Thursday, April 22, 2010

Graco and the "Minnesota effect" (GGG)

Industrial products firm Graco(GGG) is trading up 8% today, after beating earnings by 9cents. Revenues of $164.7million came in $20million ahead of expectations. One group kicking themselves today are the Goldman Sachs analysts who downgraded the stock to SELL on February 22nd at $28, or $7dollars ago...In fairness to Goldman, the shares currently trade at 43times last year's earnings and 21times 2010 estimates. No one ever said this stock market thing was easy....

Of the company's three segments (industrial, contractor and lubrication), the contractor division lagged the most. The company expects the residential market to pick up before the commercial construction market, but I worry residential could lag for a considerable amount of time, as the shadow inventory (homes that are waiting for the neighbor to sell before they go on the market) hide the true amount of over-expansion this country saw in recent years.

Those concerns aside, investors LOVE this company, for its high quality products and impressive operational history. I've always thought that they spend rather lavishly, but that isn't all bad. An acquirer could come along (invited or not!) and strip out costs, and the big development spending will result in nearly 30% of revenues coming from new products in a few years. The stock IS pricey, but I'm of the opinion that a buyout would have to be $10 higher...

Graco's largest shareholder is an interesting case in itself.

Mairs & Power is a Minnesota-based investment firm that truly "shops local." They are hugely overweighted in Minnesota companies, and it has served them well.

Portfolio manager William Frels was quoted in Barrons last year, citing the Minnesota effect:
"The Minneapolis-St. Paul area has one of the highest concentrations of large, multinational industrial and financial companies in the U.S.," Frels observes. "Local surveys claim that Minnesota public companies consistently have outperformed the general stock market, year after year, with the exception of the past two years."
When I used to read about Mairs & Power many years ago, a part of me wondered if it was a small bit of laziness to be investing so heavily so close to home. Truth is, the results speak for themselves. The median stock in the state of Minnesota returned 85% over the past ten years, versus 53% for the average US stock. But wait you say! Minnesota is heavily weighted towards industrials. That doesn't matter either, as Minnesota industrial stocks beat industrials from other states quite handily:

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