MSC Industrial Supply (MSM 81.71, -2.93, -3.47%) opened lower (-7%) after the
company reported 3Q18 (May) earnings this morning.
MSC Industrial Supply is a distributor of metalworking and maintenance, repair, and operations (MRO) products and services. It offers more than 1 mln stock-keeping units (SKUs) through its master catalogs; weekly, monthly, and quarterly catalogs; brochures; and website, mscdirect.com.
Many of its products are carried in stock, and orders for these in-stock products are typically fulfilled the day on which the order is received. The company’s business strategy is to provide integrated, lower cost options for its customers' day-to-day MRO needs. Its extensive catalog of product offerings enables customers to ease the administrative burden of relying on many separate suppliers to meet their various MRO needs.
Its customers include a range of purchasers of industrial supply products, including entities as diverse as individual machine shops and Fortune 100 companies and government agencies, such as the General Services Administration (GSA) and the Department of Defense. The company focuses its business on selling relatively higher margin, lower volume products. Product categories include abrasives, clamps, fasteners, hand tools, tubing, janitorial supplies, milling (drill bits), power tools, saw blades, and welding equipment.
Almost every industrial, manufacturing, and service business has ongoing need for MRO supplies. MSM believes that, except in the largest industrial plants, inventories for MRO supplies are generally not effectively managed or monitored, resulting in higher purchasing costs and increased administrative burdens. In addition, within larger facilities, such items are frequently stored in multiple locations, often resulting in excess inventories and in making duplicate purchase orders in error.
MRO items are frequently purchased by multiple personnel in quantities that are not economical. A substantial portion of most facilities' MRO supplies are generally "one-time purchases," resulting in higher purchasing costs and time-consuming administrative efforts by multiple plant personnel. Awareness of these inefficiencies has been driving large companies to streamline the purchasing process by using a limited number of large suppliers like MSM. MSC Industrial’s concentrated lower-cost solutions and broader offering of products help to resolve inefficiencies.
Turning to the MayQ results, EPS rose 27.5% year/year to $1.39, which was in-line with market expectations. Revenue rose 11.3% year/year to $828.3 mln, which was within the range of prior guidance of $820-835 mln. In terms of guidance for Q4 (Aug), MSM expects EPS to come in around $1.26-1.32 while revenue is expected to come in around $829-844 mln. The guidance for both EPS and revenue is below market expectations. In terms of margins, operating margin remained stable at 13.9% vs 13.7% in the prior year period.
MSM says the manufacturing environment in MayQ was healthy, and the pricing environment was sustained, with positive price/cost in the quarter. MSM continued to deliver gross margin stability, and its ongoing productivity efforts resulted in operating margin expansion. This was despite sales growth that was somewhat below expectations due to the impact of its sales effectiveness initiatives and the related lower sales headcount.
In sum, the weakness of the company’s Q4 (Aug) guidance largely explains why the stock is lower today. MSM concedes that the AugQ organic growth guidance fell short of expectations for performance in this environment. However, the company expects a return to more typical organic growth levels after a couple of quarters as MSM completes its sales force effectiveness initiatives and expand its sales team. As it does that, MSM will benefit from the leverage inherent in its business model, and the company expects to continue achieving its long-term annual incremental margin target range.
The stock had been trading sideways in the $85-100 range from December to late June, but it has been weak lately, perhaps on concerns about the MayQ results/guidance. Hopefully results will start to pick up again when FY19 rolls around in NovQ.
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