Our rating on Fastenal Co. (NGS: FAST) is BUY. Fastenal Co. sells industrial and construction supplies, including fasteners and, more recently Personal Protective Equipment. The company is now a ‘critical infrastructure’ provider due to its presence with state/local governments, first responders, and food processors, among other customer verticals. The balance sheet is clean and management has focused on growing the dividend, which currently yields about 2.2%.
The beta on FAST is around 1.2.
In 2Q, the company experienced ‘surge’-type orders of PPE that did not exist a year ago. These orders offset lower sales in the company’s traditional branch, onsite and vending businesses. As expected, the ‘surge’-type orders moderated relative to 2Q though they remained elevated. Meanwhile, underlying business activity was described as ‘soft’ by management, due to a ‘generally weak industrial marketplace.’
Onsite locations, which are near a customer’s facility, and vending machines. In January 2020, the company established 2020 signing goals of 22,000-24,000 vending units and 375-400 Onsite locations. In light of the pandemic, Fastenal has suspended these two forecasts for 2020.
EARNINGS & GROWTH ANALYSIS
The FAST business model is relatively straightforward. The company generates revenues by selling industrial and construction supply and safety products to customers. FAST management attempts to offset product costs and relatively fixed operating costs through pricing strategies, innovation, and new product development. Below we review the factors that affected the business in 3Q20.
Sales grew 2.5% pro forma during the quarter, driven by solid sales of PPE that more than offset the decline in the traditional branch and Onsite operations. In 3Q, fastener (high-margin) sales accounted for a low 31% of revenue and declined 7% year-over-year, while Safety daily sales increased 34% year-over-year and accounted for 24% of total sales.
Meanwhile, Fastenal’s customer mix skewed toward national accounts, which represented 55.1% of total customers in 2Q, down 30 basis points from the prior quarter. Management noted that top customers continue to increase their spending; the growth rate was 12% for national accounts in 2Q20.
The company is attempting to boost sales through installed vending machines in stores; and its Onsite business, which provides dedicated sales and service from within or in close proximity to customers’ facilities. The vending machine count at the end of 3Q was 94,395, up 7% from the prior-year period. The company opened 62 new Onsite locations in 3Q, and the total Onsite count rose 15% from the prior year to 1,236, though management noted that Onsite sales declined at a low-single-digit rate in the quarter.
The improvement reflected management’s ability to leverage employee, occupancy, and general corporate expenses in light of higher sales. The company is also managing employee totals. Headcount at the end of 3Q was 20,336. Looking ahead, we expect modest margin improvement in the coming quarters.
FINANCIAL STRENGTH & DIVIDEND
For the first nine months, operating cash flow increased 32% and covered earnings by 118%. Last year, operating cash flow covered earnings by 107%.
The company has a share repurchase program but did not repurchase stock in 3Q.
FAST also pays a dividend. Fastenal has raised its dividend four times in the past two years – a 35% increase.
MANAGEMENT & RISKS
Holden Lewis is the CFO. We view Fastenal as a well-run company that focuses on growth, cost efficiency, and business optimization. The company is also highly transparent in discussing its results and operating strategies.
Fastenal is ‘critical infrastructure’ due to its presence with state/local governments, first responders and food processors, among other customer verticals.
We believe that Fastenal faces significant risk from the cyclical nature of the industries it serves. In particular, in 2015-2016, the company was hurt by sharp downturns in the oil and gas, agriculture, and mining sectors. Earnings have also been affected over time by weak purchasing from heavy equipment manufacturers that service these customers. The company is also exposed to the cyclical nature of the construction industry, and to negative impacts from tariffs.
Fastenal Co. sells industrial and construction supplies, including fasteners, at approximately 2,100 stores and 1,100 Onsite locations. Most of the company’s customers are in the manufacturing and nonresidential construction markets.
Compared to a group of mid-cap Industrial peers (JCI, MAS, OC, SWK), the shares trade at premium valuations, which we think are deserved given the company’s consistent performance history, dividend growth record and strong balance sheet.