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We maintained our Neutral recommendation on W.W. Grainger Inc. (GWW - Analyst Report), given the slowdown in sales, margin headwinds and the entry of Amazon.com Inc. (AMZN - Analyst Report) in the maintenance, repair & operations (MRO) space.
Grainger’s second quarter 2012 earnings increased 18% year over year to a record $2.63 per share, while revenues advanced 12% to $2.25 billion. EPS in the quarter was in line with the Zacks Consensus Estimate but revenues fell short.
Grainger remains focused on expanding its product offerings and growing the share of its private label products. The company’s catalog, issued in February 2012, offers around 413,000 products compared with 350,000 in the February 2011 issue. The company has a long-term vision to expand the count to 500,000 products by 2015. It has historically seen approximately 2% incremental growth per year on sales from products added through the program.
Currently, 23% of Grainger’s sales are from private label, but the company expects to increase that to 40% over time. Private label has been a significant driver of sustainable margin expansion over the past few years, especially in the globally sourced product category.
Grainger also focuses on expansion programs to strengthen its businesses in each of its operating regions, mainly in Asia and Latin America. Approximately 25% of 2012 sales are expected to come from outside the U.S compared with 10% in 2002.
The primary areas of focus internationally are sales and earnings growth in the existing markets, selective expansion into new markets in a phased approach and ongoing development of the global infrastructure.
E-commerce is one of Grainger’s most efficient and profitable channels as it is reportedly growing twice as fast as other channels. Grainger still continues to invest in e-commerce and expects to increase the number of customers utilizing this channel, boosting overall sales.
The e-commerce business currently generates 27% of Grainger’s revenues and there is scope to drive it up to 50% in the next five years. This channel also carries higher margins as it requires lower selling, general and administrative costs.
Grainger’s sound balance sheet, low debt level and cash flow characteristics allow the company to further invest in growth opportunities, increase dividends and reinvest capital through share repurchases. The company has been rewarding shareholders with an uninterrupted streak of increased dividends for 41 consecutive years, a record that only 12 companies in the S&P 500 can claim. Going forward, the company will continue to redeploy cash and plans to repurchase approximately 2% of outstanding shares each year.
On the flip side, we believe margins will be under pressure due to Grainger’s accelerated growth investments: product line expansion, sales force expansion, e-commerce, inventory services, distribution centers and international expansion.
Furthermore, Grainger’s sales growth of 11% in July 2012 was weaker than expected, and the lowest so far this year. Grainger’s sales growth has trailed from the highest level of 18% in February, as well as from 12% in April, 13% in May and 12% in June.
Amazon has recently launched www.AmazonSupply.com, a website offering more than 500,000 parts/supplies to business, industrial, scientific and commercial customers at competitive prices. Grainger is presently a dominant player in industrial maintenance, repair & operations distribution, with a product offering of 413,000. With the entry of Amazon in this space, we expect pricing pressure.
We have thus maintained our Neutral recommendation on Grainger. The company currently retains a Zacks #3 Rank (short-term Hold recommendation).
Illinois-based W.W. Grainger is a leading North American distributor of material handling equipment including safety and security supplies, lighting and electrical products, power and hand tools, pumps and plumbing supplies, etc. The company’s services comprise inventory management and energy efficiency solutions.
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