Fastenal (NASDAQ:FAST) unveiled relatively healthy second-quarter 2019 earnings on Thursday before the markets opened for trading. However, while the wholesale industrial and construction supplies distributor continued the fast top-line growth it recorded in the first quarter, it was circumspect about the effect of macroeconomic activity on results going forward, and also warned of margin pressure in the coming quarters. Note that all comparative numbers in the discussion that follows are presented against the prior-year quarter.

Fastenal results: The raw numbers

Metric Q2 2019 Q2 2018 Change (YOY)
Revenue $1.37 billion $1.27 billion 7.9%
Net income $204.6 million $211.2 million (3.1%)
Diluted earnings per share $0.36 $0.37 (2.7%)

Data source: Fastenal. YOY = year over year.

What happened with Fastenal this quarter?

Sparks fly as a high-precision grinding tool is applied to a steel surface.

Image source: Getty Images.

  • The company's total revenue advance was mirrored by a 7.9% increase in its all-important "daily sales" metric. Management attributed top-line growth to industrial vending, Onsite locations (the company's dedicated inventory management program at customer sites), and construction supplies sales.
  • Management also pointed to price increases from late 2018 and early 2019 as contributing to the sales improvement. These increases were instituted to offset tariff-related cost pressure, as well as the effects of inflation.
  • Fastenal noted that while general economic activity "remained positive," it saw slowing customer activity levels over the last three months in comparison to the first quarter of the year, potentially signaling slower sales ahead.
  • Fastener product sales improved by 5.5% on a daily basis and comprised 34.5% of total quarterly sales. The balance of quarterly sales was supplied by nonfastener products, which expanded by 9.5% on a daily basis.
  • Gross margin dipped by 180 basis points, to 46.9%. The company cited changing customer and product mix, as well as inflationary effects on product margins, as factors behind the decline.
  • Operating margin slipped by roughly one percentage point to 2.10%, as the lower gross margin outweighed the company's efforts at general and administrative expense control.
  • Fastenal raised its quarterly dividend from $0.215 to $0.220, an increase of 2.3%. On an annualized basis, its payout yields 2.9% at current share price.

On-premise growth and conditions going forward

As I discussed last quarter, Fastenal is focused on expanding its on-premise solutions for both supplies and inventory. The company installed 5,439 industrial vending machines during the second quarter, bringing its year-to-date total to 11,042 units. Fastenal reaffirmed its goal of installing 23,000-25,000 of these units in 2019. The company's total vending machine base jumped by 13% year over year to approximately 86,000 units.

Fastenal also maintained a steady pace of Onsite installations, in which it provides physical inventory and a team to manage both sales and service either within or in close proximity to a customer's location. The organization signed 94 new Onsite installations in the second quarter, marking 199 deals in the first half of the year, and is on track to ink between 375 and 400 Onsite deals in 2019. At quarter-end, Fastenal's installed base of 1,026 active Onsite locations represented a 35% increase over the comparable 2018 quarter.

Looking forward, Fastenal's year-to-date sales growth of 9.1% and steady progress in on-premise installations are somewhat overshadowed by sales and margin uncertainty. As noted above, management is wary of the pace of economic activity in the back half of the year. Underscoring the caution, in Fastenal's June 2019 activity report released alongside earnings, daily sales increased 7% over June 2018, a pace that's 2 percentage points off the daily sales growth of 9% recorded overall in the first half of the year. 

On the margin front, the company observed that its recent price increases helped to mitigate tariff-related cost escalation, but was inadequate in overcoming general inflationary pressures in the second quarter. According to the earnings press release, Fastenal has "taken additional actions in the third quarter of 2019 to counter the broader pressures [we] are experiencing on our costs as well as the additional tariffs that were levied on China-sourced products in May 2019." Thus, the company will attempt to stave off further gross margin pressure in the back half of the year, but for now, it hasn't promised a complete offset.

While Fastenal has enjoyed decent expansion so far in 2019, its slightly cloudy outlook for the final two quarters may have provided some investors with an excuse to book profits after a share price increase of nearly 20% year to date. Shares opened down roughly 4.5% at the outset of the Thursday trading session.

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