Illinois-based industrial distributor W.W. Grainger (GWW, Financial) reported its first-quarter results last week, logging 1.4% net sales growth to $2.54 billion and 6.4% profit decline to $174.7 million – a 6.9% profit margin compared to 7.4% in the year-earlier period.
The $13.6 billion industrial company experienced higher costs including other expenses in relation to interest expenses and losses from equity method investment, thus contributing to lower overall profits.
Â
"Overall, the first quarter clearly fell short of our expectations, driven primarily by the stronger-than-anticipated customer response to our U.S. strategic pricing actions, with a greater volume of products sold at more competitive prices.
"Based on the positive customer response thus far, we are pulling forward the remaining pricing actions originally scheduled for 2018 into the third quarter of this year. This decision requires a significant change to our earnings per share guidance for the year but should enable us to accelerate growth with existing customers and attract new customers sooner than planned.
"Our Zoro and MonotaRO businesses continued to perform very well. We continue to be challenged in Canada, although our service has improved.” – CEO D.G. Macpherson
Guidance
According to its press release, W.W. Grainger lowered its sales and earnings per share guidance for the fiscal year.
The company now expects sales growth of 1% to 4% earnings per share (EPS) of $10.00 to $11.30. W.W. Grainger’s previous 2017 guidance, communicated on Jan. 25, was sales growth of 2% to 6% and earnings per share of $11.30 to $12.40.
In review, W.W. Grainger averaged 2.41% sales growth in the past three years, according to Morningstar data. Using an EPS midpoint, meanwhile, of $10.65 per share would indicate a 7.9% growth from fiscal 2016 reported figures.
W.W. Grainger shares fell 11.4% the day after the earnings and guidance announcement.
Valuations
W.W. Grainger appeared to be overvalued, despite the recent market share plunge, compared to its peers.
According to GuruFocus data, W.W. Grainger had a trailing price-earnings (P/E) ratio of 19.9 times vs. the industry median of 16.8 times, a price-book (P/B) value of 6 times vs. the industry median of 1.3 times and a price-sales (P/S) ratio of 1.2 times vs. 0.5 times.
The company also had a trailing dividend yield of 2.5% with a 49% payout ratio.
Current market value over fiscal 2017 sales and EPS expectations would indicate multiples of 1.1 and 18.4 times.
Total returns
W.W. Grainger has failed to generate any gains for its shareholders in the past five years, including year-to-date performance of 15.5% total losses compared to the broader Standard & Poor's 500 index’s 5.5% gain (Morningstar data). In the past years, the company provided a 0.36 total loss compared to the index’s 13.7% gain.
(Annual Report)
W.W. Grainger
According to filings, W.W. Grainger is a broad line distributor of maintenance, repair and operating (MRO) supplies and other related products and services used by businesses and institutions primarily in the U.S. and Canada, with a presence also in Europe, Asia and Latin America.
Grainger uses a combination of multichannel and single-channel business models to provide customers with a range of options for finding and purchasing products utilizing sales representatives, catalogs, direct marketing materials and e-commerce.
Grainger serves approximately 3 million customers worldwide through a network of highly integrated branches, distribution centers and web sites.
In 2016, Grainger derived 77.3% or $7.83 billion of its sales from the U.S., 15.4% from other foreign countries and 7.3% from Canada.
Grainger’s two reportable segments are the U.S. and Canada.
(10-K and news release)
U.S.
The U.S. operating segment reflects the results of Grainger’s U.S. business. Further, the U.S. business offers a broad selection of MRO supplies and other related products and services through sales representatives, catalogs, e-commerce and local branches.
Also, 22% of 2016 sales were private-label items bearing Grainger’s registered trademarks, such as DAYTON® motors, power transmission, HVAC and material handling equipment, SPEEDAIRE® air compressors, AIR HANDLER® air filtration equipment, TOUGH GUY® cleaning products, WESTWARD® tools, CONDOR® safety products and LUMAPRO® lighting products.
In the first quarter of fiscal 2017, sales in the U.S. segment fell by 0.7% to $1.95 billion or 74% of total Grainger sales excluding adjustments. The U.S. business also delivered a 16% operating earnings margin –Â compared to 16.9% the year-earlier period.
Grainger also provides its return on invested capital (ROIC*) figures per segment. For the recent quarter, Grainger indicated that its U.S. segment achieved an ROIC figure of 24.7% compared to 25.6% in first-quarter 2016.
*News release: ROIC is calculated using operating earnings divided by net working assets (a 2-point average for the year to date). Net working assets are working assets minus working liabilities defined as follows: working assets equal total assets less cash equivalents (2-point average of $64.5 million), deferred taxes, and investments in unconsolidated entities, plus the LIFO reserve (2-point average of $381.5 million). Working liabilities are the sum of trade payables, accrued compensation and benefits, accrued contributions to employees' profit sharing plans and accrued expenses.
(10-K and news release)
Canada
The Canada operating segment reflects the results for Acklands-Grainger Inc., Grainger’s Canadian business. Other businesses include single-channel online businesses such as MonotaRO in Japan and Zoro in the U.S. and business units in Europe, Asia and Latin America.
In the first quarter, sales in Canada grew 4.1% to $186 million or 7% of total sales excluding adjustments, and generated losses of $16.73 million compared to losses of $12.3 million in first-quarter 2016.
Grainger reported an ROIC figure of -8.2% for Canada operations in the first quarter compared to -12.3% in first-quarter 2016.
(10-K and news release)
Other Businesses
According to filings, included in Other Businesses is Zoro in the U.S., MonotaRO in Japan and other operations in Europe, Asia and Latin America.
Zoro is an online distributor of MRO products serving U.S. businesses and consumers through its website, Zoro.com. Zoro serves Canadian customers through ZoroCanada.com.
Meanwhile, Grainger operates in Japan and other Asian countries primarily through its 51% interest in MonotaRO. MonotaRO is a catalog- and web-based direct marketer with approximately 91% of orders being conducted through Monotaro.com. According to Grainger, MonotaRO has a market share of 2% in the Japanese market for MRO products that was worth an estimated $41 billion in 2016 in Japan.
Cromwell is a broad-line industrial distributor of MRO products in the United Kingdom serving approximately 70,000 industrial and manufacturing customers. Similar to MonotaRO, Grainger estimates that Cromwell has 2% of the market share that is worth $16 billion in the United Kingdom.
Cromwell was acquired by Grainger in 2015 for about $482 million.
Â
"We have demonstrated that when we have a broad product line and supply chain scale as we do in the U.S., we can develop a profitable online model very quickly. Cromwell is a great company with an outstanding product offering, strong management team and stable supply chain and will be a strong addition to Grainger."Â –Â Jim Ryan, chairman, Grainger
In first-quarter 2017, sales in Other Businesses grew 11.7% to $497.4 million or 18.9% of total sales and delivered an earnings margin of 6.3% vs. 4.9% in first-quarter 2016.
No ROIC figures were observed for the segment.
Total net sales and net earnings
(10-K and news release)
According to Morningstar data, W.W. Grainger had a three-year sales growth average of 4.7%, profit decline average of -8.7% and profit margin average of 7.2%.
Cash, debt and book value
As of March, W.W. Grainger had $238.8 million in cash and cash equivalents, and $2.29 billion in debt with a debt-equity ratio of 1.195 times vs. 1.098 times in the earlier-period quarter.
Of $5.78 billion assets 19.4% were labeled as goodwill and intangibles having a book value of $1.92 billion compared to $2.36 billion in the earlier-period quarter.
Cash flow
(News release)
In first-quarter 2017, W.W. Grainger’s cash flow from operations increased by 12.6% to $180.95 million. Despite lower profits, the company logged higher cash flow from provisions for accounts receivable losses, inventories, current income taxes payable, accrued employment-related costs and other-net.
(Annual report and news release)
Capital expenditures were $78.8 million leaving W.W. Grainger with $102.2 million in free cash flow compared to $108.8 million the earlier-period quarter; 226% of its free cash flow or $231.3 million were allocated as dividends and share repurchases, whereas the company averaged handing out 191% free cash flow payouts in the past three fiscal years.
(Annual report and news release)
In the first quarter, W.W. Grainger took in $33.3 million in borrowings net payments.
Conclusion
In terms of averages, the revised (lower) sales growth and earnings-per-share figures is still in line with W.W. Grainger’s recent fiscal year’s of operations. The share plunge that occurred recently provides an opportunity for even the short-term speculators.
Meanwhile, Grainger did show weakness in its operations. More importantly, its Canada business has been operating on a loss since 2016. Nonetheless, the company expects the segment to break even by the end of 2017.
Grainger also carried a bit more leveraged balance sheet and a good amount of blue sky elements –Â goodwill and intangibles –Â in it.
Further, the industrial distributor exhibited a relatively steady cash flow from its operations while maintaining overly generous payouts –Â including buybacks and dividends –Â to its shareholders in recent years.
(W.W. Grainger Share Price and Price-Sales Ratio, GuruFocus)
Fifteen analysts had an average price target of $239.78 a share –Â a 23% upside from the share price of $195.15 (at the time of writing).
Calculating by using midpoint sales growth expectations for fiscal 2017 and three-year P/S average multiples before applying a 25% margin would indicate a value of $11.95 billion or $205 per share.
In summary, Grainger is a speculative buy with $230 per share value.
Disclosure: I have shares in Grainger.
Start a free seven-day trial of Premium Membership to GuruFocus.
