Fastenal Company’s (FAST - Analyst Report) adjusted earnings of 40 cents per share in the fourth quarter of 2014 were in line with the Zacks Consensus Estimate. Earnings grew 21.2% year over year driven by improved sales and higher pre-tax profits.

Fastenal reported net sales of $926.3 million, missing the Zacks Consensus Estimate of $938 million by 1.2%. Net sales, however, increased 13.8% year over year as underlying markets bettered, vending and construction trends improved, and comparisons eased.

Despite improvement in sales and pre-tax margins, gross margins remained weak.

Top-Line Growth Continues

Fastenal’s total average daily sales growth rate was 15.7%, up from 7.5% in the prior-year quarter, owing to increase in sales volume. However, foreign exchange dragged third-quarter daily sales growth rate by 0.6%.

Daily sales growth was 14.6% in October, 15.3% in November and 17.4% in December, much higher than a respective 7.7%, 8.2% and 6.7% in the corresponding prior-year months.

Daily sales to manufacturing customers (representing almost 50% of revenues) grew 13.8%, higher than 7.2% in the prior-year quarter. Daily sales growth rates to manufacturing customers improved as fasteners as well as non-fastener sales increased during the quarter.

The daily sales growth rates of fastener products (used mainly for industrial production and accounting for over 40% of the company’s business) were 11.4%, better than 1.9% in the comparable year-ago quarter due to easier comparisons.

Sales to customers engaged in light and medium-duty manufacturing are improving. The heavy manufacturing business (approximately one-fifth of the company’s business) also improved in 2014 after suffering in 2013. A major portion of the heavy manufacturing business is fastener driven.

Non-fastener product sales (used mainly for maintenance) increased 19%, up from 12% in the prior-year quarter and 17.6% in the last quarter. The non-fastener business picked up due to improvement in the industrial vending business.

In the non-residential construction market, daily sales to non-residential construction customers (representing 20% to 25% of revenues) grew 12.6%, up from 2.8% in the prior-year quarter and 9.3% in the previous quarter due to improvement in construction trends.

Vending Trends Continue to Improve

As of Dec 31, 2014, the company operated 46,855 vending machines (irrespective of the type of machine), up 2.8% sequentially and 14.9% year over year. During the quarter, the company signed 4,108 machine contracts, up 0.9% sequentially. Daily sales growth to customers using vending machines was 20%, down from 21.9% in the earlier quarter. The vending machines now account for 39.3% of the company’s sales, higher than 37.8% last quarter.

Vending trends have been improving through 2014 after remaining soft in 2013 as management’s recent efforts to improve the quality of signings/installs seems to be yielding results. Even though number of customers using vending declined sequentially, percentage of vending customers and signings improved.

Gross Margins Weak; Pre-Tax Margins Improve

In the fourth quarter, gross margin declined 10 basis points (bps) year over year and 30 bps sequentially to 50.5%.

Fastenal’s gross margins are contracting as management’s focus shifts toward top-line improvement. Additionally, lack of inflation, an unfavorable product/customer mix, pricing and competitive pressures are hurting gross margins despite gradual improvement in the top line.

Moreover, the fourth quarter is seasonally the softest as sales slow down during the holiday months of November and December. Construction activity also softens during this time. The softer sales result in lower utilization of Fastenal’s trucking network which hurt gross margins.

Increase in average store size is also pulling down gross margins as larger stores have greater business with larger customers generating lower gross margins. Gross margins at the largest stores are roughly 90 bps below the company average. However, operating margins at the largest stores are 350 bps above the company average. 

Accordingly, consistent with its “Pathway to Profit” strategy, management strongly emphasizes on increasing the store size as they have higher operating margins. This led to a 110 bps improvement in pre-tax margins to 20.4% in the quarter despite higher employee-related costs.

Fiscal 2014 Results

Fastenal’s earnings of $1.67 per share in fiscal 2014 increased 10.6% year over year and beat the Zacks Consensus Estimate of $1.66 by a penny. The company reported net sales of $3.73 billion, up 12.2% year over year. The net sales slightly missed the Zacks Consensus Estimate of $3.74 billion.

Fastenal’s gross margins in 2014 dropped to 50.8% from 51.7% in 2013 and 51.5% in 2012.

Stocks to Consider

Fastenal carries a Zacks Rank #3 (Hold). Other stocks in the broader building sector worth considering are Lowe's Companies Inc. (LOW - Analyst Report), USG Corporation (USG - Snapshot Report) and Headwaters Inc. (HW - Snapshot Report). While USG Corporation and Headwaters sport a Zacks Rank #1 (Strong Buy), Lowe’s carries a Zacks Rank #2 (Buy).