Early in 2023, I believed it was time to fasten up in the case of shares of Fastenal Company (NASDAQ:FAST). The company continued and continues to outgrow the MRO industry, granting shares a well-deserved premium versus the market at large.
The company continues to show operational outperformance, but as the growth of the MRO industry has come to a complete standstill (at best), Fastenal has seen growth slow down dramatically as well.
With shares having risen over 40% over the past one and a half years, amidst a fairly flattish earnings performance, multiples have risen quite a bit here. While I still regard Fastenal as a long-term quality, I fail to see appeal at current levels.
An MRO With A Superior Business Model
Fastenal continues to consistently outperform peers, the wider industry and markets at large, driven by a unique business model. Besides operating a huge number of traditional stores, the unique feature of Fastenal is that it operates many vending machines and actual sites at customer sites, respectively near 120,000 and 2,000 locations. These locations have come somewhat at the expense of the physical footprint, with these branches down by about a thousand locations to just over 1,500 over the past decade.
The company is a different thing to a different customer: ranging from a local relationship, a logistics company, a consultant, and generally a distributor of a wide range of industrial and construction products. A focus on people, the customer, and a decentralized customer culture have stood at the foundation of its success.
In terms of end markets, Fastenal mostly caters to heavy manufacturing and all other kinds of manufacturing, which combined makeup about three quarters of sales. This is complemented by a wide range of other segments such as nonresidential construction, resellers, transportation, warehousing, and others.
Through 2023, the company has been posting solid growth amidst a resilient economic environment and inflationary pressures. Through the first three quarters of the year, revenues were up in the mid to higher teens, with earnings coming in close to $2 per share. A $46 stock in 2023 made that shares traded at 23 times earnings, at a substantial premium to the market.
This was warranted as the company was generating about $7 billion in sales, having doubled in the decade before, while it kept operating margins flattish around 20% and managed to buy back some shares. This great track record warranted a premium in my eyes, with valuations more friendly than seen for a while, although 2023 was setting to become a bit tougher.
Sticking with a targeted entry point around 20 times earnings, I was looking and waiting to get involved around the $40 mark, levels unfortunately never seen again.
In fact, shares kept on rising through 2023 and into the first half of 2024, and after shares set a high of $79 this spring, they are now back to $65 amidst concerns about slower growth in the MRO market.
Picking Up The Trajectory
In January of this year, the company posted its 2023 results, with revenues up just over 5% to $7.35 billion, even as growth was held back by one business day less being available in the period. Margins were really steady as the company grew earnings by 6% and earnings per share by nearly 7% to $2.02 per share, after 2022 earnings came in a bit short compared to $2 per share.
Growth was slowing down amidst lower inflation, and the impact of worsening conditions on the construction markets, although that the company generated sufficient cash to deplete a modest net debt load.
Momentum cooled off significantly in the first quarter of this year, with first quarter sales up by nearly 2% to $1.90 billion as modest margin pressure meant that earnings came in flat at $0.52 per share. Adverse weather did have a small impact on sales, as the growth slowdown was attributed to softer demand for fasteners and certainly construction end markets.
The company refrained from buying back stock, resulting in the company moving into a very modest net cash position. With 574 million shares now trading at $65, Fastenal commands a $37 billion equity valuation, but with earnings only trending close to $2 per share, multiples have expanded from about 23 times earnings in 2022 to about 32 times here.
Trends have been a bit uneven here. The key daily-called metric sales grew by just 1.8% in March, 0.7% in April, 1.5% in May, and recovered to 3.3% in June. In July, Fastenal posted second quarter sales up by a similar near 2% to $1.92 billion, as a near point pressure on operating margins made that earnings actually ticked down a penny to $0.51 per share. This is actually a good thing, as the company is increasing the pace of signing up for onsite stores and vending machines, somewhat weighing on margins, but likely accelerating growth in the future.
What Now?
Quite frankly, the slowdown in the MRO industry has an impact on Fastenal as well, as growth in the mid-teens has slowed down a lot to low single digits here. That, however, stands in sharp contrast to the overall MRO industry, with peers posting revenue declines in recent times, including a big profit warning from MSC Industrial Direct Co., Inc. (MSM). This confirms the continued outperformance of Fastenal versus peers, but it still means that growth has been lackluster.
Given this background, FAST shares have risen nearly 50% since early 2023, all the result of valuation multiple inflation, with earnings multiples having risen from the low-twenties to the low-thirties.
It is this backdrop which makes me cautious here, as multiples have risen quite a bit, with no absolute (only relative) performance to show for it. This makes me cautious here, as frankly, I have been a bit too cautious early in 2023, although the performance of the shares has been in line with the market at large.
Given all this, Fastenal Company remains an impressive long-term performer. However, the overall valuation multiples here are too demanding, as a current low-thirty times earnings multiple translates into an earnings yield of just about 3%, making me patiently await better entry levels.
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