Tuesday, April 16, 2013

Fastenal and MSC Industrial Report Weak Numbers

Just when you thought it was safe to go back into industrial stocks, Fastenal $FAST and MSC Industrial Direct $MSM delivered results that raised more questions than answers. Both companies were downbeat and went to lengths to describe how their businesses weren’t performing in line with the headline manufacturing ISM numbers. So what is going on, and what is the read across from these earnings?

ISM Not Relevant Anymore to Fastenal?

Traditionally the manufacturing ISM numbers have guided the industry’s performance, and even more so when it comes to the industrial suppliers. Indeed, the theory (at least mine) was that the stronger numbers in the first quarter would lead to a resumption of growth in the industry. Well, according to Fastenal and MSC, that was not the case!

Here are the headline PMI and New Orders numbers from the ISM.

Starting with Fastenal, it declared that its sales growth was a ‘struggle’ in the quarter and conditions continued to slow down. This sort of commentary is not congruent with the ISM numbers, and its management even suggested that its performance wasn’t as correlated with the index as previously thought.

The bad news didn’t stop there, as its vending machine signings were lower than expected. In addition it had planned for 65-80 new stores for 2013 but announced that it expected to be at the lower end of the range in 2013. Although the company declared that it would still invest, even in a slowdown, it wouldn’t surprise me if it reined in some expansion plans if slow growth continues.  

To put Fastenal’s report in the context of its longer term plans I would recommend going over this article. In terms of its long term 'pathway to profit,' it is obvious that all the objectives are somewhat reliant on sales growth. Unfortunately this is something that has been slowing for Fastenal in recent quarters.

The problem appears to be in its fastener sales, and this is usually an indication of broad based weakness.The one bright spot was its metalwork products, which grew at above the company rate. I’ll come back to this point later.

MSC Weak Too

It was a difficult quarter for MSC too. Having previously announced that its end markets were in a holding pattern, which had descended into ‘paralysis’ in December, it was reasonable to expect better things this quarter. However, the company declared that the latest weak ISM number for March were more in line with what it was seeing in its current trading conditions. Indeed, it reiterated what Fastenal said about sequential weakness in the quarter with January being relatively strong leading into a weaker February and March.

Interestingly it highlighted the metalworking sector as a particular area of weakness. This is contrary to what Fastenal said, but my guess is that the latter has more exposure to aerospace and aviation. If we look at Alcoa’s $AA recent results there was ongoing strength predicted for the aerospace industry, while the US automotive sector is forecast to grow at 0-4% this year. However, Alcoa did not raise its forecast for its US commercial building & construction despite more optimistic indications from new house builds and the Architectural Billings Index. Jam tomorrow?

What Is Going On?

It is hardly a clear picture, but what we do know is that the areas of relative strength in the economy are in things like autos, housing and aerospace. This is probably a function of how weak the first two industries have been in recent years.  In other words, comparisons are easier in these industries. Furthermore they are due to grow thanks to net household formulation and the age of the US care fleet. Aerospace’s strength is due to its global exposure and the recovery in profitability of the airlines.

Allegheny Technologies $ATI is the sort of stock that will give good color on these themes. It recently outlined strong numbers from aerospace builds but weaker demand from the nuclear industry. In addition oil & gas demand was forecast to be lower thanks to inventory management actions by its customers. The story from Allegheny is one of a mixed industrial outlook and it mirrors what Alcoa said recently.

Where Next?

Fastenal and MSC are companies with limited visibility so things can turn around pretty quickly for them. Furthermore, my hunch is that there is a willingness among industrial customers to hold off purchases whenever they see political uncertainty. Obviously long cycle industries like aerospace can’t really adjust demand levels in the short term. In other words, conditions can improve, and I suspect they will.

However my issue with buying either stock is that they are not cheap enough. Falling sales growth is never a good sign, and when I buy stocks like this I would expect to buy them with some excess negativity priced in. As I write, they trade on 34x and 19x current earnings respectively. I think that’s too much to pay for a cyclically aligned sector with little visibility and falling sales growth.

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