When industrial and construction supplier Fastenal Company (FAST 0.71%) reported second quarter earnings last month, some investors were disappointed as they pointed to the results as a harbinger of declining market conditions for the manufacturing segment.
In fact, management acknowledged as much, saying, "While general economic activity remained positive, we did see slowing in the second quarter of 2019 relative to activity levels experienced in the first quarter of 2019."
Source: Fastenal Company
But looking from a broader lens, while short-term results may be negatively impacted by a lull in market demand and higher costs that the company claims are tariff-related, the longer-term growth drivers of onsite locations and vending machines continue to perform well.
Celebrating milestones
In early June, the company announced that it surpassed 100,000 active vending devices and celebrated having over 1,000 onsite locations in July. Before we look closer at these growth opportunities, let's look a little more at the recent quarterly results.
As mentioned, higher costs and a slowdown in end markets were headwinds for Fastenal. In line with 2018, for the first six months of 2019, 86% of sales occurred in the United States, so domestic macroeconomic conditions play a significant role in how the company performs. The following table compares daily net sales growth through last year (net sales divided by the number of days in the reporting period) as well as gross profit. Fastener products and non-fastener products account for approximately one-third and two-thirds of sales, respectively:
| Q2 2019 | Q1 2019 | FY 2018 | |
|---|---|---|---|
| Fastener Growth | 5.5% | 11.8% | 11.2% |
| Non-Fastener Growth | 9.5% | 12.7% | 14.7% |
| Gross Profit | 46.9% | 47.7% | 48.3% |
Data source: Fastenal financial filings.
Near-term headwinds
Though overall sales rose a respectable 7.9% for the quarter, it's apparent that the biggest highlights are trends of slowing growth and increasing costs. Management pointed to increased inflation on net product margins as a growing cost-related factor over the first quarter:
While we successfully raised prices as one element of our strategy to offset tariffs placed to date on products sourced from China, those increases were not sufficient to also counter general inflation in the marketplace. We have 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.
Building customer relationships
While it's clear there are some near-term challenges, the longer-term strategy remains on track. The milestones achieved with active vending devices and onsite locations were a reminder of the progress Fastenal has made on projects the company can control.
Both the vending machines and onsite program are meant to bring the company closer to the customer, both literally and figuratively. By setting up in a customer's facility, Fastenal creates a stickiness that helps establish a long, productive relationship for both parties. The milestone onsite facility is with an existing customer, Nutrien, the world's largest provider of crop inputs, services, and solutions. A manager at Nutrien described the benefits of the program:
Some of our locations are in remote areas, so an immediate benefit of a Fastenal Onsite program is that it shortens supply chain from a distribution standpoint [...] Integration is also very important to us. Having a fully dedicated Fastenal resource allows us to step away from tactical activities to become more efficient and focused on our core business.
Positive results from these initiatives
The most recent quarter saw continued success with these growth drivers. The following table shows what the company reported related to these initiatives, including the rate of daily sales achieved through the two areas:
| As of June 30, 2019 | YoY Growth | Daily Sales Growth | |
|---|---|---|---|
| Installed Vending Devices* | 85,871 | 12.9% | "Low Teens" |
| Onsite Locations | 1,026 | 34.8% | "High Teens" |
*This does not include more than 15,000 devices that are part of a lease locker program. Data source: Fastenal.
The quarterly results certainly highlighted some headwinds from areas out of management's control, but long-term shareholders should be satisfied that the company's focus on growth through vending devices and onsite locations is paying off.
Fastenal also announced a dividend increase in July, following a pattern that has given shareholders an annual dividend increase rate of over 15% over the past decade. With the dividend payout ratio hovering around 60%, there's every reason to think this trend will continue, giving shareholders an income stream as any macroeconomic headwinds and cycles play out. The success of management's key strategies along the way should make for an even stronger company in the future.
