In the fall of last year, I believed that shares of MSC Industrial Direct Co., Inc. (NYSE:MSM) were getting back on their feet. The MRO (maintenance, repair & operating) business saw modest growth, nothing too impressive, but not too shabby as well.
Recently, the company has seen activity slow down, and now reports year-over-year sales declines, weighing on margins as well. While this is the case and a big pullback to the guidance does not come out of the blue, I see very reasonably priced shares, although MSC has been a mediocre performer as well, truth be said.
An MRO Play
MSC Industrial is a distributor of metalworking and MRO products and services. The company helps customers improve their productivity, profitability and grow with some 2 million product offerings, inventory management and supply chain solutions.
The idea as a middle man is that MSC aims to consolidate many products from thousands of suppliers to its clients, providing a one-stop-solution. The company operates in a fragmented and growing market against some formidable competitors such as W.W. Grainger (GWW) and Fastenal (FAST), among others.
The company has seen a tough period if we look back a decade ago, in part because the company benefited from the boom in the US shale energy sector back in 2014. The company generated some $2.8 billion in sales at that time a revenue number which has grown to about $4 billion, as near 50% growth looks decent, but adjusted for inflation, growth has been not too impressive, but nonetheless solid.
The issue is really seen in the margins, as operating margins fell from 14% of sales in 2014 to about 12% more recently. One of the few bright spots is that the company bought back one in every ten shares over this time period, resulting in a bit better growth on a per-share basis. All this resulted in the shares trading in a $50-$100 range for essentially all the past decade, with shares trading at a high of $105 this spring. What followed was a big pullback in the share price, as doubts about economic growth are emerging, with shares now down to $76 per share following the latest setback.
With shares trading around $6.50 per share in the fall of last year, valuations looked quite reasonable, at a share price of $95 per share. An earnings multiple in the mid-teens and 1 times leverage ratio looked quite reasonable, although that the inflationary environment lifted all boats. With the company furthermore focusing on the elimination of its dual-class structure, I was constructive on the shares after a stagnant share price for years resulted in gradual valuation multiple contraction, potentially leaving room for multiples to expand again.
Shocking Earnings
Since the fall of last year, shares have done quite alright, with shares setting highs in the spring, but shares are down a quarter in the time frame of just three months here.
In October, MSC reported a near 9% increase in 2023 sales to $4.01 billion, although that fourth quarter sales growth slowed down to 1% and change. Slower growth in the final quarter made that margins took a beating, as full year adjusted earnings per share rose by just 2% to $6.29 per share. With the company guiding for 2024 sales to be up between 0 and 5%, and adjusted operating margins seen at 12.0-12.8% (versus 12.8% in 2023) the outlook was not too inspiring.
In January, MSC posted a 0.4% fall in first quarter sales, with margins taking another beating, as the company maintained the full-year guidance. Later that month, the company announced the purchase of KAR industrial, a bolt-on deal adding some $16 million in annual sales, less than half a percent to overall sales.
In March, it became really apparent that momentum was cooling, with second quarter sales down 2.7%, as adjusted earnings were down fifty-one cents so far this year to $2.43 per share. I found it hard to believe that the guidance could be maintained, as the risks to this were clearly growing by the day.
The real shocker came in mid-June, as the company now reported preliminary sales to be down around 7.2% to a midpoint of $979 million. As a result, the long-overdue cut in the full-year outlook made that full-year average daily sales are now seen down around 4.5%, a 7% cut from the midpoint of the previous guidance!
The company in part attributes the softer third quarter sales results to a 300 basis points headwind from non-recurring public sector orders, with macro softness attributed to weakness in heavy manufacturing and metalworking. That in itself is a poor excuse, as the full-year guidance has been cut by a huge way, and, of course, it was known during the budgeting process (at the start of the year) that difficult comparables were coming up.
With adjusted margins seen at 10.6% for the year, earnings will take a huge beating. Previously, the company guided for EBIT to come in around half a billion, now seen down by nearly one hundred million to a midpoint of $412 million. With a $45 million interest expense and near 25% tax rate, net earnings are seen around $275 million, for earnings just short of $5 per share.
The company ended the second quarter with $530 million in net debt, still very manageable. Even following the reduced guidance, adjusted EBITDA comes in around a billion.
What Now?
Currently, the company trades around 15 times earnings, as leverage remains modest at 1 times, as the $0.83 quarterly per share dividend now yields 4.3% on an annual basis.
While the latest numbers are highly disappointing, it is the amount by which the outlook has been cut which makes me cautious on MSC Industrial, as the company has been underperforming some other peers. All this hints towards a not too great competitive positioning and/or operating performance.
That is not too compelling. Overall, MSC Industrial Direct Co., Inc. trades at quite reasonable multiples amidst modest leverage, but drivers could push the shares forward here in the near term. For real structural shareholder value to be created, a structural better performance has to be delivered upon, as the latest initiatives (marketing initiatives and others) are not too drastic and long-lasting.
Read the full article here
