By: Jake Levinson
FAST’s growth of late has been solid, with November’s 12%+ the 18th consecutive month into double-digits. Going into 2019, however, we expect decelerating growth rates for many of FAST’s larger heavy machinery customers. Most have grown revs well into double-digits the past 2 years…Caterpillar up nearly 20% in 2017 and north of that this year. Average growth rates for a basket of these names (including others such as DE, PCAR, CMI, TEX and OSK) should step down materially to 5% in 2019 from 17% this year (see data on following pages). That’s still solid growth, but coming off unsustainable rates. For context, a quarter of FAST’s sales are to heavy equipment manufacturing, and large national accounts (e.g. CAT, DE) overall make up about half of total revenues, so there’s material overlap. In other words, it’s hard to envision FAST’s growth accelerating or even remaining stable at current levels into next year with a quarter of its business decelerating by 10+ points.
This matters because almost all of FAST’s historical earnings growth has come from the top-line, not margins. Earnings have compounded at the same rate as sales over the past 20 years (an impressive 12% CAGR). This has long been a knock on the FAST business model: high sales growth, but limited operating leverage (~20% avg incrementals long-term). Part of this comes down the higher variable cost nature of distribution. Lots of salespeople compensated on growth, and in upcycles FAST tends to hire more of them. FAST has also invested a significant portion of the upside into new growth initiatives, these days vending and Onsite.
Right now, the thesis seems like it needs to shift from growth to margins, but that remains a “show me”. To FAST’s credit, it runs a tight ship on costs and has the highest margin/return structure of the major MRO distributors. Which also means less upside opportunity vs. peers…FAST has a 600+ bp op margin lead over GWW/MSM. Gross margins are already under secular mix pressure from growth in lower margin products (non-fasteners), channels (vending/Onsite) and customers (national accounts). And FAST is contending with cost inflation from tariffs and labor/freight in addition to higher investment levels. Op margins have positively surprised the past 2 quarters, expanding despite gross margins down y/y. Though it’s not clear to us yet how sustainable this is.
If growth decelerates and margins don’t expand, it’s tough to justify the premium stock valuation. Shares have held in surprisingly well in what’s been an overall ugly tape for industrials, outperforming the XLI by nearly 15% since the end of October. FAST now trades north of 20x 2019 consensus EPS compared to GWW at sub-17x and MSM at only 14x. And customers like CAT in the single digit range (though not entirely apples-to-apples given a very different growth/margin/return profile). If management can deliver, however, the stock has historically worked very well when putting up both strong top-line and margins.