By: Jake Levinson
Grainger has quickly become a high expectations story after a string of solid quarters. Even the normally sleepy sell-side has caught up to reality, with consensus already above 2018 guidance. CEO DG Macpherson has engineered an impressive turnaround over the past 2 years, making the tough decision to cut prices and aggressively going after a bloated cost structure. And a stock that was left for dead only 18 months ago had rallied 35% into the print (in a group that has had an overall terrible year). Progress in turnaround stories is rarely linear, and it seemed possible we’d get a messy quarter at some point. Today’s low quality beat and 12% stock drop isn’t surprising in that context.
Distributors overall have a had a rough month on tariff and price/cost concerns. Tariffs are unsurprisingly top of mind for many investors, given many distros source a large chunk of their product from China (GWW states ~20% of U.S. COGS direct, though indirect likely higher). We worry less about the inflationary tariff impacts and more about supply chain disruptions…distributors have a long history of being able to recoup inflation with price, though it typically takes a few quarters. Ironically, tariffs may end up helping larger distros if smaller “mom & pop” competitors are unable to adjust.
What provides GWW some cushion relative to some other distros, notably FAST, is an outsized cost opportunity. GWW has long struck as a somewhat sleepy company that rode a wave of secular share gains for the better part of the 2000s. When eCommerce hit an inflection point in the last few years, GWW was caught flat-footed and pricing drifted off-market. Despite corrective actions taken so far, margins in the U.S. remain ~250 bps below peak of 18%+, and “entitlement” may be even higher. Canada has been a disaster, with the oil & gas downturn in 2015/2016 compounded by a mis-executed ERP roll-out. The business here is still losing money, with margins still more than 1,000 bps below peak of ~12%. Though as this quarter shows, these turnarounds can take much longer to play out than expected.
Last, developments in GWW’s international businesses seem to have fallen off investors’ radar, but today’s Cromwell impairment will bring them back into focus. GWW has had mixed success internationally…its MonotaRo investment in Japan was a home run, but the rest of the portfolio has been more disappointing. Cromwell in the UK was acquired only a few years ago in Sept 2015 and was intended to provide an infrastructure backbone from which to export into continental Europe. In hindsight, this turned out to be poor timing with the Brexit vote only 15 months later in June 2016. Brexit aside though, it was never clear to us that GWW had the scale to compete in Europe, which is a more consolidated distribution market. It may make more sense for GWW to exit Europe entirely and focus on its core Japan/U.S. eCommerce businesses.