Axalta Coating Systems is an industry icon built on a legacy of more than 150 years. The company is a leading global supplier of liquid and powder coatings for automotive and commercial vehicles, as well as other products that require protection from harsh environments. Axalta’s roots date back to the 19th century, when the company developed protectants for carriages. Today it is a global brand that has changed the automotive industry. The company invented the first-ever spray-applied, quick-dry paints for vehicles, which help car manufacturers and repair shops work more efficiently. Axalta is the #1 supplier to the automotive refinish market. Its superior technology and scale provide enduring competitive advantages that are undervalued in the current market.
Innovation is an Underappreciated Competitive Advantage
Despite its storied history, Axalta continues to innovate and adapt to evolving customer needs. The key to profit growth is ensuring adequate supply of defect-free coatings. Superior products are tailored to meet customer preferences and improve the durability of the vehicles and industrial goods they protect. Successful coatings also enhance productivity and reduce energy usage for both manufacturers and their end users. Technological leadership is what separates the ‘good’ from the ‘great’ in the coatings industry. Axalta has developed industry-leading technology that is personalized to its customers, and the company continues to invest in R&D in this area. In fact, 10 percent of its 13,000 employees are highly skilled scientists, engineers and technicians. Technology is the driving force behind Axalta’s breadth, scale, low-cost production and customer service.
Complex Color Matching is Simplified & Digitized
In a body shop, the quality of a repair is judged by how well the new surface matches the rest of the vehicle. This requires precise color reproduction. Axalta delivers enhanced accuracy, efficiency and control over the color-matching process through its digital coatings identification system. To do so, Axalta maintains the world’s leading digital coatings formulation database. This database enables it to find precise formulaic matches from billions of permutations. Customers use Axalta’s proprietary device, called the “spectrophotometer,” to match colors. When the device is held against any vehicle, it identifies a digital formulation to match the precise combination of colors and textures. Then, the spectrophotometer sends a specialized digital code to the appropriate equipment to begin mixing the formulation, allowing customers to seamlessly recreate coatings without headaches, wasted time or materials.
Behind a Pandemic Cloud
Throughout its history, Axalta’s largest and highest margin business, called “automotive refinish,” has remained relatively resilient during recessions. The COVID-19 pandemic has been an exception. Due to federal restrictions on non-essential travel over the past year, automotive use declined across the globe. While travel has rebounded and driving has recovered, volumes have only increased to approximately 85% of pre-pandemic levels. Some experts argue that work-from-home trends will shift populations away from urban areas, keeping many permanently off the roads. Our experience has shown that extreme outcomes are usually unlikely. However, it is worth noting that historically, there has been a strong inverse correlation between population density and vehicle ownership.
The Light Beyond the Cloud
Axalta shares are still trading at a substantial discount to the company’s normalized earnings power. Three of Axalta’s four end-markets (light vehicle, commercial vehicle and industrial) were experiencing cyclical downturns even before the pandemic. While the pandemic exacerbated these downturns and upended the normally stable refinish market, Axalta executed meaningful structural cost improvements, setting the stage for long-term margin improvement. Also, the company’s balance sheet has steadily strengthened. Axalta will require relatively little incremental investment to meet recovering demand in its various end markets. These factors, combined with its strong competitive advantages, translate to substantially higher long-term returns on invested capital than are currently reflected in its share price.
Since its founding over a century ago, Snap-on has revolutionized the tool industry. The company was born from a simple but ingenious idea—wrench handles with interchangeable sockets that would “snap on.” This concept was novel for the industry in 1920, and the company continues to innovate today. Snap-on is a leading manufacturer of tools, equipment, diagnostics, repair information and systems solutions. The company predominately serves independent automotive vehicle repair centers. Snap-on offers more than 65,000 SKUs in its product line, which spans 130 countries around the world. Its highly respected brand has remained strong through an intimate and direct connection with customers. We are optimistic about its potential to capitalize on key organic revenue growth drivers.
A Respected and Reliable Brand Built Over a Century
The Snap-on brand is known by automotive mechanics for its reliability and trust. Customers are confident in the quality of Snap-on’s product suite. As a result, the company holds significant pricing power over its competitors. For example, a Snap-on wrench sells for a price that is several times higher than the average comparable tool. The company continues to experience strong sales from loyal customers due to its superior materials, best-in-class designs and unmatched product durability. Snap-on builds on its legacy by consistently creating new offerings to meet evolving customer needs. These factors reinforce brand loyalty.
Unique Distribution Chain Offers Access and Data
Snap-on utilizes a franchise structure for a significant portion of its product sales and distribution. The company’s franchisees carry Snap-on inventory in over 4,500 customized vans and make weekly visits to current and prospective customers. The vans sell products to both mechanics and garage owners. These frequent and personalized interactions between franchisees and mechanics offer Snap-on a unique understanding of customer needs. This competitive advantage also provides the company with greater insight into customer credit risk.
Organic Revenue Growth Drivers
Snap-on tools typically last for decades, which is why its customers are willing to pay a premium. However, that same quality and durability periodically raises investor concerns around the company’s growth prospects. Fortunately, as vehicle designs continue to evolve, so does the automotive industry’s need for differentiated tools. For example, the shift from gas combustion engines to hybrid and electrical vehicles presents an opportunity for Snap-on to offer mechanics new tools and diagnostic capabilities with enhanced efficiency and safety from electrical shock. The market also continues to underappreciate several other growth tailwinds for Snap-on, including market share gains by independent garages and the increasing age of vehicles on the road.
We believe Wall Street is underestimating Snap-on’s ability to evolve its product offering and grow organic revenue. We are confident the company will continue to innovate, and we like its conservative balance sheet. Snap-on is a company we view as a long term holding that will continue to grow.
As of March 31, 2021, shares traded at $230.74, an 18.7x forward P/E.
Stericycle is a market leader in regulated waste management services and secure information destruction. For more than three decades, the company has served customers across several industries with operations around the world. Stericycle’s key offerings include: medical waste (e.g., needles and blood products, expired pharmaceuticals, and hazardous chemicals and solutions); and secure information destruction (e.g., collection of confidential material). While the company’s stock remains under a cloud after a challenging year of pandemic-related headwinds, Stericycle is beginning to turn the corner on its long-term mission to rebuild. A new management team is now well-positioned to deliver revenue, earnings and free cash flow improvements. We expect Stericycle to deliver long-term results to patient investors.
Transformation is Underway and Ongoing
Since we initiated our investment in Stericycle in 2018, we anticipated the company would overcome surmountable barriers to uncovering the true value of the business. Stericycle has successfully executed on these initiatives, including small-customer pricing settlements and a rationalization of the companyts service portfolio. While there has been significant progress, Stericycle’s transformation is ongoing.
In May 2019, Cindy Miller became President and Chief Executive Officer. Miller brings 30 years of experience at UPS and a dynamic leadership style to the organization. She is focused on achieving operational excellence. This includes addressing the high-cost infrastructure required to maintain the company’s 450+ business applications and 65+ financial systems. In 2019, Janet Zelenka was also appointed Chief Financial Officer. Zelenka took on the additional role of Chief Information Officer to capitalize on her extensive informational technology experience. She is leading the organization through the implementation of an Enterprise Resource Planning (ERP) software system. While this program is costly and disruptive in the short-term, it should deliver meaningful operating efficiencies and margin upside.
The company is focused on several other initiatives that will increase efficiency and profitability, including: right-sizing its fleet and facilities; standardizing processes; optimizing route planning; and expanding service options. Growth in service offerings should improve customer retention rates and allow Stericycle’s team to focus on acquiring new client relationships. Additionally, Stericycle has sold eight businesses since February 2019. These divestitures have helped the company pay down debt, improved its balance sheet metrics and enabled management to focus on the core regulated waste and destruction service businesses.
Temporary Impact of COVID-19
Stericycle, like many organizations serving industries that were hurt by the pandemic, was negatively impacted by COVID-19. Office closures caused a significant drop in the company’s Secured Information Destruction business. However, management proactively sought opportunities to offset pressure on the business and help fight the pandemic. When the implementation of the new ERP system in the U.S. and Canada was shifted to begin in 2021 due to social distancing restrictions, the management team took this opportunity to use free cash flow to pay down debt. The company also aggressively engaged with large quarantine sites, testing facilities, vaccine centers and temporary hospitals.
The Path to Long Term Growth
Even in the difficult environment over the last year, the company has maintained its strong market share position, increased operating efficiency, lowered debt levels and produced solid free cash flow. The company’s transformation will lead to revenue, earnings and free cash flow improvements. We believe our patience will be significantly rewarded in the long-term. Even though the cloud continues to pressure the stock as the company implements its transformation strategy, we believe this contrarian call will bear fruit as the new management team’s initiatives succeed over the next several years.
As of March 31, 2021, Stericycle shares traded at $67.51, a 28% discount to our $93.39 private market value estimate.
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On this page, we candidly discuss three individual companies to illustrate our investment process. These companies are current holdings of certain Funds. The information and our opinions were current as of May 3, 2021, but are subject to change. The information shown does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security. These securities do not represent all securities purchased, sold, or recommended to investors during the period. Past performance does not guarantee future results. The performance of any single portfolio holding is no indication of the performance of other portfolio holdings of any Fund or of any particular Fund itself. Portfolio holdings are subject to change. Click here for the top holdings of the Funds.