One of the nice things about Wall Street is that you can very quickly and directly get a read on what investors think about things by simply watching stock prices. So when Fastenal's (FAST 0.04%) stock rose 7.5% after the company reported third-quarter earnings, it was clear to see that Wall Street liked what it read. The problem is that, sometimes, investors as a group focus on the wrong things. Here's the bad news that investors may be missing at Fastenal today.
Fastenal sells directly into the industrial engine
It is important to understand what Fastenal does. For starters, it is an industrial company, so it sells to other companies, not directly to consumers. Second, it sells fasteners and tools that are, basically, consumable items that are vital to manufacturers's operations.
Image source: Getty Images.
Fastenal works to integrate itself into its customers' supply chains. That includes an increasing focus on being onsite at customer facilities. It also involved the company taking on extra inventory during the coronavirus pandemic's height, so its customers could be sure that they would have what they needed to stay up and running. Fastenal's business approach has historically produced very strong results, but as its industrial customers' businesses ebb and flow along with economic activity, so, too, does Fastenal's business.
To Fastenal's credit, it has long navigated cyclical swings in its business with relative ease. That shows up most notably in the 24 consecutive annual dividend increases the company has under its belt. It's helped along by a rock-solid balance sheet, with a debt-to-equity ratio of just 0.075 times. That's incredibly low, considering that the company covers its trailing interest expenses by a huge 127 times.
The bad news that investors aren't looking at closely enough
But that strong financial foundation actually brings us back to the troubles that are showing up in the business today. The company is, basically, ensuring it can withstand economic downturns and full-out recessions while still managing to reward investors with dividend increases. What exactly does an economic downturn look like here? Falling sales numbers.
This is where things get troubling. In Q3, the company's overall daily sales rate came in at 4%. That's a positive figure, which is good. Positive metrics here mean that sales increased year over year while a negative figure would represent a year over year decline. But the quarter's daily sales rate was down from 5.9% in the second quarter and 16% in the year-ago period. To be fair, the coronavirus pandemic created some strange trends, so the year-ago period probably isn't the best comparison point. But the trend is very clear -- the daily sales rate has been falling for six quarters. That's a bad sign, suggesting things are getting worse, not better, and the big hit is coming from volume declines.
Looking under that top level figure, examining end markets, heavy manufacturing sales (about 43% of the top line) grew 9%, but have been in a downtrend for well over a year. Sales to other manufacturers (31%) grew just 2.5% and have also been in a broad downtrend. And all other sales (the remainder of the top line) fell 1.3%. While that was an improvement from the last quarter, it is still a negative number, so sales in this segment of the business are effectively shrinking. Once again, the big takeaway is that the sales trends, driven by weakening demand, across Fastenal's main end markets are negative.
Looking at the breakdown by product type, sales of fasteners (about a third of revenues) fell 2%, continuing a multi-quarter downtrend. Safety supplies (21%) rose 9.2% but have treaded an uneven path since the pandemic, which isn't exactly shocking. All other products (the remainder) saw sales increase 6.8%, but again, that was a continuation of a slowing trend. Once again, the trends are largely negative.
Basically, there's no clear sign of strength in the business when you start to examine the details. That suggests that Wall Street could be pricing in a lot of good news here that may not actually exist.
A great company, but maybe not a great investment
None of this is meant to disparage Fastenal as a business. It is an exceptionally well-run company, but it is still a cyclical company. There's no way to know when the next big economic slowdown will arrive, but so far it looks like Fastenal's business is, indeed, slowing down. That makes it kind of hard to justify the post-earnings excitement here.
Notably, the price-to-sales and price-to-book value ratios are above their five-year averages, while the price-to-earnings ratio is basically in line with its longer-term average. That seems like way too positive a view of a cyclical business that's seeing a business slowdown.
