Distribution can be a great business; offer your customers the goods they want and take a little cut of each transaction for yourself. With a huge inventory of goods available for next-day delivery, MSCIndustrial (NYSE:MSM) has continued its run of increasingly profitable growth in the industrial supply market.
For the company's fourth quarter, sales rose more than 12% while operating income grew 19% on yet another expansion in operating margin. Moving on down the income statement, net income grew better than 26% while earnings per share grew more than 31% and surpassed both the mean estimate and the high estimate for the quarter.
One of the things I find most attractive about MSC's business model is that it eschews the branch-based approach of competitors like Grainger (NYSE:GWW) and Fastenal (NASDAQ:FAST), and that significantly reduces the capital needs of the business. In fact, MSC produced almost $114 million in free cash flow for its fiscal year. That's better than 10% of sales, a ratio considerably better than that of those two competitors. Although the company will have a bit more capital spending next year for a new warehouse management system, I would expect that to be an investment that pays off pretty quickly with better margins.
While there are no doubt some customers that like the convenience of knowing they can walk into a store and get a tool they need, the fact that MSC can offer something like half a million SKUs through next-day delivery is attractive in its own right. What's more, this is a hugely fragmented market, and even Home Depot's (NYSE:HD) efforts to compete more in the maintenance, repair, and operations supply space won't really put MSC at a disadvantage.
One other major item from the quarter is the company's transition to a new CEO. David Sandler has been promoted to the position after 16 years at the company. This will mark the first CEO who isn't a member of the founding family -- unless former CEO Mitchell Jacobson decides to retroactively adopt him. Given the tenure of Sandler at the firm and the fact that the Jacobson family still has a major ownership interest in the shares, I am very much inclined to assume that business will continue on as before.
Although I'll concede that these shares don't look cheap by the conventional P/E approach or the slightly less conventional enterprise value-to-free cash flow approach, I still see value here. Not only does the company generate an excess return on capital, but also there is considerable operating leverage and incremental profit potential as it continues to grow.
For more industrious Takes:
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Fool contributor Stephen Simpson owns shares of MSC Industrial.
