W.W. Grainger, Inc. (GWW) delivered adjusted earnings per share (EPS) of $1.99 in its third quarter ended September 30, 2010, up from $1.51 in the year-ago period. The company exceeded the Zacks Consensus estimate of $1.82.
The third quarter’s EPS excluded a 7 cents per share benefit from a change for employee paid time off policy. In the third quarter of fiscal 2009, Grainger obtained a majority ownership of MonotaRO Co., Ltd. in Japan, and recognized a one-time, non-operating gain of 37 cents per share, from the revaluation of this investment. Including these items, EPS in the third quarter of fiscal 2010 was $2.06 comoared with $1.88 in the year-ago quarter.
Revenues in the quarter were $1,899.4 million, a 19.5% jump from $1,589.7 million in the year-ago period and above the Zacks Consensus of $1848 million. Foreign exchange contributed 1% while acquisitions added another 5 percentage points to the growth in the quarter. Pricing was flat and volumes were up 9%. Sales of oil spill related products contributed 3 percentage points. On a daily sales basis, sales showed a declining trend with July, August and September, posting increases of 21%, 20% and 18%, respectively.
As a percentage of revenue, the cost of merchandise declined a marginal 6 basis points to 58.4% and warehousing, marketing and administrative expenses as a percentage of revenue decreased 142 basis points to 28.3%. Consequently, gross margin increased 6 basis points to 41.6% and operating margin expanded 148 basis points to 13.2% in the quarter.
Segment Performance
Revenues from the United States segment surged 15% (13% excluding acquisitions) year over year to $1,608.4 million as all the end markets showed improvement. Monthly sales, however, showed an declining trend with daily sales increasing 17% in July, 15% in August followed by 13% in September. Sales of products used for the oil spill clean up contributed 3 percentage points to growth and sales of seasonal products added 1 percentage point due to the hot weather experienced across much of the United States in July and August.
Operating income for the segment upped 29% (25% excluding the change in the paid time off policy) to $262.8 million, primarily driven by positive cost leverage. Segment operating margin expanded 172 basis points to 16.3%.
Revenues from the Acklands-Grainger business in Canada leaped 22% to $202.2 million. In local currency, revenue increased 15%. Strong growth to customers in the agriculture and mining, oil and gas, heavy manufacturing and forestry sectors were partially offset by decline in sales to the government. Local currency sales on a daily basis were up 13% in July, up 14% in August and up 19% in September.
Operating income in Canada increased 74% (64% in local currency) to $14.5 million. Gross margin improved 340 basis points due to lower product costs, positive foreign currency translation and improved mix driven by an increase in sales of private label products. However, this was partially offset higher operating expenses driven by increased payroll and benefits costs due to higher commissions and bonuses on higher sales, increased volume-related headcount, start-up costs for a new distribution center in Vancouver, British Columbia and incremental costs for acquisitions made during the last 12 months.
Revenues from the other businesses (which include Japan, Mexico, India, Puerto Rico, China and Panama) were up 191% to $101.6 million ascribed to incremental sales from the Japanese and Colombian businesses acquired in the last 12 months, combined with strong sales growth in Mexico, India, China and Panama.
Operating earnings of $4 million for the Other Businesses were a stark contrast to the loss of $2 million in the year-ago period. In addition to the earnings contribution from acquired businesses, the Mexico and Panama businesses reported a strong quarter and China reduced its loss versus the prior year.
Financial Position
Grainger had cash and cash equivalents of $286 million as of September 30, 2010, down from $388 million as of June 30, 2010.
The company generated net cash from operating activities of $216.3 million from continuing operating activities in third-quarter of fiscal 2010 compared with $275.5 million in the year-ago period.
Grainger returned approximately $248 million to shareholders through the repurchase of nearly 2.3 million shares of common stock during the quarter. The company paid dividends of approximately $39 million, reflecting the 17% increase in the quarterly dividend announced in April 2010.
Debt-to-capitalization ratio was 19% as of September 30, 2010, compared with 18.6% as of June 30, 2010.
Outlook
Grainger is hiring another 150 sales representatives and onsite inventory services managers, expanding its eCommerce capabilities and developing services that complement its broad product offering to accelerating its growth. The company expects these investments to contribute to continued market share growth by helping its customers improve their productivity.
However, in the near term the company expects fourth quarter organic revenue growth to moderate given increasingly tougher comparisons, lower sales contribution from products used to clean up the Gulf of Mexico oil spill and the slowing of the inventory build cycle with its customers.
Based on strong performance so far in 2010, Grainger upped its sales growth guidance for fiscal 2010 to a range of 14 to 15% from its previous projection of 12 to 14% percent. Earnings per share guidance has also been raised to a range of $6.40 to $6.70 from the previous range of $6.10 to $6.40.
Grainger remains focused on increasing its market share. It is also is on track with its investments to secure long-term growth. Grainger’s balance sheet remains strong and given its cash position, we believe Grainger can further invest in growth opportunities, increase dividends and reinvest capital through share repurchases. The company has been rewarding shareholders with an uninterrupted streak of increased dividends for 38 consecutive years. Based on the third quarter earnings beat and increased guidance, we maintain our Zacks #2 Rank (Buy) on Grainger.
Performance of Competitor
Fastenal Co. (FAST) reported a third quarter EPS of 51 cents, a 59.4% jump from 32 cents a year ago, a penny beyond the Zacks Consensus Estimate of 50 cents per share. Sales rose 23.4% to $603.8 million, higher than the Zacks Consensus Estimate of $597 million. This was attributable to a 30.6% increase in the company’s manufacturing customers, which accounts for 50% of sales.
Illinois-based Grainger is a leading North American distributor of material handling equipment, safety and security supplies, lighting and electrical products, power and hand tools, pumps and plumbing supplies, cleaning and maintenance supplies, forestry and agriculture equipment, building and home inspection supplies, vehicle and fleet components, and various aftermarket components; and services comprise inventory management and energy efficiency solutions.
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