Friday, November 17, 2006

Graco (GGG)

This is a spectacular company. They manufacture equipment for handling fluids: spraying, pumping, dispensing all kinds of fluids. They dominate this niche market. Much of their usefullness is in adding cheap but high-value-added properties to products. For example, spraying the coat of paint on a new car doesn't actually cost the car maker that much compared to say making the engine of the car. However customers expect an excellent coat of shiny paint. It is what they see after all. A cheap paint job which may save the car company $100 will devalue the car by $1000 in the eye of the customer. It simple isn't tolerated. Car companies will pay for quality paint equpment since it is crucial to making their cars.

Similarly, a factory that dispenses a fluid (say Hershey's chocolate, a Graco customer) needs to do this is a precise way. They need to put a precise amount of the fluid into packages. They need to be able to keep the equpment running. They have no tolerance for pumps that jam, sprayers that get clogged, or equipment that otherwise breaks. They also don't want to spend their time solving these kind of problems. They hire Graco who is the world expert on solving these problems. Pumping fluids around is exactly the kind of thing that is a weak link. Whatever the factory is, you can bet that if they can't provide the right fluid (oil, water, chocolate, tomato paste, paint, adhesive, solvent, lubication whatever) at the right place at the right time, then their whole operation shuts down. The need the job done right and they call Graco to deliver the solution.

This enables Graco to attain high profitablity making a huge variety of products that are variations on a similar set of well understood ideas. They have been growing at about 17% for a decade. They are well mananged and return a significant amount of earnings to share holders. Average return on equity (ROE) is an incredible 50% over the past 10 years.

They trade at about 19 times earnings which is a reasonable price if not exactly cheap. Free cash flow yield is about 5% and per share FCF is growing at 18% with capital expenditure showing no long term upward trend. I will probably acquire some GGG in a week or so. Hoping for a downturn of a few percent. This would probably be a better stock to pick up during a recession which may finally come in 2007.