The Construction Business Is One of the Best Economic Recovery Plays

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

With the U.S. economy showing signs of finally producing a sustainable recovery, there are opportunities to be found in some of the companies that produce items that will benefit the most from an improved economy. One area that should tremendously benefit from improving economic fundamentals is the construction industry. An improved economy means more new homes being built, more renovations of existing homes, more commercial construction projects, and more infrastructure projects, such as roads being rebuilt. One of my favorite ways to play this is with Fastenal (NASDAQ: FAST), one of the world’s leading manufacturers of fasteners for the construction industry.

About Fastenal

Fastenal has grown tremendously over its 45-year history and now operates over 2,600 stores in all 50 states and 16 countries around the world. The company’s main products are its line of almost 600,000 different types of threaded fasteners and related accessories. 

In addition to fasteners, the company also sells tools and equipment, cutting tool blades, fluid transfer components, welding supply items, and safety equipment, just to name a few. Most of the products sold in the company’s stores are made by other companies. Fastenal’s supplier and customer bases are both extremely diverse, with no one supplier or customer accounting for a significant percentage of the company’s business.

Fastenal has expanded aggressively over the past decade, with revenues more than tripling during that time period:

Looks expensive, but don’t be fooled

At over 33 times last year’s earnings, Fastenal seems a bit expensive upon first glance. However, I feel that Fastenal’s growth potential and strong financial position completely justify its valuation. One of the company’s new growth strategies is to put vending machines at customer job sites with various fasteners and other supplies they may need. Since beginning this strategy, Fastenal has over 25,000 vending machines currently in operation, and plans to add another 30,000 this year. 

Due to the combination of their new growth initiatives and the continued economic recovery, Fastenal is projected to grow its sales at a double-digit rate going forward. Combined with a renewed emphasis on cost controls which are expected to produce wider margins, Fastenal is expected to grow its profits at a very impressive pace. For 2013, Fastenal is projected to earn $1.59 per share, rising to $1.85 and $2.14 in 2014 and 2015, respectively. This translates to a three year average forward earnings growth rate of 14.7%. The combination of this with Fastenal’s excellent balance sheet with no long-term debt whatsoever leads me to think that shares are still very reasonably valued.

A new threat?

One interesting threat to Fastenal’s business is Amazon’s (NASDAQ: AMZN) entry into the construction supply business with its launch of AmazonSupply just over a year ago. While still in its early stages, this new venture is certainly worth keeping an eye on. While I have no delusions that bricks-and-mortar retailers such as Fastenal will be able to effectively price-match with Amazon’s amazing supply chain efficiencies, I believe that Fastenal’s vending-machine concept buys them some degree of immunity from this. While Amazon’s “prime” customers can get free two-day shipping on all orders for just $79 per year, having instant access to the construction materials you need while on a job site beats two-day delivery every time.

W.W. Grainger: An alternative

W.W. Grainger (NYSE: GWW) is another option to play the economic recovery through construction. While virtually all construction-related companies are trading at premium valuations, they are also expected to produce very high growth over the next several years, and Grainger is no exception. 

Grainger is the world’s largest distributor of maintenance and industrial supplies, such as pumps, tools, motors, and safety equipment. Similarly to Fastenal, the company has an excellent financial position.  Although it does have some debt, the cash on its balance sheet effectively makes up for it. Grainger trades for a slightly lower valuation of 26.4 times TTM earnings, which are projected to rise at around 13% going forward.

Conclusion

It is hard to go wrong with any construction supply company in the current economic environment, especially if you believe (as I do) that the recovery will continue for several more years. I give the slight edge long-term to Fastenal due to its vending machine initiative, which should be very effective at keeping online competitors from having too much of an effect on their bottom line.


Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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