Dividend Aristocrats In Focus Part 34: GWW

Author's Avatar
Nov 05, 2014

In part 34 of the Dividend Aristocrats In Focus series I take a look at the growth prospects and competitive advantages of W.W. Grainger (GWW, Financial). W.W. Grainger is the U.S. leader in the maintenance, repair and operations (abbreviated as MRO) supply industry. The company has a market cap of $17 billion and has increased its dividend payments for 42 consecutive years. W .W. Grainger is one of the quickest growing dividend aristocrats; the company has managed to grow revenue per share at a CAGR of over 10% per year. The company’s operations are analyzed in detail below.

Business overview

W.W. Grainger operates in three segments; United States, Canada and Other Businesses. The United States segment is far and away the largest. The United States segment has contributed 93% of operating income through the first three quarters of fiscal 2014. The Canada segment is responsible for 6% and Other Businesses just 1%.

W.W. Grainger’s business model is to sell maintenance, repair and operational products both online and through its network of stores. The company has 19 distribution centers and 395 branches in the U.S., six distribution centers and 182 branches in Canada, and 149 branches and nine distribution centers spread throughout Europe, China, Japan, South America and the Caribbean.

Competitive advantage

W.W. Grainger’s United States segment is home to its strongest competitive advantages. As the U.S. leader in the highly fragmented maintenance, repair and operation industry, the company has a scale advantage over its competitors. This allows it to purchase its inventory at a slightly lower price than competitiors as it can place substantially larger orders and put leverage on suppliers.

The primary competitive advantage W.W. Grainger enjoys is its strong U.S. distribution network. The company has 395 U.S. branches and 19 distribution centers scattered throughout the U.S. This distribution network would be very costly for a competitor to replicate. The distribution network gives W.W Grainger better efficiency as it can supply businesses throughout the nation rather than in one geographic location.

Growth prospects

W.W. Grainger has solid growth prospects ahead. The company has maintained a 15% EPS CAGR and 10% revenue per share CAGR over the last decade. Further, the company has paid increasing dividends for 42 consecutive years, so it was returning cash to shareholders while on its impressive growth run.

The company’s growth is being fueled by its slow consolidation of the U.S. MRO industry. The company currently controls just 6% of the highly fragmented MRO market and it has the highest market share of any business. W.W. Grainger has been growing by acquiring several smaller businesses in “bolt-on” acquisitions. These acquisitions further boost the company’s supply chain and reinforce the company’s efficiencies of scale in a virtuous cycle.

As an example, the company recently acquired WFS Enterprises, a tools and supplies distributor operating in Southern Ontario and the US. The company has 12 locations and generated about $87 million in sales over the last twelve months. Bolt on acquisitions like this have driven W.W. Grainger’s growth. The company has a long growth runway ahead as it currently controls just 6% of the MRO market.

Dividend analysis

W.W. Grainger currently has a dividend yield of 1.7%. The company has a payout ratio of just 30%. I expect W.W. Grainger to continue growing in double digits. Dividends should grow faster than overall revenue growth, and at least in line with EPS growth. The company’s low payout ratio gives it room to raise dividends even faster than current growth. Based on this, I expect W.W. Grainger to grow its dividend payments by 10% to 15% over the next several years. If the company grows its dividend payments at 12% per year, its future yield on cost will look like this:

  • Yield on cost in 3 years of 2.4%
  • Yield on cost in 5 years of 3.0%
  • Yield on cost in 10 years of 5.3%

Recession performance

W.W. Grainger performed well throughout the last recession. The company remained profitable, but saw EPS dip slightly in 2009. W.W. Grainger sells its products primarily to business customers. As a result, sales tend to dip as the economy enters recessions because businesses put off purchases as much as possible to manage weaker cash flows. W.W. Grainger’s EPS leading up to the recession and through recovery are shown below to give you an idea of how the company performed through the Great Recession of 2007 to 2009.

  • 2007 EPS of $4.94
  • 2008 EPS of $6.09
  • 2009 EPS of $5.25 (recession low)
  • 2010 EPS of $6.81 (new high)

As you can see, the company was only minimally effected by the Great Recession. EPS dipped slightly in 2009, but the company set a new EPS high the next year, in 2010.

Valuation and final thoughts

W.W. Grainger has a PE ratio of about 21.5. The company is trading at a slight premium to the S&P500 which has a PE ratio of 19.6. W.W. Grainger has traded at a premium of about 1.15x over the last five years. I believe the company’s premium valuation is warranted given its strong competitive advantages and excellent growth prospects. At current market prices, W.W. Grainger appears to be close to fair value. If the S&P 500 were to revert to its historical PE ratio average of about 15, W.W. Grainger’s fair valuation multiple would be about 17.3. I believe the company is fairly valued at current market prices, and somewhat overvalued on an absolute basis due to the overall elevated stock market.

W.W. Grainger is a high quality business with excellent growth prospects. The company is a Top 20 stock based on The 8 Rules of Dividend Investing due to its excellent revenue per share growth rate, decent dividend yield, and relatively low payout ratio. I believe the company makes a solid buy for investors who are looking for solid dividend growth going forward.