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Fastenal Skates by Earnings Obstacles

By Asit Sharma - Oct 13, 2019 at 3:15PM

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The industrial supplier is boosting its top and bottom lines in a volatile environment.

Industrial and construction supplies wholesaler Fastenal (FAST 3.05%) saw its stock surge by 17% on Friday, after the release of its fiscal third-quarter 2019 results. The company's earnings exceeded investor expectations, and its year-over-year growth rate hit the high single digits. Importantly, the results also alleviated worries over the potential for trade tariffs to cut into the organization's profit margins.

As we review the quarter, note that all comparative numbers are presented against those of the prior-year quarter.

Fastenal results: The big-picture numbers

Metric Q3 2019 Q3 2018 Change
Revenue $1.38 billion $1.28 billion 7.8%
Net income $213.5 million $197.6 million 8%
Diluted earnings per share $0.37 $0.34 8.8%

Data source: Fastenal.

Critical details from the quarter

Detail of pulley mechanisms on an industrial manufacturing engine.

Image source: Getty Images.

  • Daily sales increased 6.1% from higher unit sales at industrial vending machines and Onsite locations. To a lesser extent, the revenue advance was assisted by higher pricing. Management noted that it continues to implement product price increases to offset general and tariff-related product inflation.
  • The advance in site-specific sales -- industrial vending and Onsite -- pushed gross margin down by 90 basis points, to 47.2%, as these sales carry a lower margin than Fastenal's sales at branch locations. However, the lack of a significant margin headwind from import tariffs suggests that the company's price increases are successfully absorbing any untoward profit damage.
  • Fastener product sales expanded by 3% on a daily sales basis and made up roughly one-third of quarterly sales, while non-fastener sales supplied the balance of revenue and grew at an 8% clip as measured by daily sales. 
  • The company controlled operating and administrative expenses this quarter, improving overhead by one percentage point to 26.8% of sales. However, this wasn't enough to offset the effect of lower gross margin: Operating margin decreased by 30 basis points to 20.2%.
  • Full-time equivalent (FTE) employee count rose by 4% over the prior-year period to 19,060 FTEs. This number dropped 3% sequentially against Q2 2019. The improvement from the second quarter resulted from operational efficiency and a net decrease of 20 public Fastenal branches, leaving the quarter ending with 2,146 public branches. 
  • Cash flow widened noticeably over the prior-year quarter, as Fastenal generated $590 million in cash from operations against $496 million in the third quarter of fiscal 2018. Management attributed the greater cash flow to the higher sales during the quarter and to more efficient working capital management. 

On-premise growth update

Fastenal's strategy of on-premise growth through supplies vending machines and the more comprehensive Onsite inventory solution has made it an enticing investment candidate over the past several quarters. Expansion continued in the third quarter: Fastenal signed 5,671 industrial vending machines, bringing its total signings to 16,713 machines in the first nine months of the fiscal year. Total installed machines grew 12% year over year to 88,327.

Nonetheless, management observed that "slower economic activity has lengthened the sales cycle for vending." Executives currently expect to complete 22,000 vending machine signings this year, versus a previously stated goal of 23,000 to 25,000 units. That still represents a fairly brisk growth target.

During the organization's earnings conference call, CEO Daniel Florness attributed some of the reduction in the pace of vending machine signings to customers' hesitation because of the uncertainty in the global economy. The CEO lauded the company's ability to push through appreciable signings under these conditions and also highlighted the fact that Fastenal's average revenue per installed vending machine increased during the past three months on a year-over-year basis.

The company added 84 new Onsite locations during the past three months and has tacked on a total of 283 new locations in the first three quarters of 2019. Management still believes its full-year goal of 375 to 400 new installations is within reach. Fastenal counted 1,076 active Onsite locations at quarter's end.

Looking toward fiscal 2020

As Fastenal heads into the final quarter of the year and looks ahead to fiscal 2020, it appears to be gaining momentum despite a vulnerable growth environment in the supplies distribution business. Fastenal has skated past the earnings obstacle of tariffs through timely price increases, and it's overcome broader economic inertia by ramping up on-premise installations to gain market share. The supply chain specialist will look to close out 2019 in very decent shape: With just a few weeks left in the fiscal year, shares are up nearly 40% year to date.

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