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Why Fastenal Could Be a Short Opportunity

February 14, 2012 | About:
Fastenal (FAST), a construction supply company that employs a retail network of stores and trucks to deliver fasteners, has been very strong over the past year. Shares have gotten ahead of themselves given the weak real estate market. In my opinion, this could be a short candidate.

On a fundamental basis the real estate market remains weak. Much of the company's growth over the last decade relied on sales to smaller home builders and repair outfits. These contractors wield very little pricing power. Unfortunately for Fastenal, loan growth to construction companies has stagnated and smaller contractors are now "dead men walking." Larger home builders will be able to exert pricing pressure and could significantly compress Fastenal's margins and earnings multiples.

Fastenal's trailing five-year valuation metrics suggest that the stock could be overvalued, as all three of the metrics are in the higher end of their respective five-year averages. Fastenal's current P/B ratio is 9.53 and it has traded in a range of 4.2 to 9.5 over the past five years. Fastenal's current P/S ratio is 5.02 and it has traded in a range of 2.1 to 5.0 over the past five years. Fastenal's current P/E ratio is 38.7 and it has traded in a range of $18.4 to $38.5 over the past five years.

The forward valuation metric has the same conclusion.

Fastenal is currently trading at about $49 a share with analysts expecting EPS of $1.76 next year, an earnings increase of 19% year over year, for a forward P/E ratio of 26.7. Taking a look at the company's publicly traded comparisons will give us a better idea of the stock's relative valuation. MSC (MSM) is currently trading at about $76 a share with analysts expecting EPS of $4.59 next year, an earnings increase of 13% year over year, for a forward P/E ratio of 16.6. W.W. Grainger (GWW) is currently trading at about $195 a share with analysts expecting EPS of $11.97 next year, an earnings increase of 15% year over year, for a forward P/E ratio of 16.3. The mean forward P/E of Fastenal's competitors is 16.4 which suggests that Fastenal is overvalued relative to its publicly traded peers.

Analysts suggest that the stock is a short. The consensus price target for the analysts who follow Fastenal is $46. This also suggests that the stock has limited upside and should be avoided at its current stock price.

The analysts have credibility here. Analysts have had a good knack for predicting the company’s results. Fastenal has beat EPS estimates twice in the past four quarters. The company's EPS figures have come in between 0 and 2 cents from consensus estimates or about 0% to 6.7% from analyst estimates. The company's earnings have been relatively close to consensus estimates which suggests that analysts are good at projecting the company's results and share upside from earnings surprises will be limited.

Significant selling pressure could come from institutional shareholders looking for better bargains in this market. The top two funds that own Fastenal are T. Rowe Price Growth Stock, which owns 8.9 million shares or 3% of the shares outstanding, and T. Rowe Price Mid-Cap Growth, which owns 5.5 million shares or 1.86% of the shares outstanding. The top two institutions that own Fastenal are T. Rowe Price Associates, which owns 40.8 million shares or 13.82% of the shares outstanding, and Ruane, Cunniff & Goldfarb, which owns 22.6 million shares or 7.67% of the shares outstanding.

Looking at the chart, Fastenal is up 60.8% over the past year, outperforming the S&P 500, which is up 3.7%. Looking at the technicals, the stock is currently above its 50-day moving average, which sits at $44.73 and above its 200 day moving average, which sits at $37.75. In my opinion, shares remain overvalued and could be due for a fall. The market does not currently appreciate the fact that the company could see margin compression as larger contractors chip away at Fastenal's profitability even if the company can maintain volumes. The current earnings multiple is therefore unwarranted.

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