Franklin Electric: A Changing of the Guard
We attended the Franklin Electric annual shareholders’ meeting today, as we do every year. The venue has rightfully changed this year, symbolic of a changing of the guard at the top of the company. For a long time, the company held the annual meeting at their headquarters in Bluffton, then decided to rotate it around to other cities in the U.S. where they had facilities, then finally bring it back to the Grand Wayne Center the last few years. This year, however, Franklin hosted the meeting at their new headquarters on Airport Expressway, which was our first time in the building. If you ever have an opportunity to check it out, do so…it’s beautiful. We plan to make a return to trip this summer to spend some time with the company’s new leadership, which segues back to the title of this post…
Scott Trumbull is retiring as CEO, and today, Gregg Sengstack begins his reign. While there were some moments of nostalgia at the annual meeting, and a brief round of applause for Scott, the meeting was otherwise all business, which is apropos if you know Scott.
While we’d been long-time followers, admirers, and shareholders of Franklin in the 1980s and 1990s, we started buying its stock in earnest in 1998-2000, which was a pretty good time to get in, given what has happened since. Bill Lawson was a very successful CEO, managing Franklin to keep its high market shares, and profit margins, in motors and related parts intact. He executed this strategy nearly flawlessly. The next couple years after his retirement would see unprecedented upheaval in the water pumping systems business, and Scott turned out to be more than the right man for the job. Soon after he started, his two largest customers, who installed Franklin motors into their pumps, told him they would be designing their own motor for their pumps. This would take a few years to develop, so Scott made the tough choice to cut them off more quickly than they had hoped, which resulted in the two customers buying up all the Franklin motors they could before the deadline, just so they’d have enough to sell before their own motor was ready for showtime. Scott then proceeded to turn his company into a pumping system company by buying up pump manufacturers of all kinds, moving into all sorts of new product markets (Jacuzzi was one of his first acquisitions), and moving into new geographies (in particular emerging markets) for production and for new customers.
It started to become somewhat clear by 2008 that Franklin was out to an early lead in the war, although there would still be years of production realignment and trench battles to win the confidence of their long-time contractor user base. Franklin kept pounding away at their strategy, even through the ugly recession. While business is a war that never ends, as we write this, Franklin has crushed its competitors by taking over market share in pumps, by cementing long-term relationships with distributors and contractors globally, and by putting the best product on the market. Early skeptics on the company’s move into pumps argued that its margins and returns would suffer, because motors were the highest-profit part of the whole pump. While returns on equity are lower, this is primarily a result of all the acquisitions the company has made. Meanwhile, the company’s operating margin last year had climbed back up to 13.2%, which is as high as the motor-only days, when 12-14% as the norm. Sales? +164% in 10 years.
So, clearly, they made the right decision to go into pumps, AND they chose the right strategy, AND they executed it. But what if they hadn’t seen the need to go overseas to find more growth? The slides shown at their annual meeting pretty much answer that question. Scott presented “the past” of Franklin, and Gregg presented “the future.” Good news! You can see both of their slideshow presentations, which were included in an SEC filing they made today, here. If you’re interested in Franklin, and can stomach some financial data, you’ll enjoy the slideshows. There’s plenty of pie charts and pictures to go around. As we reflect on the 11 years of Scott’s tenure, the one pie chart that stands out is on page 4, which shows sales by region of the world. Fully 38% of Franklin’s water sales now are in emerging markets. 46% are in the U.S., and 16% are in Canada, Europe, and the developed Far East. A similar chart deeper into the presentation shows that 31% of their fueling systems (20% of total company sales) sales are in emerging markets. Let that sink in. Those numbers (38% and 31%) are far higher than most global multinationals, including Monarch’s core stocks. This is a little company from Bluffton, Indiana. 11 years ago, 65% of sales were in the U.S., and most of the rest were in Europe and Canada.
It seems kind of obvious now that selling pumps in places with no clean surface water is a good idea, but there was always that small issue of not having the money to pay for it. What if Franklin hadn’t foreseen these markets opening up to them? Not only would the company not have those 38% of its water systems sales, but arguably less of the other 62%. Thanks to their acquisitions in places like Brazil, Turkey, China, Russia, and South Africa, they’ve utilized technologies at the acquired companies to incorporate into new pump models sold elsewhere in the world.
Management also announced a 16% increase in its dividend payout for 2014 today. While the new yield is a meager 0.9%, the increase is a good sign of confidence from management. What you also need to remember is that Franklin, as you have read, is a growing company. They pay out only 18% of their earnings as dividends, and they don’t buy back lots of stock, because of the need for strategic acquisitions. Not acquisitions just because they happen to have a lot of cash overseas that they don’t want to repatriate back stateside (we’re looking at you, Pfizer), nor acquisitions because they have cash burning a whole in their pockets (Google), but acquisitions to further their mission of providing the best, most technologically-advanced, most comprehensive set of water pumping and fuel pumping systems to the world.
We remain positive on the long-term outlook for the company. There aren’t many companies as perfectly positioned to take advantage of the world’s growing need for safe, clean water, and advanced fueling systems which reduce air pollution and save gas station owners money. Layer on that two nascent businesses–solar-powered water wells and dewatering shale oil and gas wells–and it could be a story that gets even more exciting. We acknowledge that the stock is still a little pricey, and earnings need to grow at a superior rate in order to justify its premium valuation, but we believe they will. We have faith that Gregg Sengstack will continue Scott’s legacy. Franklin has a very experienced leadership team who know what they need to do.