By Jay Peroni, CFP®
Many industrial companies go through wild booms and busts through volatile economic times, yet WW Grainger stock has returned an average of 19% per year for the past decade.
WW Grainger Stock Analysis
Sometimes being in the right place at the right time can be rewarding, especially when it comes to investing. Being in the right asset class, the right country or even the right sector when they are in favor can pay off big time and boost your portfolio’s returns. Though it’s difficult to time the market, clearly some investors have advantages when it comes to stock picking.
All-Weather investing is all about high quality and low volatility. Though choosing winning stocks is not easy, it pays to find quality companies. For example, I often look for industry leaders that continue to reward shareholders year after year. One of the sectors that sometimes gives investors trouble is the industrials sector. It is a highly sensitive sector that often lives and dies by the overall health of the global economy. When times are good, manufacturing takes off, but when things slow down, the sector can see very difficult times. Just ask shareholders of companies like Caterpillar (NYSE: CAT), Boeing (NYSE: BA), or Precision Castparts Corp. (NYSE: PCP) who have seen a rollercoaster ride over the past 5 years.
One of the ways I like to play this volatile sector is through industrial distributors. The industrial distribution industry is highly fragmented with the top 50 distributors representing about 30% of the roughly $140 billion North American market. Though this is a highly competitive field with low customer switching costs, not much protection from new entrants into the market, and plenty of choices, one company has clearly been able to rise above the pack and deliver solid, consistent returns for its shareholders.
The company I am referring to is WW Grainger (NYSE: GWW). Since 1927, it has been an industrial distributor of maintenance, repair and operations supplies for businesses and institutions primarily in the United States and Canada. Grainger helps customers save time and money by providing them the right products to keep their facilities up and running. It serves over 2 million businesses and institutions in 157 countries. It works with more than 3,500 suppliers to provide customers with access to more than 1 million products including adhesives, fasteners, hand tools, lighting, motors, office furniture, plumbing supplies, and much more.
Through increasing its product offerings and scale, Grainger has been able to offset cost inflation, expanding its gross margins from 32% in 2002 to 43.8% in 2012. It has been able to boast 17% returns on invested capital for the past 15 years while many of its competitors are still in single digits. Because it is the largest customer for 7 of its 10 largest suppliers margins should continue to expand and shareholders could continue to see solid returns for years ahead.
One of the ways Grainger has been able to stand out is by aggregating demand on a national level. This enables manufacturers to operate closer to optimal utilization levels and minimize inventory risk. Manufacturers prefer partners like Grainger because it performs the selling functions for suppliers who then have to spend less on marketing and sales. Grainger also has a competitive advantage by upselling its services beyond inventory supply. When it creates on-site accounts with clients, revenues typically grow 2-3 times the normal growth rate of the company. The online sales channel has grown at double the company’s overall growth rate and now represents almost 20% of its total sales. As Grainger places further emphasis on this sales outlet, it should boost profitability because online selling is the firm’s most profitable avenue.
Today, Grainger controls approximately 5% of this market, and this could double over the next decade. I believe with its current pace, Grainger should be able to go from $9 billion in revenue, which it saw in 2012 to $18 billion by 2022. With an annual growth rate in excess of 10%, Grainger should be able to boost its North American sales and expand internationally.
Take a look at WW Grainger stock since 2009:
Grainger is in solid financial shape with over $486 million in cash, modest financial leverage at a 15% debt/capital ratio, and EBIT interest coverage ratios well above 90 times during the past three years. It recently reported record earnings per share for its 2013 first quarter as management now expects 2013 sales growth of 5%-9% and earnings per share of $11.30-$12.00.
It also reported daily sales increased 6%, gross margins increased 0.80% to 45.2%, while operating margins expanded 1.2% to 15.1%, its highest quarterly level since 2006.
Risks to Consider
Industrial distributors have not been able to gain much of a foothold in the emerging markets thus far. Though Grainger has presence in places like India and China, it has not seen the impressive international growth one would expect. If manufacturers move more production overseas, this could impair Grainger’s profitability. Additionally about 70% of Grainger’s sales volume is shipped to customers based on a requisition order, not in-store purchases. This allows its customers to comparison shop and limits Grainger’s ability to raise prices.
Bottom Line: W.W. Grainger stock (NYSE:GWW) is a good buy up to $250. It pays a $3.20 dividend, which is about a 1.3% yield and has raised its dividend every year since 1972. My target sell is $325, representing a 35% upside over the next 12-18 months.
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Disclaimer: Investing involves risk. Always do your own due diligence and consult a trusted financial professional before making any investing or financial decisions. Jay Peroni is a Certified Financial Planner and is part of our Christian Financial Advisor Network. FTMDaily is affiliated with Jay Peroni and Faith Based Investor, LLC.