W.W. Grainger, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Grainger distributes maintenance, repair and operating supplies and related services, primarily in the U.S. and Canada. Figures below are unaudited; dollar amounts are in U.S. dollars.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $2.831 billion | $2.636 billion | $8.458 billion | $7.792 billion |
| Gross margin | 38.1% | 38.6% | 38.8% | 39.5% |
| Operating earnings | $189 million | $278 million | $868 million | $799 million |
| Net earnings attributable to Grainger | $104 million | $162 million | $573 million | $435 million |
| Diluted EPS | $1.82 | $2.79 | $10.04 | $7.39 |
| Operating cash flow | Nine-month period: $743 million | Prior-year nine-month period: $721 million |
Q3 sales rose 7%, driven mainly by U.S. volume growth, market-share gains, stronger demand and continued double-digit growth in single-channel businesses. Q3 reported operating earnings fell 32% and diluted EPS fell 35%; excluding restructuring, impairment and specified other items, management reported adjusted operating earnings growth of 15%, adjusted net earnings growth of 43%, and adjusted diluted EPS of $4.19 versus $2.90. These adjusted measures are non-GAAP.
For the first nine months, sales increased 9%, reported operating earnings increased 9%, and diluted EPS increased 36%. Management’s adjusted figures were operating earnings of $1.034 billion, up 19%, and diluted EPS of $12.74 versus $8.52, up 50%.
Margins, segments and material changes
- Q3 gross margin declined 0.5 percentage point year over year; management attributed approximately 0.5 point to revenue-standard adoption, which reclassified certain KeepStock service costs from SG&A to cost of goods sold. Excluding that impact, Q3 gross margin was flat. For nine months, margin declined 0.7 point, including a 0.5-point accounting impact and pressure from U.S. pricing actions.
- The U.S. was the principal growth driver: Q3 sales increased 9% and segment operating earnings rose 11%. Nine-month sales rose 8% and segment operating earnings rose 13%.
- Canada remained challenged: Q3 sales fell 20% and nine-month sales fell 10%, mainly from lower volume following branch closures and sales-coverage changes. Nine-month operating losses improved to $38 million from $59 million.
- Other businesses’ Q3 sales rose 13%, but reported a $100 million operating loss, principally due to Cromwell impairment charges. Nine-month sales rose 17%; reported operating loss was $23 million.
- Reported Q3 SG&A rose 20%, largely reflecting approximately $139 million of Cromwell goodwill and trade-name impairment charges. The filing describes a $105 million goodwill impairment and a $34 million trade-name impairment; the goodwill charge had no tax benefit. Nine-month restructuring and impairment charges, net of specified gains and other charges, were $166 million.
Cash flow, balance sheet and capital allocation
- Nine-month operating cash flow was $743 million. Investing activities used $105 million, including $169 million of additions to property, equipment and intangibles. Financing activities used $437 million, including $283 million of treasury-stock purchases and $232 million of dividends.
- Cash and cash equivalents were $517 million at September 30, 2018, versus $327 million at December 31, 2017. Current assets were $3.583 billion and current liabilities $1.467 billion; the current ratio was 2.4, versus 2.2 at year-end. Management reported working capital of $1.913 billion, up $244 million, primarily due to higher receivables and inventory.
- Total interest-bearing debt was approximately $2.235 billion, including short-term debt and current maturities; long-term debt net of current maturities was $2.148 billion. Debt as a percentage of total capitalization declined to 51.6% from 56.2% at year-end.
- Grainger paid dividends of $4.00 per share in the first nine months. On October 31, the board declared a $1.36 quarterly dividend, payable December 1, 2018. The company repurchased approximately 244,000 shares in Q3.
Outlook, commentary and risks
- Management projected a 23%–26% effective tax rate for full-year 2018; it did not provide a clear revenue or EPS forecast in this filing. It expected to complete its Tax Act accounting estimates in Q4 and did not anticipate a material impact from remaining estimates.
- Management priorities include growing U.S. large- and mid-size customer share, completing the Canada business-model reset, improving profitability in international operations, growing single-channel businesses, and investing in digital, e-commerce and supply-chain capabilities.
- U.S. tariffs on a significant number of Chinese imports may affect product availability, costs, margins and results. Grainger said it was validating increases, working with suppliers, seeking alternatives and evaluating pricing actions.
- Cromwell’s weaker performance, U.K. market uncertainty including Brexit, and higher interest rates led to revised forecasts and impairment charges. Further goodwill or intangible impairment is possible if forecasts or economic conditions deteriorate.
- Other stated risks include competitive pricing, supply interruptions, currency and commodity volatility, labor and transport constraints, cybersecurity or IT disruption, litigation and regulatory proceedings, and changes in tax rates. The company said pending legal and administrative matters were not expected to have a material adverse effect individually or in aggregate.
Most important facts for investors to verify
- Whether U.S. volume and market-share gains persist, and whether pricing and tariffs affect gross margins.
- Whether Canada’s volume and operating performance improve as restructuring and coverage changes continue.
- Whether Cromwell meets its revised outlook and whether further impairment testing results in charges.
- How much of reported earnings growth reflects ongoing operations versus non-GAAP adjustments, tax effects and share-count changes.
- Whether working-capital investment, debt levels, repurchases and dividends remain consistent with cash generation and liquidity.