W.W. Grainger, Inc. — Q1 2020 Form 10-Q
Business context and period: Unaudited results for the three months ended March 31, 2020, compared with Q1 2019. Grainger distributes maintenance, repair and operating products and services; its reportable segments are the U.S. and Canada, with other businesses including Zoro, MonotaRO and smaller international operations.
Financial performance
| Metric | Q1 2020 | Q1 2019 / change |
|---|---|---|
| Net sales | $3.001 billion | $2.799 billion; up 7.2% (up 5.5% per sales day) |
| Gross profit / margin | $1.121 billion / 37.4% | $1.095 billion / 39.1% |
| Operating earnings / margin | $159 million / 5.3% | $363 million / 13.0% |
| Adjusted operating earnings | $343 million | $365 million; down 6% |
| Net earnings attributable to Grainger | $173 million; $3.19 diluted EPS | $253 million; $4.48 diluted EPS |
| Adjusted net earnings attributable to Grainger | $230 million | $255 million; down 9% |
| Operating cash flow | $244 million | $127 million |
| Capital expenditures | $50 million | $60 million |
| Cash and cash equivalents | $1.492 billion | $360 million at Dec. 31, 2019 |
| Total debt, including current and short-term debt | Approximately $3.341 billion | Approximately $2.215 billion at Dec. 31, 2019 |
Reported net earnings were affected by unusual items, particularly Fabory impairment charges and a related tax benefit. Gross margin fell 1.8 percentage points, primarily due to lower-margin pandemic-related sales and mix effects. The reported effective tax rate was negative 30.4%, versus 25.4% a year earlier; excluding the Fabory tax benefit and specified restructuring and impairment items, the adjusted rate was 25.6%.
Material changes and liquidity
- COVID-19-related product sales accounted for an estimated half of sales growth. Increased demand, especially for PPE and safety products, was partly offset by lower-margin product mix and additional operating costs.
- SG&A rose 31% to $962 million, including $177 million of Fabory impairment charges and higher restructuring costs. Excluding restructuring and impairment charges, adjusted SG&A increased 7%.
- Fabory’s goodwill and tradenames were determined to be fully impaired; related goodwill and intangible impairment charges totaled approximately $132 million. Additional long-lived asset impairment charges were approximately $44 million.
- Cash increased largely after Grainger drew $1.0 billion on its new $1.25 billion revolving credit facility as a precautionary liquidity measure. The company reported more than $1.7 billion in available liquidity, including approximately $1.5 billion in cash, and paused share repurchases.
- Grainger issued $500 million of 1.85% senior notes due 2025. Total debt, including lease liabilities, was 63.8% of total capitalization, up from 54.3% at year-end. The company reported compliance with debt covenants and investment-grade ratings.
- Working capital was $2.239 billion; the current ratio was 2.6, unchanged from year-end.
Outlook, risks and other notable matters
- Management withdrew any implication of predictable near-term results: it said the duration and financial effects of COVID-19 could not be forecast. It expects possible reductions in sales, earnings and operating cash flow, and stated that current liquidity and cost contingency plans were considered sufficient for impacts then anticipated.
- 2020 capital spending was expected to be $150 million to $175 million. No specific earnings or sales guidance is provided in the filing text.
- Management cited supply shortages, facility disruptions, customer and supplier financial stress, demand and product-mix shifts, margin pressure, cybersecurity exposure, and potential economic recession as risks. Canadian business is also exposed to low oil and gas prices.
- Canada sales declined 4.6% reported and 6.1% per sales day; U.S. sales increased 7.4% reported and 5.7% per sales day. Other-business sales grew 10.2%, but that group reported a $138 million operating loss, largely due to Fabory impairment.
- The company recorded $7 million in restructuring charges, primarily employee termination costs. It also changed depreciation estimates prospectively, reducing Q1 depreciation expense by $8 million.
- Legal matters include product-liability lawsuits related to a refinery explosion and asbestos/silica litigation. Grainger said it intended to defend these matters and did not expect their resolution to materially adversely affect consolidated results or financial condition.
Important facts for investors to verify
- How COVID-19 affected subsequent-quarter sales, margins, operating costs, working capital and cash flow, and whether supply constraints or customer credit risks worsened.
- Whether the Fabory impairment is complete and whether further goodwill or intangible impairments are required as economic and valuation assumptions change.
- The sustainability of reported and adjusted earnings, including the effects of lower-margin pandemic demand, operating expenses and the Fabory-related tax benefit.
- Use and repayment of revolving-credit borrowings, leverage trends, available liquidity and the status of share repurchases.
- Whether the stated $150 million to $175 million capital-spending outlook or other management expectations changed after the filing date.