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 July sales were trending inline with June despite of 4th July holiday (Holidays usually affect industrial distributors negatively unlike consumer retailers). This means there was some acceleration in underlying demand in the month off July.
A lot of investors were concerned about volatile macro environment and inline results and demand acceleration caused a relief rally in the shares of Grainger. I believe abating near term concerns coupled with long term secular growth outlook makes Grainger a good buy and it can outperform the broader markets in 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 $160 bn MRO market. There is a secular tailwind for these companies as they gain market share from weaker regional and local (mostly Mom & Pops) players. Last downturn witnessed a lot of smaller player going out of the business and industrial companies 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 7-10% normalized run rate for the next several years as it expands product offerings, market presence, and customer coverage. There is also the long term potential from 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 the sales in the near term. Although this is a valid concern, I find recent results reassuring that things are going in the right direction and industrial companies 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 shares gains from local mom and pop players who find it difficult to survive in a downturn. In fact investors should use any correction in the Grainger’s stock price because of macro concern to build/increase their position in the company.
Competition from Amazon (NASDAQ: AMZN): Amazon recently announced launch of AmazonSupply.com for industrial distribution. Some analysts are calling it a threat for industrial distributors and believe that this announcement would keep PE multiples of industrial distributors in check. However, I don’t think any of these concerns are valid. Amazon does have a 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 relationship with their customers. At the 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 market share gain story. 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.