Spruce Point Capital Management Announces Investment Opinion: Releases Report and Strong Sell Research Opinion on Generac Holdings Inc. (NYSE: GNRC)
NOTE TO EDITORS: The Following Is an Investment Opinion Issued by Spruce Point Capital Management
Believes that Generac’s Recent Financial Performance Was Fueled by Black Swan Events and Is Showing Signs of Deterioration as the Economy Slows
Forensic Review Indicates that Generac Is Experiencing Pressures from Legacy Growth Products Such as Portable Generators, Where It Cut Prices by Almost 20% to Combat an Onslaught of New Foreign Imports
Believes Generac’s Highly Touted Clean Energy Business Was Assembled Via Numerous Questionable Acquisitions and Its Recent Investment in Its European Business Was at an Irrationally Low Valuation Amidst Signs of Channel Stuffing
Notes Generac Maintains Partnerships with Several Dubious Solar Distributors that Are Alleged to Be Misleading Consumers in a Failing Attempt to Keep Pace with Residential Solar Competitors Like Tesla
Contends Chairman and CEO Aaron Jagdfeld Is Unfit to Lead and Should Resign Given His Lack of Relevant Skillsets in M&A and Clean Energy and Significant Stock Sales
Sees 40% to 50% Downside Risk to Generac’s Share Price and Urges Investors to Visit www.SprucePointCap.com and Follow @SprucePointCap on Twitter for the Latest on $GNRC
June 22, 2022 08:45 AM Eastern Daylight Time
NEW YORK--(BUSINESS WIRE)--Spruce Point Capital Management, LLC (“Spruce Point” or “we” or “us”), a New York-based investment management firm that focuses on forensic research and short-selling, today issued a detailed report entitled “Powering Down And Generating Losses” that outlines why we believe shares of Generac Holdings Inc. (NYSE: GNRC) (“Generac” or the "Company") face up to 40% to 50% downside risk, or $110.00 – $132.00 per share. Download or view the report by visiting www.SprucePointCap.com and follow us on Twitterhttps://twitter.com/notifications @SprucePointCap for additional information and important updates.
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Spruce Point Report Overview
Founded in 1959, Generac is a global designer and manufacturer of a wide range of energy technology solutions. The Company provides power generation equipment, energy storage systems, grid service solutions and other power products serving the residential, light commercial and industrial markets. Spruce Point finds evidence of core problems in Generac’s “Legacy Growth Drivers,” including home standby generators (“HSBs”) and portable generators. In search of new growth angles and to burnish its environmental, social and governance (“ESG”) positioning, we believe Generac has recently increased its acquisition spending, notably in the area of Clean Energy, and launched its first commercial product called PWRcell in 2020 after acquiring and integrating Pika Energy and Neurio Technology. PWRcell is a residential solar energy solution that competes with the likes of Tesla’s Powerwall. After conducting an evaluation of Generac’s Clean Energy business, we also find evidence of problems and growth challenges. Key findings of our report on Generac include:
- Core Product Challenges in Home Standby Generators and Portable Generators. Generac’s core products are heavily marketed toward the residential and consumer market as an “insurance” policy from grid and power outages. We find evidence that since its IPO, the Company’s penetration has failed to grow at the rate of other discretionary home products. Recently, Generac modified a key slide in its investor presentation to show that the penetration rate was actually lower than expected. It even introduced, but has since retracted, a slide classifying HSBs as “Legacy Growth Drivers.” Due to the stay-at-home effect from COVID-19 and the Texas power outage of 2021, we believe Generac experienced a black swan demand event for its products, causing a one-time surge in sales and profits. Generac, along with competitors such as Kohler and Briggs & Stratton, announced plans to increase capacity by 2x – 4x in early 2021 in response. However, with supply chain complications, Generac’s ability to bring on new capacity has fallen behind schedule. Now, with the economy slowing, we expect Generac to be stuck with excess capacity. Complicating matters, we find evidence that in its portable generator business, Generac recently stopped making market share claims of “high 20%.” Based on our research, we find an onslaught of new competitors, and that Generac slashed prices by nearly 20%. We estimate this to be a $100 million headwind to cash flow.
- Generac Faces Product Recalls, Lawsuits and Potential Government Investigations. Consumer Reports, a well-regarded independent consumer review and advocacy group, has reviewed Generac’s products. Generac’s core competency has always been HSBs. However, a recent study shows that brands such as Champion, Briggs & Stratton, Cummins and Winco receive overall higher scores. In the category of inverters, where engines tend to be more complex and expensive, Generac did not even make the list. Generac has conducted two recent product recalls, one related to finger amputations, and another related to the risk of carbon monoxide poisoning. There has been a raft of lawsuits, and Generac even made subtle changes to its “Forward Looking Statements,” noting “significant legal proceedings, claims, lawsuits or government investigations.” A recent investigation into companies in the generator industry, including Generac, by the Texas Tribune and ProPublica found that the industry has historically resisted measures to make the products safer.
- Generac’s Financial Statements Are Showing Extreme Financial Stress. There are many signs that Generac is under increasing financial strain. Its working capital to sales ratio has increased for three quarters in a row, and its short-term borrowings at foreign subsidiaries hit a multi-year high. Gross margins are declining, inventory turns are decreasing and earnings quality, as measured by the difference between net income and cash flow, is deteriorating. It appears that Generac is significantly stretching out its payables, which would help improve cash flow, but may be agitating suppliers. Furthermore, as more of its products are offered online, and to remain competitive, we find evidence that Generac has been absorbing higher shipping costs. However, despite growing payables, cash from operations has been declining and turned negative in Q1 2022, producing the worst quarterly operating cash flow in Generac’s public history. Liquidity, as measured by its cash and ABL borrowing capacity is just 12.2% of sales and has fallen markedly from the prior year at 37.1% of sales. Now, 15% and 10% of Generac’s sales and EBITDA are international. Notably, it has unhedged exposures to the Euro, British Pound and Mexican Peso. A strengthening of the US Dollar hurts Generac. Unfortunately, the DXY Dollar Index is up ~9.0% YTD 2022 and will add pressure to results.
- Generac Recently Increased Its Investment in Pramac (Italy), its European Platform, Which Shows Strong Signs of Channel Stuffing and Business Dealings with an Imprisoned Executive. Pramac IPO’ed in Italy in 2007, issued lofty expectations it never achieved, saw its stock halted and entered into liquidation in 2012. Generac acquired a controlling 65% interest on March 1, 2016 for $60.1 million and an additional 15% interest in 2021 in an amount closely related to the size of its net income, and at an irrationally low valuation multiple. Furthermore, the additional minority interest investment was classified as a “financing” cash flow. Why? A close look at Pramac’s Italian regulatory filings and two of its largest European subsidiary regulatory filings show multiple red flags pointing to revenue inflation through channel stuffing. For example, when looking at Pramac’s UK subsidiary filings since 2017, its sales have increased 94% with accounts receivables up 444%. A new “key source of estimation uncertainty” related to trade receivables was recently added. At its French subsidiary, which shows the receivables to sales ratio almost 3x Generac’s consolidated ratio, we also find an auditor warning related to receivables. Spruce Point also questions Generac’s interest in Pramac Racing. In 2019, the head of Alma Group, a key sponsor, was arrested and imprisoned in a tax evasion scandal. Pramac Racing’s foreign filings show it has received sponsorship money and lent money to “a company with a 50% indirect interest in Pramac Racing.” Generac should disclose what entity has an indirect interest in its subsidiary and if it has had any business dealings with Alma Group, its related entities or executives.
- Generac’s Pivot to Clean Energy Products Through Acquisitions and Partnerships Is Showing Signs of Slowing Growth and Challenges. In early 2019, Generac started making acquisitions oriented toward clean energy products and solutions, a strategy we believe is fraught with risk given our evidence that Generac has faced challenges with prior acquisitions. Specifically, Spruce Point questions Generac’s rapid growth from two speculative acquisitions in 2019 of Pika Energy and Neurio Technology that have formed the basis of PWRcell, its home residential storage solution. We find evidence of prior failures at Neurio, revenue reporting concerns and that the acquisition value was revised lower in a non-transparent way. At Pika, we find evidence of a large sales increase to Puerto Rico ahead of Generac’s acquisition. One of Pika’s notable distributors in Puerto Rico was Dynamic Solar, whose President and Partner was arrested in a kick-back scheme. Generac claims PWRcell revenues have grown from $115 million in 2020 to $230 million in 2021 and are projected to grow by another 50% in 2022. However, none of these claims are backed with firm reporting in SEC filings. Generac also once claimed superior product attributes to Tesla’s Powerwall but has since retracted such claims. Spruce Point not only finds evidence of dealer growth slowing, but also evidence that key dealers have stopped selling Generac. Our recent channel checks into 12 Generac-promoted large regional distributors indicates that only six still carry its products. Even worse, some Generac clean energy distributors are alleged to be using deceptive marketing practices to fuel sales growth. Powerhome, (now doing business as Pink Energy) one of Generac's largest partners doing business in over 13 states, has had multiple investigations into its sales practices and has allegedly overcharged for Generac batteries. It is also reportedly under FTC investigation. Despite this, Generac continues to promote Powerhome as a partner on its website.
- We Believe Generac’s Chairman and CEO Lacks Relevant Skills to Continue Leading the Company. The Company’s own skill matrix included in Generac’s 2022 definitive proxy statement shows that CEO and Chairman Aaron Jagdfeld lacks expertise in M&A and clean energy markets, which is exactly the strategy Generac has opted to pursue. Looking carefully, we also observe that Mr. Jagdfeld formed a family foundation entity in late October 2021 and entered into a new 10b5-1 stock sale program on November 8, 2021, right after Q3 2021 results, where he said Chief Marketing Officer Russ Minick was “incredibly bullish.” Mr. Minick subsequently retired in February 2022, forfeiting substantial stock compensation tied to the new Clean Energy business. The CEO’s new stock sale program wasn’t disclosed until a Form 4 filing on February 1, 2022. The CEO was still selling stock under his old program enacted on October 30, 2020 through January 3, 2022. While not illegal to have two insider trading programs, the SEC is looking into making modifications to rules that would prohibit such practices. The SEC has identified a concern that insiders enter into multiple 10b5-1 plans at the same time to strategically execute trades under one plan and terminate trades on another to exploit material non-public information.
- We Estimate Between 40% – 50% Downside Risk to Generac’s Share Price as its Premium Multiple Contracts and Lofty Expectations Are Missed. Sell-side analysts are resoundingly bullish on Generac, seeing 74% upside with no analyst saying “Sell.” The enthusiasm is based on confidence that Generac’s financial results will improve throughout 2022. However, there are numerous reasons to be skeptical of this outcome. Generac’s discretionary products and revenue are highly susceptible to weakened consumer spending, a slowdown in the housing market and a rising US dollar for its international revenues. In addition, based on our dealer checks, we find evidence that Generac has lost partnerships in its Clean Energy business, while its overall dealer count has stopped growing. Generac trades at a premium valuation at 3.2x and 16.0x 2022E sales and EBITDA compared with other power and clean energy stocks. Furthermore, its multiple is still expanded from its pre-COVID-19 levels. Valuing Generac at a discount to peers on our lower-than-consensus estimates, we see 40% – 50% downside risk ($110 – $132 per share).
The research note can be found at www.sprucepointcap.com and updates will be posted on twitter @sprucepointcap.
