Here's Why You Must Hold On to Graco (GGG) Stock for Now

We have issued an updated research report on Graco Inc.GGG on Sep 3.

This industrial machinery maker currently carries a Zacks Rank #3 (Hold). Its market capitalization is approximately $7.9 billion.

Let's delve deeper and discuss the company's potential growth drivers and probable headwinds.

Factors Favoring Graco

Financial Performance & Outlook, Share Price Performance: Graco delivered better-than-expected results in two of the last four quarters while lagging estimates in two. Average earnings surprise is a positive 4.26%.

In the second quarter of 2018, the company's earnings of 48 cents per share grew 26% year over year. The bottom-line improvement was primarily driven by solid sales volume, impressive factory activity and solid operational performance.

Also, the company's top line increased 12% year over year on the back of forex gains and acquired assets. Segmental sales performance was solid, with 8.9% growth recorded for the Industrial, 15.9% for the Process and 13.6% for the Contractor segments.

For 2018, Graco anticipates demand for its products to remain strong in end markets served. It predicts organic sales to grow in mid- to high-single digit in the year. On a geographical basis, organic sales are likely to grow in mid- to high-single digit in the Americas and in high-single digit in the Asia Pacific. Forex gains are likely to add 1% to sales growth in 2018 while earnings per share will benefit by 3%.

In the past six months, Graco's share yielded 5.5% return, outperforming 1.8% growth recorded by the industry it belongs to.

Product Development & Shareholder Return: Over the long term, Graco anticipates growing through penetration into new markets, expanding footholds globally, end-user conversion, acquisitions (separately discussed below) and product development. Earnings are anticipated to grow more than 12% (CAGR).

In 2017, the company spent 4.1% of its sales for the development of products, way higher than 1.7% for the peer group. Many products were introduced in the past few quarters, including New King pneumatic airless sprayers and ToughTek F800e for the Industrial segment; TexSpray FastFinish and DutyMax GH 675DI for the Contractor segment; and Electric Grease Jockey for the Process segment.

Another interesting aspect about Graco is its commitment toward rewarding shareholders handsomely. It has repurchased approximately 3.5 million shares in the first half of 2018 and has roughly 5 million authorization left to be accomplished in the future. Also, the company paid dividends, amounting to $44.7 million in the first half of 2018.

Strengthening Portfolio Through Buyouts: Over time, Graco has easily penetrated into unexplored markets, added products to the portfolio and expanded geographical footprints, with the help of acquired assets. It's worth mentioning here that buyouts added 3% to sales growth in the second quarter of 2018. Benefits from buyouts are anticipated to augment sales by $40 million in 2018. Of many, two buyouts have been briefly discussed below:

In December 2017, the company successfully acquired Smith Manufacturing in a bid to fortify its line striping and pavement maintenance equipment offerings. This buyout was integrated with the Contractor segment. In March 2018, the company acquired ProHydro, Inc., a manufacturer of groundwater sampling system - Snap Sampler. This buyout has aided the company's Process segment.

Factors Working Against Graco

Poor Valuation and Earnings Estimates: Graco, when compared with the industry, appears overvalued, considering the Price-to-Earnings (P/E) multiple for the past six months. While the stock's P/E (TTM) multiple is 27.9, above the industry's 22.3. This overvaluation somewhat makes us cautious on the stock.

Also, the Zack Consensus Estimate for the company's earnings is currently pegged at $1.84 for 2018 and $1.98 for 2019, reflecting decline of 2.6% and 2.5% from the respective tallies 60 days ago. Also, estimates for the third quarter of 2018 have been lowered by six brokerage firms against one upward revision. It currently stands at 46 cents, down 4.2% from 48 cents recorded 60 days ago.

Rising Costs an Impediment: Graco is grappling with the adverse impacts of rising cost of products sold and expenses. In 2016, its sales from the cost of products sold increased 3.2% year over year while expanded 9.8% in 2017. The trajectory continued in 2018 as well, with roughly 14.8% increase recorded for the first half of 2018. Input price inflation is considered as one of the prime reasons for the cost increase.

Likewise, the company's selling, marketing and distribution in the first half increased 14.1% compared with the year-ago comparable period while general and administrative expenses grew 10.6%.

Graco predicts the inflationary pressures caused by material and freight costs, as well as tariffs, to lower margins by 50 basis points in the second half of 2018. The impact of this might double in the next year.

Debts & Other Headwinds: A highly leveraged balance sheet can inflate financial obligations and prove detrimental for Graco's growth prospects. Long-term debt balance was $297.3 million at the end of second-quarter 2018, reflecting sequential increase of 4.2%. Its total debt to total equity was at 41.8% versus 39.2% for the first quarter of 2018.

Likewise, the company recorded 26.2% sequential increase in debt in the first quarter of 2018 while its total debt to total equity of 39.2% was higher than 31.3% for the fourth quarter of 2017.

Also, acquisition-related expenses can be concerning for Graco. In the second quarter of 2018, operating expenses were inflated by $2 million due to buyout-related costs.

Stocks to Consider

Some better-ranked stocks in the industry are Colfax Corp. CFX , Altra Industrial Motion Corp. AIMC and Barnes Group Inc. B . While Colfax sports a Zacks Rank #1 (Strong Buy), both Altra Industrial Motion and Barnes Group carry a Zacks Rank #2 (Buy). You can see the complete list of today's Zacks #1 Rank stocks here .

In the past 60 days, earnings estimates for each of these stocks improved for the current year and the next year. The average positive earnings surprise for the last four quarters was 7.91% for Colfax, 4.01% for Altra Industrial Motion and 6.88% for Barnes Group.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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