Industrial supply companies always give good insight into broader economic conditions, as they tend to be the first companies to catch a cold when the economy sneezes. Indeed, the latest results from MSC Industrial (NYSE:MSM) served notice of what's to come this earnings season.
It was a fascinating report because, at first glance, the numbers looked acceptable. However, a deeper dig into the details makes clear that the industrial sector is heading into a very difficult quarter. Here's why.
The results were OK ... superficially
Investors couldn't have been expecting too much from MSC's fiscal second-quarter earnings report, which covered the period ending Feb. 29. After all, with shutdowns and turmoils occurring across key end markets like automotive, aerospace, and oil and gas, it's natural to expect an industrial supply company would take a major hit.
However, on a superficial level, the results weren't that bad. After all, the decline in average daily sales growth (see chart below) merely seems to be a continuation of a longer-term downward trend in the industrial economy. That's obviously not good, but it seems to be a better result than most people would have predicted.
You could even make the case that those three months were being compared to a very strong fiscal Q2 2019 in terms of MSC Industrial's growth. In this context, a 5.8% decline in March, the first month of its Q3, isn't that bad. It certainly doesn't look like the kind of Armageddon scenario that the markets seemed to be pricing in earlier in the year.
Putting all of this together, you could begin to build a case for the results being pretty good under the circumstances, but as you will see in a moment, it's a bit more complicated than that.
The devil is in the details
To understand why, you have to dig into the earliest available details from MSC Industrial's fiscal third-quarter -- which management also discussed during the earnings call -- and specifically, the data from the five-week reporting month of March. The key points are below:
- In the first three weeks of March, average daily sales were actually up by low-single-digit percentages on a year-over-year basis.
- In the last two weeks of March, average daily sales declined in the "ballpark" of a mid-teens percentage, said CEO Erik Gershwind on the earnings call.
- The company saw "large orders and sales of safety and janitorial products" in the first three weeks of March.
- There was little difference in conditions between the fourth and fifth weeks in March, and April has begun the same for the company, according to Gershwind.
- Management didn't give guidance for the coming quarter.
When analysts asked about the relative strength in March's first three weeks, Gershwind suggested: "One theory is just in times of uncertainty customers wanted to, whether a safety product or not, buy up a little bit."
In other words, it could be that customers stocked up because they anticipated significant shutdowns which might impact their ability to get hold of certain products in the future. This was obviously good for MSC Industrial in the quarter -- it would have pulled some demand forward -- but it's not something likely to continue.
As such, the mid-teens decline in sales at the end of March is far more indicative of the underlying conditions of the business -- and the industrial economy -- than the 5.8% decline for March overall. Indeed, Gershwind noted that 20% of MSC Industrial's customers have shut down, and there's already clear evidence that many heavy industries, such as oil and gas, have already slashed capital spending. As such, don't be surprised if its sales figures take a turn from the worse from here.
What investors can make of it
The lack of guidance and superficially strong sales figures (if you can call a 5.8% average daily sales decline in March and a 4.5% decline in net sales "strong") shouldn't lead investors to be too optimistic. Clearly, MSC Industrial is walking into a very difficult fiscal third quarter, even as it comes up against some easier looking growth comparisons from last year.
That said, it's not quite all doom and gloom. After all, if the restrictions on social activity are lifted, its customers will surely start to open their factories again. However, until that happens, it's going to be a difficult period for MSC Industrial and the sector at large, and the extent of it still hasn't shown up in the company's numbers for just yet. Simply put, the headline sales numbers from MSC Industrial in the fiscal second quarter simply aren't indicative of the underlying conditions in the industrial economy right now.