Long Term Story And Abating Concerns Make Grainger A Good Buy
Ashish is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
W.W. Grainger, Inc. (NYSE: GWW) recently reported mixed results, with EPS beating consensus expectations by 1 cent and revenues slightly lower than expectations. The more encouraging fact however was that the company reported that July sales were trending in-line with June despite the July 4th holiday (holidays usually affect the sales of industrial distributors negatively, unlike consumer retailers). This means there was some acceleration in underlying demand in the month of July.
A lot of investors were concerned about the volatile macro environment and the July results, but accelerated demand caused a relief rally for Grainger shares. I believe that abating near term concerns, coupled with a strong secular growth outlook makes Grainger a good buy and that it can outperform the broader markets in the near to long term.
Long term secular growth story: Grainger along with its national peers like Fastenal (NASDAQ: FAST) and MSC Industrial (NYSE: MSM) currently have ~12% share in the $160 bn MRO market. There is a secular tailwind for these companies in the form of gained market share from weaker regional and local (mostly Mom & Pops) players. The last downturn witnessed a lot of smaller players moving out of the business and industrial companies and shifting to more reliable national suppliers with strong balance sheets. I believe this trend is likely to continue for the next several years.
Grainger is likely to grow at a 7-10% normalized run rate for the next several years as it expands its product offerings, market presence, and customer coverage. There is also the long term potential for expansion in international markets. Moreover, GWW's margin initiatives, like increased global sourcing and supply chain initiatives, should drive the company's improved operating margin performance.
Slowing Macros: The biggest concern investors have right now is slowing macros. Grainger being an industrial company has a cyclical demand pattern and any slowdown in macros might affect sales in the near term. Although this is a valid concern, I find recent results reassuring that industrial companies will continue to spend. Another important thing one should note is that although the broader economic slowdown will be a negative for the company’s near term results, it will catalyze Grainger’s market share gains from local mom and pop players who find it difficult to survive in a downturn. In fact, investors should use any correction in Grainger’s stock price from macro concerns to build/increase their position in the company.
Competition from Amazon (NASDAQ: AMZN): Amazon recently announced the launch of AmazonSupply.com for industrial distribution. Some analysts are calling it a threat to industrial distributors and believe that this announcement would keep PE multiples for this sector in check. However, I don’t think any of these concerns are valid. Amazon does have good experience in B2C business, but B2B business is a different game. I don’t see Amazon gaining any significant share at the cost of national industrial distributors which already have a wide presence and good relationships with their customers. At best, it can take some share from the Mom & Pops, but that’s not a big concern, as the market size is big enough to accommodate all these players.
Grainger is currently trading at 17.25x forward PE. This is a premium to its historical trading range. However, I believe it is warranted as investors are increasingly realizing and becoming comfortable with the company’s secular growth potential and gaining market share. Also, the company is still trading at a significant discount to its peer Fastenal which has a forward PE of 26.40x. Thus, I recommend a buy on Grainger.
TheAnalystBlog has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com and MSC Industrial Direct. Motley Fool newsletter services recommend Amazon.com and MSC Industrial Direct. 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.If you have questions about this post or the Fool’s blog network, click here for information.