in the auto market would show up.

I am inclined to not make any knee-jerk judgments with respect to my bullish recommendation on the stock, yet.  This is the second consecutive quarter where minor negatives have infiltrated what is otherwise a strong investment thesis on Snap-On, which doesn't exactly fit well with a stock valued at a premium to most industrials and relative to historic multiples, depending on the metric of choice.  Still, the company has one of the widest moats around its business from within my industrial coverage universe, and that deserves a market premium.  The question now is whether Snap-On will be able to sustain its new level of operating margins attained post Great Recession in FY11 amidst a more turbulent European climate and perhaps an elongated slowdown in auto sales.

Brian Sozzi
Wall Street Strategies

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