The past couple of years have been great for Fastenal
Part of Fastenal's performance can be attributed to the company's management of costs, which it has been known to keep an eye on. There was a slight downward trend in gross margins, but the company was able to raise prices and pass on some of increase in steel prices to its customers.
But the more important factor has been the company's CSP initiative, which changes the selling format in its stores and allows it to operate its stores at a lower cost. The new model does this by carrying more pre-packaged inventory in its stores and allowing customers to grab more items themselves, resulting in higher sales per store employee and a leaner cost structure.
While the company's income-statement growth has been strong, the cash-flow statement reveals that this strategy does affect Fastenal's free cash flow. Last year, free cash flow was hit particularly hard by the increased cost of inventory (steel) and the increase in inventory being held in the stores. So far this year, the inventory growth is back in line with the company's sales growth, and I think the strategy makes sense in the long term.
At the moment, Fastenal's shares are not cheap, trading at about 34 times trailing earnings. However, 506 of the company's stores -- about 30% -- have opened in the last 30 months, including 136 in the first half of this year. The company has stated that it generally takes about 12 months for these stores to begin turning a profit. The stores then continue growing strongly in profitability for about five years, after which the growth typically slows.
Fastenal does have some economic sensitivity, and growth would likely slow if the economy slows. However, much of what the company sells are replacement parts, and such purchases cannot be delayed for long. The market for these parts is also fragmented, leaving room for Fastenal and competitors such as MSC Industrial Direct