W.W. Grainger, Inc. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015; unaudited. Grainger distributes maintenance, repair and operating supplies, primarily in the United States and Canada, with international operations. Comparisons are with the corresponding 2014 periods unless noted.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $2,532.9 million | $2,562.3 million | $7,495.1 million | $7,454.0 million |
| Gross profit | $1,061.9 million | $1,102.8 million | $3,229.1 million | $3,259.4 million |
| Gross margin | 41.9% | 43.0% | 43.1% | 43.7% |
| Operating earnings | $340.7 million | $385.5 million | $1,048.7 million | $1,080.6 million |
| Operating margin | 13.5% | 15.0% | 14.0% | 14.5% |
| Net earnings attributable to Grainger | $192.2 million | $230.3 million | $623.8 million | $652.9 million |
| Diluted EPS | $2.92 | $3.30 | $9.24 | $9.30 |
- Q3 sales declined 1.1%; reported net earnings attributable to Grainger declined 16.6% and diluted EPS declined 11.5%. Lower earnings drove the EPS decline, partly offset by fewer average shares outstanding.
- For the first nine months, sales increased 0.6%, while attributable net earnings declined 4.5% and diluted EPS declined 0.6%.
- Operating cash flow for the nine months was $735.9 million, versus $662.8 million. Capital expenditures were $253.2 million versus $240.2 million. The resulting operating-cash-flow-minus-capital-expenditures amount was approximately $482.7 million; this is a simple calculation, not a company-reported non-GAAP measure.
- Cash and equivalents were $258.2 million at September 30, 2015, compared with $226.6 million at year-end 2014. Current assets were $3,104.7 million and current liabilities $1,549.2 million. The company reported working capital of $1,836 million and a working-capital assets-to-liabilities ratio of 2.5, using its stated definition.
- Total debt, including short-term debt and current maturities, was approximately $1,812.2 million, up from approximately $483.6 million at December 31, 2014. Debt was 42.6% of total capitalization, versus 12.8% at year-end. The company reported issuing $1 billion of 30-year senior notes at 4.60% and entering a £160 million term loan to help fund Cromwell.
- Cash dividends paid were $1.17 per share in Q3 and $3.42 per share for the nine months. The company repurchased 3.38 million shares in Q3 for approximately $752 million, based on reported share count and average purchase price.
Material changes and operating drivers
- Q3 gross margin fell 1.1 percentage points, reflecting faster growth among lower-margin customers, price deflation against slight cost inflation, and lower supplier rebates. Nine-month gross margin fell 0.6 percentage points for similar reasons.
- Q3 operating earnings fell 11.6%. Operating expenses included $11 million of U.S. branch-closure and restructuring costs; excluding these charges, operating earnings declined 9%.
- Canada was a significant weakness: Q3 external sales declined 23% in reported dollars and 8% in local currency; nine-month sales declined 14% reported and 2% in local currency. Lower oil prices and weakness in Alberta and oil-and-gas markets weighed on results. Canadian segment operating earnings fell 87% in Q3 and 67% year to date.
- U.S. Q3 segment sales were approximately flat, with strength in some commercial, light manufacturing, retail and government markets offset by weakness in natural resources, heavy manufacturing and resellers. Other-business sales rose 18% in Q3, including acquisition and currency effects; performance benefited from Zoro, Japan and Cromwell.
- Foreign exchange reduced reported sales: management attributed a 3% negative impact to currency for both Q3 and the nine-month period. Volume supported nine-month growth, while price was a headwind.
Outlook, significant items and risks
- On October 16, 2015, Grainger lowered 2015 sales-growth guidance from 0%–2% to -0.5%–0.5%, and EPS guidance from $12.00–$12.50 to $11.60–$11.80, citing continued economic weakness.
- Grainger acquired all issued share capital of U.K. distributor Cromwell on September 1, 2015. The initial purchase price was £310 million (approximately $476 million), subject to customary adjustments; approximately $353 million of goodwill and intangibles was recorded. Purchase-price allocation remained provisional. Cromwell reported approximately £285 million of fiscal 2015 sales before acquisition.
- A clean-energy equity-method investment generated $10 million of equity losses in the first nine months, while associated energy tax credits lowered the effective tax rate. Management said the investment provided positive net earnings and cash flow; the filing reports a $6 million net-earnings contribution for the period.
- Legal and administrative proceedings are described as incidental to the business; management did not expect their resolution, individually or in aggregate, to materially adversely affect financial position or results.
- Risks cited include economic and market weakness, commodity and currency volatility, competitive pricing, customer or supplier disruption, litigation and regulatory matters, IT or data-security disruption, and the ability to realize Cromwell’s strategic benefits and synergies.
- Management concluded disclosure controls were effective at quarter-end and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the revised 2015 sales and EPS guidance was achieved, and the subsequent effect of weak Canadian and natural-resource markets.
- Cromwell’s final purchase-price adjustment, integration costs, contribution to results, and realization of expected strategic benefits.
- The sustainability of gross margins, supplier rebates and operating performance after restructuring and growth-investment spending.
- Debt repayment and interest-cost implications, including the planned debt-funded share-repurchase strategy and targeted debt-to-EBITDA range of 1.0–1.5x.
- The net economics, tax-credit availability and funding obligations of the clean-energy investment, which the company expected to fund through January 2019.