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When thinking of companies with a wide moat or margin of safety that would make it difficult for another company to replicate its business model, most would think of companies such as Coca-Cola (NYSE:KO) or railroad CSX Corporation (NYSE:CSX) to name a couple. It would be extremely difficult to start a company that could compete against these type of companies because they have such a huge head start, excellent brand recognition, large customer base, as well as assets owned (railroad tracks and the property they are on) that would make it almost impossible to gain any traction to steal market share very quickly.

One company that I believe is not thought of as having this advantage is Fastenal (NASDAQ:FAST). This is a company that many households are not familiar with because its main customer focus is the industrial and construction markets. Because of this focus, they do very little in the way of advertising to the general public until recently in the NASCAR racing series.

Brief History

Fastenal was start as a fastener supplier in 1967 by founder Bob Kierlin in Winona, Minnesota. After taking the company public in 1987 it has since diversified into selling everything from toilet paper to power tools. The best way to think of the products it sells is, if an industrial or construction company uses it, this company sells it. It is also interesting to note that Fastenal has been the best-performing stock since the 1987 stock market crash with a total return of 38,565%.

It was added to the S&P 500 in late 2008 and has grown to having over 2,600 stores mostly based in the USA. I find that very encouraging as it still has the emerging markets to start tapping into for even more growth.

Key 10-Year Average Statistics

  • Revenue growth of 12.96%
  • EPS growth of 18.97%
  • 17.96% operating margin
  • Steadily increased gross margin by 2.36% to 51.8% at the end of 2012
  • Operating expenses only grew at 8%
  • 32.4 P/E
  • 1.7% Dividend Yield

Let's review some of these metrics.

Fastenal has done an excellent job of keeping expenses low while continuing to grow its earnings at a healthy clip. One way I believe it does this is by keeping one of the most important values Mr. Kierlin has instilled in this company at the top of its priority list by squeezing the most out of every penny available and investing it into the right areas of the business. If you have ever visited a Fastenal store or had a chance to drive by its corporate headquarters, you would see that these are not flashy, polished pieces of property like an Apple (NASDAQ:AAPL) or a Macy's (NYSE:M) department store. Don't get me wrong, its properties are not run down shanties, just basic buildings and leased spaces in small strip malls. What's another way of keeping your hard-earned dollars invested into the company rather than spending it somewhere else? Have your own trucking system to move your product. While its competitors use external carriers to ship their goods to the customer, Fastenal has put together its own logistics operation. Yes, there are expenses incurred with this but when you can charge shipping fees back to the customer that are in line with carriers such as UPS (NYSE:UPS) and FedEx (NYSE:FDX), have the product delivered in the same amount of time, you can profit from distributing the product as well as selling it. In fact, if Fastenal wanted to dip its toes into the package delivery service it could be competitive in that area of business as well with having over 2,000 stores from coast to coast and boarder to boarder in the USA alone. OK, that business venture may be a little far fetched but you get the picture.

The current CFO, Dan Florness, has also played an outstanding role in the expense and investment department as well. Under his financial leadership he has done an amazing job of frequently keeping the EPS growth higher than Fastenal's tremendous sales growth. In 2012 he also made the Wall Street Journal's top 10 list of best CFOs.

Fastenal has also done a very good job not only maintaining its gross margin while growing into a 3 billion dollar a year in sales company, but actually raising it over 2%. Keep in mind this was not starting from a low base either; last quarter it reported a gross margin of 52.3%. This exemplifies the company's focus on not just being an "auction house" of products and trying to beat competitors' prices but focusing on creating value for its customers in many ways.

One area of focus investors have some trouble with dealing with is its high P/E ratio compared to its peers. Historically this has been around 65% higher than its competitors Grainger (NYSE:GWW) at 18 and MSC (NYSE:MSM) at 20. Fastenal does have some strong arguments that warrant a high valuation considering its consistent sales and profitability growth, strong management and proven method of growing itself mostly organically. It has only made a couple of acquisitions in its 46-year history with the most recent and largest in 2009 being Holo-Krome, a domestic fastener manufacturer with a great quality product reputation.

Industrial Vending Machines

This is one of the primary reasons in conjunction with the local presence of the 2,600 stores already in place that I believe Fastenal has a very safe, and growing safer, moat surrounding its business. These are essentially small stores that are open 24 hours a day 7 days a week, stocked specifically with products that the individual customer uses, inside the company's building. Fastenal's largest competition on a national level are "catalog" companies Grainger, McMaster-Carr and MSC Industrial Direct. Yes, Grainger and MSC do have some brick and mortar stores as well as offer vending machines but nothing near the scope of Fastenal. They have a different business model as far as how they approach servicing their customers.

With all of those stores in place, the outside sales personnel in each location and over 25,000 vending machines and currently growing at over 4,000 machines per quarter, it is going to be very difficult for the competition to react to this. Yes, it could also start placing machines at the customer locations as fast as Fastenal has been doing but who will fill and service these machines? The coverage Fastenal has with its stores gives it the advantage of being able to have a representative at the site in no more than an hour and in most cases 5-10 minutes if need be. Another mouth-watering incentive Fastenal has shown for implementing these machines into customer locations is that, on average, the overall sales growth of a customer with a vending machine is 24% versus a non-vending customer.

Conclusion

Fastenal seems to have started the slowing process of placing new stores in the United States but that leaves the rest of the world to grow into. With this slowing of openings, it has focused on adding more sales specialists in the existing locations to better the quality and quantity of face-to-face sales coverage. I believe with this strategy along with the vending initiative, Fastenal is only getting started as being a wholesale powerhouse.

I respect the quality of readers and authors that the Seeking Alpha website draws to it so I would really like to hear any constructive feedback on Fastenal. Positive, negative or otherwise. I believe when making investment decisions you always need to bounce ideas off of others and listen to every angle put on a company's story to help build a solid thesis.

Disclosure: I am long FAST. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: A Company With An Overlooked Widening Moat