W.W. Grainger, Inc. (GWW) reported third-quarter 2014 earnings per share of $3.30, up 12% from $2.95 per share in the year-ago quarter and ahead of the Zacks Consensus Estimate of $3.28 by 1%. The year-over-year improvement was driven by strong volume growth and positive operating leverage in the U.S. business.
Operational Update
Revenues in the quarter were $2.56 billion, up 7% from $2.40 billion in the year-ago quarter but short of the Zacks Consensus Estimate of $2.58 billion. There were 64 selling days in the first quarter, same as the prior-year quarter.
Acquisitions (net of dispositions) had a positive impact of 2 percentage points, which was offset by a 1 percentage point reduction from foreign exchange.
Organic sales (excluding acquisitions and foreign exchange) increased 6% on the back of increase in volumes (6 percentage points) and 1 percentage point effect from pricing, partially offset by 1 percentage point decline from lower sale of seasonal products,
Cost of sales increased 8% year over year to $1.46 billion. Gross profit increased 5% year over year to $1.102 billion. Gross margin contracted 80 basis points to 43%, affected by unfavorable mix from the acquired businesses, faster growth with lower gross margin customers and lower gross profit margins from the international businesses.
Operating expenses increased 8% to $1.46 billion due to increased growth and infrastructure spending as well as incremental expenses from the acquired businesses. Operating income in the quarter increased 11% to $385 million from $347 million in the prior-year quarter. Operating margin expanded 50 basis points to 15% in the quarter.
Segment Performance
Revenues from the United States segment increased 7% year over year to $2.05 billion, driven by favorable volume and acquisitions. However, it was somewhat offset by the negative impact of lower sales of seasonal products. Solid growth was witnessed in the Heavy and Light Manufacturing, Natural Resources, Retail and Commercial customer end markets.
Operating income rose 13% to $386 million, driven by higher sales growth and positive expense leverage. However, lower gross margin had a deterring effect.
Revenues from the Canadian Acklands-Grainger business increased 3% (8% in local currency) to $278 million led by solid growth to customers in the Commercial, Transportation, Oil and Gas, Government, and Heavy and Light Manufacturing end markets. Operating income in Canada, however, plunged 14% (down 10% in local currency) to $27.5 million, hurt by lower gross margins and negative expense leverage.
Revenues from Other businesses (which include Asia, Europe and Latin America) increased 16% to $300.8 million. Growth from volume and price (18 percentage points) was offset by a 2 percentage point dip due to unfavorable foreign exchange. Improved performance in the single channel businesses, MonotaRO in Japan and Zoro in the United States and from the business in Mexico, led to the improvement.
The segment reported an operating profit of $5.2 million, down 16% from $6.2 million in the year-ago quarter due to incremental expenses associated with the start-up of the single channel business in Europe and continued soft performance from the multichannel business in Europe (Fabory). This was, however, partially offset by improved performance in Mexico and continued strong results from the single channel models in Japan and United States and narrowing of losses in China.
Financial Position
Grainger had cash and cash equivalents of $314.7 million as of Sep 30, 2014, compared with $431 million as of Dec 31, 2013. The company generated cash flow from operating activities of $658 million during the first nine month period of 2014, down from $740 million in the prior-year comparable period. Long-term debt was $385 million as of Sep 30, 2014, compared with $445 million as of Dec 31, 2013.
During the quarter, Grainger paid dividends worth $74 million and spent $82 million to buy back 0.3 million shares. At the quarter end, the company had 9.4 million shares remaining on its share repurchase authorization.
Guidance
Grainger reduced the top end of its earnings per share (EPS) guidance for fiscal 2014 to the range of $12.20 to $12.30 from $12.20–$12.60. This excludes the 15 cents per share charge for the Fabory retirement plan transition in the second quarter of 2014. The company now projects 5-5.5% growth in sales, lower than the previous expectation of 5-7% growth.
The previous earnings guidance assumed an effective tax rate of 37.5-37.8%. Grainger has factored in an effective tax rate of 38.3% in its revised guidance due to a higher proportion of earnings from the U.S. segment, reducing earnings for the full year by approximately 12 cents per share.
Our Take
Grainger is focused on expanding its product offerings, sales force as well as the share of its private label products, which will lead to long-term growth. Grainger continues to invest in e-commerce expecting an increase in the number of customers utilizing this channel and its percentage of overall sales. Furthermore, Grainger’s sound balance sheet, low debt level and cash flow allow the company to invest in growth opportunities, raise dividends and reinvest capital through share repurchases.
Further, Grainger continues to grow through acquisitions. Its three recently acquired businesses in the U.S., Techni-Tool, E&R Industrial Sales and Safety Solutions, are outperforming their sales and earnings projections and the company remains on track with its integration plans.
Recently, Grainger’s Canadian business, Acklands-Grainger, closed the acquisition of WFS Enterprises Inc., a leading distributor of tools and supplies to the industrial markets in Southern Ontario and select U.S. locations. This will facilitate greater customer value through broader product offering, additional solutions and technical expertise.
Grainger’s business in Canada had performed below expectations in the first half of the year. Even though the business delivered top-line growth in the third quarter, margins remain under pressure due to currency and additional investments.
Grainger’s single channel businesses in Japan and the United States continue to perform well and the company is evaluating and testing additional markets for expansion of this model. On the contrary, outside of North America, the performance of several multichannel businesses has not been as per expectations. The company remains focused on improving or exiting these operations.
W.W. Grainger is a leading North American distributor of material handling equipment, safety and security supplies, lighting and electrical products, power and hand tools, pumps and plumbing supplies, cleaning and maintenance supplies, forestry and agriculture equipment, building and home inspection supplies, vehicle and fleet components, and various aftermarket components.
Grainger currently carries a short-term Zacks Rank #3 (Hold). Some better-ranked stocks in the sector include Middleby Corp. (MIDD), HD Supply Holdings, Inc. (HDS) and The Babcock & Wilcox Co. (BWC). While Middleby Corp. sports a Zacks Rank #1 (Strong Buy), Babcock & Wilcox and HD Supply Holdings carry a Zacks Rank #2 (Buy).
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