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We are maintaining our Neutral recommendation on W.W. Grainger Inc. (GWW - Analyst Report), a leading North American distributor of maintenance, repair and operating supplies, as well as other related products and services.

Grainger’s third quarter 2012 earnings increased 12% year over year to $2.81 per share, while revenues advanced 8% to $2.28 billion. However, both fell short of the respective Zacks Consensus Estimates.
 
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 come 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 in the international market 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 businesses, 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 offers further 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 consistent dividend hikes over the last 41 years, a record that only 12 companies in the S&P 500 can boast. Going forward, the company will continue to redeploy cash and plans to repurchase approximately 2% of outstanding shares each year.
 
On the flip side, Grainger’s sales growth of 6% in October 2012 was the lowest so far this year. Grainger’s sales growth has trailed from the highest level of 18% achieved in February to growth in the low double digits before dipping to 10% in August and 9% in September. 
 
Even though daily sales growth in November is trending higher than the October levels, boosted by increased sales of products related to recovery effort from the Hurricane Sandy, Grainger expects the timing of the holidays (Christmas and New Year's Day) to have a negative impact on sales in the fourth quarter.
 
Earlier this month, in light of a weak economy, Grainger narrowed its earnings guidance for 2012 to a range of $10.55 to $10.75 per share from the previous guidance of $10.50-$10.80. The Zacks Consensus Estimate for the year is at $10.62 per share. Grainger reiterated its sales growth guidance of 11%-12% for 2012. 
 
For fourth-quarter 2012, Grainger expects sales to be in the range of 7% to 9%. It anticipates earnings to lie within $2.55-$2.75 per share. The Zacks Consensus Estimate for the fourth quarter is currently pegged at $2.61 per share. Grainger also provided its outlook for 2013. It envisions sales to grow 2% to 8% and earnings to be in the range of $10.85-$12.00 per share.
 
Amazon.com Inc. (AMZN - Analyst Report) 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. The company competes with Applied Industrial Technologies Inc. (AIT - Snapshot Report) and WESCO International Inc. (WCC - Analyst Report).

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