W.W. Grainger, Inc. — Q1 2018 Form 10-Q
Business context and period: Grainger distributes maintenance, repair and operating supplies and related services, primarily in the U.S. and Canada. This unaudited report covers the three months ended March 31, 2018, compared with the same period in 2017.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $2.766 billion | $2.541 billion | +9% |
| Gross profit / margin | $1.092 billion / 39.5% | $1.019 billion / 40.1% | Profit +7%; margin down 0.6 percentage points |
| Operating earnings / margin | $335 million / 12.1% | $293 million / 11.5% | +14% |
| Net earnings attributable to Grainger | $232 million | $175 million | +32% |
| Diluted EPS | $4.07 | $2.93 | +39% |
| Operating cash flow | $147 million | $181 million | Down $34 million |
Gross margin pressure primarily reflected U.S. strategic pricing actions; adoption of the new revenue standard also reduced U.S. segment margin by 0.6 percentage points through cost reclassification. Operating earnings benefited from higher sales and expense leverage. The effective tax rate fell to 21.6% from 32.4%, primarily due to the Tax Cuts and Jobs Act. Adjusted diluted EPS, excluding specified restructuring costs and branch-sale gains, was $4.18 versus $2.88.
Liquidity, debt and capital allocation
- Cash and equivalents were $302 million at March 31, 2018, versus $327 million at year-end 2017. Operating cash flow was lower mainly because of higher annual incentive and benefit payments and direct purchases.
- Current assets were $3.307 billion and current liabilities $1.504 billion; the reported current ratio was 2.4. Working capital, as defined by the company, was $1.889 billion, up $220 million from year-end.
- Total interest-bearing debt was approximately $2.412 billion, including $138 million short-term debt and $2.274 billion long-term debt, net of current maturities and issuance costs. Debt was 55.6% of total capitalization, versus 56.2% at year-end.
- Financing activities included $173 million of treasury-stock purchases and $72 million of dividends paid. The company repurchased 668,384 shares in the quarter. Q1 dividends paid per share were $1.28; a $1.36 quarterly dividend was declared April 25, payable June 1, 2018.
Material changes and operating trends
- Sales growth comprised volume +8%, foreign exchange +2% and seasonal effects +1%, offset by price and divestiture effects of 1% each. E-commerce sales rose 18% to $1.469 billion, or 53% of sales versus 49% a year earlier.
- U.S. segment sales rose 8%, led by volume growth, share gains and improved demand; strategic pricing weighed on margin. Canada sales fell 2% reported and 6% in local currency, with volume down 13%, partly offset by price increases and currency. Canada remained loss-making at the segment operating level.
- Other businesses’ sales increased 18%, supported by growth in Europe, Asia and Latin America and favorable foreign exchange; segment operating earnings rose to $36 million from $32 million.
- Net interest expense and other expense increased, primarily due to interest on $400 million of debt issued in May 2017 and higher operating losses from clean-energy investments.
Guidance, risks and unusual items
- On April 19, 2018, Grainger raised 2018 guidance: sales growth to 5%–8% from 3%–7%, and EPS to $14.30–$15.30 from $12.95–$14.15. Management cited better-than-expected U.S. volume and improved gross profit. The company projected a full-year effective tax rate of 23%–26%.
- Restructuring actions continued in the U.S., Canada and other businesses. Q1 restructuring costs, net, were $8 million; reserves were $67 million at March 31. The company expected approximately $15 million of additional costs through year-end 2018 for active programs, excluding real-estate sale results.
- The company had not completed its analysis of all Tax Act effects as of March 31 and recorded no additional adjustments to year-end estimates. Adoption of the new revenue standard had no material ongoing financial-statement impact; it principally reclassified certain service costs.
- Management reported no goodwill or intangible-asset impairment trigger in Q1, but future impairment could result from changes in assumptions, performance, economic conditions or execution of growth and productivity plans.
- Legal and administrative matters include product, employment, environmental, privacy, cybersecurity and government-contract issues. The company did not expect their resolution, individually or collectively, to materially adversely affect consolidated financial position or results.
- Key disclosed risks include competitive pricing, product costs, supply disruption, execution of pricing and technology strategies, economic and currency volatility, cybersecurity, litigation and regulatory matters, labor and transportation disruptions, and changes in tax rates or credit ratings.
Important facts for investors to verify
- Whether U.S. volume and share gains can continue while strategic pricing pressure weighs on gross margin.
- Progress on Canada’s business-model reset, including the path to reducing segment operating losses.
- Whether raised full-year sales and EPS guidance is achieved, and the assumptions behind the projected tax rate.
- Cash conversion, working-capital trends, and the sustainability of share repurchases and dividends alongside debt levels.
- Restructuring execution and spending, clean-energy investment losses, and any additional Tax Act or impairment adjustments.