Fastenal Company: A Trade War Survivor

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Fastenal Company (NYSE:FAST) is a leading supplier of threaded fasteners and other industrial tools and products primarily to commercial users. One of the challenges for the company over the past year has been dealing with tariffs in place on steel-based products, including fasteners, which has added to uncertainty for the company. The stock fell by nearly 20% off its highs this past summer when at the time tensions in the U.S.-China trade dispute had escalated. Separately, the business is highly cyclical and emerging growth concerns have also weighed on sentiment in recent months. Fast forward and the company just reported better than expected Q3 results, which largely cast aside any notion of a deep deterioration in the business. Despite some weaker operating figures this year and decelerating growth, the outlook has improved and FAST is now trading at a new all-time high. This article recaps the latest earnings and our view on where the stock is headed next.

(source: FinViz.com)

Q3 Earnings Recap

FAST reported its fiscal Q3 earnings on October 11 with GAAP EPS of $0.37 which beat expectation by $0.01. Revenue of $1.38 billion, up 7.8% year over year, was in line with published consensus estimates. Despite slowing revenue growth relative to the 13% y/y rate last year, the overall better than expected result can be traced to the decline in operating expenses to 26.8% of sales, down 80 basis points from Q2 2018. FAST has been able to effectively control costs while balancing some of the tariffs impact through higher pricing. The company noted that while the gross margin declined by 90 bps compared to the period in 2018, it increased by 30 bps from Q2.

(source: Company IR)

The stock surged by as much as 17% on the day of the result, flying to a new all-time high, while we think some of that exuberance was based on the day’s favorable headlines of progress on the U.S.-China trade negotiation. The idea is that since the ongoing tension has been one the main culprits pressuring global growth expectations and weak sentiment among U.S. industrial production, a resolution would naturally support the operating environment for a company like FAST that deals with customers exposed to these trends.

FAST Forward Looking Commentary

On the other hand, management noted a softening of economic conditions that were evident through weaker operational figures. Among decelerating growth, measures like the daily sales rate which is net revenues by business days among end markets and by product category showed a meaningful slowdown in Q3. The company noted that while “consumer-related customer” trends remained steady, commercial and industrial business were soft. The earnings results were overall impressive considering these trends.

(source: Company IR)

Manufacturing firms, including those of heavy-equipment, represent nearly 70% of its total end-markets for the company and the result in Q3 showed the company was relatively isolated from broader macro trends at least at the financial level. Manufacturing as an industry has been one of the weakest areas in the overall economic outlook in the U.S. given a Manufacturing ISM index which is in a contraction zone reading of 47.8, the weakest level going back to 2009. Broader industrial production has also decelerated and a growth of 0.8% y/y in the month of August was well below the levels from last year.

(Source: CNBC)

Favorable developments in the U.S.-China trade dispute represents a potential bottom for the currently weak economic indicators which would drive upside for the operating environment for FAST and the broader market. Beyond the positive headlines today, we want to see a recovery in hard economic data to follow through going forward.

Valuation

Keeping in mind that forward consensus estimates have yet had a chance to be revised presumably higher, the chart below shows that given the spike in the stock price, trading multiples between a forward P/E, and the forward P/S ratio are now trading at the highest levels of the year. FAST is expected to reached EPS of $1.37 for the full fiscal year 2019, which if confirmed would represent a 4.5% increase from $1.31 in 2018. Estimates for revenues at $5.325 billion for the year would be a more solid 7.8% increase compared to 2018.


Data by YCharts

The stock is also responding favorably to higher free cash flow. The company has generated about $765 million in cash flow from operations over the trailing twelve months, and considering stated capex spending of $59.7 million in Q3, we calculate a free cash flow over the trailing twelve months at $515 million, representing a current price to free cash flow ratio of 34.5x, which is about average for the past 3 years.

The other consideration here is the dividend that now yields 2.35%, approaching the tightest levels going back to 2014. We take these metrics cumulatively to suggest that the stock is at least more expensive now than it’s been over the past year while recognizing the move on earnings is based on a more improved outlook. Beyond the headlines from the U.S.-China trade dispute, economic indicators in the U.S. will still need time to confirm a rebound higher and improved sentiment and it’s not clear if that will happen. It’s possible that underlying deceleration of the U.S. economy and recent weakness in industrial production and manufacturing is independent of the uncertainty that has surrounded the trade negotiations.


Data by YCharts

Takeaway

Long time FAST investors have to be feeling pretty good about the earnings release and response from the market, with shares trading at a new all-time high. The company proved that it was able to navigate a challenging period by presenting solid earnings. Based on some of the valuation figures discussed above, we think it’s probably too late to initiate a large long position in the stock as it appears to have incorporated the new bullish sentiment. We rate FAST as a Hold, looking to see in the upcoming quarters how the operating level figures rebound given the recent macro developments. Monitoring points should be the daily sales rate and margins for the company.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.