The industrial supply companies are always closely followed because they give a good early reading on the manufacturing sector in the United States. Consequently, MSC Industrial Direct's (MSM 0.03%) fourth-quarter earnings on Tuesday will be followed with great interest. I've picked out five key metrics and markers to look out for in the earnings presentation.
Headline sales
At the time of the third-quarter results in July, management disappointed the market by guiding toward sales of $735 million to $747 million in the fourth quarter. CFO Jeff Kaczka referred to the third-quarter trading environment as being "challenging."
It gets worse.The indications from the Institute for Supply Management, or ISM, Purchasing Managers Index are that conditions worsened in the past three months. In other words, the company's sales growth could come under pressure.
ISM Purchasing Managers Index data by YCharts.
Manufacturing and non-manufacturing sales
Of course, the ISM numbers only give a broad overview of the manufacturing market. In reality, each company will have its own specific end markets of importance. As such, MSC Industrial tends to generate 70% of its sales from manufacturing customers and 30% from non-manufacturing (primarily construction), and the following breakout of its sales growth by customer reveals the weakening in its core manufacturing sales.
Data source: MSC Industrial Direct presentations.
Oil and gas, heavy industrial spending
Another issue related to the composition of its sales concerns its exposure to customers who are servicing the oil and gas industries. Indeed, in the third quarter CEO Erik Gershwind referred to the "lingering effects of the fall in oil prices" on some of its customers. Moreover, the fall in mining commodity prices has also put pressure on many heavy industries that service the mining markets.
At some point these commodity-focused customers will see a bottoming out of their prospects, and the U.S. manufacturing sector may see a pickup in activity thanks to low energy prices. All told, investors should look out for what management says about the overall effects of low energy prices on its sales.
Large and small customers
As discussed previously, MSC Industrial has a long-term growth opportunity from consolidating a highly fragmented industrial supply market, and from spreading its capacity to service national customers -- they tend to be large accounts.
Indeed, the company is actively investing in scaling up to service large accounts, and a look at its growth decomposition year to date indicates that most of its growth has come from large accounts. Unfortunately, they tend to be lower-margin, so it's worth keeping an eye on this figure because a shift to servicing large accounts implies pressure on margins.
Data source: MSC Industrial Direct presentations. All figures in millions of U.S. dollars.
Gross and operating margin
The shift to large accounts has pressured margin in the past couple of years, but there are signs that gross margin is starting to stabilize.
Data source: MSC Industrial Direct presentations.
However, as you can see below, operating margin remains in decline, and in the absence of strong sales growth, the company will be under pressure to keep operating expenses under control.
MSM Operating Margin (TTM) data by YCharts.
MSC Industrial's fourth quarter
All told, the company's sales growth will provide an indicator as to the strength of the U.S. manufacturing sector in the last three months. Moreover, investors should focus on its sales to its core manufacturing customers as a better indicator of conditions. The impact of lower commodity prices has hurt MSC Industrial this year, but it will be interesting to hear what management thinks about the impact in future quarters.
Meanwhile, the company's long-term expansion plans -- building scale, expanding sales to national accounts, and so on -- are pressuring margins. Investors will want to see continued stabilization in gross margin as well as some signs of recovery in operating margin.
