Written by R.W. Baird analyst David J. Manthey, CFA 10/9/18
The seasonally adjusted FDI for September was 55.8, decelerating m/m vs. August’s 62.5 reading. Selling conditions decelerated more sharply, with the seasonally adjusted sales index coming in at 46.5 (vs. August 74.7). Qualitative commentary indicated fewer selling days this month and softer demand in some end markets weighed on September results, while respondents also expressed some unease about the 2019 outlook. The six-month outlook was also less bullish vs. recent trends, while the Forward- Looking Indicator came down vs. last month (54.7 vs. August 63.4).
About the Fastener Distributor Index (FDI). The FDI is a monthly survey of North American fastener distributors, conducted with the FCH Sourcing Network, the National Fastener Distributors Association, and Baird. It offers insights into current fastener industry trends/outlooks. Similarly, the Forward-Looking Indicator (FLI) is based on a weighted average of four forward-looking inputs from the FDI survey. This indicator is designed to provide directional perspective on future expectations for fastener market conditions. As diffusion indexes, values above 50.0 signal strength, while readings below 50.0 signal weakness. Over time, results should be directly relevant to Fastenal (FAST) and broadly relevant to other industrial distributors such as W.W. Grainger (GWW) and MSC Industrial (MSM).
September FDI further retreats. The seasonally adjusted September FDI (55.8) decelerated vs. August’s 62.5 reading, still strong in absolute terms but nonetheless meaningfully lower for the second straight month. In the September survey, just 22% of respondents indicated sales were “better” relative to seasonal expectations vs. 63% in August. This produced a seasonally adjusted sales index of 46.5 (August 74.7), the lowest recorded reading since October 2016. Of note, several respondents indicated having just 19 selling days this month was a headwind, potentially skewing overall results more negatively than daily sales growth might have reflected. Importantly, the seasonal adjustment factor for the FDI accounts for variations in the number of calendar days among months (i.e., September has 30 days vs. February 28), but not the number of selling days in any given year. With September ranging anywhere from 19-21 selling days historically, this year’s 19 selling days in September was on the very low end of historical trends, which likely impacted FDI results. Positively, pricing remains higher among a large majority of respondents, with 85% seeing pricing gains y/y vs. 84% in August. The resulting FDI pricing index of 92.6 was essentially unchanged m/m. Regarding customer inventories, a majority of respondents view inventory levels as in line with expectations (70% of responses), while 19% believe customers’ inventories are too low. This compares to 59% in line and 38% too low in August.
September FLI decelerates. The seasonally adjusted FLI came down m/m, registering 54.7 vs. 63.4 in August, mainly attributable to a lower employment index and a less bullish 6 month outlook. Nonetheless, a 54.7 reading suggests market conditions are likely to remain in growth mode (although the rate of growth could be stabilizing), and with four additional selling days in October relative to September, we would not be surprised to see the FDI rebound next month off of a low September base.
Manufacturing employment down slightly. Hiring sentiment was slightly lower this month among survey respondents. 30% of respondents saw higher employment levels in September relative to seasonal expectations vs. 38% in August, while 63% saw employment as in line (August 59%). The resulting FDI Employment Index was 61.1 vs. 67.2 last month. Meanwhile, the September US jobs report was a bit weaker than expected with +134,000 jobs added (~185,000 expected), though the unemployment rate dropped to a lower-than-expected 3.7% (August 3.9%). September’s largest gains were registered in professional and business services, healthcare, and in transportation and warehousing. Manufacturing employment continues to trend upwards (+18,000 jobs in September), with most of the gains coming from durable goods manufacturing. As of September, total number of manufacturing jobs added over the past year stands at +278,000. Average hours per work week for manufacturing employees were just modestly lower at 40.8 hours.
Respondents express some caution in commentary. The overall tone of qualitative commentary was again more cautious this month, with respondents noting a softening in demand in September and some unease regarding 2019. For example, one respondent commented, “The tech industry in California has softened… We have had customers request in September a push out on deliveries.” Several others commented on fewer selling days impacting results this month saying, “A 19 selling day month sure doesn’t help.” Regarding 2019, one survey participant said, “[We’re] going with same on 6 month outlook, but ITR Economics, which is widely used in our industry, has been forecasting a slower 2019 so we will be waiting on their December report.” Reflecting this, survey data this quarter pointed to less optimism regarding activity over the next six months, with just 26% of respondents expecting higher activity levels over the next six months and 52% expecting similar activity. For context, the percentage of respondents expecting higher activity had been steadily around ~50% over the past five months.
Fastenal reported +13.7% August daily sales growth, above our +12.0% estimate, reflecting sequential daily sales growth slightly above average historical m/m trends. Underlying “core” growth (excluding foreign exchange) was +14.1%, the 15th straight month of double-digit growth. Fasteners again saw solid growth at +10.8% y/y. Looking forward, we view the September FDI results as a somewhat mixed read- through for FAST September daily sales (reported on 10/10), and model +13.5% growth y/y. While reported weakening in underlying demand would be as much of a headwind for FAST as it was for FDI respondents, fewer selling days (which incrementally weakened the FDI this month) should conversely slightly benefit FAST’s September daily sales growth due to statistical differences in the data sets (FAST presents daily sales growth vs. FDI is overall growth). Historically when a month has fewer selling days than is typical FAST daily sales growth tends to slightly exceed the long term m/m trend. With September 2018 having 19 selling days, which is on the lower end of the historical 19-21 range, this phenomenon is likely to produce a slightly higher m/m rate. Based on FDI data and other research inputs, we expect continued solid top-line trends across public industrial distributors through the remainder of 2018, with Fastenal y/y daily sales growth expected to remain in the double digits through year-end.
Fastener Distributor Index (FDI); Seasonally Adjusted
Source: Baird, FCH Sourcing Network, Company reports
1-Month Lagged FDI vs. FLI (Both Seasonally Adjusted)
Source: Baird, FCH Sourcing Network
Fastenal: Risks include economic sensitivity, pricing power, relatively high valuation, secular gross margin pressures, success of vending and on-site initiatives, and ability to sustain historical growth.
Industrial Distribution: Risks include economic sensitivity, pricing power, online pressure/competitive threats, global sourcing, and exposure to durable goods manufacturing.
Appendix – Important Disclosures and Analyst Certification
Covered Companies Mentioned
All stock prices below are as of 10/9/2018.
Fastenal Company (FAST-$56.68-Neutral)
W.W. Grainger Inc. (GWW-$345.89-Neutral)
MSC Industrial Direct Co. Inc (MSM-$84.83-Neutral) (See recent research reports for more information)
Robert W. Baird & Co. Incorporated makes a market in the securities of FAST, GWW, and MSM.
Robert W. Baird & Co. Incorporated and/or its affiliates have been compensated by Fastenal Company for non- investment banking-securities related services in the past 12 months.
Robert W. Baird & Co. Incorporated and/or its affiliates have been compensated by MSC Industrial Direct Co., Inc. for non-investment banking-securities related services in the past 12 months.
Robert W. Baird & Co. Incorporated (“Baird”) and/or its affiliates expect to receive or intend to seek investment- banking related compensation from the company or companies mentioned in this report within the next three months. Baird may not be licensed to execute transactions in all foreign listed securities directly. Transactions in foreign listed securities may be prohibited for residents of the United States. Please contact a Baird representative for more information.
Investment Ratings: Outperform (O) – Expected to outperform on a total return, risk-adjusted basis the broader
U.S. equity market over the next 12 months. Neutral (N) – Expected to perform in line with the broader U.S. equity market over the next 12 months. Underperform (U) – Expected to underperform on a total return, risk-adjusted basis the broader U.S. equity market over the next 12 months.
Risk Ratings: L – Lower Risk – Higher-quality companies for investors seeking capital appreciation or income with an emphasis on safety. Company characteristics may include: stable earnings, conservative balance sheets, and an established history of revenue and earnings. A – Average Risk – Growth situations for investors seeking capital appreciation with an emphasis on safety. Company characteristics may include: moderate volatility, modest balance- sheet leverage, and stable patterns of revenue and earnings. H – Higher Risk – Higher-growth situations appropriate for investors seeking capital appreciation with the acceptance of risk. Company characteristics may include: higher balance-sheet leverage, dynamic business environments, and higher levels of earnings and price volatility. S – Speculative Risk – High growth situations appropriate only for investors willing to accept a high degree of volatility and risk. Company characteristics may include: unpredictable earnings, small capitalization, aggressive growth strategies, rapidly changing market dynamics, high leverage, extreme price volatility and unknown competitive challenges.
Valuation, Ratings and Risks. The recommendation and price target contained within this report are based on a time horizon of 12 months but there is no guarantee the objective will be achieved within the specified time horizon. Price targets are determined by a subjective review of fundamental and/or quantitative factors of the issuer, its industry, and the security type. A variety of methods may be used to determine the value of a security including, but not limited to, discounted cash flow, earnings multiples, peer group comparisons, and sum of the parts. Overall market risk, interest rate risk, and general economic risks impact all securities. Specific information regarding the price target and recommendation is provided in the text of our most recent research report.
Distribution of Investment Ratings. As of September 28, 2018, Baird U.S. Equity Research covered 688 companies, with 56% rated Outperform/Buy, 43% rated Neutral/Hold and 1% rated Underperform/Sell. Within these rating categories, 10% of Outperform/Buy-rated and 4% of Neutral/Hold-rated companies have compensated Baird for investment banking services in the past 12 months and/or Baird managed or co-managed a public offering of securities for these companies in the past 12 months.
Analyst Compensation. Research analyst compensation is based on: (1) the correlation between the research analyst’s recommendations and stock price performance; (2) ratings and direct feedback from our investing clients, our institutional and retail sales force (as applicable) and from independent rating services; (3) the research analyst’s productivity, including the quality of such analyst’s research and such analyst’s contribution to the growth and development of our overall research effort; and (4) compliance with all of Baird’s internal policies and procedures. This compensation criteria and actual compensation is reviewed and approved on an annual basis by Baird’s Research Oversight Committee. Research analyst compensation is derived from all revenue sources of the firm, including revenues from investment banking. Baird does not compensate research analysts based on specific investment banking transactions.
A complete listing of all companies covered by Baird U.S. Equity Research and applicable research disclosures can be accessed at http://www.rwbaird.com/research-insights/research/coverage/research-disclosure.aspx. You can also call 800-792-2473 or write: Robert W. Baird & Co., Equity Research, 777 E. Wisconsin Avenue, Milwaukee, WI 53202.
The senior research analyst(s) certifies that the views expressed in this research report and/or financial model accurately reflect such senior analyst’s personal views about the subject securities or issuers and that no part of his or her compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in the research report.
Baird prohibits analysts from owning stock in companies they cover.
This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy.
ADDITIONAL INFORMATION ON COMPANIES MENTIONED HEREIN IS AVAILABLE UPON REQUEST
The Dow Jones Industrial Average, S&P 500, S&P 400 and Russell 2000 are unmanaged common stock indices used to measure and report performance of various sectors of the stock market; direct investment in indices is not available. Baird is exempt from the requirement to hold an Australian financial services license. Baird is regulated by the United States Securities and Exchange Commission, FINRA, and various other self- regulatory organizations and those laws and regulations may differ from Australian laws. This report has been prepared in accordance with the laws and regulations governing United States broker-dealers and not Australian laws.
The information and rating included in this report represent the research analyst’s views based on a time horizon of 12 months, as described above, unless otherwise stated. In our standard company-specific research reports, the subject company may be designated as a “Fresh Pick”, representing that the research analyst believes the company to be a high-conviction investment idea based on a subjective review of one or more fundamental or quantitative factors until an expiration date specified by the analyst but not to exceed nine months. The Fresh Pick designation and specified expiration date will be displayed in standard company-specific research reports on the company until the occurrence of the expiration date or such time as the analyst removes the Fresh Pick designation from the company in a subsequent, standard company-specific research report. The research analyst(s) named in this report may, at times and at the request of clients or their Baird representatives, provide particular investment perspectives or trading strategies based primarily on the analyst’s understanding of the individual client’s objectives. These perspectives or trading strategies generally are responsive to client inquiries and based on criteria the research analyst considers relevant to the client. As such, these perspectives and strategies may differ from the research analyst’s views contained in this report.
Baird and/or its affiliates may provide to certain clients additional or research supplemental products or services, such as outlooks, commentaries and other detailed analyses, which focus on covered stocks, companies, industries or sectors. Not all clients who receive our standard company-specific research reports are eligible to receive these additional or supplemental products or services. Baird determines in its sole discretion the clients who will receive additional or supplemental products or services, in light of various factors including the size and scope of the client relationships. These additional or supplemental products or services may feature different analytical or research techniques and information than are contained in Baird’s standard research reports. Any ratings and recommendations contained in such additional or research supplemental products are consistent with the research analyst’s ratings and recommendations contained in more broadly disseminated standard research reports. Baird disseminates its research reports to all clients simultaneously by posting such reports to Baird’s password-protected client portal, https://bol.rwbaird.com/Login (“BairdOnline”). All clients may access BairdOnline and at any time. All clients are advised to check BairdOnline for Baird’s most recent research reports. After research reports are posted to BairdOnline, such reports may be emailed to clients, based on, among other things, client interest, coverage, stock ownership and indicated email preferences, and electronically distributed to certain third-party research aggregators, who may make such reports available to entitled clients on password-protected, third-party websites. Not all research reports posted to BairdOnline will be emailed to clients or electronically distributed to such research aggregators. To request access to Baird Online, please visit https://bol.rwbaird.com/Login/RequestInstLogin or contact your Baird representative.
Dividend Yield. As used in this report, the term “dividend yield” refers, on a percentage basis, to the historical distributions made by the issuer relative to its current market price. Such distributions are not guaranteed, may be modified at the issuer’s discretion, may exceed operating cash flow, subsidized by borrowed funds or include a return of investment principal.
United Kingdom (“UK”) disclosure requirements for the purpose of distributing this research into the UK and other countries for which Robert W. Baird Limited holds a MiFID passport.
The contents of this report may contain an “investment recommendation”, as defined by the Market Abuse Regulation EU No 596/2014 (“MAR”). This report does not contain a “personal recommendation” or “investment advice”, as defined by the Market in Financial Instruments Directive 2014/65/EU (“MiFID”). Please therefore be aware of the important disclosures outlined below. Unless otherwise stated, this report was completed and first disseminated at the date and time provided on the timestamp of the report. If you would like further information on dissemination times, please contact us. The views contained in this report: (i) do not necessarily correspond to, and may differ from, the views of Robert W. Baird Limited or any other entity within the Baird Group, in particular Robert W. Baird & Co. Incorporated; and (ii) may differ from the views of another individual of Robert W. Baird Limited.
This material is distributed in the UK and the European Economic Area (“EEA”) by Robert W. Baird Limited, which has an office at Finsbury Circus House, 15 Finsbury Circus, London EC2M 7EB and is authorized and regulated by the Financial Conduct Authority (“FCA”) in the UK.
For the purposes of the FCA requirements, this investment research report is classified as investment research and is objective. This material is only directed at and is only made available to persons in the EEA who would satisfy the criteria of being “Professional” investors under MiFID and to persons in the UK falling within Articles 19, 38, 47, and 49 of the Financial Services and Markets Act of 2000 (Financial Promotion) Order 2005 (all such persons being referred to as “relevant persons”). Accordingly, this document is intended only for persons regarded as investment professionals (or equivalent) and is not to be distributed to or passed onto any other person (such as persons who would be classified as Retail clients under MiFID).
All substantially material sources of the information contained in this report are disclosed. All sources of information in this report are reliable, but where there is any doubt as to reliability of a particular source, this is clearly indicated. There is no intention to update this report in future. Where, for any reason, an update is made, this will be made clear in writing on the research report. Such instances will be occasional only.
Please note that this report may provide views which differ from previous recommendations made by the same individual in respect of the same financial instrument or issuer in the last 12 months. Information and details regarding previous recommendations in relation to the financial instruments or issuer referred to in this report are available at https://baird.bluematrix.com/sellside/MAR.action.
Robert W. Baird Limited or one of its affiliates may at any time have a long or short position in the company or companies mentioned in this report. Where Robert W. Baird Limited or one of its affiliates holds a long or short position exceeding 0.5% of the total issued share capital of the issuer, this will be disclosed separately by your Robert W. Baird Limited representative upon request.
Investment involves risk. The price of securities may fluctuate and past performance is not indicative of future results. Any recommendation contained in the research report does not have regard to the specific investment objectives, financial situation and the particular needs of any individuals. You are advised to exercise caution in relation to the research report. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice.
Robert W. Baird Limited and Robert W. Baird & Co. Incorporated have in place organisational and administrative arrangements for the prevention, avoidance, and disclosure of conflicts of interest with respect to research recommendations. Robert W. Baird Limited’s Conflicts of Interest Policy, available here, outlines the approach Robert W. Baird Limited takes in relation to conflicts of interest and includes detail as to its procedures in place to identify, manage and control conflicts of interest. Robert W. Baird Limited and or one of its affiliates may be party to an agreement with the issuer that is the subject of this report relating to the provision of services of investment firms. Robert W. Baird & Co. Incorporated’s policies and procedures are designed to identify and effectively manage conflicts of interest related to the preparation and content of research reports and to promote objective and reliable research that reflects the truly held opinions of research analysts. Robert W. Baird & Co. Incorporated’s research analysts certify on a quarterly basis that such research reports accurately reflect their personal views.
This material is strictly confidential to the recipient and not intended for persons in jurisdictions where the distribution or publication of this research report is not permitted under the applicable laws or regulations of such jurisdiction.
Robert W. Baird Limited is exempt from the requirement to hold an Australian financial services license and is regulated by the FCA under UK laws, which may differ from Australian laws. As such, this document has not been prepared in accordance with Australian laws.
Copyright 2018 Robert W. Baird & Co. Incorporated
This information is prepared for the use of Baird clients and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of Baird. Any unauthorized use or disclosure is prohibited. Receipt and review of this information constitutes your agreement not to redistribute, retransmit, or disclose to others the contents, opinions, conclusion, or information contained in this information (including any investment ratings, estimates or price targets) without first obtaining expressed permission from an authorized officer of Baird.