Thoughts On Fastenal Company (FAST) by John Huber, Base Hit Investing

Fastenal (FAST) reported earnings yesterday. I love reading Fastenal’s press releases. They are more like investor letters than they are press releases. I didn’t even see one “Adjusted EBITDA” reference in the entire release—which is written in layman’s terms more than corporate jargon. Management’s candidness and depth of discussion regarding the company’s operating results is a breath of fresh air.

So I thought I’d jot down a few notes and put it into a post. This is not really an analysis of the company, but more or less just a clipping of portions of the letter I thought were worth commenting on. It’s mostly a summary of the press release, but I’d definitely recommend getting in the habit of reading these once a quarter. If nothing else, it’s a respite from the typical corporate-speak that permeates most of what I find in the company filings I read.

To briefly summarize, the company has an outstanding history of growth, but that growth has been challenged lately—in small part due to Fastenal’s increasing size, but much more likely due to the significant difficulties in the heavy manufacturing and commodity-based businesses (who represent a sizable portion of Fastenal’s customer base).

Fastenal has always been able to grow throughout the business cycle, but this cyclical downturn is proving to be one of the more difficult periods that they’ve had to navigate so far.

That said, to this point they are still squeaking out some growth:

Fastenal

They think that revenue has been hit because their customers have felt the effects of a strong dollar, and of course the slowdown in the oil and gas business.

Making Their Own Luck

Interestingly, they have been aggressively adding employees during this downturn. Fastenal has always felt that they employees are one of the largest competitive advantages they have. A knowledgeable, well-trained sales force that understands how to effectively engage with the customer base is an advantage that often doesn’t show up directly in the numbers, but like the left tackle that is diligently and thanklessly protecting the quarterback all game, it’s an invaluable part of the team.

Fastenal has ramped up hiring:

FAST-Hiring

In addition to expanding the headcount, they plan to open an additional 60-75 stores (around a 2-3% increase in store count) in the next year.

Fastenal management describes the company as two businesses:

  • Fastener distributor (40% of business)
  • Non-fastener distributor (60% of business)

Fastener Business

This is the business Fastenal started with 50 years ago. Fastenal is a distributor. They supply their customers with a variety of basic fasteners such as nuts, bolts, screws, washers, etc… The company sources these products from many different suppliers, and then sells to their more than 100,000 customers at a healthy markup (Fastenal’s gross margins generally are around 50%). Fastenal’s customers are usually the manufacturers at the end of the supply chain (farm manufacturers, oil producers, truckers, railroads, miners, etc…). The company also sells to non-residential construction contractors (plumbers, electricians, general contractors, etc…).

Roughly half of this business is production/construction and the other half is maintenance. The production portion of this business is very cyclical, with 75% of the customers engaged in some type of heavy manufacturing. This business is struggling right now. Fastenal mentioned that although they are steadily adding new national accounts (large customers), 44 of its largest 100 customers are reducing their spending on Fastenal products, many because they are seeing significant revenue declines in their respective businesses and thus tightening the spending belt is a necessary result. This hurts Fastenal in the near term, although the company expects this cyclical capital spending to work in their favor once the recessionary conditions in the energy and mining businesses subside.

But the downturn in commodities and the heavy manufacturing sector has caused growth in Fastenal’s industrial production business to go negative:

FAST-Industrial Business

Non-Fastener Business

Fortunately for Fastenal, the sale of fasteners is a sticky business because it’s difficult (expensive and time consuming) for customers to change their supplier relationships. This stickiness has probably even improved as Fastenal grows its vending machine business which primarily focuses on distributing non-fastener products (instead of candy bars, FAST is popping out tools, equipment, and other non-fastener products through vending machines at their customers’ own facilities):

So with a Fastenal vending machine onsite at the customer’s location (along with knowledgeable Fastenal employees providing service and product replenishment), this creates a resilient line of business for FAST. In fact, they now have around 53,000 machines onsite at their customers’ facilities—all doing an average of around $1000 per month of business (that’s a $600 million business that grew 17% in the last year).

So strong results from the industrial vending business is helping the non-fastener segment of Fastenal’s business, but the overall segment has seen growth slow from 18% in the last half of 2014 to 6% growth in Q3:

FAST-Non-Fastener

So this non-fastener business is still growing, albeit at a much slower rate. And management says that they are still taking market share.

Macro Winds Impacting Fastenal’s Business

Fastenal believes growth is impacted generally by three categories:

  • Execution
  • Currency Fluctuations
  • Economic Fluctuations

My take is Fastenal is executing very well–as best as they can in this environment. So the latter two are the culprits. Currency fluctuations only impacted Fastenal’s growth by 1.1%, so not a significant decline due to the weak Canadian dollar. However, Fastenal’s US customers represent 89% of sales, and many of those customers are impacted by the strong US dollar. So I think that Fastenal is probably impacted much more indirectly by the strong US dollar than they are directly as a result of their Canadian operations.

Economic Conditions

Sales to customers engaged in heavy manufacturing are estimated to be about 20% of overall FAST net sales. These businesses include the mining, agrictultural, and construction end markets, and all of these sectors have been hit hard by the bear market in oil and other commodity prices and a slowdown in construction and weak Chinese demand for heavy equipment.

PMI Index

The Institute for Supply Management conducts monthly surveys of private sector companies to gauge the health of the manufacturing sector. The oft-cited Purchasing Managers’ Index (PMI) oscillates between 0 and 100 (spending most of its time between 40 and 60) and basically measures manufacturing expansion when readings are over 50 and contraction when the index drops below 50. The PMI can be thought of as a general barometer of the current strength or weakness in the buying power of Fastenal’s customers that do business in the heavy manufacturing sector (again, approximately 20% of Fastenal’s revenue is impacted here). The PMI has spent most of its time since the recession in the mid-high 50’s but dropped to 50.2 in September, the lowest reading in 3 years:

FAST-PMI

So who knows what economic conditions will look like in a year (I certainly don’t), but the slowdown in the manufacturing sector has, for the first time, really affected Fastenal’s top line growth.

Valuation and Some Commentary

I think FAST is an outstanding

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