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Summary

  • Fastenal shares dropped the most in six months after the company missed revenue estimates in the second quarter.
  • Fastenal's weakness is temporary, as the company should benefit from an improving construction and industrial market.
  • Fastenal, though pricey on a trailing P/E basis, is a good long-term bet due to its strategies and sound fundamentals.

Industrial and construction supplies company Fastenal (NASDAQ:FAST) has had an indifferent year in 2014. So far, shares of the company have dropped almost 5%. Moreover, Fastenal's second-quarter revenue was not up to the mark, triggering its biggest drop in six months when it released its report in July. Investors were disappointed as Fastenal couldn't meet revenue expectations, even though it delivered decent year-over-year growth in both revenue and earnings.

Good, but not good enough

Fastenal announced net sales of $949.9 million in the second quarter, representing an increase of 12.1% from last year. However, its revenue missed the analyst estimate of $952.95 million. Fastenal also reported net earnings of $130.5 million, an increase of 7.9% from the year-ago period. However, Fastenal trades at a steep valuation of almost 30 times last year's earnings, way more than the industry average of 21. So, investors were expecting more from Fastenal.

But, the fact that Fastenal is gradually improving should be noted. Its business is gaining momentum, as evidenced by a rise of 10% in sales from its old stores in the previous quarter. In addition, old store sales gained momentum as the quarter progressed. The company is gaining good traction in the industrial and construction markets, as both these are getting better. In fact, Fastenal's sequential growth increased almost 15% from January till June, while the construction business in particular grew above 20%.

Better times can be expected

Looking ahead, strength in the construction and industrial market should help Fastenal sustain its double-digit growth. According to The American Institute of Architects, the construction market in the U.S. is doing well. This year, the construction market is expected to do better than last year, and the momentum is expected to continue next year. According to AIA:

Nonresidential building activity had a disappointing performance in 2013, with spending levels largely unchanged from those of 2012. However, 2014 looks to be a better year, with building activity increasing 5.8 percent overall, including a double-digit gain for commercial facilities. The recovery will continue into 2015, with spending increasing 8 percent overall and 6 percent for institutional buildings.

Moreover, according to the Bureau of the Census, the residential construction market usually grows at a faster rate than the non-residential sector. Thus, all in all, the construction market is expected to grow at a good pace going forward, and aid Fastenal's impressive growth.

Making smart moves

To tap this market, Fastenal is employing sound strategies. The company is expecting a solid vending performance, driven by healthy signings. The company is also looking to improve its margins in vending. In addition, Fastenal is keen on improving its performance with efforts at the T hub facility, and focusing on improved packaging.

The THUB facility, which became operational a year ago, is growing impressively. It delivered a 2.5 times improvement in picking activity from May to June, along with vending replenishments related to the facility. Now, with improved packaging and an improving end-market, this facility should lead to growth for Fastenal in the long run. According to CFO Dan Florness, the facility will benefit the company:

And we still have ton of opportunity. And what comes as that improves is it creates great efficiency at the store level. It helps us on working capital but it creates greater efficiency at the store level because we're picking that product of replenishment for those machines as high frequency product.

Moreover, to make its operations efficient, Fastenal is closing down some of its stores during the second half of the year. Management is now focused on determining demand in the local market and adjusting its supply and presence accordingly.

At the same time, Fastenal aims at opening a number of stores in areas where it expects growth. It has allowed its team to identify the best place to open stores, and based on their preferences, to consolidate some stores into fewer locations. Thus, Fastenal is focused on becoming leaner with this move, and since it is consolidating stores, its costs should come down.

Valuation and more

As mentioned earlier, Fastenal trades at an expensive trailing P/E ratio of almost 30, which is greater than the industry average. However, the company's forward P/E of 23 indicates that its earnings are expected to grow in the future. In addition, Fastenal's dividend yield of 2.20% is impressive. It should be able to continue its dividend on the back of robust cash flow. Moreover, the company has cash of $106 million on the balance sheet, which is greater than its debt of $70 million.

Finally, in the coming five years, Fastenal's earnings are expected to grow at a CAGR of 16%, which is greater than the industry average of 14%. So, even though Fastenal dropped short of expectations in the previous quarter, investors should have faith in its long-term prospects. The company's end-markets should improve going forward, while its efficiency moves are another reason to invest in the stock, along with its sound fundamentals.

Source: Why Fastenal's Post-Earnings Drop Could Be A Buying Opportunity