Ron Jadin - Chief Financial Officer, Senior Vice President
Laura Brown - Senior Vice President, Communications & Investor Relations
John Inch - Analyst, Bank of America Merrill Lynch
W.W. Grainger Inc. (GWW) BAML 2011 Global Industrials Conference December 6, 2011 9:05 AM ET
So just as a quick reminder, for those of you who haven’t seen the agenda. Tonight, starting 4:30 we are going to have a cocktail session. I believe it’s on this floor. So this the chance to get free drinks from Bank of America, which I’m always up for that. Hopefully everyone appreciates the format of this year’s conference. I think the age of the obnoxious fireside chat hopefully is going to be put to rest with an analyst drawing on about themselves mostly. So this is your chance to talk to the companies and ask them questions, not listen to analysts take about their own agendas.
With that, it gives me great please to introduce management team of Grainger. If there’s one stock one could own forever, it’s probably this one, at least forever as in a Wall Street context. So I’ll put those brackets around it. Lets call it my lifetime if anyone is listening.
And I would like to introduce both Ron Jadin and Laura Brown. Ron has been the CFO now for a number of years. He stirred this company I think in a direction that we would all agree has been completely and squarely in the interest of creating shareholder value. This is the management team on everyone’s side. So with that, let me introduce Ron.
Thanks John and thanks for having us today. I really appreciate it and thanks all of you for attending. I don’t normal make stock recommendations, but I have to admit, I did just place an order with my wife for four shares with GreenBay Packers stock this morning for my four children. So if you do need to place your order while I’m speaking, I certainly understand. There’s only 250,000 shares available.
I’m going to just take about 20 minutes or so with some prepared comments and into Q&A and if there’s two points I could leave with you, one would be that Grainger’s really investing a lot in its foundation and what I mean by that, its ensuring that our customers have a very high availability, today or tomorrow, of a very broad offering of products, so we can serve them better than anyone else in our space.
The second point is, we are investing at a more rapid rate this year and into next year, around a lot of growth investments, so we can take share at a faster rate than before, despite a tough economic outlook.
You’ve had a chance to see our forward-looking statement. For those of you who don’t know Grainger, we are about a 84 year old company. We are a distributor of MRO products, maintenance repair and operating supplies and we’ve been growing internationally and through other means and I’ll go through some of those in the slides to come.
The pie chart on the left hand side gives you a visual idea of the diversity of the end customer segments in which we sell. If we did a pie chart like this for the products who we sell, you’d see a similar picture. We sell a very diverse offering of products to a very diverse set of customers. Our commercial, is commercial office building; its healthcare, its things like that.
Government, we could do a pie chart on government that would also look like this. So federal, state, local, all the arms of the military, the post office, higher education, prison system, I can go on and on, 1000s of buyers within government. Government’s been up 2%, you can see on the right hand side towards the bottom. Actually a pleasant surprise for us; government I don’t think is spending more, but certainly we are taking share. We’ve got a very large, dedicated government sales force. We do a significant amount of business with the government. Barrier to entry, they are very difficult and we are very good at it, so it’s helped us.
Within government we’ve seen some softness in sate and local, but strength in military and then federal and that’s helped us. And you could see, have been manufacturing high teams and so on. The reseller is negative because of tough comps with 2012 sales related to the oil spill cleanup, otherwise that would be positive.
These are year-to-date numbers, but if you looked at every month during the year, very consistent by-segment type of growth rates. So we really haven’t seen any downturn. We expect some softening as we finish the year, but nothing of a significant nature. We haven’t seen it yet, but we are anticipating softening in the economy and that’s what’s influenced our guidance for next year.
When we think about the economy, we use industrial production as a bit of a, at least over time indicator for us of economy growth. You can see the yellow line is industrial production growth over time and the red line is our sales growth over time, you can visually see a decent correlation and you can see towards the right hand side the more recent years, the red line is more often above the yellow and that means we are taking share. And in the far right, you can see that as the economy is predicted to drop off from 2010 to ‘11 and ’12 that we continue to take share and in fact we believe that will be at an expanding rate. We even sold share through the downturn, the most recent one at least.
Some of the reason for that, I’m going to go through a number of slides around some of or growth initiatives, product line expansion is one that we are well into. For those of you who follow us these numbers may not look familiar, these are total company. So we’ve gone from 200,000 skews to roughly 600,000 skews in our own path to a million skews.
Within the US the numbers that you may be familiar with are around 80,000 skews going to 350,000 skews to 500,000 skews in the next few years. And when we talk about that, we are talking about skews that are in stock, readily available for our customers today or tomorrow. So in addition to this, there’s well over another 0.5 million skews that are available through drop ship from our customers, are available online to order through Grainger.com and other sites throughout our business.
We see two to three percentage points of growth from this investment and a nice tailwind for us to keep adding products for the next few years and there’s a maturity curve of another three years or more to that once we stop adding skews, so quite a few left to grow and some nice momentum into next year from the investments we’ve already made.
Sales force expansion, we’ve been adding sales people. The 2010 number is 3,100, on its way to 5,000 for the company in the next three to five years. Certainly ramping that up. In fact in the U.S. alone, this year we will be adding 400 territory sales reps or TSRs. We hired 150 in the second quarter, we talked about hiring another 150 in the fourth quarter and we planned to then start hiring another 100 in the first quarter of next and we’ve accelerated that into this year.
Not sure we’ll get them all hired with the holidays, but our plan is to have ideally 100 hired and another 400 people. So as we go to the first quarter of next year, while 400 more sales people in the U.S. than we did a year earlier in the first quarter. We think that’s going to be a nice driver of additional growth for us.
The breakeven for those sales peoples is about 18 to 21 months and that’s been coming down. Each year we’ve been adding in phases of around 150 at a time and we’ve been testing each of those, making improvements for each in terms of who we hire and how we hire, how we train, how we target, how we set geographies for those sales people and we’ve seen great progress.
E-commerce, the percent of our sales through e-channels has expanded significantly in time. You can see 15% to 25% in 2010, expanding to 50% in the next three to five years. The U.S. loan is at 30% today. In Japan well, we are doing over $200 million of business, its 70% very unique, that’s a growth model. We see lot of opportunities to expand there with a natural momentum with our customers converting to the e-commerce channel, but also because of some significant investments we’ve been making in this space.
As we speak we are adding customers to new platform, which is on SAP and they will bring even greater integration and real time information to our customers and investing in mobility devices like apps on an iPhone which we demoed in November and over the next year we’ll be migrating all of our customers on to this new site and introducing them to more of this capability.
A great example is in the future our customers on their phone, which will be GPS enabled, they will be able to tell where they are relative to any of our branches in the market and be able to see what product they are looking for and where it may be available in that market, at which location and be able to see their price and place an order online through a hand held device. So same productivity we plan on giving all of our sales reps. So when we have 3,000 sales people going to 5,000 and you give them that same productivity, it’s a huge tailwind for us. So we are very excited about the growth potential for e-commerce in the years to come.
A lot of productivity for us when the customer enters the order, average order sizes are larger, there is much discounting that can occur, its shifts out of a distribution center, then out of a branch and that’s more productive for us; a lot of reasons why this channel has worked really well for us and for our customer. We are making it easier and easier for our customers to do business with us by trading the applications and the improvements like search ability and more key work searchers for this application.
Inventory service is another one that we’ve been after now for about five years. We are at about 15,000 keep stock installs going to 45,000. Within each of these numbers are actually many applications that may be at each customer site and these range from CMI customer managed inventory, where we provide the technology and the standards to our customers to put the product away and scan it.
To VMI where we do it, Vendor Managed Inventory, we’ll bring the products to our customer locations, stock it on their shelves or vending that solution, we are actually putting it in a vending machine that will provide all the way to an onsite branch, where we’ll actually put a branch of ours in a customer location with our people and our technology and dedicated inventory. We see that customers who order or transition to these types of applications drove at about 15 percentage points faster than customers who don’t, so some nice aggressive growth from that investment.
With regard to international expansion, the red is where we have a physical presence today. The dots are where we are using resellers or export sales people, selling to over 120 countries in the world and continuing to expand acquisition as a great way for us to do that.
The red color there is Columbia, where we own 80% of the business. We acquired that a little over a year ago. The 20% owner is the son of the Founder who is running the business and we are into maybe a five-branch operation there. We’ll probably double that footprint organically and possibly then start doing some acquisitions. So that’s a great model for us as we think about extending our reach for the south.
The reason we think a lot about Latin America is we’ve got tremendous buying power in the U.S. and we can extend that and we’ve done that in Mexico where the margins are very strong. In Mexico we see the opportunity to progress for the south and bring that same kind of buying power into other parts of Latin America.
Similarly Asia is an important area for us to expand. We have a lot of buying power in Asia, and particularly in China, where we do a lot of sourcing there for the U.S. and other parts of the world and also places in Asia are very heavy manufacturing intensive and manufacturing uses a lot of MRO, a lot of the kind of products we sell.
So those are the geographies we are looking to expand. M&A or acquisitions is a way for us to do that most easily, because we can buy into great leadership teams. People who know the culture and know the business model. We can bring the supply chain expertise.
There are also a few other companies that we are targeting, that if they came open for sale, we would be interested in buying them and Fabory is a great example of that, of the business in Europe; we just closed on September 1. A great footprint in Central and Eastern Europe; great opportunity to expand; a very strong fastener business that we can add safety and tools to.
It’s not going to be an MRO generalist, they don’t have the footprint for that, but we think we can add a lot of product line expansion and provide them the ability to expand their stores as well. It’s a very high gross profit margin business, so we like that. Its expense to sales ratio is too high and they need to grow into their cost structure. They are in about 15 countries and we think we can help them accelerate their growth.
So and we’ve also been leveraging our scale. Our operating margin has improved significantly in the last five years and we project it to continue down that path. We talked a lot about expanding our margins, 50 basis points or better when our organic business grows in the strong single digits and we’ll talk about that a little bit more in our guidance.
On the right side I included some of the reasons for our expansion and purchasing leverage is a big one. We certainly have a lot of buying power re-priced to the market, so we feel we are very competitively priced, but we often times can buy a little bit better than our competitors. Those of you who know our space understand this, but for those of you who don’t, I mean our space is very fragmented. 60% to 70% of our competitors are very small local players whose buying power isn’t as significant as ours. Most of them make their investments in e-commerce and mobility like we can. So we think we the investments we are making will further distance us from the vast majority of our competitors.
I won’t go through each of these, but private label is probably one I’d like to touch on. We’ve got some great momentum there. About 23% of our sales are private label. About half of that is Asia sourced and we expect that 23% over time to grow to 30%, maybe 1% a year, it really depends on how the rest of our sales grow and they’ve grown, so it’s been tough to have that percentage go up by a lot.
But we think that, today half of that 23% is Asia sourced and in the future we think two-thirds of that 30% or 20% on 30% will be Asia sourced and the significance of that is Asia sourced margins are upward to 60%. Our private label overall is about 50% and our business overall is in the low 40% range, so some nice leverage there as we expand.
Certainly we are leveraging our North American platform, especially from the supply chain basis and how we manage our business across borders from a supply chain, from a buying perspective and how we do distribution. Starting as we come from a global company and put in America’s SAP over the next couple of years, which is really leveraging our U.S. instance and building it out for Canada, Mexico and the rest of Latin America.
It begins to make sense for us to think about back office consolidation and we’ve announced some of that over a year ago. We’re starting to execute on that starting this year, this coming year, around consolidating some of our back office like accounts payable in places like Panama.
Our guidance that we gave in November is about $8 billion in sales, a sales growth of 11% to 12%, EPS growth of 30% to 32%, so some nice leverage, upped margin expansion in the range of 170, 180 basis points improvement year-over-year. Around three years of improvements and won some significant increases there. Certainly there are some acquisitions in there that will hopefully drive the top line. Not much of an impact in acquisitions on EPS overall. A little dilution from the Europe business; a little accretion from the business in Columbia, overall earnings neutral.
When we think about our growth opportunities going forward, I wanted to highlight the difference between the economy and share gain. This is one of my other key points I wanted to highlight at the beginning so that you take away as we expect to take more share going forward and we’re already doing that.
In 2010 in the far left, the economy was strong coming out of the downturn and our share gain was about 2% out of our 8%. 8% is our organic growth on a real basis, so no price here and then if you look at 2011, a richer mix between the economy and share gain and in 2012 we are thinking of 1% to 3% growth from the economy, kind of a average of 2% and then share gain of 4% to 5%. Really leveraging the momentum from product line expansion and a lot of our ongoing initiatives in the foundation and then leveraging things like e-commerce and our sales adds.
So these numbers if we go to the next slide, you’ll see on the top line, this is a comparison of our sales growth. The left side is 2012, the right side is 2011. That 5% to 8% and the 7% to 8% are really the heights of those bars on the preceding page and again then price, roughly 2% this year. Earlier in the year it was rounding up to 2%, now it’s kind of rounding down to 2%. The price next year is in the 2% to 3% range.
We are seeing a little bit more inflation risk in Canada as the U.S. dollar strengthens and the purchases they make from the U.S. will have a little bit more inflation with a little bit higher pricing as a result. That was a benefit for them in preceding years of course. So 7% to 11%, so the low end is lower than this year at 9% to 11% because of our concern about the economy, but at 11% that high end of the range organically is higher than this year based on the share gain opportunities and potential we see.
Oil spill, that really technically should be part of organic, but it has really to do with 2010, so I pulled it out of here for comparison purposes and then the other big one is acquisitions and I think an important thing to note here is this is really Europe. This is the acquisition we already made.
We don’t give guidance. I mean our guidance doesn’t include acquisitions or dispositions that have not yet closed, so really this is four months of Europe in 2011, that’s the 2% and the 3% is the carry over effect of another eight months. It really rounds down to 3%, here it’s about 3.5%. When we look at the company at the bottom 10% to 14% and exclude acquisitions based on rounding it’s really 6% to 10%. So when we think about what’s driving earnings per share, it’s our organic growth of 6% to 10%.
Our guidance for 2012, roughly $9 billion in sales, 10% to 14% sales growth. Again, that’s from the bottom of the preceding slide. Organically it’s 6% to 10%, 20 to 50 basis points of margin expansion. There’s a drag from the acquisition in Europe of about 30 basis points. So again, if you think about it organically, the 20 to 50 is 50 to 80. 50 to 80 makes a lot of sense for us from an organic growth perspective on that 6% to 10% sales growth.
Our thinking around the contribution from acquisitions, that four percentage points sales growth really is probably 3% to 5% EPS growth. We had guided previously back in I think August September timeframe that we thought that the acquisition in Europe might be $0.10 to $0.12. Because of our concern about the softness in Europe, we’ve taken it down to $0.03 to $0.05, but think long term certainly Central Eastern Europe is a great place for us to be, based on the purchase price that we made and the synergies that are running ahead of what we had expected and the integration that’s running ahead of our plans.
We really think that this is a great model for us and in fact we deem it a great acquisition if we can get just 4% sales growth every year based on what we paid for the business and certainly we expect to get a lot more than that, because we are going to keep investing in expanding to what they call shops. Branches are much like a small faster distributor, 3,000 to 4,000 square feet. We only probably got 20 a year there and then help out that safety and tools in terms of product line expansion.
So when we mentioned 20 to 50 basis points of margin expansion, the mid point is about 35 basis points. This is really just looking at the mid point of the range just to simplify it, but 35 basis points is just adding up the three numbers on the page. The numbers are pretty big though. 35 seems like a small number, but there’s a lot going on there if you peal it back and so on if you highlight it.
A tremendous amount of productivity around a lot of the things I already mentioned. The one I didn’t mention is we announced closing up some branches back in November over a three year period. We probably have closed around 50 or more branches in the US on a basis of about 440, so it’s fairly substantial and we are thinking about fewer bigger branches in the US, so that’s kind of what’s – as we think about what our customers are doing, they are buying changes, buying behavior changes, we are thinking about fewer bigger branches. More inventory locally, certainly for a higher availability, but more and more we want to bring the product to our customers.
So adding more sales people, adding more inventory services people, shipping more, the shipping out of branches have declined over time. I think with the advent of better shipping capability in our industry, throughout the network and also the advent of e-commerce has driven more of the shipments, which used to be 50-50, now 80-20, 80% of the DCs, 20% of branches. But branches provide great value for our customers for immediate same day need. Those branches, certainly that model is important to us, though we think two are bigger.
So 140 basis points there. Our drag is 75 basis points on growth, so $60 million to $70 million of spending this year on top of last year. Next year that’s about $150 million because of the carry over and the ramp up of additional sales people in particular. $150 million though isn’t 75 basis points on $9 billion, its probably half that $150 million. So what’s in the 75 basis points, as well as revenue left from those investments, so that 75 basis points is net of the revenue that is generated. Still a drag on our margin, but not as much as the $150 million if you do the math. And then acquisitions in Europe and that’s the 30. So those are kind of the building blocks.
We expect to generate $860 million in cash and we are going to reinvest about 26% of it in CapEx. Similarly this year we purchased 360 million to 420 million shares net of acquisitions and dividends $200 million to $250 million, it’s around 14% to 22% implicit increase in our dividend.
This chart was usually showing 10 years of data. I split it into two groups of five, because it’s kind of interesting what’s been going on in the last five I think versus the first five. The height of the bars is the dollars and billions of cash deployed, so $2 billion going to over $4 billion. Over half of its driven by improved operations in our business and improved cash generation, but there also is some borrowing in there and also some higher cash balances as we started, so its not all operations but over half of it is.
If you look at the percent, kind of two-thirds give back to the shareholders, that’s 61% and the 66%, the divided piece is getting to be a little bit bigger as we expand our dividend with a faster rate. The one-third used to be primarily CapEx and now you can see acquisitions as a bigger piece, still around one third.
18% increase in dividends per share on the left hand in the last five years, 17% reduction in shares outstanding on a net basis and share repurchase will probably be a little bit less next year than the trend, because we bought the business in Europe and while we funded it 50-50 with debt, to put some euro debt on the balance sheet for hedge in the fourth quarter, effectively paying down the equivalent of that debt in U.S. commercial paper. So by the end of the year we would have done that deal effectively on a cash basis on a $350 million deal.
And that is the conclusion of my prepared comments. I could open it up to Q&A.
Two questions; one, when you’re talking about share gain potential in the U.S. I think you mentioned 60% to 70% of your customers businesses were smaller mom and pop type places. How much of that is truly addressable by you guys? Is that all potentially addressable or there are segments you’d have to move into in order to access that. So that’s one question.
Second question is, you guys obviously have a lot of leavers on margin. One of the things that I’m trying to understand a little better is there’s clearly competitive benefits to your scale in the U.S. on distribution and purchasing. To some degree, you think that the purchasing would apply to Europe and ex-U.S. markets, but its not having the distribution advantage as would apply as well. From a profitability perspective and I guess competitive landscape perspective, sorry I’m asking a couple of questions here, can you talk about Europe in that regard please.
Sure, so you had mentioned 60% to 70% of our business I think was small customers, in fact the majority is more with our larger customers. Oh competitors, I’m sorry.
Yes, so share gain central.
So our share gain is going to come from the small competitors for sure. They just don’t have the capacity to invest in the scale that we’ve already built and the scale that we continue to build. In fact I would argue that many of our larger competitors have not yet built that kind of sale. So when we talk about building e-commerce platform on SAP and we’ve been on SAP in the U.S. for over six years now, fully integrated.
The seamless nature of how we can do business though e-commerce, where you can place an order on e-commerce channel and then call our customer service people and ask them about the order, you know in the next minute they can see the same thing and everybody can see availability real time with the new platform we are building, that’s something I don’t think many people have to offer and when we think about E-commerce capability like that, we are thinking about the best in the industry around e-commerce, not our direct competitors.
So the challenge for the small competitors will be more and more significant with the investments we are making, so we don’t see how they can continue to keep pace. We don’t have facts on who is closing and who is not, but we know that’s who we come across, so most of them we seem to take share most from.
Our buying power is Asia is a particular value driver for us that we can bring anywhere in the world. Many of the companies we buy aren’t buying in Asia at all or if they are they are not buying well. So we’ve got hundreds of millions of dollars of buying power in Asia that we can bring anywhere we go.
And when we think about the synergies, first and foremost its what the supply chain leverage we can deliver to whoever it is we buy or partner with and so it’s the purchasing power around the product that we buy with common suppliers and then from Asia and if it’s a U.S. based or local, its more what else can we do with fright leverage as well.
And then any revenue upside, we like to think of that as just upside to the deal and not try to count too much on revenue for the synergies of our acquisitions, which is how we can think about Europe, how we can think about 4% sales growth as being sufficient to make that be a good deal. The lower that sales growth number has to be, the more confidence we have in doing the deal.
Ron, could you talk about the process of introducing all these FKUs. I mean a lot of people might be seem to think that this is just a simple process and I don’t know, I guess the question is, how do you make sure you’ve got the right products and manage it effectively as you still got this big base and I mean I guess the question also comes down to, do you feel comfortable in your ability to implicitly manage a million skews and then call it several years out. Do you kind of hit a wall in terms of our growth, because that’s obviously been driving an important path of your growth then or is there some other, kind of a – its all about what next. Your kind of crystal balling a little bit, but still if you could sort of help us there.
Sure, so we think there’s a couple of more years for sure, two to three years more product line expansion and then on top of that another three to four years of kind of momentum from that as we growth at a faster rate than the economy. Those products aren’t accepted a 100% day one. It’s about a three to four year maturity curve to that, so quite a few years left.
But we really count on the expertise of our product management team, our suppliers and our customers when we are adding product. So e-commerce gives us a lot of search information where customers search for something and couldn’t find what they wanted. May be we need to improve our key word search, because we actually had the product, may be we don’t have the product and if we get enough null searches, it becomes a candidate.
If we get a lot of sourcing requisitions to bring in product as a drop ship, because we don’t have it in stock, we might start carrying that or even if we have been carrying it, may be it becomes a candidate to stock, so its available today or tomorrow.
Our suppliers give us a lot of information around product add, because a lot of what we add is product line expansions. Also new categories like fasteners and fleet services and pluming, every year it seems to be we kind of add a new category, but really our biggest growth is when we are filling in those gaps in our existing product line, what those categories are best know for.
And when we bring the products in from a financial perspective, what I like is we bring it all to our Chicago DC initially and its starts in one location and it earns its way out into other locations, distribution centers typically, possibility branches, but its based on demand. And so we reserve the right with our suppliers and certainly they are encouraging us to carry more, because when it goes into Grainger.com or on the website, they sell a lot of products. But if by chance it doesn’t, we reserve the right to send it back years later and if its all in one location and it hasn’t sold well, its very each for us to return to suppliers and get our money back and suppliers see that as a good kind of an R&D effort on their part as well.
Half a million skews in the U.S. is what we see as kind of a theoretical max right now. We’ll learn more as we go. Its really driven by the side of a building. You know we have a number of now four million square foot buildings roughly in the U.S. East, West and Central and then – or two centrally located and as we continue to globally expand some of our buildings out of kind of 400,000 to 500,000 square feet over the next five years. Possibility three more of those buildings might become 600,000 to 800,000 square feet or bigger. So we’ll continue to expand our footprint, but half a million skews kind of make sense to us right now and that ability to return.
So we talk about adding 50,000 skews here, that’s a net number. There could be returns of 10,000 skews a year in that number and so there’s an inflow and outflow as we continue to change that mix. Even that half million number over multiple years will have a burn and where we’ll continue to reshape what skews are in there.
And then the next step is, continue to sell that value proposition to more and more customers, because we really added it, because customers said yes, I believe in your value proposition. It makes sense for me to reduce the number of suppliers that I work with. I’ll give more of my volume to Grainger free of cash. Don’t stock it on the shelf, because I count on Grainger to get it to me today or tomorrow and here’s everything I buy. And they gave us a list and years ago we couldn’t fulfill all that and now we can fulfill a high percentage and getting higher everyday and that endures us more and more to our customers and makes it easier for them to reduce their procurement cost, which indirectly is very high.
Hi. You noted that your keep stock customers grow two or three time faster than your traditional customers. Could you also compare the upper Asian margin profile and return on capital profile of that business versus the traditional business.
We really haven’t analyzed the return on capital profile of that as a separate project. The capital involved is similar to the capital in our business, because they are really just – we are not dedicating much inventory to our customers. We in fact pull it out of our DCs, pull it out of our branch, so its inventory there for everyone.
The inventory that we put away then is sold to the customer, so we are not necessarily putting inventory into customer locations that’s consigned. They own it for the most part, so if there’s any level of consignment, its very, very small, so its negligible in terms of a drag and the up margins are essentially the same. The price that we sell to the customers is the same. The cost we do have is to have a person go there, so there’s a little bit of a drag on up margins as a result to that, but it’s quite small.
And the way we mange it is, we for the most part we are able to borrow labor through our branch talent who then can go out and we try to make that cost as variable as possible. So we only do the work to put the product away and come back and work in the branch, so that helps us manage that quite well. So it’s pretty small in terms of more pop margin drag and so it’s profitable for us as a result out of the box.
Where are your same store inventories year-over-year by region?
Okay, so we don’t really talk about same store sales, because we kind of have the same stores. We really have expanded square footage not so much stores, but our inventory turns have been relatively flat over the last five years, working capital in general. There has been a little bit of an up tick recently just with adding inventory into our Northern California DC. So that’s a new building, its 800,000 square feet.
We put inventory in there to serve customers who want to grow into that investment, but for the most part product line expansion has been funded from productivity through the base business as we’ve gotten smatter and smarter around algorithms to predict demand, so how can we carry less safety stock, and still have this high availability of better than every before. We’ve done that a lot.
We’ve reduced cycle times with our suppliers to bring product in and more importantly reduce the standard deviation around their commitment of which date they are going to delver product. So we’ve gotten a lot of productivity out of the base business in terms of inventory. So as we’ve added products, really hasn’t been a drag on turns.
The only other small drag we see as we grow internationally, inventory turns are not quite as good, DSOs are a little bit higher, but if you look at that over time its relatively flat, our working capital and inventory turns. DSO is I think better than anybody in our space, kind of in the 36, 37 days roughly as a company. Inventory turns at or better than anybody in our space at about four.
And your expectation for a cost inflation next year?
Is in the range of our price inflation. It’s in that 2% to 3% range. We typically try to price in the 10s of basis points, a little bit above, so that’s for every year. No matter what inflation is, we’ve had a couple of years ago, where we actually had a small cost deflation and our pricing was flat during the kind of the bottom of the downturn. So even when our pricing was flat we had a slight benefit to our favor and that’s what we try to mange every year and typically its that buying power, vis-à-vis our compotators.
I think you had mentioned that in the future you think 50% of your sales will be Internet. And can you just chat about whether you think that source of sales would lead to higher or lower revenues, lower margins.
We think higher margins and we are already seeing it. Its really that shit of 50% of our business being fulfilled out of a branch and 50% our of DC, that’s shift is going to, 80% of the DC is one less pick back and ship. The cost for distribution in that model is very productive for us. Certainly the advent of the conversion of business going through the e-channel has helped with that, because that business is all shipped and that in the customer and in the order. Its about 200 to 400 basis points margin improvement on orders that go through the e-channel versus who are not.
Could you talk a little bit about how the mix in your government business has been changing over time and also recently clearly when the governments are stressed they make different types of decisions. I’m also aware that your largest government customer I believe is the postal service, which has unique challenges of its own.
Yes, I would say that what’s evolved is more and more contracting with government, so more and larger contracts across all arms of the military, all facets of the government. So it’s still very diverse. There are tens and tend of thousands of buyers off of government contracts, many of them who have never even seen the contract, right.
We are introducing them to a contract and we are telling the kind of price and they can get off of that contract. We kind of own the accountability for making sure both of us adhere to the contract. So it’s kind of ironic that way, it’s complicated that way and we are very good at it and that’s why we think it’s been an opportunity for us to grow and take share even in a downturn.
And the post office is our biggest customer and its less than 1% as a company; in the U.S. its probably one. So again, we probably need to a do a pie chart in just the government to highlight how small the post office is. So we are seeing that drag already from the post office.
We are seeing a drag in state and local, but we seeing strength in military, strength in federal, not that the federal government is spending more, but we just know we are taking more share and I think with over 400 to 500 at least dedicated government sales people, who only sell to the government to understand complexity of that, especially the contracting fees where we really made a lot of progress in the last five years of so, we see a lot of momentum there yet for us to keep what we have and also to grow it. Because there’s always a challenge in keeping what we have as well and we’ve done a good job keeping what we have.
Good morning. You gave organic sales growth of 7% or 11% for 2012. I was wondering if you could comment what kind of growth you are expecting by region, whether it be North America, Europe, Asia emerging markets. Thank you.
Sure. I am just going to split it between U.S. and other; I think it’s the simplest way to think of it. You could probably take 1% off of that and think about the U.S. as being one percentage points less on each end of that range. The U.S. bill next year is 75% of the company.
So kind of as the U.S. goes, so does the company overall, but we certainly expect sales growth and we’ve seen it this year from many countries outside the US at 15% to 20% or higher. We expect that again for next year in many of the places, because the share potential is so significant and the value we are bringing into those markets that no one else seems to be able to deliver has been significant, so we expect that to continue, but when you weigh it at 25%, its really an incremental 1% on top of the overall company growth.
Have you seen any financing issues in China or Europe with your customers?
We really haven’t. Our average order size in the U.S. is just over $200 and in another countries its some of it’s above, some of it is below. I mean I wouldn’t characterize the business they do at Grainger as a big dollar purchase. So financing really doesn’t come into play for the products we sell and the nature of our transitions.
Ex-U.S. can you talk about why someone else can’t just do what you guys are doing. I guess the buying power, that’s clearly a competitive advantage for you guys. But if you look at Europe or Central Eastern Europe and other markets, to some degree a lot of what you’re doing is sort of consolidating and extending. Why can’t someone else do that and what distinguishes you that way?
I think we got a big head start, so we’ve been buying in China for over a decade now and so we just got a lot of momentum and a lot of expertise. I think not as many people have just started that process or is far along and so we also think there is a first mover advantage to getting into Colombia from my example earlier, by a business with five branches, double it in the next few years, start making some built on acquisitions. I don’t that we’ll do those, but that’s how we are thinking about it at least; is buy it, grow it organically and as you see success start to do some acquisitions.
And all these markets are highly fragmented just like the U.S. They are just a very similar pattern, so we see the opportunity. So that’s why we are trying to aggressively get into these places. Colombia is tiny. Its not going to move the needle for the company, but it’s a great example and if we do enough of those over time, they can start to build some meaningful scale and we are in the long term for these kinds of investments and we think it’s got some good momentum.
We’ve got about a minute left.
Hi, what is the branded part, manufactures competitive response to your private label effort.
I think it’s a challenge. So we love branded products, our customers’ love branded products. There are some products that we will always carry that are branded and the majority of our – I mean we say 30% in the future, that’s still a ways out, that still leaves 70% branded.
Some of our compactors don’t care of branded products; we think that differentiates us from some of our competitors. Customers like standardization and some of the branded products are exceptional in that area. So we’ve had great relationships with those customers. It is a challenge and it creates some friction for sure, but we have great partnerships with our suppliers.
There are also products that customers don’t care about brand at all. Many products that might be behind a wall, so certain pluming fixtures, certain fastener categories, customers really don’t care about brand and so nobody will read the basis on those sorts of things. Those have very naturally become no branded or private label. And so far it really hasn’t been an issue and I think that’s what’s going to cause us to get to some point where we say we are not really going to go much further, is we’ve gotten all the easy stuff and there’s too much of value driven by our branded suppliers that we wouldn’t go any further, but it helps us negotiate with then as well when we are negotiating on price, it’s the threat of it, even if we don’t switch.
I think we are out of time. Okay, thank you.