W.W. Grainger, Inc. — 2014 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended September 30, 2014; unaudited. Grainger distributes maintenance, repair and operating supplies, primarily in the United States and Canada, with other international and online businesses.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $2.562 billion | $2.399 billion | $7.454 billion | $7.061 billion |
| Gross profit | $1.103 billion | $1.051 billion | $3.259 billion | $3.130 billion |
| Operating earnings | $386 million | $347 million | $1.081 billion | $1.040 billion |
| Net earnings attributable to Grainger | $230 million | $211 million | $653 million | $640 million |
| Diluted EPS | $3.30 | $2.95 | $9.30 | $8.92 |
Q3 sales rose 6.8% and operating earnings rose 11.2%; diluted EPS increased 12%. For the nine-month period, sales rose 5.6%, operating earnings 3.9%, and diluted EPS 4%. Gross margin was 43.0% in Q3 versus 43.8% a year earlier, and 43.7% year to date versus 44.3%. Nine-month operating margin was 14.5%, compared with 14.7%.
Cash flow and investment: Nine-month operating cash flow was $663 million, down from $740 million. Capital expenditures were $240 million, principally for supply-chain investments. Investing cash outflow was $235 million and financing cash outflow was $531 million. Cash ended the period at $320 million, down from $431 million at year-end 2013.
Liquidity and debt: Working capital was $1.768 billion, with a working-capital assets-to-liabilities ratio of 2.6, versus $1.621 billion and 2.5 at December 31, 2013. Total debt was approximately $457 million at September 30, 2014, compared with approximately $543 million at year-end; debt was 11.6% of total capitalization, down from 14.0%. The company repaid $150 million on its U.S. term loan and its Canadian subsidiary drew C$125 million under a new revolving facility.
Grainger repurchased $317 million of treasury stock and paid $215 million in dividends during the first nine months. Quarterly dividends paid per share were $1.08, versus $0.93 in Q3 2013. The board declared another $1.08-per-share dividend, payable December 1, 2014.
Changes and operating drivers
- Q3 sales growth reflected volume of 5%, acquisitions of 2%, price of 1%, and foreign exchange of negative 1%. Year-to-date growth reflected volume of 4%, acquisitions of 2%, price of 1%, and foreign exchange of negative 1%.
- The U.S. business delivered Q3 sales growth of 7% and operating earnings growth of 13%. Canada sales rose 3% in reported dollars (8% in local currency), but operating earnings fell 14%. Other-business sales rose 16%, while operating earnings declined $1 million to $5 million.
- Lower gross margins were attributed to acquired businesses, international operations, and faster growth among lower-margin customers. In Canada, unfavorable currency effects on U.S.-sourced products, lower supplier rebates, and higher freight costs also weighed on margins.
- Year-to-date results included a $14 million non-cash expense related to transitioning the Netherlands retirement plan from defined benefit to defined contribution. Management said operating earnings growth excluding this charge was 5%, versus reported growth of 4%.
- In Q2, the company also recorded a $4 million non-cash write-off of capitalized software and incurred $3 million of additional IT costs after choosing one integrated North American IT system rather than separate instances.
- On September 2, Grainger acquired Canadian distributor WFS Enterprises, which had approximately $87 million in 2013 sales. The purchase-price allocation remained preliminary.
Guidance, risks, and contingencies
On October 16, 2014, Grainger lowered 2014 sales growth guidance from 5%–7% to 5.0%–5.5%, and EPS guidance from $12.20–$12.60 to $12.20–$12.30. The revised EPS range excludes the $0.15-per-share second-quarter retirement-plan transition charge. Management said it was evaluating certain multichannel businesses outside the U.S. and was committed to improving or exiting those operations.
Management cited positive U.S. and Canadian economic forecasts but noted pressure on Canada from a weaker Canadian dollar and lower metals and minerals prices, affecting a business with significant natural-resources exposure. Forward-looking risks include competitive pricing, customer or supply losses, execution of technology and business strategies, currency and commodity volatility, economic conditions, litigation and regulatory matters, labor, transportation, and operational or data-security disruptions.
The company reported routine legal and administrative matters, including product, employment, environmental, and government-contractor pricing matters; management did not expect their resolution to materially adversely affect consolidated financial position or results. Disclosure controls were assessed as effective, and no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether full-year sales and EPS meet the revised guidance, including the stated exclusion of the retirement-plan charge from EPS guidance.
- Whether gross-margin pressure persists, particularly from acquisitions, lower-margin customer mix, and international operations.
- Whether Canada’s operating performance improves as currency, commodity markets, and end-market conditions evolve.
- Returns from supply-chain and growth investments, including eCommerce, sales hiring, and the integrated IT-system change.
- Acquisition integration and the final WFS purchase-price allocation, alongside Grainger’s plan to improve or exit selected non-U.S. multichannel businesses.
- Cash generation and capital allocation, including debt repayment, share repurchases, and dividends.