W.W. Grainger, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Grainger distributes maintenance, repair and operating supplies, primarily in the United States and Canada, with additional international operations. Financial statements are unaudited.
Financial performance
| Metric | Q3 2016 | Q3 2015 | First nine months 2016 | First nine months 2015 |
|---|---|---|---|---|
| Net sales | $2,596 million | $2,533 million | $7,666 million | $7,495 million |
| Gross margin | 40.0% | 41.9% | 40.8% | 43.1% |
| Operating earnings | $323 million | $341 million | $945 million | $1,049 million |
| Net earnings attributable to Grainger | $186 million | $192 million | $545 million | $624 million |
| Diluted EPS | $3.05 | $2.92 | $8.82 | $9.24 |
| Operating cash flow | Not separately reported for the quarter | $670 million | $736 million |
Quarterly sales rose 3%, while gross profit fell 2% and operating earnings fell 5%. Diluted EPS increased 4%, principally reflecting fewer average shares outstanding despite lower earnings. For the first nine months, sales increased 2%, but operating earnings declined 10% and attributable net earnings declined 13%. Reported sales growth benefited from Cromwell and online businesses; management’s daily-sales bridge showed price declines partly offsetting acquisition and volume contributions.
Quarterly eCommerce sales were $1.24 billion, up 16% and 48% of total sales. For the nine-month period, eCommerce sales were $3.55 billion, up 15% and 46% of total sales. These figures exclude KeepStock; including it, management reported eCommerce and KeepStock at 57% of quarterly sales and 55% of nine-month sales.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $286 million at September 30, 2016, versus $290 million at year-end 2015. Current assets were $3.13 billion and current liabilities $1.54 billion.
- Working capital, as defined by the company, was $1.90 billion, up from $1.79 billion at year-end; the working-capital-assets-to-liabilities ratio was 2.7 versus 2.5.
- Total interest-bearing debt was approximately $2.28 billion, comprising $388 million short-term debt and $1.89 billion long-term debt. Debt was 51.3% of total capitalization, up from 45.8% at year-end.
- Nine-month operating cash flow was $670 million; investing activities used $185 million, including $214 million of property and equipment additions. Financing activities used $500 million, including $613 million of treasury-stock purchases and $221 million of dividends.
- The company issued $400 million of 3.75% senior notes due 2046 and entered into a €110 million term loan due 2021. A quarterly dividend of $1.22 per share was declared for payment in December 2016.
Material changes, outlook and risks
- Gross margin pressure was driven by unfavorable customer mix and price deflation exceeding product-cost deflation in the U.S.; in Canada, product-cost inflation, foreign exchange and delayed price increases also pressured margins.
- Canada remained particularly weak: Q3 sales fell 16% and the segment recorded a $15 million operating loss. Nine-month sales fell 20%, and the segment reported a $55 million operating loss. Management cited weak end markets, oil-sector exposure in Alberta, and disruption from the February 2016 SAP implementation.
- Other businesses’ sales increased substantially, primarily reflecting Cromwell, acquired September 1, 2015, and growth at online businesses. Cromwell’s inclusion affects year-over-year comparability.
- Management revised 2016 guidance on October 18: sales growth to 1.5%–2.5% from 1%–4%, and diluted EPS to $11.40–$11.70 from $11.20–$12.20. The revision reflected modest expected Q4 sales growth and continued U.S. gross-profit pressure, as well as Canadian product-cost inflation.
- Restructuring costs included approximately $32 million of severance expense for the first nine months; the severance reserve was approximately $29 million at quarter-end. Canada also recorded a $10 million inventory adjustment in Q2.
- Clean-energy equity-method investments generated $22 million of losses for the nine months, alongside a reported $26 million tax benefit including energy tax credits. The company reported a 35.4% effective tax rate for the period; excluding discrete tax benefits, it was 36.9%.
- A putative class action concerning 2009 fax marketing remained pending, with cross-motions for summary judgment outstanding. Grainger said it could not predict the outcome but did not expect a material adverse effect. It also identified economic weakness, pricing competition, execution of technology changes, currency movements, litigation and acquired-business integration among forward-looking risks.
Key facts investors should verify
- Whether revised full-year sales and EPS guidance was achieved, and how much growth reflected acquisitions versus underlying demand.
- Whether U.S. price-cost pressure and Canadian SAP-related operational and margin issues improved after Q3.
- Whether operating cash flow, receivables and working capital remained sound as customer payment terms and debt increased.
- The ongoing impact of share repurchases, higher debt and interest expense on EPS and financial flexibility.
- Developments in the TCPA litigation, clean-energy investment results and tax benefits, and potential impairment exposure at Fabory.