Anyone looking for some signs of a pick-up in U.S. manufacturing activity would have been left disappointed by MSC Industrial Direct's (NYSE:MSM) third-quarter results. Its earnings report highlighted a company struggling manfully in a difficult environment. In short, the positive news from the quarter relates to the company's expense management, rather than any help from its end markets. Time to look closer at what happened.
MSC Industrial Direct's third-quarter earnings
Heading into the quarter, management sounded an optimistic note, with talk of stabilization and a possible improvements to come. Unfortunately, neither stability nor improvements arrived, and sales of $727.5 million in the quarter missed even the bottom end of the $729 million to $741 million guidance range.
However, as noted above, management is doing a pretty good job of managing expenses, which allowed the company to achieve a gross margin of 45%, in the middle of the 44.8% to 45.2% guidance range. Moreover -- and this is the really positive story from the quarter -- operating expenses came in at $221.2 million compared to guidance for $229.3 million. In other words, better than expected expense control (by $8 million) contributed to net income rising $1.5 million to $64.8 million -- EPS rose 2% to $1.05.
What went wrong with sales
Discussing the matter on the earnings call, CEO Erik Gershwind said, "We saw the potential for some stabilization on the horizon. Unfortunately, that did not materialize and in fact things weakened."
He went on to describe a weakening industrial economy in which customers were taking a more negative view on growth, amid a soft pricing environment. The reason?
According to Gershwind, it's a continuation of the same negative trends that have been impacting the industrial sector for the last year or so:
- Low oil prices impacting energy related capital spending
- Impact of the strong dollar on U.S. manufacturing
The end result is ongoing weakness among the heavy machinery and metal cutting businesses that MSC Industrial makes a substantial share of its sales to. If MSC Industrial's commentary is accurate, then Illinois Tool Works (NYSE:ITW) could see some weakness in its welding segment in the quarter. As readers already know, in Illinois Tool Works' last set of results, management said that welding was the only segment not to be stable in the quarter. Similarly, Dover Corp.'s (NYSE:DOV) energy-related earnings could come under even more pressure.
Details of MSC Industrial's quarter
The company's quarter -- at least in terms of end markets -- can best be summarized by the following charts. First, here is a look at monthly average daily sales growth. As you can see below, there is no indication yet that a corner has been turned.
Honing in on the specific end markets, a breakout of manufacturing vs. non-manufacturing sales highlights the weakness in manufacturing.
Fourth-quarter guidance for sales of $730 million to $742 million implies growth of 0% to 2%, but don't get too excited -- the results will benefit from an extra week's trading. In fact, management's forecast for average daily sales to decline by 4% to 6% in the quarter represents a continuation of negative trends -- see the first chart above.
On a more positive note, guidance for gross margin in the 44.7% to 45.1% range implies a continuation of the stabilizing of gross margin at around 45% -- no mean feat in a deteriorating sales environment.
With oil trading at around $50 a barrel now, investors will no doubt be hoping that conditions soon improve for energy-related manufacturing customers. Until then, the focus for MSC Industrial will be on generating expense savings in order to grow the bottom line. In a tough business environment, that's about all one can hope for.
Lee Samaha has no position in any stocks mentioned. The Motley Fool owns shares of and recommends MSC Industrial Direct. The Motley Fool recommends Illinois Tool Works. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.