FAST - Fastenal: Q2 Results Show Business Is Less Rosy For Industrials

2023-07-14 05:58:44 ET

Summary

• Industrial and construction supply distributor, Fastenal, reported Q2 results that were largely in-line with consensus estimates.
• But the company's Onsite signings, a key aspect of the growth thesis, were notably weak during the quarter.
• Strength in other growth drivers, such as FMI device signings and eCommerce growth, provided a partial offset to the Onsite weakness.
• A cautious outlook set against declining manufacturing activity warrants a "hold" view on the stock following their Q2 results.

On a day where markets were mostly focused on the earnings results of Delta (DAL) and Pepsi (PEP), whose outlooks appear positive, investors may have missed important developments elsewhere. Fastenal's (FAST) results showed that business is less rosy for the industrials.

FAST Q2 Results

Industrial and construction supply distributor, Fastenal, reported total quarterly revenue and EPS growth of 5.9% and 4.6%, respectively. This was more-or-less in-line with consensus estimates.

Sales growth was attributable to higher volume due to growth in the number of Onsite locations. This offset lower revenues in construction and reseller end markets.

Pricing also contributed 190 to 220 basis points ("bps") to growth during the quarter. This represented a moderation from the 290 to 320bps contribution in Q1. Further moderation is also expected through the remainder of the year.

Since the strongest growth came from their Onsite locations, this created an unfavorable customer mix during the quarter. Combined with a greater share of sales attributable to non-fastener products, FAST experienced margin pressure during the quarter due to the customer/product mix. Q2 gross and operating margins were down 100bps and 60bps, respectively.

Market Reaction To FAST's Q2 Earnings

Shares lagged the broader markets on Thursday following their release. The stock closed the day down 3.5%. This compares to a positive close in the three major indexes.

And since a prior update on the stock, where I viewed shares as a "hold" due to the slowing environment, shares are up about 6%. This lags the S&P's 8.5% gain over the same period.

The track record is better on a YTD basis. Over this period, the stock is up about 20%. It is also up about the same over the past one year. This represents outperformance to the market index.

Key Takeaways Of Fastenal's Q2 Results

Onsite Signings Weaker Than Expected: An increase in the number of Onsite locations, which is a customer-specific service model that entails proximity to the customer, is a key aspect of FAST's growth strategy. According to company filings , the marketplace is believed to have the ability to support between 375 to 400 new Onsite signings annually.

FAST is on pace to miss the market opportunity. In Q2, the company had just 86 signings. Based on the signings over the past six months, the company expects to sign 350 locations in fiscal 2023. The miss would be the third straight year of falling under the target.

The weakness in Onsite signings is offset in part by strength in their two other growth drivers, weighted devices and eCommerce. In Q2, FAST signed 106 devices per day. That's up from 86/day in the same period last year.

Activity through the platform also rose to a greater share of sales in the current period, up to about 40% from 35.6% in Q2FY22 and 30.7% in Q2FY21. Sales through their digital footprint also continue to increase at a healthy rate and is believed to be tracking in-line with expectations.

Concerning Trend In Daily Sales Rate ("DSR"): The steady decline in this metric since Q1FY22 is concerning. The steeper drop into Q2 is even more so. The declines here are attributable in part to softer manufacturing activity. The purchasing managers' index ("PMI"), for example, averaged 46.7 in Q2. And it came in at 46 in June. The sub-50 reading is associated with contraction.

The weakness wasn't necessarily associated with their manufacturing customers, which represent three quarters of sales. To the contrary, DSR grew 10.4%. Rather, the weakness was concentrated on their non-residential customers. Despite the growth, CFO, Holden Lewis, did note that the company experienced a sequential decline in May and June.

Favorable Working Capital Trends: FAST continued to benefit in Q2 with a high cash conversion rate. Historically, their conversion is about 60% to 70%. But since the fourth quarter of 2022, the company has been running at a rate of over 100%. In Q2, the company generated +$302.1M in operating cash flows. This represents 101.4% of net earnings.

Granted, this is a drop-off from Q1. But it's still well over their historical averages. The higher cash flows are attributable to the working capital environment. While receivables, a negative working capital adjustment, were up 6.1%, inventory fell by roughly the same percentage. This contributed to a sizeable positive working capital adjustment.

Combined with a more conservative posture on capital spending, FAST is afforded the ability to add to their healthy cash balance, which stood at just under +$240M at period end, while also steering to debt paydown. In Q2, total debt was just 9.4% of capital compared to 13.7% in the same period last year.

Is FAST Stock A Buy, Sell, Or Hold?

CEO, Dan Florness, didn't dance around in his opening lines of the Q2 conference call. He noted the macro-specific challenges faced during the quarter and acknowledged company-specific shortcomings, such as weaker than expected growth in gross profit dollars.

Looking ahead, FAST appears to have a tough hill to climb. The pace of Onsight signings, a key aspect of the growth thesis, has fallen behind internal targets. The negative revision downward in full-year expectations is a further setback.

DSR growth has also fallen to levels last seen in the first quarter of fiscal 2021. Weaker manufacturing data, as indicated by the PMI, doesn't provide confidence of a material reversal in DSR growth in the near-medium term.

And though the company is benefitting from high cash conversion, their capital spending forecast remains conservative, which is reflective of the cautious operating outlook.

Even after the post-release decline, the stock is still trading at the upper end of their 52-week range at a forward multiple of nearly 30x. While FAST's challenges, which appear mostly macro-driven, will inevitably abate in due time, the present doesn't appear to be the most opportune time for new or further investment in the stock.

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