FAST - Fastenal: Good Execution But Tough Macros And High Valuations

2023-04-11 09:52:46 ET

Summary

• I expect Fastenal to keep executing well.
• The macroeconomic environment is challenging, and the company faces tough comps.
• Valuation is expensive.

Fastenal ( FAST ) is set to report its Q1 earnings on Thursday, April 13th, 2023. I previously covered the company last year in August and gave the stock a neutral rating. The stock is up a modest ~2% since then, almost in line with S&P 500 ( SPY ). While the company has executed well, the worsening macros and high valuation have limited the stock upside.

Looking forward, I believe the company’s outlook is a tale of two stories. On the one hand, the company is executing really well, on the other hand, a slowing macroeconomic environment and tough comps are a risk.

The company is focusing on increasing its onsite offering as well as its digital footprint, which includes FMI (Fastenal Managed Inventory) and other e-commerce sales, to drive sales. In Q4 2022, the company signed 62 onsite locations and finished with 1,623 active sites, up 15% Y/Y. This was a meaningful acceleration after a slow 2020 and 2021. FY2023 is poised to be another strong year and the company plans to open 375 to 400 Onsite locations in the current year.

The company is also doing a good job of increasing its digital sales. Its FMI platform sales represented almost 39% of sales in Q4 2022, up from 35% in Q4 2021 and 27% in Q4 2020.

E-commerce is growing even stronger and daily e-commerce sales rose ~48% in Q4 2022. Overall, digital sales as a percentage of total sales increased to ~52.6% of total sales in Q4 2022, which is a good increase from 46.5% in Q4 2021. Management has shared their goal to increase digital sales to 65% of the total sales in the near term indicating continued growth.

One benefit of increasing onsite and digital sales is that it enables the company to rationalize its branch footprint. The company has steadily reduced its branch count since 2013 and ended the last year with 1,683 branches. Despite this decreasing branch count, the company has been able to increase sales per branch and total branch sales for the last several years.

The reduction in branch count has helped the company reduce its SG&A expense, and last quarter despite a significant Y/Y gross margin headwind, the company was able to maintain its operating profit margins.

Management’s ultimate target is to reduce branch locations to 1,450. So, we should continue to see further cost reduction in the coming years.

While the company is doing a good job in terms of execution and driving market share, of late, macroeconomic headwinds have started impacting the demand and the company. The company also faces some tough comps in early 2023 as daily sales were up over 18% Y/Y in Q1 2022 and Q2 2022. So, the company’s near-term performance is going to be determined by how much its execution is able to offset these headwinds.

The good thing is Fastenal does provide intra-quarter updates and releases its monthly sales. So, we can get a sense of the extent to which the company’s execution has been able to offset the abovementioned headwinds.

The company reported 11.2% Y/Y growth in daily sales in January. For February, its daily sales growth was 9.6% Y/Y . If we look at the daily sales growth numbers from the previous year, January was up 14.9% , and February was up 21.3% . So, the comparisons were 640 bps tougher in February and the company’s 160 bps sequential growth slowdown is a testament to its good execution. For March 2022, daily sales were up 19.1% Y/Y . So sequentially, comparisons eased versus February. While the macros did become slightly worse in March, I believe the company’s good execution and a slight easing of monthly comps in March should help it post March daily sales growth in line with or slightly better than February. So, overall the company’s daily sales growth for Q1 should be in the low double digits. If we look at the current consensus estimates of ~ 9.38% Y/Y sales growth it does look slightly conservative and we can see a beat on the topline in Q1. The sales growth number for Q2 at ~ 7.09% Y/Y also looks a bit conservative and can be revised upward after management commentary on the upcoming earnings call. In terms of margins, supply chain constraints and cost inflation are moderating which should help and I expect positive commentary there as well. Further, the company’s cost discipline in terms of reducing SG&A as a percentage of sales should continue. Looking at the first two months of the year, it appears Fastenal is nicely navigating macroeconomic headwinds and I am optimistic about management's execution.

My only problem with Fastenal’s stock is its premium valuation. The company is trading at a FWD P/E of 26.23x and an FWD EV/EBITDA of 18.06x, which is in line with its historical average and a significant premium to its peers like W.W. Grainger ( GWW ) (trading at ~19.57x forward P/E and ~13.33x forward EV/EBITDA) and MSC Industrial Direct ( MSM ) (trading at ~13.57x forward P/E and ~9.24x forward EV/EBITDA). I just don’t see enough upside to justify a buy rating at the current levels. Hence, I have a neutral rating on it as I believe its growth prospects are already getting reflected in the stock price.

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