MSM - Msc Industrial Direct

[ZenaidaMacroura]

MSC Industrial and Fastenal are medium-sized players in the industrial distribution space.  Wolsley, WESCO, Anixter, Distribution Now, MRC Global all have a larger market shares in industrial distribution than MSC or Fastenal.

 

Per MSC Industrial's latest investor presentation, the top 50 players in the US MRO industry account for 30% of the market.  Per Grainger's latest presentation stated that the top 11 players make up about 30% of the market.  Either way, it's a lot more than Grainger, Fastenal, and MSC that account for the top 30%.

 

I'm not sure exactly how MSC maintains such strong margins and/or returns on investment - they claim that a 99% fill rate is their source of competitive advantage, but Grainger 'targets' a 99.9% fill rate.  Perhaps the latest slip in returns aren't a blip, but a new normal for them?  I'm just speculating...

 

If you're going to pay a big multiple (P/Rev or P/E) on a company, I'd take Grainger over MSC (although Mecham would likely claim otherwise).  Grainger has three times the market share of MSC, and 40% of sales are online.  They're the 13th largest e-tailers in the country.  They're a beast.  They get the best prices and they have the most customers.

 

Personally, I think a company like Anixter or WESCO makes for a more interesting play - they have larger market shares than MSC and some heavy hitters are getting involved.  Alex Roepers and Jeff Ubben each just purchased 1MM shares in WCC - Grainger's EBITD margin is double WESCO's...if these guys can get WESCO's margins anywhere near Grainger, you're looking at some serious gains in the next few years...

 

The attractiveness with DNOW is their super-clean balance sheet.  They could add $100M in annual cash flows via acquisition and still have a balance sheet cleaner than most distribution companies right now - it looks like with their recent acquisitions they're already getting started too.

 

Best of luck!

Helluva first post, welcome to the board!!

[valuedontlie]

If accessible, I highly recommend today's note from WM Blair on AMZN threat to distributors. The analyst conducted an interview with a Fortune 100 procurement manager. Small accounts could certainly be experiencing something different but at large accounts it appears the trend is towards consolidating MRO suppliers.

 

Plenty of interesting tidbits:

- Manager disliked Amazon's lack of 1P fulfillment

- No product expertise or account reps to call on (again back to the "service" being provided by distributors)

- Looking to outsource MRO as opposed to building "an army of procurement people who are knowledgeable about all the different SKUs."

[kab60]

Just wanted to update with Q4 results - revenues flat y/o/y, operating earnings down 4,4 pct. and EPS above midrange of guidance. Pretty much confirms, like Fastenals earnings, that the industry is facing headwinds. The most positive takeaway, I think, is the new CFO who seems to focus very much on taking costs out. There's no doubt in my mind that MSC could learn from Fastenal and at least it seems like they're focusing very hard. I like it at these levels.

[Sionnach]

Really like this here - downside is the exposure to manufacturing with rising USD/ oil & gas/ low growth. The call explained pretty clearly why near term pain = long term gain. It's true for many distributors with scale + value add service. New CFO definitely is a spark to the company. Loved this quote from the call - sounds like a pre war speech:

 

"While the 70% of the market that's made up of local and regional distributors is on its heels, we are on our toes. While others are

cutting inventories and receivables to preserve cash, our strong free cash flow generation allows us to invest and to

provide customers with industry leading service. While others are retrenching and only focusing on a handful of

accounts, we're attracting new accounts and increasing our share of wallet with existing ones. While others are hanging

on to what they have, we're aggressively pursuing improved purchase cost and supplier deals and pursuing new

supplier relationships that will add to the strength of our product portfolio."

[farbelow]

I like all three companies, FAST, MSM and GWW, but I picked MSM to invest in. MSM is the most exposed to the metalworking industry and this business is facing more headwind than other sectors due to:

• Lower demand for steel products due to low oil & gas price
  
• Lower gross profit due to low metal prices (even though gross profit margins for MSM hold well)
  

 

I believe that MSM's EBITDA is therefore more suppressed than FAST's or GWW's. And MSM is valued at the same EV/EBITDA multiple, 9.5, as GWW and much less than FAST, 12. So, as KCLarkin stated, MSM's EBITDA should mean revert and give it's stock price a boost.

 

[Sionnach]

Farbelow - Well said. I agree. MSM is near trough margins whereas GWW and FAST are closer to peak.

 

Just to give a little more color:

 

GWW: 16% ebitda margin vs. 13% in '08

FAST: 23% vs. 17% in '08

MSM: 15% vs 15% in '08

 

Although this does obviously reveal that MSM is much more exposed to manufacturing cycles.

 

I think MSM also has better competitive barriers than GWW. GWW has gone into serving small businesses online-only. MSM is focused on value-added integrated services to large customers. I think the latter is much more resistant to competitors (AMZN).

 

 

 

[farbelow]

I read about Jet, a new start up by Marc Lore that takes on Amazon head on. I find this kind of ironic: we are discussing Amazon's threat to these well established MRO businesses which have been built up in decades, have billions of dollars of revenue, throw off cash and operate well away from Amazon's core B2C realm. And then there is this guy: he has worked for Amazon, decides to compete directly in B2C and he manages to raise 500M valuing Jet at 1B.

[Sionnach]

Ya I think its pretty ridiculous that MSC, which has been building a great business for 3 generations, has a valuation of $4 billion and back in july with no revenue Jet was talking about a $3 billion valuation. Its just silly

[KCLarkin]

Industry is firming up:

http://www.mmsonline.com/blog/post/gardner-business-index-metalworking-march-2016-497

 

With US Dollar weakening, oil prices stabilizing, and manufacturing exiting "recession", things should improve for MSM. Of course, stock is up YTD so this might be priced in

 

[fisch777]

Outlook sounds more mediocre to me.  What is going to drive manufacturing growth going forward?

[KCLarkin]

Outlook sounds more mediocre to me.  What is going to drive manufacturing growth going forward?

 

Outlook is mediocre. When I say "firming up", I mean MSC could see YoY revenue declines stop by the end of FY 2016. If manufacturing can get back to flat in 2017, MSC should return to modest growth due to share gains.

 

Manufacturing grew in March:

http://marketrealist.com/2016/04/us-ism-manufacturing-pmi-showed-expansion-will-investors-sentiment-advance/

 

Metalworking business index is still contracting slightly but near "break-even".

 

 

[KCLarkin]

The prepared remarks in the presentation give the best overview of MSC that I have seen:

http://wsw.com/webcast/rj99/msm/index.aspx

[coc]

The prepared remarks in the presentation give the best overview of MSC that I have seen:

http://wsw.com/webcast/rj99/msm/index.aspx

 

Thanks for posting this. That was a good overview.

[KCLarkin]

MSM is repurchasing about 8.2% of the common via a tender offer.

 

The Company expects to repurchase a total of approximately 5.0 million shares of its Class A common stock through the tender offer and the stock purchase agreement at a price of $72.50 per share, for a total cost of approximately $365.0 million, excluding fees and expenses. These shares represent approximately 8.2% of the Company's total outstanding common stock as of August 1, 2016.

 

The Company expects to fund the share purchases in the tender offer and under the stock purchase agreement with proceeds from the issuance and sale of $175.0 million in aggregate principal amount of unsecured senior notes that was completed on July 28, 2016, and through borrowings under its existing revolving credit facility.

[Spekulatius]

MSM is repurchasing about 8.2% of the common via a tender offer.

 

The Company expects to repurchase a total of approximately 5.0 million shares of its Class A common stock through the tender offer and the stock purchase agreement at a price of $72.50 per share, for a total cost of approximately $365.0 million, excluding fees and expenses. These shares represent approximately 8.2% of the Company's total outstanding common stock as of August 1, 2016.

 

The Company expects to fund the share purchases in the tender offer and under the stock purchase agreement with proceeds from the issuance and sale of $175.0 million in aggregate principal amount of unsecured senior notes that was completed on July 28, 2016, and through borrowings under its existing revolving credit facility.

 

Levering up becomes ever more popular, due to low interest rates. This would make sense if the shares are cheap, but that is not the case with MSM.

[KCLarkin]

Levering up becomes ever more popular, due to low interest rates. This would make sense if the shares are cheap, but that is not the case with MSM.

 

MSM is borrowing $365M at a weighted average of 2.09% pre-tax. After tax, this is less than $5M in annual interest.

 

MSM currently pays $1.72 per share in dividends (2.4% yield). This is $8.6M per year.

 

$8.6M dividends - $5M interest = $3.6M "cash saved" per year.

 

In other words, they are borrowing at 1.29% (after-tax) to purchase shares that are yielding 2.4%. This seems smart to me, even if you think MSM is fully valued.

 

--

This would make sense if the shares are cheap, but that is not the case with MSM.

 

MSC is trading at the same valuation as August 2008, based on EV/sales. If you believe that the U.S. manufacturing industry will grow and MSC's operating margins revert to normal and MSC continues to take market share, MSC is cheap on "normalized earnings".

 

If you believe that MSC will lose market share to Amazon, this tender is a mistake.

 

 

[Spekulatius]

Levering up becomes ever more popular, due to low interest rates. This would make sense if the shares are cheap, but that is not the case with MSM.

 

MSM is borrowing $365M at a weighted average of 2.09% pre-tax. After tax, this is less than $5M in annual interest.

 

MSM currently pays $1.72 per share in dividends (2.4% yield). This is $8.6M per year.

 

$8.6M dividends - $5M interest = $3.6M "cash saved" per year.

 

In other words, they are borrowing at 1.29% (after-tax) to purchase shares that are yielding 2.4%. This seems smart to me, even if you think MSM is fully valued.

 

--

This would make sense if the shares are cheap, but that is not the case with MSM.

 

MSC is trading at the same valuation as August 2008, based on EV/sales. If you believe that the U.S. manufacturing industry will grow and MSC's operating margins revert to normal and MSC continues to take market share, MSC is cheap on "normalized earnings".

 

If you believe that MSC will lose market share to Amazon, this tender is a mistake.

 

While I agree that the tender is accreditive, it limits their flexibility going forward to either invest in their own business (organic or acquisitions) or talk advantage of potential future opportunities to purchase their own shares when they should become really cheap.

[KCLarkin]

While I agree that the tender is accreditive, it limits their flexibility going forward to either invest in their own business (organic or acquisitions) or talk advantage of potential future opportunities to purchase their own shares when they should become really cheap.

 

MSC doesn't really have organic investment opportunities (low capital intensity), they don't have the appetite for big acquisitions and they have high FCF. So their options are: buybacks, special dividends, or deleveraging. In 2014, they chose a $3 special dividend. In 2015, they de-levered. In 2016, they chose a tender. So they seem to be thoughtful about their capital allocation (which makes sense given the insider ownership).

[KCLarkin]

With a reading of 53.8, the Gardner Business Index showed that the metalworking industry grew in January for the first time since March 2015, reaching its highest point since May 2014. This also is close to its fastest rate of growth since April 2012.

-- http://www.mmsonline.com/blog

 

Fastenal also showed very strong SSS growth in January:

http://files.shareholder.com/downloads/FAST/1349745324x0x926485/49C6D773-89EA-4333-AC61-6C9BF58372BC/01.2017_sales_numbers.pdf

 

Along with MSMs strong Q1 results and Q2 guidance, it looks like the industry has bottomed. MSM should have very nice operating leverage this year. Of course, after the monster run over the last year, a significant rebound is already priced in.

[AzCactus]

Made this a smallish position today.  Dropped ~17%.  I think management is solid and long term this will work out.  If it keeps getting hammered I might be adding some more. 

[KCLarkin]

Made this a smallish position today.  Dropped ~17%.  I think management is solid and long term this will work out.  If it keeps getting hammered I might be adding some more.

 

Why the big drop today? I haven't been following too closely since I sold out early this year. But guiding to 7% ADS growth looks good. Is this drop due to margin concerns? Or just Amazon angst?

 

On vacation, so I haven't had time to listen to the call. But price is getting interesting again.

[MrB]

Made this a smallish position today.  Dropped ~17%.  I think management is solid and long term this will work out.  If it keeps getting hammered I might be adding some more.

 

Why the big drop today? I haven't been following too closely since I sold out early this year. But guiding to 7% ADS growth looks good. Is this drop due to margin concerns? Or just Amazon angst?

 

On vacation, so I haven't had time to listen to the call. But price is getting interesting again.

 

Trump bump slump

[Phaceliacapital]

I think part of it also came from FAST's CFO concerning a possible Amazon threat and that margins in 5 years would be lower than today's. I thought it was interesting that he did not mention AMZN in the conf call and that Amazon already tried to break in the industry with Amazon Supply (which they later closed down).

 

Why would you prefer MSM over FAST?

[AzCactus]

Personally, I think both companies are very well run.  And I have a small position in both.  I also think that people have this notion that Amazon will take over everything.  And  I know they are in this space---but I think when people are buying supplies etc for their companies having ~3000 locations like FAST has is valuable. 

[sleepydragon]

I am reading the 2016 proxy. For The 2016 buyback they did, the sellers are the chairman, ceo and other family members. This group sold 1m shares at 72 during the "buy back"..

Not sure this is that positive