|Shares Out. (in M):||57||P/E||23.1||22.2|
|Market Cap (in $M):||5,259||P/FCF||17.1||20|
|Net Debt (in $M):||554||EBIT||369||369|
|Borrow Cost:||General Collateral|
MSC Industrial Direct Co., Inc (MSM: $92.92) – Short
The Trump rally caused a major short squeeze in MSM. The shares now trade at 23x run rate EPS and 13x EV/LTM EBITDA, yet revenues and EPS were down in FY 2016 (ending September 2016) and management gave guidance for continued declines in Q1 FY 2017 (ending December 2016). MSM has experienced 16 straight months of declining average daily sales and, with the recent strength in the USD, has little visibility on any improvement in its metalworking end market. The recent jump in its shares reflects a knee jerk reaction to Donald Trump’s election and his (potential) infrastructure upgrade plan. Shorting MSM offers an attractive risk/reward profile since if Trump follows through on his promise, a substantial improvement in MSM’s end market is already priced in. On the other hand, if history repeats and Trump, like most politicians, follows through on only a small fraction of what he has promised, MSM faces +50% downside risk to $40.
MSM is a North American distributor of metalworking and maintenance, repair and operations (“MRO”) products and services. MSM is #1 in the metalworking space, with 10% market share, and is significantly bigger than its next largest competitor. Its customers range from individual machine shops, to Fortune 100 manufacturing companies to government agencies. MSM operates in the U.S, Canada and the U.K. and offers +1 million SKUs through its website, mscdirect.com, as well as through its +4,500-page master catalog, known throughout the MRO industry as “The Big Book.” The company’s MRO products comprise of cutting tools, measuring instruments, tooling components, metalworking products, fasteners, raw materials, hand and power tools, electrical supplies, etc.
One of MSM’s competitive advantages is its next-day delivery in the U.S. for qualifying orders placed by 8 p.m. ET. MSM adds value to customers through 1) lower prices due to its private label products, 2) reducing customer inventory through just-in-time inventory management, and 3) production floor cost savings and productivity improvements through its team of metalworking experts (a value-added service). Manufacturing customers make up 76% of sales and non-manufacturing comprises 24%. The company's largest end market is the metalworking sector, for which the Metal Working Business Index (MBI) tracks business activity.
MSM was carrying an 11 day short position when the world found out Donald Trump was going to get his chance to Make America Great Again. The squeeze took MSM from $72 to its current ~$93. The squeeze does have a rational explanation as Trump promised an infrastructure upgrade program which would, in combination with a corporate tax cut from 35% to 15%, turbo charge U.S. GDP growth to 4% from its current 2%. This best-case scenario, however, appears to be fully priced in now.
MSM executed a modified Dutch tender in August 2016 and bought back ~8% of its shares outstanding at $72.50. After adjusting for the 53-week year, the $4.01 in run rate EPS shown below reflects FY 2016 net income on the current (post buyback) FD share count (56.6 million). The stock trades at 23.2x run rate EPS and 13.2x EV/LTM EBITDA. The market is pricing in a substantial rate of future growth, which reflects a complete reversal in the decline rate of MSM’s end market.
Growth in Average Daily Sales (ADS) at MSM turned negative in July 2015. As we approached July 2016, the bull case was that MSM faced easy comps and ADS would soon turn positive. That did not happen as the strong USD (which recently strengthened even further; see below) and low oil prices continued to depress end market demand in the metalworking sector.
Average Daily Sales (ADS) by Month