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Grainger Falls Short of Estimates

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W.W. Grainger, Inc. (GWW - Free Report) reported adjusted earnings per share of $2.42 for the fourth quarter of 2012, up 14% year over year from $2.13 but well short of the Zacks Consensus Estimate of $2.61.

Including restructuring charge (18 cents) for improving the long-term performance of the businesses in Europe, India and China and 3 cents per share related to branch closures in the United States and an impairment charge of 4 cents per share related to acquisition of Alliance Energy Solutions in November 2009, EPS in the quarter was $2.17.  
Including 16 cents per share charge from the closure of 27 branches in the U.S, and a gain of 7 cents per share from the sale of the company's investment in MRO Korea, EPS in the prior-year quarter stood at $2.04. 
Operational Update
Revenues in the quarter were $2,226.1 million, up 7.2% from $2.08 billion in the year-ago period but missed the Zacks Consensus Estimate of $2,237 million. On a daily basis, sales improved 6% on volume growth, pricing, acquisitions and increase in sales from Hurricane Sandy-related products, offset by a negative impact due to the timing of the December holidays.  On a daily basis, sales improved 6% in October, 8% in November and 2% in December.
Adjusted operating income in the quarter increased 18% to $283 million, primarily driven by higher sales volume and operating expense leverage as expenses grew at a slower rate than sales. Operating margin expanded 110 basis points to 12.7% in the quarter.
Segment Performance
Revenues from the United States segment increased 5% year over year to $1.71 billion, driven by favorable volume, price growth, increased sales due to Hurricane Sandy related sales, offset by the timing of December holidays. On a daily basis, sales improved 4% in October, 6% in November and 1% in December.  Operating income rose 17% to $276 million, driven by higher sales and positive expense leverage.
Revenues from the Acklands-Grainger business in Canada climbed 14% to $280 million, led by strong growth in the commercial, construction, oil and gas, and utilities end markets. On a daily basis, segment sales improved 12% in October, 8% in November and 5% in December. Operating income in Canada was up 2% to $30 million as benefits from a favorable foreign exchange, modest expense leverage, were partially offset by lower gross margins. 
Revenues from Other businesses (which include Asia, Europe and Latin America) increased to $263.8 million from $226.9 million in the year-ago quarter, driven by strong growth in Japan and acquisitions in Brazil. Sales for Other Businesses increased 10%, excluding the effect of the acquisitions. The segment reported an adjusted an operating profit of $3.3 million compared with $5.4 million in the year-ago quarter.
During the quarter, Grainger announced structural changes to the businesses in Europe, India and China to improve its long-term performance. This resulted in $13.7 million in restructuring charges. Including this, the segment reported an operating loss of $10.4 million.
Fiscal 2012 Performance
Grainger reported adjusted EPS of $10.43 in fiscal 2012, up 15% from $9.04 in the prior fiscal but fell short of the Zacks Consensus Estimate of $10.62. Including one-time items, EPS in the fiscal stood at $9.52 compared with $9.07 in 2011. Revenues in fiscal 2012 were $8.95 billion, up 11% year over year but missed the Zacks Consensus Estimate of $8.96 billion.
Financial Position
Grainger had cash and cash equivalents of $452 million as of fiscal 2012 end compared with $335.5 million as of fiscal 2011 end. Long-term debt was worth $467 million as of fiscal 2012 end, compared with $175 million as of fiscal 2011 end.
The company generated cash flow from operating activities of $816 million during the year, up from $746 million in the prior year. Grainger expended $250 million in capital expenditures during the year compared with $197 million in the prior year, driven primarily by investments to expand the distribution center network in North America.
Grainger paid dividends worth $220 million in 2012 and spent $341 million to buy back 1.7 million shares. The company has approximately 5.3 million shares remaining in its share repurchase authorization.
Grainger reaffirmed its EPS guidance in the range of $10.85-$12.00 per share for fiscal 2013. Grainger, however, increased its sales growth guidance to a new range of 3% to 9%, up from the prior projection of 2% to 8%. The increase in guidance reflects the acquisition of Techni-Tool, Inc. in December.
Our Take
Grainger remains focused on expanding its product offerings and growing the share of its private label products. The company currently added 80,000 products during the year, bringing its current offering to 413,000 products. Grainger has a long-term vision to expand the product count to 500,000 by 2015. The company has historically seen growth of approximately 2% per year on sales from products added through the program.
Grainger also focuses on expansion programs for strengthening its businesses in each of its operating regions, mainly in Asia and Latin America. Revenues from Other Businesses continue its solid growth run, reflecting strong growth in Japan and Mexico and acquisitions.
E-commerce is one of Grainger’s most efficient channels as it is reportedly growing twice as fast as other channels and is deemed to be Grainger’s most profitable channel. Grainger continues to invest in e-commerce and expects to increase the number of customers utilizing this channel and its percentage of overall sales.  
Grainger posted $2.7 billion in eCommerce sales in fiscal 2012, representing 30% of the total company sales and an increase of 23% from the prior year. There is also scope to increase it up to 50% in the next five years. This channel also carries higher margins as it requires lower selling, general and administrative costs.
However, the recent slowdown in the sales growth rate raises our concern. Margins are expected to remain under pressure due to Grainger’s accelerated investments in product line expansion, sales force expansion, eCommerce, inventory services, distribution centers and international expansion. Grainger currently retains a short-term Zacks Rank #4 (Sell).
Illinois-based 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.
Grainger’s peers such as Codexis, Inc. (CDXS - Free Report) , Hudson Technologies Inc. (HDSN - Free Report) , and TMS International Corp. , have yet to announce their earnings results. 

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