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Morningstar | Fastenal's Sales Growth Was Strong and Steady in 2018 as Vending and On-Sites Gain Traction

Fastenal closed its fiscal 2018 with solid fourth-quarter results that met Wall Street estimates. The wide-moat industrial distributor's fourth-quarter revenue grew 13.2% year over year to $1.2 billion and adjusted EPS, which excludes a $3.2 million discrete tax expense, also increased 13.2% to $0.60. Revenue growth was strong across Fastenal's product lines. Non-fastener product revenue grew 14.6% and fastener products grew 11.3% year over year. Fastenal's key growth strategies--national accounts, industrial vending, and on-site locations--continue to support the company's growth as these initiatives gain traction with customers. Compared with the prior-year quarter, national account sales increased 18.1%, new vending signings grew 16.7%, and new on-site location signings grew 17.5%.

Fastenal's gross margin declined 110 basis points year over year to 47.7%, mainly due to customer and product mix and rising product and freight costs. As we've noted before, national accounts, industrial vending, and on-site locations--Fastenal's key growth contributors--tend to generate lower gross margins. However, the incremental gross profit dollars generated by these growth drivers can result in increased operating leverage and operating margins. Indeed, despite the 110 basis-point gross margin contraction, Fastenal's fourth-quarter operating margin expanded 30 basis points to 19%. Fastenal's full-year operating margin was flat at 20.1% even though its gross margin declined 100 basis points to 48.3%. As Fastenal replaces branches with more capital-efficient on-site locations, returns on invested capital should improve as well. We saw that occur in 2018 as ROIC (based on our calculations) increased 120 basis points to 23.9%.

We increased our fair value estimate to $57 per share from $55, mainly due to the time value of money since our last update, as well as a small upward revision to our long-term earnings before interest growth assumption (6% versus 5.5% previously).

At the end of the fourth quarter, Fastenal had 81,137 vending machines installed at customer facilities and operated 894 on-site locations, up 13.6% and 47.8% year over year, respectively. Management is targeting 23,000 to 25,000 vending and 375 to 400 on-site signings in 2019. In 2018, Fastenal's 22,073 vending signings met management's goal of 21,000 to 23,000 signings, but the 336 new on-site locations signed in 2018 missed management's goals of 360 to 385 new on-site signings.

Besides product and customer mix, Fastenal's gross margin has been unfavorably impacted by product cost inflation, including tariffs. Management noted that while product sales prices are "trending favorably," Fastenal has not yet achieved a state of price/cost neutrality. Given that management expects tariff-related cost pressure to become a larger headwind in 2019, we don't expect Fastenal will close its price/cost gap this year. That said, assuming economic conditions hold steady, we're confident that Fastenal can continue to generate strong growth and leverage its operating expenses to drive improved operating margins. We continue to target a 21% midcycle operating margin for the firm.

In terms of sales performance by end market, fourth-quarter construction-related sales increased 15%, on average, versus the year-ago quarter, and sales to manufacturing customers grew about 13%, on average.

On Jan. 16, Fastenal announced it's increasing its quarterly dividend 7.5% to $0.43 per share. Fastenal has consistently increased its dividend since it began paying one in 1991.