Where I Stand
Originally published on Nov. 10 at 9:45 a.m. EST.
- The prospective 2011-2012 outlook for economic and corporate profit growth is not supportive of current stock prices.
Originally published on Nov. 9 at 6:57 a.m. EST. Overnight there were two news releases that will affect stocks that I have mentioned on The Edge. First, Madison Dearborn is selling 10 million shares of Cinemark ( CNK - Get Report) this morning in a secondary. I have a paired trade on -- long Regal Entertainment ( RGC) / short CNK. Second, the New York Post reports that KKR is interested in taking Yahoo! ( YHOO) private. At the time of publication, Kass was long Yahoo! and Regal Entertainment and short Cinemark.
Kass Katch: Short Fastenal
Originally published on Nov. 9 at 8:45 a.m. EST.
- The company faces slowing store growth, saturated markets, increased cyclicality and disappointing sales.
BackgroundFastenal ( FAST - Get Report) was founded in Winona, Minnesota, in 1967. The company's strategy was to supply "threaded fasteners to customers in small, medium-sized, and, in subsequent years, larger cities." At year-end 2009, Fastenal operated 2,370 stores (mostly in the U.S.) that sell industrial and construction supplies to the wholesale and retail markets. The company operates 14 industrial centers in North America from which Fastenal distributes its products to its stores. In what could be the first shot across the company's bow, Fastenal's shares fell by $3 a share in August, when it reported earnings that were only modestly ($0.01) ahead of expectations. (The shares have rallied back a bit since then.) The company is experiencing a sharp cyclical recovery in sales growth against easy compares -- third-quarter 2009 sales were a disaster, down 22% vs. third-quarter 2010 back up 23.5%. The recovery has now been in place for several quarters but was offset in the most recent quarterly report by some gross-margin erosion (negative mix/larger manufacturing customers) and very modest quality of earnings/balance sheet issues (embodied in a slightly lower quarterly tax rate and heavier inventories).
The Short Case
- Slowing store growth. Fastenal has grown from 900 stores in 2000 to over 2,400 stores today. From 2000 to 2005, annual store growth was approximately 13% to 15%. By 2006-2007, the rate of expansion materially dropped to high-single-digit growth. The company is targeting 7% to 8% annualized growth in 2010 (only 7% to 10% in 2011) and indicated on the most recent quarterly conference call that store growth in fourth quarter 2010 will be toward the lower end of the 7% to 8% range.
- Saturated markets. A maturing concept characterized by slowing store growth, signs of saturation -- the company has publicly stated that it will reach its store saturation point by 2014 (but with nearly half the Fastenal stores within 10 miles of another Fastenal store, it could come sooner than that) -- and increased competition translates to limited margin-expansion opportunity and a slowing secular profit growth rate (10% to 13%).
- Increased cyclicality. The sharp and unprecedented drop in sales in the 2008-2009 recession ($2.35 billion to $1.95 billion) underscores the company's maturation and increased vulnerability to the business cycle.
- October sales a bit disappointing. October results continued to show acceleration but fell 1.5% sequentially from September, slightly worse than the 0.7% historical sequential drop. This was the first month since June 2010 below the historical pattern.
- Vulnerability to an economic slowdown or uneven economic growth. Fastenal's daily sales track industrial production. An extended period of weak U.S. commercial construction activity and/or a faltering or uneven pattern of manufacturing growth will expose Fastenal to an earnings disappointment. Distributor W.W. Grainger (GWW - Get Report) recently reported an earnings beat, too. Similar to Fastenal, however, Grainger cautioned of margin pressure, owing to similar mix shifts to larger customers. Grainger also cautioned about moderating sales growth (more difficult comps, less selling days and reduced restocking expectations by customers).
- Premium valuation at risk. After trading with a P/E at 18x in late 2008/early 2009, Fastenal's multiple has returned to its average over the past five to six years (25x). If a lower-than-historical EPS growth rate becomes more evident, Fastenal's "cult" status (reflected in its 50%-plus premium valuation to peers) is likely to be in jeopardy, especially since the share base is dominated by institutions (85%). Insiders own 10% and are selling with regularity (450,000 shares in the last six months). As recently as Friday, Fastenal Chairman Robert Kierlin reported another 100,000-share sale.
- Possible earnings shortfall. The 2010 consensus earnings estimate for Fastenal is $1.80 a share, which will be met (as there is only one quarter left to be reported in this fiscal year). The 2011 consensus earnings estimate is $2.19 a share. My 2011 earnings forecast (based on a weakening economy in mid 2011) is $1.95 a share to $2.00 a share. My target to the downside is (a still-generous) 20x that 2011 forecast, or about $40 a share vs. the current price of $53 a share.
Risks to Fastenal Short
- Easy sales comparisons. The company provides monthly sales releases, and compares remain easy for a few more months after a disastrous fall-off in 2009. By March 2011, however, comparisons become more difficult.
- Strengthening economy. A protracted and self-sustaining economic recovery produces better-than-expected store growth (10%), which generates better operating leverage/incremental margins and a higher P/E.
- Strength of balance sheet. The company has no debt and $200 million ($1.50 a share) in cash.
- Crowded short. Twelve percent of the float (15 million shares out of 132 million shares) is short and against average daily trading volume of 1.3 million shares.