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Is Generac Holdings Inc. Destined for Greatness?

http://www.fool.com/investing/general/2014/03/14/is-generac-holdings-inc-destined-for-greatness.aspx

Alex Planes
March 14, 2014

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Generac Holdings (NYSE: GNRC) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Generac's story, and we'll be grading the quality of that story in several ways:

  • Growth: Are profits, margins, and free cash flow all increasing?
  • Valuation: Is share price growing in line with earnings per share?
  • Opportunities: Is return on equity increasing while debt to equity declines?
  • Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Generac's key statistics:

GNRC Total Return Price Chart

GNRC Total Return Price data by YCharts.

Passing Criteria

Three-Year* Change

Grade

Revenue growth > 30%

150.6%

Pass

Improving profit margin

16.2%

Pass

Free cash flow growth > Net income growth

118.6% vs. 206.7%

Fail

Improving EPS

184.5%

Pass

Stock growth (+ 15%) < EPS growth

456% vs. 184.5%

Fail

Source: YCharts. *Period begins at end of Q4 2010.

GNRC Return on Equity (TTM) Chart

GNRC Return on Equity (TTM) data by YCharts.

Passing Criteria

Three-Year* Change

Grade

Improving return on equity

37.7%

Pass

Declining debt to equity

153.4%

Fail

Dividend growth > 25%

(16.7%)

Fail

Free cash flow payout ratio < 50%

149.9%

Fail

Source: YCharts. *Period begins at end of Q4 2010.

How we got here and where we're going
Generac puts together a passable -- but not compelling -- performance by racking up four out of nine possible passing grades. One major source of that weakness is the company's free cash flow, which has diverged markedly from its net income, and that presently seems unable to support the company's dividend payments, assuming that Generac maintains a similar payout this year. However, Generac's shareholders have enjoyed strong growth in both fundamentals and share prices over the past three years, and the stock hits new peaks with regularity. But does that mean Generac will continue to rally higher, or will the backup-power generation manufacturer find its free cash flow weakness holding it back this year? Let's dig a little deeper to find out.

Generac delivered market-topping revenue and earnings per share in its latest quarter, results primarily driven by rising demand for home standby generators and for commercial and industrial backup-power generation as wretched weather continues to pound much of the United States. Fool contributor Steve Symington notes that Generac purchased the generator-product assets of ABB Group's Baldor Electric subsidiary, which is bound to result in a larger industrial product line for North American and international markets. Generac seems poised to capture more of this market because of greater scalability and a heightened focus on organic growth in commercial and industrial power generation.

However, Generac also continues to strengthen its product portfolio with inorganic growth (read: acquisitions) over the past few years. The company recently completed its acquisition of Tower Light, an Italian manufacturer of mobile light towers, which complements Generac's purchase of North American light-tower and mobile generator manufacturer Magnum Products. Fool contributor Eric Volkman notes that the acquisition of Tower Light positions Generac as a global leader in mobile power equipment rental markets, allowing the company to leverage broader product lin