FAST- Fastenal

[rpadebet]

I couldn't find a thread on this, so opened one for discussion

 

This is a pretty well known company, so I wouldn't want to rehash all the details here.

 

Given that the stock hasn't done much over the last 4 years and now that the PE valuation has come down a bit and is near the lower end of the range over the last 10 years (still a high 25 PE to call it a traditional value), I would like to see what people think of the following:

 

1. Valuation: Reasonable?

2. Business Prospects: Has the store growth in US saturated? Does the vending program allow more room for growth? thoughts about future growth outside US.

3. Management: Comments on the "outsiderish" CEO William Oberton resigning and insights into the new CEO Leland Hein

 

I am considering an investment here, but basically my decision boils down to whether the PE compression is a PE re-rate due to decreased growth prospects or just a Mr. Market thingy?

 

I also don't know what to make of the new CEO, but since the ex-CEO is still on as chairman and given their company tradition and focus on people, I am willing the roll the dice on this one.

 

My investment rationale is quite simple actually. If FAST can grow earnings at the 12-13% rate they have grown over the last 9-10 years and I keep getting a 2.5%+ dividend, even if the PE stays flat, I can see a 15% compounder. Risk is clearly sustainability of the historic earnings growth and further PE compression if that doesn't materialize.

[philly value]

One thing to note on valuation is that NWC really works against you here. Free cash flow is considerably below reported earnings, even if you try to subtract out some growth capex. Using the full capex figures, FCF in 2014 was $309M vs net income of $494M. If you assume something, like, say MCAPEX = 1.25*D&A instead of using the full capex number, you'd get $408M FCF vs $494M net income. NWC is ~31% of revenues.

 

So while earnings multiple now looks reasonable, using LTM FCF you are getting a 2.5% yield. Capex will go down in 2015 AFAIK, but still won't be more than 3.0-3.5% forward yield.

 

 

[rpadebet]

A growing retailer is expected to have cash flows below earnings right? (Because they have to invest in inventory and working capital to grow.) If working capital is going down, unless there are some  efficiency improvements in utilization or payback from previous inventory build up, I think that would be a negative for growth in a retailer all else equal.

 

Also i don't see why MCapex needs to be very different from Depreciation. MCapex is defined as the Capex necessary to maintain the revenues from the previous period. I guess the Gross PPE/Sales ratio method of  estimating maintenance capex is the way to go here.

 

Finally, I would focus on the Rev/WC or Rev/Inventory number for a retailer and those seem to be steadily improving here.

[NBL0303]

Thank goodness for you.  I have been waiting for a long time for someone to write a valuation of Fastenal on here - one of my all-time favorite companies.  Not that the price has always made sense over the last few years, and I have many many thoughts on Fastenal, so maybe I will write a valuation of it up here at some point - but for now I just wanted to point out that the recent drop because sales growth in February was 8% or whatever and not 12% is absurd.  The company was not worth anything like $500 million less because of that, and given a number of February specific factors, that should have been entirely expected.  The current valuation may be justified, my point is that the recent price activity is silly if the catalyst was in fact the January and then February sales growth rates - which it seems to be.

 

One interesting question is, what earnings number could they put up next year that would justify this valuation?  Obviously, one year's earnings are never determinative and there are a million other factors - but Fastenal could earn close to $600 million next year.  If their revenue growth this year is 10%, which is at the low-end of what it will likely be given the trajectory they were on last year and near 15% daily sales growth in November and December last year - if their margins improve a moderate amount - this year's earnings could grow substantially.  They had less CapEx and fewer other expenses in 4Q last year, and given the discussions about reducing non-labor costs this year by management, I wouldn't be surprised if they approach $600 m this year.

[philly value]

A growing retailer is expected to have cash flows below earnings right? (Because they have to invest in inventory and working capital to grow.) If working capital is going down, unless there are some  efficiency improvements in utilization or payback from previous inventory build up, I think that would be a negative for growth in a retailer all else equal.

 

Also i don't see why MCapex needs to be very different from Depreciation. MCapex is defined as the Capex necessary to maintain the revenues from the previous period. I guess the Gross PPE/Sales ratio method of  estimating maintenance capex is the way to go here.

 

Finally, I would focus on the Rev/WC or Rev/Inventory number for a retailer and those seem to be steadily improving here.

 

Yeah, most traditional retailers or any business that requires a lot of working capital is going to have this same characteristic. But still, that is a negative aspect of these types of businesses that should be accounted for in a valuation. All else equal a business requiring little or no working capital is clearly more valuable. Look at AMZN, negative working capital. A $1 of earnings from such a business translates more directly into cash flow than a business like Fastenal. And cash flow is all that matters in the end.

 

It doesn't need to be very different, but for many businesses it is likely higher [with some major exceptions]. If I bought a machine 10 years ago and need to replace it today, just given inflation it probably costs more. So depreciation is backwards looking whereas capex is what it costs me today.

 

At the end of the day FAST is a fantastic business, but I'm just saying that the P/E understates the price you are paying.

[rpadebet]

NBL0303- Where can you see the monthly sales numbers?

 

philly value - I hear you on AMZN. Its a favorite of mine as well, but business model is different. Agreed that their neg WC is more valuable, but they have different challenges as their maintenance capex takes the form of buying up competitors, since getting into web retailing isn't that difficult.

 

The thing I like about FAST is their service oriented retail and that they service relatively low cost components to businesses instead of regular people. Its difficult to replicate the relationships they have built over the years. They have a soft moat because they have embedded themselves into customer processes. The book "Art of Profitability" talks about the value in these kinds of business models.

[Guest roark33]

They post the monthly sales figures on their websites, usually first week of each month. 

 

One thing about the recent drop is that it has a lot to do with the potential impact of oil and gas customers more than anything else.  Can't remember who, but someone put out a note that oil and gas customers fell off a cliff in January and that was the recent for the sharp decline....

 

Fastenal valuation has already been crazy, and someday it may no longer be crazy and the investor who bought hoping it would always be crazy might lose money...but very little risk of capital loss in the long term is worth something in my book.

 

 

[Guest roark33]

I am not sure if you are joking about that analysis being well done--but I would agree it is fairly off the cuff.  I don't really have any special insight into fastenal, but I have been buying recently. 

[Phaceliacapital]

That is very thoughtful take on Fastenal.  Well done.

 

I agree that Fastenal is always pretty well priced, I recently did a backward testing on when exactly you should buy this company (and what would happen if you bought at these levels).

 

I went back to the IPO date and gathered P/E data on a 3 month basis. If you bought the business at a 27x multiple or less, your minimum return would have been 8% (excluding dividends & repurchases). Not too shabby.

 

 

edit: Before I get the remark, I know the analysis is full of biases, hindsight is 2020 right.

[elevensecsrt4]

I too like the business... it has always been richly valued. I am taking a deeper longer look at the business. I have been trying to read the annual report as of late and haven't got through it as fast as I hoped. Sequoia has always talked well of management and their margins. I have started a small tracking position, with the growth they have had and a 2.7% div I would rather have this in my portfolio than a larger cap lower growth company, considering I plan to hold it long term.

[orthopa]

I have been working through the annual reports and like what I see so far. What really has impressed me has been the ROE and ROIC over the last 10 years. The div and its future growth looks to be a sweetener at this point.

 

I think the PE compression that has occurred is investor worry about amazon and such taking market share but there is nothing like getting a part the day of from Fastenal to finish a job. Amazon supply can get it to you quick (if in stock and one of their sellers) but not within an hour with a nearby Fastenal. When this is breached I think is when you worry about the competition.  Managements immediate response has been vending machines. Cant get much quicker then that. I have not seen one in person but I would imagine it would stock the 50-100 parts used most often at that site and the customer is almost forced to use it as its sitting 10 feet away in the shop.

 

There was a good article in Forbes a little while back talking about the stinginess of management and how they constantly keep costs low. As a shareholder I like that as well as the unwillingness to issue shares.

 

So quickly I think you can reason if you think the likely hood of future cost control and de minimis share issuance offsets the PE somewhat. There has been some insider buying lately also.

 

I have read a couple posters already comment that this is a great business. Maybe this falls into Buffets buying a "great business at a fair price" with its current premium to the markets valuation as a whole.

 

 

 

 

[rpadebet]

Whoever came up with vending machine idea is a genius...

No way Amazon or anyone else tops that...this I say as a AMZN shareholder.

 

They also monitor customer inventory at warehouses using cameras and sensors, top up the inventory if it's running low. All so seamless to the customer. Why on earth would they go for another vendor? I wish Amazon did this for my groceries.

 

Plus, fasteners, nuts and bolts are always such a small bill item for the customers that, they wouldn't think about marginal cost savings there by going with competitors.

 

I am amazed at this moat each time I think about it. The form of moat itself is innovative even if nothing else is.

[Phaceliacapital]

I think somewhere in one of the annual reports they actually mention that when the firm was founded they wanted to start with vending machines, but that is was not feasible from a technological standpoint.

 

An additional point that reinforces their moat comes from the technical knowledge of their salesforce, when stuff starts breaking down the blue people are immediately there to help. (often fast employees visit the customer once a day).

 

You should watch some of the clips on the Fastenal youtube channel, the switching costs become apparent quite rapidly.

[rishig]

I think somewhere in one of the annual reports they actually mention that when the firm was founded they wanted to start with vending machines, but that is was not feasible from a technological standpoint.

 

An additional point that reinforces their moat comes from the technical knowledge of their salesforce, when stuff starts breaking down the blue people are immediately there to help. (often fast employees visit the customer once a day).

 

You should watch some of the clips on the Fastenal youtube channel, the switching costs become apparent quite rapidly.

 

Steven Romick recently spoke at a CFA conference and he talked about how he thinks about distribution businesses such as Fastenal. @rainforesthiker forwarded the speech to me but I think it's a great read. I highly recommend it if you are looking at distribution businesses:

http://www.fpafunds.com/docs/special-commentaries/cfa-society-of-chicago-june-2015-final1.pdf

[frommi]

Steven Romick recently spoke at a CFA conference and he talked about how he thinks about distribution businesses such as Fastenal. @rainforesthiker forwarded the speech to me but I think it's a great read. I highly recommend it if you are looking at distribution businesses:

http://www.fpafunds.com/docs/special-commentaries/cfa-society-of-chicago-june-2015-final1.pdf

 

From what he wrote i am under the impression that he just analyzed the financial statements and didn`t really looked at the business. Its really interesting that they are simply growing by employing more people. And its one of the only distributors that uses their salespeople as distributors and the local stores as fulfilment center. I mean how can Amazon/UPS be faster/cheaper in delivery than them?

The only negative i found is that they are directly bound to the ups and downs of the manifactoring sector that is maybe in a secular downtrend. (Or is it temporary? who knows?)

But since they still have only a small piece of a fragmented market this is maybe an opportunity to grab more marketshare.

They have so many people employed, is the raising minimum wage or rising real wages a problem? (Can they compensate with pricing power? probably yes.)

 

 

[crastogi]

I have had my eye on FAST for some time now.  Getting close to pulling the trigger.

[orthopa]

I have had my eye on FAST for some time now.  Getting close to pulling the trigger.

 

What do you think of the valuation. Looks like it still trading ~17-18 times next years earnings.

[no_free_lunch]

I have it on my watch list as well.  My concern is that free cash flow is consistently below earnings.  It looks like $320m last year, probably higher though this upcoming year.    So at $10.5b it is 32x last year's fcf.  I am sure maintenamce fcf is substantially higher but not sure how to calculate it.  At any rate, I think you are paying 30x to get the growth.  I think I would need a lower price.

[KCLarkin]

My concern is that free cash flow is consistently below earnings.

 

Distributors suck up working capital as they grow. If revenue drops, FCF will exceed earnings as working capital unwinds.

[no_free_lunch]

Thanks KC, makes sense.  I have it on my watch list but haven't done much work on it.  So do you think PE is the more appropriate metric then?

[crastogi]

My concern is that free cash flow is consistently below earnings.

 

Distributors suck up working capital as they grow. If revenue drops, FCF will exceed earnings as working capital unwinds.

 

+1

[AzCactus]

I am starting to get kinda interested at these levels.  anyone else?

[kab60]

I am starting to get kinda interested at these levels.  anyone else?

I've gone with MSC instead but I like most of them at these levels even though they're more pricey that what I'm usually comfortable with.

[spartansaver]

Do any of you think that as the vending machines grow they will cannibalize the stores in a major way? The benefit of the vending machine is that you have a sticky customer. The drawback is that you continually have to go to customer sites, stock their machines and continually monitor those machines.

[Williams406]

I view the vending machines as an extension of the local store moreso than a separate sales channel.  The machine, placed at a customer's location, moves oft-used  Fastenal inventory that much closer to the customer and hedges against lower-than-needed inventory guesses by the customer. It's a few square feet of Fastenal store right at the customer's site. Sure, a Fastenal sales rep will deliver needed stuff same day, but the vending machine is right over there. When it needs restocking, that comes from store inventory. So I think of the machines as a tool for the local stores to better serve customers.

 

You list having to continually go to customer sites as a drawback, but my sense is that Fastenal reps are doing that anyway in a lot of cases for large customers without the vending machines. I don't see how the vending machine forces more visits to sites, but I could be wrong. Seems like it would reduce the "emergency delivery" visits a bit.

 

Quick anecdote: I bought a Craigslist couch in great condition except for five springs that had given way causing the couch to list hard to starboard. Visits to ACE and Home Depot were fruitless for the type of fastener I needed, which surprised me. Went to a local Fastenal store and one of the reps helped me scour the fastener aisle of the right one. Picked up seven fasteners with corresponding screws for $5 and change. Definitely not their typical transaction/customer. They had an empty vending machine in the store and they aren't massive vaults of inventory so I'd guess reps are putting in plenty of face time with customers even with an installed machine.