MSM - MSC Industrial: Muted Revenue With No Significant Growth Potential

2024-01-12 09:21:25 ET

Summary

• MSC Industrial Direct Co., Inc. reported weak Q1 FY2024 results, with stagnating revenue growth and declining profit margins.
• The company has been focusing on expanding its online business, but the overall market slowdown has resulted in muted sales growth.
• Despite trading at a cheaper valuation compared to the industry standard, it is not advisable to initiate a buying position at the current price level.

Investment Thesis

MSC Industrial Direct Co., Inc. (MSM) is a leading metalworking and MRO products and services provider headquartered in Melville, New York. In this thesis, I will analyze its first-quarter results along with its future growth prospects. I will also be analyzing its valuation at the current price level and the upside potential in its stock price. It has been experiencing stagnating revenue growth and declining profit margins with no significant visibility of revenue growth in FY24, and hence, I assign a hold rating for MSM.

Company Overview

MSM is a leading distributor of metalworking, maintenance, repair, and operations ((MRO)) products and services in the United States. It focuses on the distribution of metalworking and MRO products, offering a vast array of items such as cutting tools, abrasives, hand tools, machinery, safety products, fasteners, and janitorial supplies. MSM serves its diverse customer base through multiple channels, including direct sales representatives, catalogs, e-commerce, and telesales. It caters to a wide range of industries, including manufacturing, metalworking, aerospace, automotive, energy, and more.

Q1 FY2024 Results

MSM recently reported weak quarterly results, missing both the revenue and EPS estimates. I believe the overall slowdown in the market resulted in weak demand for its products, particularly the MRO products. The public sector sales proved to be the outperformer, with a 9% growth in sales. However, the sales from other business segments remained disappointing. I would like to highlight the point that it has been focusing extensively on expanding its business online, and it has made several changes to its website, including AI integration, which could help the company in the coming years. However, the overall slowdown in the market has resulted in muted sales growth for the company.

It reported net sales of $954 million, flat compared to $957.7 million in the same quarter last year. As I mentioned earlier, the slowdown has resulted in stagnating revenues. The increased inventory levels for their clients due to lower-than-expected sales are resulting in lower order levels for MSM. The company reported operating income of $101.6 million, down 12.5% compared to $116 million in the corresponding quarter last year. This represents an operating margin of 10.6%, down from 12.1% y-o-y. I believe the higher raw material cost, coupled with higher administrative expenses, resulted in this decline in operating margins. I believe the lack of organic sales growth amplified the deterioration in the operating income and margins. The net income was reported at $69.1 million, a significant decline of 15% compared to $81.3 million in the same quarter last year. This brings the diluted EPS for the quarter to $1.22. As of December 15, 2023, it announced a quarterly dividend of $0.83 , bringing the forward annual dividend yield to 3.56%. The company has been consistent with its dividend payout in the past, and I expect it to continue to do so, considering its past dividend payout data over the past ten years.

Now, let us have a look at its balance sheet. As of December 2, 2023, it reported cash and cash equivalent of $25.8 million against long-term debt of $294.3 million. The inventory levels were stable at $709.3 million compared to the previous quarter. I think the company has a healthy balance sheet, and I do not see any significant issues with respect to the debt or the inventory levels.

Overall, the company failed to perform on multiple parameters, including revenues and profit margins. The future guidance by the company doesn't paint a different picture either. The management expects the FY24 revenues to be in the range of $4-4.2 billion, representing a 0%-5% growth compared to FY23 revenues of $4 billion. The FY24 operating margins are expected to be in the range of 12%-12.8%. I think the company will report numbers closer to the lower end of its estimates, given the declining sales trajectory over the past few quarters and the expected rise in the cost of raw materials.

Valuation

MSM is currently trading at a share price of $93, a YTD decline of 8%. It has a market cap of $5.23 billion. It is trading at a forward GAAP P/E multiple of 15.85x, compared to the industry standard of 21.5x. MSM is a market leader, and I think it is trading at a fair valuation. Considering the muted revenue growth and no significant earnings improvement in sight, I think initiating a fresh buying position at the current price level is not advisable. I would recommend investors hold the stock for now and wait for clear signs of a revival in revenues.

Conclusion

The continued softening of demand has resulted in muted revenue figures for the company. The deteriorating profit margins reflect the impact of low organic revenue growth and higher operating expenses. The FY24 guidance by the management doesn't instill much confidence, with no visibility of revenue growth or operating margins y-o-y. It is trading at a cheaper valuation compared to the industry standard, but the financial performance doesn't indicate a buy at the current price level. Considering all these factors, I assign a Hold rating for MSM.

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