Generating Fast Profits From Industrials

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

The manufacturing and construction industries should no doubt be big beneficiaries of the rising economy. What's one of the best ways to play the industry? Fastenal (NASDAQ: FAST) is the leading distributor of fasteners and industrial supplies in the U.S. One of the big reasons I like the stock is because the company pays a modest 2.1% dividend yield, but boasts a 27% return on equity. 

Sales are expected to be up 8% in 2013 and 15% in 2014 on the back of a rebounding economy. The company has managed to grow sales nicely over the past couple of years despite a weak operating environment; in 2012, sales were up 13% year-over-year.

Meanwhile, over the last five years the company slowed its store-opening rate to between 3% and 8%. It has used the money saved by lowering store openings to reinvest in its headcount. Fastenal is expected to add some 100 to 150 employees per month over the next six months. The increased headcount should also allow Fastenal to better cater to higher demand. 

One of Fastenal's other big initiatives involves vending. The company has launched FAST solutions--an industrial-vending process where Fastenal installs vending machines at customer locations and then refills them periodically. The vending machines inform the customer of which products they are using, helping them control inventory and costs. Fastenal has installed 30,000 machines, and the units currently account for more than 30% of the company's sales. 

Unexpected comp 

Many of the products that Fastenal makes are ultimately sold by other companies, but as far as competition goes, the e-commerce giant, Amazon (NASDAQ: AMZN), is one of the company's top competitors. Amazon is a relatively new entrant to the industrial-supply space, having launched Amazon Supply in early 2012. Amazon started out selling books, but has grown into a seller of virtually any and all products. 

Its major segment is its electronics and general merchandise North American unit (over 40% of revenue). Amazon's international business only accounts for 14% of revenue, leaving a solid opportunity for growth. I don't think Amazon will be spending much time trying to build out its industrial business--rather, the company will likely buckle down in the tech and hardware space. This includes possibly developing a new Kindle. 

Amazon posted a $0.02 loss for 2Q, versus the $0.01 in income for the same period last year. Despite the loss, revenue was up 22% year-over-year. Revenue is expected to be up 22% in 2013 after being up 27% in 2012. Continued revenue growth, but when will earnings follow? The company is continually taking market share from conventional retailers, but at a large loss.

I think Amazon is still the place for media and entertainment, and still has a long way to go before becoming  formidable in the industrial-supplies market. However, do keep a close eye on Amazon, as it's not to be dismissed completely. The likes of Best Buy and RadioShack too quickly dismissed the e-commerce giant and have been trying to recover ever since. 

Other major industrial comp 

W.W. Grainger (NYSE: GWW) is another major comp. The company is the largest global distributor of industrial and commercial supplies, such as hand tools, electric motors, light bulbs and janitorial items. It is seeing strong results of late, with 2Q EPS coming in at $3.00 versus $2.63 for the same period last year. Sales are expected to be up 8% in 2013 thanks to growth in heavy manufacturing in the U.S. 

The company owns some 6% share of the estimated $118 billion U.S. facilities- maintenance market and an 8% share of the Canadian market. Yet, China is the face of Grainger's future.

The company estimates that the current facilities-maintenance-supplies market in China is worth $38 billion, and is expected to approach $70 billion by 2014 end. In conjunction with its 2Q EPS, the company upped the lower end of its full 2013 EPS guidance by $0.10, expecting to post $11.40 to $12.00. 

Bottom line

Driving the industrial-supply companies over the interim should be growth in the U.S. manufacturing market. Fastenal does trade at an out-sized P/E of 32 times, but its debt-free balance sheet makes the stock compelling.

Grainger trades at 25 times earnings and could also be a solid investment in the industrial-supply market, but its dividend isn't quite as strong as Fastenal's at only 1.4%. Together, Fastenal and GWW command some 40% of the market share for industrial products. I am still not a fan of Amazon, given the company's continued loss of money quarter after quarter. 

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Marshall Hargrave 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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