W.W. Grainger (GWW, Financial) is the leader in the United States maintenance, repair, and operations (abbreviated MRO) supply industry.
The company has 377 stores in the United States as well as 181 in Canada, 34 in Latin America and 89 in Europe.
In addition, W.W. Grainger runs the MRO ecommerce sites Zoro and MonatoRO. Zoro Tools serves customers in North America and Western Europe, while MonatoRO serves customers in Japan.
W.W. Grainger was founded in 1927 and generates 88% of its revenue in the United States and Canada. W.W. Grainger has grown to reach annual sales of $10 billion since that time.
An unlikely growth story
When most people think of fast-growing stocks, the MRO industry is not what comes to mind. W.W. Grainger’s growth prospects are much better than you may expect.
Over the last decade, W.W. Grainger has compounded its earnings-per-share at 15% a year. W.W. Grainger is not a new company. It has paid increasing dividends for 43 consecutive years, making the company a member of the exclusive Dividend Aristocrats Index.
W.W. Grainger has realized rapid growth by consolidating the MRO market in North America. The company is the industry leader in North America, yet it controls just 6% if the United States MRO market and 8% of the Canadian MRO market.
The larger a MRO business becomes, the more efficient supply chain it can manage. Economies of scale allow margins to rise, resulting in greater profits. W.W. Grainger uses these profits to fund both organic growth and bolt-on acquisitions, fuelling further growth and resulting in greater economies of scale.
With its small market share relative to the large MRO market, W.W. Grainger has many decades of growth ahead.
Ecommerce growth
W.W. Grainger is seeing rapid growth in its MRO ecommerce stores. The company operates online stores that serve the United States and Canada, Western Europe, and Japan.
The company is taking advantage of Japan’s small geographic footprint and dense population to quickly build a viable distribution network in the country. The Japanese MonatoRO MRO ecommerce site served over 600,000 customers in 2014.
W.W. Grainger is expecting sales of $500 million from MonatoRO in fiscal 2015. The company expects to double sales from MonatoRO to $1 billion in just five years. This is not unprofitable growth. MonatoRO has a ROIC (return on invested capital) of around 40%.
Japan is not W.W. Grainger’s only rapid ecommerce growth market. European sales are expected to grow from a very small base currently to about $200 million a year by 2020. U.S. sales are expected to more than triple from $300 million currently to $1 billion over the same time period.
Growth is nice, but what about safety?
With the recent financial crises in Greece and Puerto Rico any new investment’s performance during recessions should be considered.
Many companies with rapid growth rates perform well during times of prosperity, but suffer during recessions. W.W. Grainger is not one of those companies as evidenced by its performance over the Great Recession.
W.W. Grainger performed well during the Great Recession of 2007 to 2009. The company’s earnings per share fell 14% in 2009 during the worst of the recession.
While a 14% earnings-per-share decline does not sound like "good performance," it was considering the circumstances. Many businesses suffered severe losses during the Great Recession. A 14% earnings-per-share decline shows that W.W. Grainger was able to be very profitable through the worst recession since the Great Depression.
W.W. Grainger hit all-time earnings-per-share highs in 2010, the first year of recovery after the Great Recession. The company performs well during recessions because it sells relatively low products that businesses need regardless of the economic climate.
W.W. Grainger is conservatively financed. The company has around $240 million in cash on hand and total debt of about $630 million. In 2015, W.W. Grainger had net profits of $858 million – enough to wipe out its debt in one year if so inclined.
Exceptional total return potential
Investors in W.W. Grainger can expect excellent total returns going forward. Total returns should reach 15% to 20% a year over the next three years.
The biggest driver of returns will be revenue growth. W.W. Grainger is targeting revenue growth of between 7% and 12% a year over the next five years. Growth will come from continued expansion in North America as well as rapid ecommerce growth.
The second-largest growth driver for W.W. Grainger is share repurchases. Management is committed to repurchasing $3 billion worth of shares over three years. This is no trivial amount for a company with a market cap of under $16 billion. Repurchases will average about 6% of shares outstanding a year over the next three years. Management will likely take on low interest long-term debt to help fund these repurchases.
W.W. Grainger stock currently has a 2% dividend yield which further boosts total returns. In addition, the company could see even faster growth if margins continue to rise for the company. In 2005, W.W. Grainger had operating margins of 11.4%. By 2014, the company grew operating margins to 16.3%.
To summarize, the company will generate 15% to 20% annual returns over the next 3 years from:
- Revenue growth of 7% to 12% a year
- Share repurchases of ~6% a year
- Dividends of 2% a year
- Potentially faster growth from margin improvements
What about valuation?
W.W. Grainger currently trades for a price-to-earnings ratio of 19.2 (using adjusted earnings). For comparison, the S&P 500 currently trades at a price-to-earnings ratio of 20.3. I’m not sure why W.W. Grainger is trading around the same price-to-earnings ratio of the S&P 500 despite having about twice the expected total return.
W.W. Grainger appears undervalued at current prices given its expected total returns, industry leading position, and safety. W.W. Grainger is a Top 10 stock using The 8 Rules of Dividend Investing. The stock should appeal to dividend growth investors looking for high total returns.
