Description

Fastenal (FAST), at one time a popular stock with the fundamental investment community, is now largely ignored.  However, we believe the business is undergoing a significant structural shift underappreciated by investors with earnings power that should significantly exceed consensus expectations.  This is also a very high-quality business run by a strong management team, and based on our 2021 EPS estimates of approximately ~$3.90/share (consensus = $3.28/share), we believe the stock will be worth ~$100-$110/share within 1-2 years if FAST trades at its historical average multiple of 25x.

Fastenal is the most profitably run U.S. industrial parts and fasteners distributor. These parts are primarily sold to manufacturers and other construction-oriented companies. It sounds like a simple, commodity business – but it’s not.  The service levels require local density with national logistics and inventory infrastructure to meet same-day delivery demands of customers who need parts on short notice.  Delays in delivery equal days of customer downtime which equals lost profit for those manufacturers and construction firms.

Our field research indicates FAST generates consistently superior returns to its peers (GWW, MSM), based on its network density (~2,200 branch locations, ~950 onsite locations and over 83,000 vending devices) and national logistics infrastructure capable of superior delivery times.  Management is also best-in-class with compensation tied to the long-term profitability of the organization.

Since 2014, the stock has largely been forgotten by the investment community due to the perennial “Amazon fear”, industrial cycle concerns, Chinese tariffs and stagnant stock performance for multiple years.  Compounding these fears was the April 2019 average daily sales (ADS) number, which grew 7.4% annually, a marked slowdown from the low teens experienced over the past two years. 

However, a combination of common sense and additional field work suggest the April ADS deceleration was a blip and not a new trend.  Note that Q119 earnings were released April 11^th when the CEO issued rather optimistic commentary on what he is currently seeing in the business / marketplace such that a rapid shift in the last 19 days of the month would be improbable.  Our field research also suggests that ending the month mid-week combined with holiday and weather factors can occasionally cause monthly numbers to swing significantly.

The recent increase in Chinese tariffs to 25% on $200 billion of imports has also hurt sentiment for FAST, and there is legitimate concern for that as the company’s customer base will be negatively impacted.  That said, we have confidence the underlying business performance is still sustainable based on continued market share gains from winning new national accounts.

Consensus expectations have growth decelerating significantly from the low-teens as of Q119, down to high-single digits for the remainder of 2019 and mid-single digits in 2020 and beyond. We find this odd particularly after Fastenal has made large, multi-year investments to build a new channel serving national accounts, which represents approximately half of the business now with the ability to help drive consistent double-digit growth for the overall company. Why would growth slow so significantly within one to two years as consensus suggests?  We went into the field to find out.

Our industry conversations painted a very different picture, stating the national account business was hitting critical mass, which would support sustainable low-to-mid-teens growth at FAST for the foreseeable future. In addition, our field research suggests investor expectations underappreciate the margin profile for national accounts. 

Consensus believes margins will stagnate.  However, new accounts have high fixed setup costs that depress margins upfront, but as new customer account revenue ramps, margins naturally expand over the 2-3 year penetration period as the fixed cost structure is leveraged.

National accounts also require less infrastructure than the core branch business, with G&A savings offsetting the lower gross margins, resulting in similar operating margins for both businesses. Therefore, we believe Fastenal’s operating margins will expand modestly over the coming years as the national account business grows while consensus calls for margin stagnation.

As a result, we project 2021 EBITDA for FAST of $1.7 billion while consensus expects $1.2 billion.  The delta derives from our expectations for low-double-digit revenue growth through 2021 and 90 bps of EBIT margin expansion over that period.  As growth and margins exceed investor expectations and illustrate the sustainability of Fastenal’s current growth trajectory, the stock should trade at its historical average multiple of 25x EPS.

This results in fair value of at least $100/share over the next 1-2 years, including the $9/share of FCF that accrues to shareholders over that time. This represents upside of 50%-60% from the current price.

Catalyst

Revenue and earnings exceed expectations.

Sentiment improves as DD growth and modest margin expansion prove sustainable.