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Will Slower Demand Offset Fastenal's Ongoing Growth Efforts?

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Fastenal Company (FAST - Free Report) has been gaining traction, particularly on the back of the strong industrial vending business and existing Onsite locations. Also, the company’s cost-saving efforts are aiding the business to generate improved earnings.

Notably, its shares have gained 47.9% in the past year compared with the industry's 29.8% growth. The outperformance can be attributable to the company’s solid earnings surprise history, having surpassed analysts’ expectations in four out of the last six quarters. Also, revenues surpassed the Zacks Consensus Estimate in nine of the trailing 11 quarters.

However, slower end-market activity throughout the business has been a concern for Fastenal over the last few quarters. Also, negative customer/product mix, higher freight expenses and stiff competition raise concerns. Its 2020 earnings are expected grow at a rate of just 5.7% on a year-over-year basis.

Let’s delve deeper into the factors that justify its current Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Major Growth Contributors

Fastenal’s performance has been robust over the last few quarters. The Industrial vending business is one of the primary growth drivers having the potential to significantly increase its sales and profits in the future.

Through FAST Solutions, the company installs vending machines at the customer’s location and keeps it filled with the products they need. These machines help customers in controlling their inventory and administrative costs, while reducing product consumption. Notably, the non-fastener product line has benefited significantly from its initiatives pertaining to industrial vending.

Sales through vending devices continued to grow at a double-digit pace during the first nine months of 2019 and the company is likely to have signed about 22,000 vending devices in 2019.

Fastenal has Onsite locations, in which a mini-Fastenal shop is located in a customer’s plant, helping to serve customers better. The company signed 14 new Onsite locations during the first nine months of 2019. The increased number of onsite locations is likely to expand its market share.

In a bid to reduce costs arising from tariffs and freight expenses, the company has undertaken various cost-control measures. The strategies include automating warehouses, increasing delivery efficiency through its trucking network and selling more private-level products with higher margins. The initiatives will aid Fastenal to improve efficiency level, thereby increasing returns.

Ongoing Headwinds

While the company is making progress to mitigate persisting weakness, slower end-market activity and ongoing U.S.-China trade negotiations remain a significant headwind for Fastenal and other industry players like BMC Stock Holdings, Inc. (BMCH - Free Report) , GMS Inc. (GMS - Free Report) and Builders FirstSource, Inc. (BLDR - Free Report) . In third-quarter 2019, the company’s daily sales growth was recorded at 6.1%, lower than 7.9% and 13% increase in second-quarter 2019 and the prior-year period, respectively.

During the third-quarter earnings discussion, Fastenal reduced the 2019 vending machine target to approximately 22,000 from the previous goal of 23,000-25,000 units, as a result of slower economic activity.

Also, headwinds from customer mix, which shifted toward the large-account end-market that produces low-margin gross profit but stronger operating income, are raising a concern. Fastenal ended the first nine months of 2019 with a gross margin contraction of 120 basis points from the year-ago level, mainly due to lower daily sales, price/cost deficit and higher freight expense.

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