W.W. Grainger, Inc. — Q2 2016 Form 10-Q
Business and period: Grainger distributes maintenance, repair and operating supplies and related services. This unaudited filing covers the quarter and six months ended June 30, 2016. Cromwell, acquired in September 2015, is included in results from its acquisition date.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $2.564B | $2.523B | $5.070B | $4.962B |
| Gross margin | 40.6% | 42.6% | 41.1% | 43.7% |
| Operating earnings | $305.6M | $356.7M | $622.7M | $708.0M |
| Net earnings attributable to Grainger | $172.7M | $220.5M | $359.4M | $431.6M |
| Diluted EPS | $2.79 | $3.25 | $5.77 | $6.32 |
Sales rose 2% in both periods, but earnings and margins declined. Management attributed margin pressure primarily to price deflation exceeding cost deflation and unfavorable customer mix. Q2 eCommerce sales increased 14% to $1.183B, or 46% of sales; first-half eCommerce sales rose 15% to $2.308B, also 46% of sales.
Cash flow, balance sheet and financing
- First-half operating cash flow was $326.4M, versus $369.5M in 2015. Capital expenditures were $105.7M, compared with $170.9M.
- Cash was $316.0M at June 30. Current assets were $3.190B and current liabilities $1.641B. Management-defined working capital was $1.936B, up from $1.794B at year-end; its working-capital-assets-to-liabilities ratio was 2.7, versus 2.5.
- Interest-bearing debt was approximately $2.271B, comprising short-term debt, current maturities and long-term debt, versus approximately $1.989B at December 31, 2015. Debt was 50.3% of total capitalization, up from 45.8%.
- Grainger issued $400M of unsecured 3.75% senior notes due in 2046. First-half financing also included $412.6M of treasury-share purchases and $147.5M of dividends.
Changes, outlook and notable items
- U.S. Q2 segment sales declined 3%; Canada sales fell 19% reported and 16% in local currency. Canada recorded a $10M additional inventory reserve after its SAP conversion and reported a $27.7M operating loss. Other businesses sales increased 49% on a daily basis, substantially reflecting Cromwell and growth in online businesses.
- On July 19, Grainger lowered 2016 sales-growth guidance to 1%–4% from 0%–6%, and raised the low end and lowered the high end of diluted EPS guidance to $11.20–$12.20 from $11.00–$12.80. Management cited weaker-than-expected U.S. and Canadian volume, partly offset by anticipated second-half gross-profit improvement and operating-expense leverage. It expected a 36.8%–37.8% full-year effective tax rate excluding a tax-settlement benefit.
- Q2 operating results included restructuring costs, a $10M Canadian inventory reserve adjustment, and a $9M corporate-aircraft write-down related to planned aviation-department outsourcing. A $7M benefit from settling certain federal tax audit issues reduced the Q2 tax expense.
- Management described weak U.S. business investment and exports, and a weak Canadian environment affected by low oil prices and Alberta wildfires. Risks cited include competitive pricing, economic and currency changes, supply or IT disruptions, litigation, regulatory matters, and integration of acquired businesses.
- The company is defending a putative class action alleging violations of the Telephone Consumer Protection Act related to a 2009 fax campaign. It says it has defenses and does not expect a material adverse effect, but cannot predict the outcome. Other routine legal matters are not expected to be material.
Investor facts to verify
- Whether the reduced 2016 guidance is supported by a second-half recovery in volume, margins and expense leverage.
- Whether Canadian sales, inventory reserves and SAP-related disruption improve, and whether oil-market and wildfire effects persist.
- How continued margin pressure and higher interest expense affect earnings and cash generation.
- Debt levels, share repurchases and the outcome of the TCPA litigation and other contingencies.