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Analyst Blog

On Nov 22, we maintained our Neutral recommendation on distributor of facilities maintenance, repair and operating supplies, W.W. Grainger Inc. (GWW - Analyst Report). Our recommendation is based on expectations of growth opportunities through product and geographic expansion and e-commerce, partially offset by the recent slowdown in sales, impact of sequestration and the government shutdown and impending pressure on margins.

Why Reiterated?

Grainger reported third-quarter 2013 earnings per share of $2.95, up 5% from $2.81 per share in the year-ago quarter. Grainger expects sales to grow 6% to 8% year over year in the fourth quarter. Earnings per share are expected to range between $2.53 and $2.73 for the quarter.  This reflects a 5% to 13% increase from year-ago quarter’s earnings of $2.42 a share. Grainger forecasts revenue growth in the range of 5% to 6% in fiscal 2013 and earnings between $11.45 and $11.65 a share, reflecting an annual increase of 10% to 12%.

For 2014, the company initiated guidance with sales growth projected between 6% to 10% and earnings per share in the band of $12.25 to $13.00. Grainger also provided an update on its longer-term financial objectives. By 2019, operating margins are targeted to be in the range of 16% to 17%. This is expected to be driven by organic sales growth in high-single digits and operating margin expansion of approximately 30 to 60 basis points per year.

We appreciate Grainger’s focus on expanding its product offerings as well as the share of its private label products. Grainger expects to increase its product count from the current 413,000 to 500,000 products by 2015. The company has historically seen annual growth of approximately 2% on sales from products added through the program.

The company continues to expand its businesses across its operating regions, mainly in Asia and Latin America. Grainger also continues to invest in e-commerce, as it is reportedly growing two fold compared to other channels and is deemed to be the company’s most profitable channel. e-commerce sales currently represents 33% of total company sales. Grainger’s target is to increase it up to 50% by 2015.  This channel also carries higher margins as it requires lower selling, general and administrative costs.
 
On the flipside, Grainger's overall sales growth continued to show a downward trend. Sales growth has remained choppy in 2013, ranging from 8% in Jan and Apr 2013 to 3% in March. In October, Grainger reported sales growth of 7%. According to Grainger, daily sales growth in the U.S in November is trending in line with the October level. However, sales are reportedly lower than October outside the U.S.

Pricing and unfavorable foreign exchange were a headwind in the third quarter and are expected to remain so for the balance of the year. Unlike 2012, Grainger is not expecting any interim price increases for the remainder of 2013. Grainger now expects contribution from pricing for the year to be 1 percentage point, down from its prior view of 2 percentage points. For 2013, Grainger has projected incremental growth-related spending of $135 million. Even though these initiatives will lead to additional share gains in the future, the increased spending will weigh on margins.

Other Stocks to Consider

Grainger retains a short-term Zacks Rank #4 (Sell). However, some better-ranked industrial product stocks include Hudson Technologies Inc. (HDSN - Snapshot Report), ScanSource, Inc. (SCSC - Snapshot Report) and Graham Corp. (GHM - Snapshot Report). All these stocks carry a Zacks Rank #2 (Buy).

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