W.W. Grainger, Inc. — Q1 2016 Form 10-Q
Business and period: Grainger distributes maintenance, repair and operating supplies. This unaudited report covers the three months ended March 31, 2016, compared with Q1 2015; balance-sheet comparisons are with December 31, 2015.
Financial results
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net sales | $2,506.5 million | $2,439.7 million | +3%; +1% per sales day |
| Gross profit / margin | $1,045.1 million / 41.7% | $1,093.7 million / 44.8% | Profit down 4%; margin down 3.1 percentage points |
| Operating earnings / margin | $317.1 million / 12.7% | $351.2 million / 14.4% | Down 10% |
| Net earnings attributable to Grainger | $186.7 million | $211.0 million | Down 12% |
| Diluted EPS | $2.98 | $3.07 | Down 3% |
| Operating cash flow | $153.7 million | $156.2 million | Down $2.5 million |
| Cash and cash equivalents | $279.9 million | $290.1 million at Dec. 31, 2015 | Down $10.2 million |
| Total debt | $2,092.3 million | $1,988.8 million at Dec. 31, 2015 | Up $103.5 million |
Investing cash use was $45.4 million, including $51.8 million of capital spending; financing cash use was $131.3 million. Total debt was 46.9% of total capitalization, versus 45.8% at year-end. Working capital was $1.862 billion and the company-reported working-capital assets-to-liabilities ratio was 2.6, up from 2.5.
Material changes and drivers
- Sales growth was led by the 2015 Cromwell acquisition and single-channel online businesses. Reported sales benefited from one additional sales day; price was down 3%, volume up 1%, and foreign exchange reduced sales by 1%.
- Gross margin pressure reflected price deflation exceeding cost deflation, a shift toward lower-margin customers, and a change in vendor trade-show funding classification. Operating expenses fell 2%, but included $16 million in restructuring costs; excluding those costs, expenses fell 4%.
- U.S. sales were essentially flat, with daily sales down 2%; U.S. operating earnings declined 9%. Canada sales fell 24% reported and 16% in local currency, and the segment swung from $9 million operating earnings to a $12 million operating loss, amid weak oil and commodity markets and SAP implementation effects.
- Other businesses’ sales increased 50%, largely reflecting Cromwell and growth in Zoro; operating earnings rose to $22 million from $10 million.
- Interest expense rose to $13.7 million from $1.6 million, primarily reflecting the $1 billion of senior notes issued in 2015. The company also recorded a $6.4 million loss from equity-method investments.
Outlook, risks and unusual items
- On April 18, 2016, Grainger narrowed 2016 sales-growth guidance from -1% to 7% to 0% to 6%, and EPS guidance from $10.80–$13.00 to $11.00–$12.80. Management cited increased gross-profit pressure, partly offset by improved pricing expected over the rest of the year, cost savings and operating-expense favorability.
- The company recorded approximately $16 million of restructuring costs, including costs associated with planned closure of 55 U.S. branches; the restructuring reserve was approximately $37 million at quarter-end.
- Refined-coal investments generated $6 million of equity losses and a $10 million tax benefit, including energy tax credits; the investments contributed $4 million to net earnings for the quarter.
- The 2015 Cromwell acquisition cost approximately $464 million; its purchase-price allocation remained subject to change. Goodwill and intangibles recorded were approximately $357 million.
- Risks highlighted include weak industrial and Canadian oil-related markets, pricing and product-cost pressures, foreign-exchange and commodity volatility, competition, acquisitions and integration, cybersecurity and operational disruptions, and litigation or regulatory matters.
- Grainger reported that it could not predict the outcome of a TCPA fax-marketing lawsuit or Canadian environmental charges, but did not expect either matter to have a material adverse effect. Disclosure controls were reported effective; the Canadian SAP implementation was not considered to have materially affected internal control over financial reporting.
Important facts for investors to verify
- Whether full-year sales and EPS guidance remains achievable given gross-margin compression and weak end markets.
- How pricing, cost deflation, customer mix and vendor funding affect gross margins in subsequent quarters.
- Whether Canadian sales and profitability stabilize, and the effect of the SAP implementation.
- Cash generation, commercial-paper borrowing and debt levels, including funding for repurchases and planned restructuring.
- The realized benefits and costs of branch closures, restructuring and Cromwell integration, and the continuing tax and earnings effects of refined-coal investments.
- Any material developments in the TCPA and Canadian environmental proceedings.