Profit First From Industrial Suppliers

Don't expect our ailing economy to turn around too rapidly. Sure, President Obama rejected the notion we needed a second stimulus package, saying instead that the massive infusion of cash he's already approved needs a chance to work. His appeal came right after the Institute of Supply Management (ISM) reported that its manufacturing index shows signs that the economy's rate of contraction may be slowing.

Yet those aren't exactly conclusive signs that we're marching toward recovery, even if they remain better than all those green shoots that suddenly wilted and died.

The ISM surveys purchasing and supply executives to gauge the direction of production, new orders, inventories, employment, and deliveries. After crunching the numbers, an ISM index greater than 50 means the manufacturing sector is expanding. Anything below that level indicates we're in a period of contraction. However, any number above 41.2 signals growth in the overall economy.

There's a reason economics is the dismal science
Still, the latest report looked relatively less grim, clocking in at just 44.8. That marked the second month of broader economic growth, but the 17th consecutive month of manufacturing contraction. The Bureau of Labor Statistics says manufacturing jobs are falling at their fastest rate since 1946, down 12.2% over the past year. With the manufacturing sector employing about 10% of this country's workforce, we just might need a second, third, and fourth round of government spending to reach the 20% goal that General Electric (NYSE: GE  ) CEO Jeffrey Immelt set as the minimum percentage of jobs the U.S. should accept in manufacturing.

In a more positive light, the index itself is well above the December low of 32.9, and June's job loss numbers are better than they were in January, when they hit 741,000. The ISM also says that seven of the 18 industries it tracks reported growth in June, while its Production index rose to 52.5%, a gain of more than 12 points over the last two months. It concludes that "a slow recovery for manufacturing is forming."

Cleaning up in industrial supplies?
Manufacturing helped lead us out of the Great Depression, so it might be natural to assume it will be the birthplace of this recession's recovery as well. Although manufacturing is a much smaller component of our economy now than it was back then, investors might still find companies in the forefront of any rebound, like the industrial suppliers that fill the shelves of manufacturers.

These would seem to be the leading-edge businesses of a leading-edge industry. Companies went through an aggressive destocking phase during the depths of the recession and with the cupboards now bare, they'll need to order parts, materials, and supplies again. However, even with Warren Buffett's ultimate buy signal suggesting a green light for the economy, I wouldn't stock up on these companies just yet.

MSC Industrial Direct (NYSE: MSM  ) reported better earnings earlier this month than analysts had expected. However, CEO David Sandler admits his industry is in a severe funk, and he fully expects his customers to undergo longer and more frequent shutdowns this summer. With limited visibility for the fourth quarter, his guidance trailed what analysts were anticipating. In light of W.W. Grainger's (NYSE: GWW  ) steady, yearlong reports of declines in daily sales, this really isn't a surprise.

Not so fast
If you're still looking to mop up here, you'll want only financially stable companies. Debt-free Fastenal (Nasdaq: FAST  ) seems to fit the bill, but its margins took a hit this quarter. At 17 times earnings, it's not cheap, particularly when you compare it to MSC and Grainger, which also have low debt profiles.

Company

Cash

 Total Debt

Debt-to-Equity

Quick Ratio

Op. Margin (TTM)

P/E

Div. Yield

Anixter (NYSE: AXE  )

$100

$1056

0.96

1.6

5.9%

8.2

NA

Fastenal

$175

$0.0

NA

3.1

16.9%

18.1

2.20%

IDEX (NYSE: IEX  )

$63

$544

0.47

1.4

16.4%

16.4

2.10%

MSC Industrial Direct

$208

$206

0.26

1.5

15.2%

14.6

2.30%

W.W. Grainger

$258

$530

0.27

1.4

11.4%

13.4

2.30%

Wesco (NYSE: WCC  )

$105

$1024

1.32

1.0

5.4%

5.2

NA

Source: Motley Fool CAPS and Capital IQ, a division of Standard & Poor's. Cash and debt figures in millions.

Fastenal is a leader, but it's always been priced as such. I think investors will do better looking at either MSC Industrial or Grainger for better growth opportunities, with the scales tipping toward the latter.

Slippery when wet
While both rivals seem equally positioned, MSC, like Fastenal, has seen margins weaken considerably over the past year, while Grainger has steadily improved. At just 13 times earnings, it also offers investors the best risk-reward ratio of the bunch, with a nice dividend for your troubles.

There seems to be little question that our economy is still in for rough times, so I don't know that I'd jump in to these plays too soon. But when the recovery does come, industrial suppliers will be the first companies to profit, as they stock the shelves with the basic goods necessary to keep manufacturers' own growth engines running smoothly.

MSC Industrial Direct is a Motley Fool Stock Advisor recommendation. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Rich Duprey does not have a financial position in any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.


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