Fastenal Company (FAST - Analyst Report) reported adjusted earnings of 48 cents per share in the second quarter of 2015, beating the Zacks Consensus Estimate of 47 cents by 2.1%. Earnings grew 9.1% year over year as the weak sales performance was offset by better pre-tax margins.
Sales Remain Weak
Net sales of $997.8 million increased 5% year over year, but missed the Zacks Consensus Estimate of $1.017 billion by 1.1%.
After struggling in 2013, Fastenal’s top line turned around in 2014 as underlying markets improved, vending re-vamped, sales improvement efforts yielded results and comparisons eased. In order to accelerate sales growth, Fastenal took the strategic decision to increase sales personnel at its stores which largely boosted sales in 2014.
However, sales slowed down significantly in the first half of 2015 due to lower sales from the oil & gas industry and overall weakness in the industrial economy. Fastenal garners approximately 10% to 12% of its sales from stores located in the oil producing regions (Texas, Western Pennsylvania, Western Canada, etc.) where sales are being hurt by a slowing economy due to lower oil prices.
Fastenal’s total average daily sales growth rate was 5% in the second quarter, much less than 12.1% in the prior-year quarter. Foreign exchange dragged second-quarter daily sales growth rate by 1%. A strong dollar significantly hurt the company’s export related activity.
Daily sales growth was 3.7% in June, 5.3% in May and 6.1% in April lower than 12.7%, 13.5% and 10% improvement, respectively, in the corresponding year-ago months.
The industrial and construction supplies wholesale distributor serves customers in the manufacturing and non-residential construction markets. Both of these end markets witnessed moderating growth due to weak industrial environment.
Daily sales to manufacturing customers (representing almost 50% of revenues) grew 3.8%, down from 11.2% growth in the prior-year quarter and 6.9% in the previous quarter. Daily sales growth rates to manufacturing customers softened due to subdued sales of both fasteners and non-fasteners.
Daily sales growth rate of fastener products (used mainly for industrial production and accounting for nearly 40% of the company’s business) remained flat in the quarter, much weaker than 5.5% improvement each in the previous and the year-ago quarter.
Lower demand from heavy machinery manufacturing customer base – mainly from those engaged in oil and gas business – hurt fastener sales as this customer base contracted their production requirements. The heavy manufacturing business represents approximately one-fifth of the company’s business.
Non-fastener product sales (used mainly for maintenance) increased 9%, down from 17.1% growth in the prior-year quarter and 11.7% in the last quarter. The non-fastener business also weakened over the last six months as improved vending trends were offset by overall weakness in the industrial environment.
In the non-residential construction market, daily sales to non-residential construction customers (representing 20% to 25% of revenues) grew 1.6%, down from 7.5% in the prior-year quarter as well as 6.2% in the previous quarter. Slowdown in the energy sector also hurt sales in this market.
Vending Trends Continue to Improve
As of Jun 30, 2015, Fastenal operated 50,620 vending machines, up 15.7% year over year. During the quarter, the company signed 5,144 machine contracts, up almost 30% from the last quarter. Daily sales growth to customers using vending machines was 8.6%, down from 12.3% in the previous quarter. The vending machines now account for 40.9% of the company’s sales, higher than 40.5% in the prior quarter.
Vending trends improved through 2014 and the first half of 2015 after remaining soft in 2013 as management’s recent efforts to improve the quality of signings/installs paid off. Even though the daily sales growth to customers using vending declined sequentially, the percentage of vending customers and signings improved.
Gross Margins Down, Pre-Tax Margins Improve
Gross margin in the second quarter declined 50 basis points (bps) both year over year and sequentially to 50.3%. Lack of inflation, unfavourable product mix (less fasteners which generate higher margins) and pricing and competitive pressures are affecting gross margins.
A strong emphasis on growing average store sales is also pulling down gross margins. Under its Pathway-to-Profit initiative, Fastenal focuses on increasing the average store size (measured in terms of monthly sales). As the average store size increases, gross margins will decline due to higher mix of larger customers which generate lower gross margins.
However, larger store size leads to better earnings leverage by spreading operating costs over higher sales and thereby improves pre-tax margins. This resulted in an 80 bps improvement in pre-tax margins to 22.6% in the reported quarter.
The company recorded operating and administrative expenses (SG&A) of $276.6 million in the quarter, almost flat year over year.
Stocks to Consider
Fastenal has a Zacks Rank #3 (Hold). Some better-ranked stocks in the broader building sector are The Home Depot, Inc. (HD - Analyst Report), Lennar Corp. (LEN -Analyst Report) and Gibraltar Industries, Inc. (ROCK - Analyst Report). While Lennar and Gibraltar Industries sport a Zacks Rank #1 (Strong Buy), Home Depot carries a Zacks Rank #2 (Buy).
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