FAST - Fastenal: Fasten Up

Summary

• Fastenal continues to do very fine, outgrowing the wider MRO industry.
• While times might get tougher, the 2022 performance has been strong while shares have been lagging.
• Earnings multiples have contracted to about 23 times here, a well deserved premium to the market.
• I typically do not like paying a big premium but Fastenal certainly deserves one, with appeal on the increase despite higher interest rates.

It has been all the way back to 2017 when I last covered Fastenal ( FAST ) after its shares enjoyed a great post-election run at the time, which perhaps was too much of a move in a too short time span.

At the time, Fastenal was a $45 stock which incidentally is the same price at which shares trade today, albeit shares have split on a two-for-one basis in 2019, meaning that investors have seen the value of the investment double over a more than five-year timeframe, of course excluding dividends received in the meantime.

A Recap

In the past, I have long admired Fastenal given its consistent outperformance versus peers and thereby the rest of the industry, driven by a superior business model, albeit at the time held back by dollar strength and headwinds from the shale oil boom collapsing.

At the time operating nearly 2,500 stores, the company was actively opening up onsite locations, pretty much a Fastenal shop located on the premises of the client. The business furthermore included the famous vending machines of course, with the unit count totaling more than 60,000 at the time.

Pretty much a $4 billion business at the time, posting sky high margins of 20% amidst strict cost control and high gross margins of around 50%, the business was on track to earn more than $1.80 per share in 2017. This translated into a 25 times earnings multiple. The company operated with very little debt, in fact just about a quarter of a billion all while EBITDA trended around a billion. Given the low capital spending requirements, Fastenal has typically paid out a compelling yield, at the time paying out a 3% dividend yield.

With $4 billion in sales, Fastenal was still tiny in relation to a $140 billion North American marketplace. Believing in the long term potential of the business, I decided to get involved at around a 20 times earnings multiple which would work down to an entry point in the high-thirties (or around the $20 mark adjusted for the split), levels actually seen in the summer of that year as I picked up a modest position at the time.

Full Steam Ahead

Post the stock split in 2019, shares have done alright, trading at $35 (or $70 ahead of the split) at the start of the pandemic to rise to a high around $65 (or $130 ahead of the split) by year-end 2021. Ever since, it has seen concerns on slower growth and inflation which hurt shares as well, with shares now back to $45 per share, in part because very fat valuation multiples have come down as well.

Forwarding to early 2022, the company posted its 2021 results, which followed a strong 2020 already. Revenues rose more than 6% to $6.01 billion and that is despite 2021 having two fewer business days. The changing business composition led to gross margins falling to 46% (used to be around 50% in the past) but operating margins were stable around 20%. Net earnings rose 8% to $925 million, equal to $1.60 per share. In traditional fashion, net debt has been very limited.

Comparing this to 2017, the company has grown sales by about 50% and earnings per share by about 75% (adjusted for the stock split, thanks to buybacks), while shares doubled and the balance sheet integrity was maintained. Trading around the $60 mark at the start of the year, the company was valued at 40 times earnings based on strong earnings, a huge valuation of course.

The company has been off to a very strong start for the year, with first quarter sales up 20% to $1.70 billion, driven by an additional business day and strong margin performance. The company hiked the quarterly dividend to $0.31 per share over the summer, albeit the yield is low given where interest rates have been moving. After being an active buyer in the mid 2010s, the company refrained from buying shares in 2021, yet it bought 1 million shares at $49 in the first quarter of 2022 again as the stock sold off a bit.

Second quarter sales rose 18% to $1.78 billion with margins holding up well, while third quarter sales growth slowed down to 16%, again with stable margins. This quality of growth is deteriorating with pricing becoming a bigger component of the sales growth. Net debt inched up a bit to $324 million on the back of the accelerated payouts to investors, still a very modest amount given the superior profitability of the business.

Through the first three quarters of the year, earnings have risen twenty-six cents to $1.46 per share, making a run rate near $2 per share attainable, for about a 23 times earnings multiple here.

Through the quarter, the company nearly hit the 100,000 mark in terms of vending machines while the number of onsite locations has surpassed the 1,500 mark now, nearly on track to surpass the number of branch locations which has gradually been coming down.

Concluding Remark

While 2023 is set to become a tougher year, as clearly ventilated by management, that does not mean a decline as valuations have been a lot friendlier than they have been for a while.

The long term quality of the franchise remains unparalleled, and after some recent valuation multiple contraction, I am sticking with a targeted entry point around 20 times earnings, or about $40 per share here to add to my 2017 position.

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