Fastenal Company (FAST) hit a 52-week low on Oct 10, the day it reported the third-quarter 2014 results. Though the industrial and construction supplies wholesale distributor outperformed on the top line front, its margin weakness continued.
Despite sales growing 14.3% year over year and beating the Zacks Consensus Estimate, the stock lost almost 5% on Oct 10 as it lowered the long-term gross margin expectations.
In the third quarter, gross margin declined 90 basis points (bps) year over year to 50.8%. Pre-tax margins declined 30 bps to 21.7%. Gross margins remained flat sequentially but missed management’s expectations. Management predicted near-term gross margins to remain at the lower end of its long-term guidance range 51–53%. In fact, management updated the long-term gross margin range to “around 51% from 51%–53%” at the third quarter conference call, which propelled the stock decline, in our view.
Fastenal’s margins are contracting as management’s focus shifts toward top-line improvement. Additionally, an unfavorable product/customer mix, pricing and competitive pressures are hurting gross margins despite gradual improvement in the top line. Fastenal’s gross margins in the first nine months of 2014 dropped just below 51%.
Moreover, management has been slowing down store growth in order to increase headcount to drive near-term sales. Such initiatives increase employee costs. Higher store headcount and field leadership as well as higher investments behind vending are increasing operating costs, thus dragging pre-tax margins. Fastenal’s employee-related costs shot up to 11% of sales in the first nine months of 2014 compared with 4.7% in the same period of 2013.
The accelerated hiring pace will continue through the rest of the year, which could further pressure margins. At the conference call, management announced plans to increase labor at the stores at a rate of about 10% more hours which translates to about 5% or 6% higher labor cost plus commissions.
Other Stocks to Consider
Fastenal carries a Zacks Rank #2 (Buy). Other stocks in the building sector worth considering are Home Depot, Inc. (HD), Lowe's Companies Inc. (LOW) and Vulcan Materials Company (VMC). While Vulcan Materials sports a Zacks Rank #1 (Strong Buy), Home Depot and Lowe's have the same Zacks Rank as Fastenal.
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