W.W. Grainger, Inc. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015; comparative periods are the corresponding 2014 periods. Financial statements are unaudited. Grainger distributes maintenance, repair and operating supplies and related services, primarily in the United States and Canada.
Financial performance
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Net sales | $2,522.6m | $2,506.1m | $4,962.2m | $4,891.7m |
| Gross profit | $1,073.4m | $1,080.7m | $2,167.2m | $2,156.7m |
| Operating earnings | $356.7m | $340.8m | $708.0m | $695.1m |
| Net earnings attributable to Grainger | $220.5m | $205.9m | $431.6m | $422.6m |
| Diluted EPS | $3.25 | $2.94 | $6.32 | $6.00 |
| Gross margin | 42.6% | 43.1% | 43.7% | 44.1% |
| Operating margin | 14.1% | 13.6% | 14.3% | 14.2% |
Q2 sales rose 0.7% year over year (reported as 1% rounded); volume contributed 4%, partly offset by foreign exchange (-3%) and price (-1%). Operating earnings increased 4.7% and Grainger-attributable net earnings increased 7.1%. Diluted EPS grew 11%, helped by higher earnings and fewer average shares. For the first half, sales rose 1.4%, operating earnings 1.9%, attributable net earnings 2.1% and diluted EPS 5%.
Gross margin pressure reflected growth with lower-margin customers, lower supplier rebates and price deflation relative to cost inflation associated with foreign exchange. Q2 operating expenses fell 3.1%; excluding specified restructuring and prior-year retirement-plan transition charges, they declined 2%, despite $25m of incremental growth and infrastructure spending. First-half operating expenses were approximately flat, with $58m of incremental growth and infrastructure spending offset by payroll savings and productivity initiatives.
Cash flow, liquidity and debt
- First-half operating cash flow was $369.5m, versus $328.5m in 2014. Investing used $170.4m, including $170.9m of capital expenditures and $10.2m invested in the refined-coal venture. Approximate operating cash flow less capital expenditures was $198.6m, versus $172.3m.
- Financing provided $401.6m, primarily reflecting $995.9m of proceeds from long-term debt and commercial paper, offset in part by $442.6m of treasury-stock purchases and $153.9m of dividends. Cash increased $593.1m to $819.8m.
- At June 30, cash was $819.8m; current assets were $3,523.7m and current liabilities $1,047.1m. Management-defined working capital was $1,847m, up $150m from year-end; its working-capital-assets-to-liabilities ratio was 2.9, versus 2.4.
- Total debt was approximately $1,405m, including $1,348.6m of long-term debt, $26.3m of current maturities and $30.5m of short-term debt. Total debt to total capitalization rose to 31.2% from 12.8% at year-end. Cash exceeded debt by approximately $585m.
Segments and material changes
- United States: Q2 external sales were $1,965.2m, up 1% from $1,943.6m; segment operating earnings were $369.5m, up 1%. First-half external sales rose 2% to $3,873.5m and segment operating earnings rose 2% to $735.6m. Government, commercial services and light manufacturing performed well; natural resources and resellers weakened.
- Canada: Q2 external sales fell 9% to $239.4m, but increased 2% in local currency; segment operating earnings fell 51% to $9.5m. First-half sales fell 9% to $473.9m, while increasing 2% in local currency; operating earnings fell 53% to $18.9m. Foreign exchange and weaker oil-related activity weighed on results. Alberta, over one-third of Canadian sales, declined 18% in Q2.
- Other businesses: Q2 external sales increased 7% to $317.9m and segment operating earnings were $15.2m, versus a loss of $0.5m a year earlier. First-half sales increased 7% to $614.8m and earnings were $24.7m, versus $8.0m. Growth included Zoro; foreign exchange reduced reported sales.
Outlook, commentary and notable items
- On July 17, Grainger reduced 2015 sales-growth guidance from 1–4% to 0–2%, and diluted EPS guidance from $12.25–$12.95 to $12.00–$12.50, citing slower expected macroeconomic growth. The company expected a 2015 tax rate of approximately 36.6–37.2%.
- Management highlighted slower U.S. economic indicators and continued weakness in Canada, particularly energy-linked markets. Risks disclosed include economic and market conditions, currency and commodity volatility, competitive pricing, customer or supplier disruption, litigation and regulatory matters, technology or data-security disruptions, labor, transportation and natural disasters.
- In June, Grainger issued $1bn of unsecured 4.60% senior notes due in 2045, with no principal payments until maturity. The issuance increased interest expense. The company had announced plans to issue $1.8bn of long-term debt over three years to partially fund $3bn of share repurchases; it expected debt to EBITDA of 1.0–1.5x.
- A new refined-coal equity-method investment generated $4.3m of recognized losses through June, partly offset by energy tax credits that lowered the tax rate. The investment balance was $6m; Grainger committed to fund its share of operating expenses through January 2019.
- After quarter-end, Grainger agreed to acquire U.K. distributor Cromwell Group for £310m, subject to customary adjustments, with completion expected in early September and funding from U.K. and U.S. debt. Brazil shutdown and Europe restructuring costs were expected to continue through the second half of 2015.
- Management stated that routine legal and administrative proceedings were not expected to have a material adverse effect. The filing reported effective disclosure controls and no material second-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Whether sales growth and diluted EPS track the revised 2015 guidance, given softer macroeconomic expectations and weaker Canadian energy-related demand.
- Whether gross-margin pressure persists, including the effects of customer mix, supplier rebates, pricing, foreign exchange and Canadian distribution-center transition costs.
- Debt-funded repurchases, interest costs, planned further debt issuance and the stated debt-to-EBITDA target; also monitor cash generation relative to capital spending and shareholder returns.
- The realized tax-credit benefit and funding obligations, duration and economics of the refined-coal investment.
- Cromwell’s final purchase price, debt funding, closing and subsequent contribution to results; and remaining Brazil and Europe restructuring costs.
- Share repurchases totaled 1.29m shares in Q2 at an average $243.54 per share; verify pace and total spending against the announced repurchase plan.