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W.W. Grainger, Inc. (GWW)

Industrials
Wholesale Distributors

Rating:
Rating Since: 07/29/2011
Prior Rating:
SELL
Grade

61.7

Top-Down

SectorNEUTRAL
IndustryNEUTRAL
SentimentNEUTRAL
FundamentalBUY
09/19/2014

$253.42

Dividend Yield
1.53%
52 Wk High
$273.04
Market Cap
17,332.90
52 Wk Low
$229.29
Short Interest
Next Report
10/16/2014

Market Growth LT B-
Market Growth ST D
EPS Growth A+
Growth Potential D
Earnings Impact C
Earnings Surprise B-

While Not Entirely Negative, Growth Indicators Show Several Signs of Weakness
W.W. Grainger,'s latest financial report wasn't very encouraging from a revenue growth perspective, extending an anemic growth record also evident from a long term view. The company's total revenue last quarter was $2.51 billion, only 5.23% higher than the year earlier period's revenue of $2.38 billion. In the 12 months ended also last quarter, W.W. Grainger,'s total sales were $9.67 billion, a 26.99% rise from the $7.61 billion in revenue booked in the equivalent period ended three years ago, a poor showing over such a long period of time. As such, any boost to the company's bottom line will have to come from cutting costs, suggesting it will be important for investors to watch closely the company's margins in the next couple of quarters. It reported also that profit fell last quarter from the year earlier period, impacting also long term profit growth, which has been anemic in the last three years. We base long term profit growth on the change in full year (12-month trailing) net income from the comparable period three years before. W.W. Grainger,'s Second quarter net fell -5.15% to $203.52 million from the year earlier profit of $214.57 million (excluding extraordinary items) , which contrasts with its growth in 12-month trailing profit over a three year period. Also including last quarter's results, the company's profit grew to $779.83 million for the 12 months ended June 30, 2014, a 30.59% jump from full year profit of $597.14 million reported for the period ended three years earlier. A modest expansion in margins reported by the company in the latest quarter, with average growth in EBITDA, operating and net margins of 3.84%, represents a slowdown from its margin growth of the two previous quarters.
     Following the company's earnings announcement on July 17, 2014, in which it reported Third quarter results that missed the analyst consensus estimate by -0.32%, the stock fell -0.83%, signaling that investors were already anticipating the news and are likely looking for an improvement in coming quarters. Even after this negative report it still has a positive earnings surprise record, averaging 0.49% over the consensus estimate in the last six reported quarters.

 

Capital Structure A
P/E Analysis C
Price/Book Ratio A-
Price/Cash Flow Ratio B+
Price/Sales Ratio F
Market Value B+

Assuming the Company's Fundamentals Don't Deteriorate in Coming Quarters, the Stock's Valuation is Acceptable at this Level
W.W. Grainger,'s stock, currently priced at 19.15 times forward 12-month' earnings per share, trades 17.74% higher than our "optimum" P/E ratio of 16.26. This ratio, calculated by MarketGrader, is determined by the growth in the company's earnings in the last two years, measured over 12-month rolling periods. Based on this formula W.W. Grainger, has grown earnings per share at a 6.99% annualized rate during the last two years. The company's small margin growth, together with its positive overall Profitability grade and its EPS growth rate could stem from small market share gains, a favorable indicator of future gains for the stock. The stock's forward P/E of 19.15, based on its earnings estimate for the next four quarters, represents a premium to the S&P 500 index's forward P/E of 15.20 but is lower than its trailing P/E of 19.15. Therefore value could apparently be found in the company's future earnings growth even though relative to the market the stock might not seem cheap (the fundamentals may already be factored into the price). But assuming the company remains fundamentally strong, the stock might have further room to run, or at least be a relatively safe place to be if earnings estimates materialize into actual reported results.
     Investors are currently valuing W.W. Grainger,'s shares at 40.52 times their tangible book value (which excludes intangible assets such as goodwill), a relatively healthy valuation. When the company's intangible assets, which represent a modest 16.49% of stockholders' equity, are added back to the rest of its assets, the stock's price to book ratio drops to 5.22. Its shares seem reasonably priced at 18.93 times the $13.38 in cash flow per share generated by the company over the last twelve months, if only because its overall fundamentals are pretty healthy. Based on its price to sales ratio of 1.79, its shares trade at a sizable 160.30% premium to the Wholesale Distributors average of 0.69 times trailing 12-month sales. Our final value indicator looks at the relationship between the company's current market capitalization and its operating profits after deducting taxes. Based on this measure W.W. Grainger,'s $17.33 billion market cap is an acceptable valuation, representing a modest multiple of 17.81 times its latest quarterly net income plus depreciation.

 

Asset Utilization A-
Capital Utilization B+
Operating Margins B
Relative Margins A+
Return on Equity B+
Quality of Revenues B-

Profitability Grades Are Solid, Indicating the Company's Business Is Strong and Healthy
W.W. Grainger,'s 12-month trailing profitability record is pretty solid based on a very strong returns on shareholder equity and above-industry average operating margins. Its net profit margin was on the lighter side, as the $779.83 million it earned in net profits during the period accounted for 8.07% of total revenue. Operating income during that same period accounted for 13.78% of sales, 169.96% higher than the average operating margin for the Wholesale Distributors industry, which was 5.01%. W.W. Grainger,'s return on equity--an important measure used by MarketGrader to gauge management efficiency--is very strong, at 23.18% based on how much the company has earned in the last year. This represents an improvement from the year-earlier 23.03% return on equity, a very healthy sign of profitable growth.
     Given such strong returns the company's capital structure seems to conservative, especially assuming it could raise debt capital to invest into what is a steady and profitable business. W.W. Grainger,'s long term debt accounts for only 11.39% of total capital. W.W. Grainger,'s core earnings in the last twelve months grew moderately from the twelve months ended a year earlier. The company's EBITDA for the most recent period was $1.53 billion, or 10.99% above the $1.38 billion earned from its core operations in the prior period. EBITDA is used by MarketGrader to measure the company's true earnings power since it includes interest expenses, income taxes, depreciation and amortization, all non-operating expenses, which are nevertheless accounted for in other parts of our analysis that look at EPS gains and net income.

 

Cash Flow Growth F
EBIDTA Margin B-
Debt/Cash Flow Ratio A+
Interest Cov. Capacity A+
Economic Value A+
Retention Rate A+

Company's Cash Flow Indicators Are Solid Across the Board but Offer Some Room for Improvement
W.W. Grainger,'s cash flow declined significantly last quarter to $160.95 million, 23.51% lower than the year earlier quarterly cash flow of $210.41 million. This marks an accelerating decline from twelve month trailing cash flow, which fell to $928.14 million in the period ended last quarter, 3.80% lower than the $964.80 million in the year earlier period, underscoring the ongoing deterioration of the company's business. At the end of last quarter the company's net debt to EBITDA ratio was 0.57, significantly higher than the year earlier ratio of 0.15. Despite such a large increase the latest number is very low and doesn't imply there are any issues with the company's leverage or its ability to finance it with the cash flow generated by its operations. W.W. Grainger, net debt, defined as total debt minus cash on hand, was $235.75 million last quarter and EBITDA was $410.20 million. During the same period W.W. Grainger,'s cash on hand fell 32.13% as it may have used a larger than usual portion of its reserves to make up for shortfalls in its operations. But these steps seem to be putting the company in a better position as its total debt as a percentage of total capital fell 2.22% in the last twelve months from 14.76% a year ago to 14.43% in the latest quarter.
     An important indicator of management efficiency used by MarketGrader is Economic Value Added, or EVA, which measures each company's true return to shareholders after accounting not only for the cost of running the business (operating costs) but also the cost of the capital it employs. By measuring the real cost of capital, both equity and debt, EVA measures the creation of true economic profit. In this case W.W. Grainger, had $3.80 billion in invested capital in its most recent quarter, a combination of both equity and long term debt. However, the company's weighted cost of equity of 6.30% is much larger than the weighted cost of debt, which is 0.16%. When combined, the two result in a total cost of capital of 6.46%, quite low compared to the company's total return on invested capital of 35.10% based on 12-month trailing operating income. The result is an excellent economic value added of 28.64%, a very high return to investors after all capital costs are covered. The company increased its quarterly common dividend on December 31, 2013 by 16.13%, to 1.08 cents a share from 93.00 cents. It has now distributed dividends uninterrupted for at least five years and based on this latest payout the stock is currently yielding 1.53%. W.W. Grainger, spent $272.80 million paying out common dividends in the last 12 months, equivalent to 29.39% of its total cash flow and 34.98% of what it earned after taxes. This payout ratio, which actually represents a small increase from the 33.33% of earnings paid out in the year ended a quarter earlier, appears sustainable as long as the company maintains its generally strong fundamentals.

 

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