CIF Stock Recommendation Report (Fall 2012) Date: Nov 27 th 2012 Analyst Name: Tung Linh Company Name and Ticker: W.W. Grainger, Inc. (GWW) Section (A) Summary Recommendation Buy: No Target Price: Stop-Loss Price: Sector: Industrials Industry: Industrial Distribution Market Cap (in Billions): 13.308 # of Shrs. O/S (in Millions): 69.49 Current Price: 190.42 52 WK Hi: 221.84 52 WK Low: 172.50 EBO Valuation: 152.00 Morningstar (MS) Fair Value Est.: 192.00 MS FV Uncertainty: Avg MS Consider Buying: 134.40 MS Consider Selling: 259.20 EPS (TTM): 9.38 EPS (FY1): 10.61 EPS (FY2): 11.77 MS Star Rating: Next Fiscal Yr. End 2012 December Last Fiscal Qtr. End: Less Than 8 WK: No If Less Than 8 WK, next Earnings Ann. Date: Analyst Consensus Recommendation: Outperform Forward P/E: 16.18 Mean LT Growth: 14.57 PEG: 1.11 Beta: 0.94 % Inst. Ownership: 74.74 Inst. Ownership- Net Buy: No Short Interest Ratio: 3.6 Short as % of Float: 4.1 Ratio Analysis Company Industry Sector P/E (TTM) 20.42 18.99 22.78 P/S (TTM) 1.51 2.37 1.64 P/B (MRQ) 4.64 6.52 1.76 P/CF (TTM) 15.64 12.77 13.89 Dividend Yield 1.67 1.93 2.13 Total Debt/Equity (MRQ) 19.60 25.82 80.12 Net Profit Margin (TTM) 7.86 10.56 5.52 ROA (TTM) 14.52 7.05 2.89 ROE (TTM) 24.78 10.83 7.11 1
Investment Thesis The company is increasing its quantity of products to increase its market share and sales. Both the Fundamental valuation and relative valuation suggest that the stock is overpriced. Morningstar Direct s fair value estimate is roughly the same as the current price. Grainger is a mature company with high historical and future performance. The market has already anticipated strong outlook from the company. Summary Company Profile: An industrial distributor of maintenance, repair, and operation supplies. Large network branches, a lot of products. Fundamental Valuation: All generated values are lower than current price. With chosen above normal growth period chosen of 3 years, EBO valuation is 152.00. Relative Valuation: Ratios are similar to competitors. High price compare to the rest. Best indicated ratio: PEG. Revenue and Earnings Estimates: Good historical and future estimates. Mix results of surprises. Slightly downward trend. Analyst Recommendations: Moving toward outperform recommendation. Mean rating is 2.28. Institutional Ownership: 647 shareholders with 74.74% shares. Small change in ownership. Short Interest: A little high but not too bad compare to competitors. Stock Price Chart: Underperform in short-term but outperform in the long-term. 2
Section (B) Company Profile Company Summary W.W. Grainger is founded in Chicago in 1927. Their headquarters is located in Illinois. Over the last 85 years, the company s product line has expanded to more than 1 million products are repair parts. The company offers its products and services through local branches, catalogs, and the Internet. Their branch network includes about 711 branches such as supplier of maintenance, repair and operating products. These products are material handling equipment, safety and security supplies, lighting and electrical products, power and had tools, and services involving inventory management and energy efficiency solutions. The 2012 version of Grainger Catalog offers more than 400,000 facilities maintenance products. Grainger.com is their website and it provides more than 1 million products. Grainger s customers are 2 million businesses and institutions in 157 countries including Canada, Mexico, India and China. Its customers are small and medium-sized businesses to large corporations, government entities, and other institutions. The company works with more than 3,500 suppliers. Since 2001, the company has built a partnership with American Red Cross, providing nearly $13 million in cash, products and volunteer resources to support across the U.S. and internationally. The company has been donated to schools and they have a scholarship program named Tools for Tomorrow since 2006. Business Model, Competition, Environment and Strategy Grainger is a profitable company and has increased dividends for 36 consecutive years. According to the company s website, more than 27% of the company s annual revenue is generated through electronic channels, representing $2.2 billion in sales in 2011. They also have the first transaction capable web site in the industry. The company is trying to broaden their product range due to feedback from customers. In 2008, their catalog featured about 183,000 products and their website had over 350,000 products. In 2010, their catalog carried over 400,000 products and their online store had more than 900,000 products. One unique trait that makes Grainger different from its competitors is they have an extensive, on-site U.S. based Technical Product Support for all their products. Their specialists have a lot experience and training. 3
Revenue and Earnings History REVENUE Periods 2010 2011 2012 March 1672.35 1883.61 2193.45 June 1783.7 2003.02 2249.27 September 1899.41 2114.65 2281.21 December 1826.7 2076.9 Note: Units in Millions of U.S. Dollars EARNINGS PER SHARE Periods 2010 2011 2012 March 1.31367 2.17902 2.5709 June 1.73288 2.34323 2.62599 September 2.06494 2.50891 2.15114 December 1.82893 2.042 Note: Units in U.S. Dollars The annual revenue of Grainger was 7.18 billion in 2010, 8.08 billion in 2011 and 6.72 billion in 2012. The company s revenue has a pattern of increasing quarterly. Their third quarters have a trend of being the peak season for their business. The annual earnings per share of Grainger was 6.94 in 2010, 9.07 in 2011 and 7.35 in 2012. The company s earnings per share also has a increment pattern. Their third quarters have a trend of jumping higher then get back down in the following quarters. The most recent earnings is lower than the previous quarter and the same period previous year. The reason for this is the company has to set aside a pre-tax reserve of $70 million (15 percent decline in profit for the third quarter) for a proposed settlement to resolve pricing disclosure issues relating to government contracts with General Services Administration, and United States Postal Service. 4
Section (C) Fundamental Valuation (EBO) GWW PARAMETERS FY1 FY2 Ltg EPS Forecasts 10.61 11.77 6.00% Book value /share (last fye ) 37.58 Discount Rate 9.08% Divide nd Payout Ratio (POR 30.47% Ne xt Fsc Ye ar e nd 2012 Curre nt Fsc Mth (1 to 12) 11 Targe t ROE (industry avg.) 12.08% Ye ar 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Long-term EPS Growth Rate (Ltg) 0.0600 0.0600 0.0600 0.0600 0.0600 Forecasted EPS 10.61 11.77 12.48 13.22 14.02 14.86 15.75 Beg. of year BV/Shr 37.576 44.953 53.137 61.811 71.006 80.753 91.085 Implied ROE 0.262 0.235 0.214 0.197 0.184 0.173 ROE (Beg. ROE, from EPS forecasts) 0.282 0.262 0.235 0.214 0.197 0.184 0.173 0.163 0.152 0.142 0.131 0.121 Abnormal ROE (ROE-k) 0.192 0.171 0.144 0.123 0.107 0.093 0.082 0.072 0.061 0.051 0.040 0.030 growth rate for B (1-POR)*(ROEt-1) 0.000 0.196 0.182 0.163 0.149 0.137 0.128 0.120 0.113 0.106 0.098 0.091 Compounded growth 1.000 1.196 1.414 1.645 1.890 2.149 2.424 2.715 3.022 3.342 3.671 4.006 growth*aroe 0.192 0.205 0.204 0.203 0.202 0.200 0.199 0.195 0.185 0.170 0.149 0.120 required rate (k) 0.091 0.091 0.091 0.091 0.091 0.091 0.091 0.091 0.091 0.091 0.091 0.091 0.091 Compound discount rate 1.091 1.190 1.298 1.415 1.544 1.684 1.837 2.004 2.185 2.384 2.600 2.836 div. payout rate (k) 0.305 Add to P/B PV(growth*AROE) 0.18 0.17 0.16 0.14 0.13 0.12 0.11 0.10 0.08 0.07 0.06 0.04 Cum P/B 1.18 1.35 1.50 1.65 1.78 1.90 2.01 2.10 2.19 2.26 2.32 2.36 Add: Perpetuity beyond current yr (Assume this yr's AROE forever) 1.94 1.90 1.73 1.58 1.44 1.31 1.19 1.07 0.93 0.79 0.63 0.47 Total P/B (P/B if we stop est. this period) 3.11 3.24 3.23 3.23 3.22 3.21 3.20 3.17 3.12 3.05 2.95 2.83 Implied price 126.64 132.01 131.64 131.28 130.94 130.60 130.28 129.21 127.09 123.96 119.91 115.04 Inputs EPS forecasts (FY1 & FY2): 10.61 and 11.77 Long-term growth rate: 14.57% Book value /share: Book value: 2,628.8 million # of shares outstanding: 69.96 million Book value / share: 37.58 Dividend payout ratio: 30.47% Next fiscal year end: 2012 Current fiscal month: 11 Target ROE: 12.08% Output Above normal growth period chosen: 2015 EBO valuation: 152.00 Sensitivity Analysis EBO valuation would be: 185.94 if changing above normal growth period to 2018 5
154.09 if changing growth rate from mean (consensus) to the highest estimate 15.40% 145.62 if changing growth rate from mean (consensus) to the lowest estimate 12.00% 136.53 if changing discount rate to 10% 152.00 if changing target ROE to 11% 6
Section (D) Relative Valuation GWW Mean FY2 Earnings Estimate Forward Mean LT PEG P/B ROE Value P/S P/CF Ticker Name Mkt Cap Current Price (next fiscal year) P/E Growth Rate (MRQ) 5 yr ave Ratio TTM TTM 1 GPC Genuine Parts Compan $ 9,763.92 $ 62.77 $ 4.33 14.50 9.43% 1.54 3.20 18.46% 0.17 0.76 13.6 2 MSM MSC Industrial Direc $ 4,466.71 $ 70.65 $ 4.88 14.48 12.86% 1.13 3.77 21.59% 0.17 1.90 15.21 3 WCC WESCO International $ 2,786.24 $ 62.87 $ 5.24 12.00 13.50% 0.89 1.80 18.70% 0.10 0.43 10.5 4 AIT Applied Industrial Te $ 1,627.17 $ 38.62 $ 3.26 11.85 13.70% 0.86 2.31 14.82% 0.16 0.68 12.05 GWW W.W. Grainger, Inc. $ 13,308.91 $ 190.42 $ 11.77 16.18 14.57% 1.11 4.64 22.41% 0.21 1.51 15.64 Implied Price based on: P/E PEG P/B Value P/S P/CF 1 GPC Genuine Parts Company $170.62 $263.63 $131.32 $159.42 $95.84 $165.58 2 MSM MSC Industrial Direct Co. Inc. $170.40 $193.06 $154.72 $160.59 $239.60 $185.18 3 WCC WESCO International Inc. $141.22 $152.41 $73.87 $88.53 $54.23 $127.84 4 AIT Applied Industrial Technologies, Inc. $139.43 $148.29 $94.80 $143.35 $85.75 $146.71 High $170.62 $263.63 $154.72 $160.59 $239.60 $185.18 Low $139.43 $148.29 $73.87 $88.53 $54.23 $127.84 Median $155.81 $172.73 $113.06 $151.39 $90.80 $156.15 From the top panel In general, all five companies have similar multiples. Only one exception is Grainger s FY2 Earning Estimate. It s more than double the other competitors. I think this is a good sign showing that Grainger is a solid company with high profit expectation. That can also explain why the company s stock is expensive compare to its competitors. This reflects through the P/B (MRQ) ratio. The forward P/E also shows the same trend. Even though Grainger has a high earnings estimate, but the current stock is too high. That is why the company s forward P/E is the highest comparing to its competitors. I think this also applies for the PEG ratio. The company has the highest long term growth rate but its PEG is in the middle range of all the companies. Looking at the P/S (TTM) ratio, Grainger is in the upper range. With the company being an expensive stock, I think it is reasonable. The P/CF (TTM) shows the same result. Grainger s number is still the highest but it is still close to other competitors. From the bottom panel The implied prices from P/B and P/S ratios give the lowest results. The median prices are only about half of the current price. I don t think these ratios are reliable for estimating Grainger s price. The implied prices from forward P/E, Value Ratio, and P/CF ratios are approximately the same. They are closer to Grainger s current price but these numbers are still lower than the 52- week low. The implied price from PEG is the highest among all valuation metrics but it s only approximately the same as Grainger s 52-week low. 7
All the low implied prices derived from competitors multiples are lower than Grainger s 52- week low. High implied prices from PEG and P/S ratios are higher than the company s 52-week high. The rest of them are lower than its 52-week high. Among the valuation metrics analyzed, I think the PEG ratio is the most relevant as a valuation tool for Grainger. The ratio takes in account the stock price, earnings estimate and the long term growth rate. I think these data represent the best the condition of a big and high potential growth. 8
Section (E) Revenue and Earnings Estimates Historical Surprises Estimates vs Actual Estimate Actual Difference Surprise % SALES (in millions) Quarter Ending Sep-12 2,317.12 2,281.21 35.92-1.55 Quarter Ending Jun-12 2,265.41 2,249.27 16.13-0.71 Quarter Ending Mar-12 2,189.26 2,193.45 4.18 0.19 Quarter Ending Dec-11 2,080.88 2,076.90 3.97-0.19 Quarter Ending Sep-11 2,095.23 2,114.65 19.42 0.93 Earnings (per share) Quarter Ending Sep-12 2.89 2.81 0.08-2.89 Quarter Ending Jun-12 2.62 2.63 0.01 0.36 Quarter Ending Mar-12 2.52 2.57 0.05 2.01 Quarter Ending Dec-11 2.12 2.13 0.01 0.50 Quarter Ending Sep-11 2.33 2.51 0.18 7.52 I have explained why the result of the third quarter of 2012 missed the estimate. It wasn t because of the performance of the company, that s why I don t think these negative surprises reflect the true result of Grainger. For sales, I think there is no surprising pattern. Some of them are positive and some are negative. I don t think these surprises are important because they are only about 1 percent difference. According to Bloomberg, the stock prices slightly decreased every time after the earnings announcement (2 days period). Even though some of the surprises are positive, the stock price still dropped after the quarterly report came out. For earnings, they are all positive surprises except the latest quarter. The positive surprise of the third quarter of 2011 is high compare to the others. According to Bloomberg, the stock prices slightly fell every time after the earnings announcement (2 days period). Even though 9
most of the surprises are positive, the stock price still dropped after the quarterly report came out. Consensus Estimates Analysis # of Estimates Mean High Low 1 Year Ago SALES (in millions) Quarter Ending Dec-12 15 2,236.73 2,267.72 2,200.70 2,187.14 Quarter Ending Mar-13 11 2,295.15 2,352.20 2,244.50 2,254.70 Year Ending Dec-12 17 8,963.04 8,991.65 8,924.70 8,798.95 Year Ending Dec-13 17 9,554.07 9,815.00 9,364.30 9,486.29 Earnings (per share) Quarter Ending Dec-12 15 2.60 2.69 2.52 2.42 Quarter Ending Mar-13 10 2.76 2.83 2.67 2.74 Year Ending Dec-12 16 10.61 10.70 10.53 10.15 Year Ending Dec-13 17 11.77 12.35 11.40 11.53 LT Growth Rate (%) 6 14.57 15.40 12.00 14.95 10
Revenue Difference from High Difference from Low Quarter Ending Dec-12 1.39% 1.61% Quarter Ending Mar-13 2.49% 2.21% Year Ending Dec-12 0.32% 0.43% Year Ending Dec-13 2.73% 1.99% Earnings Difference from High Difference from Low Quarter Ending Dec-12 3.46% 3.08% Quarter Ending Mar-13 2.54% 3.26% Year Ending Dec-12 0.85% 0.75% Year Ending Dec-13 4.93% 3.14% Comparing to one year ago, all the current estimates of both revenue and earnings of all periods are higher. This shows that the analysts are thinking more bullish about the company than before. In general, the divergent are more notable for earnings than revenue. The divergent are more notable for the FY2 than the FY1 for both revenue and earnings. The number of analysts providing LT growth rate estimate is much lower than the number of analysts providing revenue and earnings estimates, roughly about 40% of the analysts. Consensus Estimates Trend Current 1 Week Ago 1 Month Ago 2 Month Ago 1 Year Ago SALES (in millions) Quarter Ending Dec-12 2,236.73 2,237.59 2,244.84 2,264.20 2,187.14 Quarter Ending Mar-13 2,295.15 2,297.59 2,334.79 2,336.60 2,254.70 Year Ending Dec-12 8,963.04 8,963.04 8,971.62 9,023.24 8,798.95 Year Ending Dec-13 9,554.07 9,554.07 9,697.84 9,824.87 9,486.29 Earnings (per share) Quarter Ending Dec-12 2.60 2.59 2.56 2.51 2.42 Quarter Ending Mar-13 2.76 2.80 2.90 2.88 2.74 11
Quarter Ending Dec-12 10.61 10.59 10.57 10.62 10.15 Quarter Ending Dec-13 11.77 11.81 12.06 12.21 11.53 I assume that reuters.com made the mistake about naming the year ending 2012 and year ending 2013 of earnings. From two month ago until now, the consensus estimates are trending downward for both revenue and earnings. When compare to one year ago, the current estimates are higher. For earnings of fourth quarter of 2012 and year end 2012, their estimates are trending upward. Estimates Revisions Summary Last Week Last 4 Weeks Number Of Revisions: Up Down Up Down Revenue Quarter Ending Dec-12 0 1 2 9 Quarter Ending Mar-13 0 0 0 7 Year Ending Dec-12 0 0 2 10 Year Ending Dec-13 0 0 0 13 Earnings Quarter Ending Dec-12 0 0 7 2 Quarter Ending Mar-13 0 0 0 8 Year Ending Dec-12 0 0 7 2 Year Ending Dec-13 0 0 0 11 12
In the last week, there is no up revision and only one down revision of revenue of fourth quarter of 2012. With only one change, I don t think there is any major change. In the last four weeks, there are total 18 up revisions and 62 down revisions. This shows that the analysts are more bearish about the future performance of Grainger. For revenue in the last four weeks, there are 4 up revisions and 39 down revisions. Analysts are most bearish about the revenues, especially year ending 2013. For earnings in the last four weeks, there are 14 up revisions and 23 down revisions. The revisions are more balance or earnings but they are also more bearish about the future performance of the company. I think the company has a good chance of making analyst consensus estimate. With strong historical increased revenue and earnings, a large network branch, Grainger will be able to expand and grow in the near future. Based on how the stock has been trading lately, I think the market has already anticipated strong outlook from the company. The Morningstar Direct s fair value estimate is $192.00, which is very close to the current price of the stock at $190.42. 13
Section (F) Analysts Recommendations Analyst Recommendations and Revisions 1-5 Linear Scale Current 1 Month Ago 2 Month Ago 3 Month Ago (1) BUY 6 5 5 4 (2) OUTPERFORM 3 2 2 2 (3) HOLD 8 9 8 8 (4) UNDERPERFORM 0 1 0 0 (5) SELL 1 1 2 2 No Opinion 0 0 0 0 Mean Rating 2.28 2.50 2.53 2.62 Over the last three months, the trend of analyst recommendations is moving toward outperform. There is no notable change of analyst opinions. The company has received four out the five possible ratings over the period with an exception of 1 month ago with all five different ratings. Most of the analysts recommendations are either buy or hold. The amount of underperform or sell recommendations are insignificant. What I see here is consistent to the comments in Morningstar analyst s research report. 14
Section (G) Institutional Ownership GWW Ownership Activity # of Holders % Beg. Holders Shares % Shares Shares Outstanding 69,494,976 100.00% # of Holders/Tot Shares Held 647 99.08% 51,940,545 74.74% # New Positions 49 7.50% # Closed Positions 55 8.42% # Increased Positions 224 34.30% # Decreased Positions 314 48.09% Beg. Total Inst. Positions 653 100.00% 51,291,147 73.81% # Net Buyers/3 Mo. Net Chg -90 41.64% 649,398 0.93% Ownership Information % Outstanding Top 10 Institutions % Ownership 34.00% Mutual Fund % Ownership 0.58% Float % 94.37% > 5% Ownership Holder Name % Outstanding Report Date Grainger (David W) 7.7 3/19/2012 Vanguard Group, Inc. 5.7 9/30/2012 Slavik (James D) 5.6 11/1/2012 Institutions, on net basis, have been decreasing ownership but it is not significant compare to the amount of holders. There are 647 shareholders and a 3 months net change of -90. With 34 percent of institution ownership, I think the stock has sizable institution interests and support. There are three holders with more than 5% ownership. I think the change in institutions ownership is not significant, and the company does have 3 big holders. This could be a bullish indication of future stock price movement. 15
Section (H) Short Interest 16
Share Statistics Avg Vol Avg Vol Shares (3 month) (10 day) Outstanding Float 643,114 677,780 69.49M 59.90M Shares Short Short Ratio Short % of Float Shares Short (as of Oct 31, 2012) (as of Oct 31, 2012) (as of Oct 31, 2012) (prior month) 2.41M 3.60 4.10% 2.65M I think the market is bearish about the stock. The short ratio and the short percentage of Float are pretty high. The days to cover has been also high with a peak of 10 days. In general, it s hard to say if the sentiment has turned more bullish or bearish over the last year. Looking at the two closest competitors, I see that Genuine Parts Company s short interest is in the worse condition while MSC industrial Direct Co. Inc. s short interest is in a better condition than Grainger s short interest. The short ratio and short percentage of Float of Genuine Parts are 6.80 and 4.10% respectively. The short ratio of MSC industrial Direct is 3.50 and the short percentage of Float is not available. Therefore, I think short interest of Grainger is not too bad compare to its competitors. 17
Section (I) Stock Charts A three months price chart Looking at the three months price chart, Grainger s stock seems to underperform compare to the market, the industry, and its competitors. Being a cyclical stock, the price has dropped harshly compare to the rest. A one year price chart Looking at the one year price chart, I can see that the stock has been going up and down with the business cycle. It s still showing the sign of being a cyclical stock, but it s not as sensitive as its competitors. 18
A five year price chart Looking at the five year price chart, the stock price tells a different story. The stock is still behaving similarly to the market, the industry and its competitors. The difference is from mid- 2011 until now, the stock has been outperformed the rest. I think Grainger is more of a longterm oriented company, that s why there is difference when I look at the short-term and longterm stock price. References http://finance.yahoo.com/ http://www.reuters.com/ http://www.nasdaq.com/ http://money.msn.com/investing/ http://www.businessweek.com/ 19
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