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Morningstar | MSC Reports a Solid Finish to Fiscal 2018; Maintaining $100 FVE

MSC closed out its fiscal 2018 with solid fourth-quarter results that met or exceeded management's guidance. Reported revenue of $838 million grew 11% year over year, and organic revenue, which excludes acquisitions, grew over 4.5%. Last quarter, we noted that management's efforts to revamp its sales organization was a headwind for organic revenue growth. That headwind lingered in the fourth quarter, but management commented that it expects to see stronger top line growth in 2019.

While reported operating margin contracted 40 basis points year over year to 12.9%. the decline was due to the contribution from lower-margin acquisitions as well as a $3.2 million charge for purchase accounting and other acquisition-related costs. Excluding acquisitions, MSC's operating margin expanded 30 basis points to 13.8%, which tells us that MSC is doing a good job managing its cost structure. Diluted EPS increased 21% year over year to $1.29 per share driven by an 8% increase in operating income and a lower effective tax rate. We didn't make any material changes to our long-term forecast following MSC's fourth-quarter results, and we therefore maintained our $100 per share fair value estimate.

MSC unveiled its 2019 operating margin framework in its fourth-quarter investor presentation. This framework is a scenario analysis of sorts that projects full-year 2019 operating margin based on revenue growth and gross margin assumptions. The 2019 framework contemplates MSC's operating margin ranging between 12.9% (assuming 5.5% to 9.5% sales growth and gross margin contraction) to 14.2% (assuming 9.5% to 13.5% sales growth and gross margin expansion). The 2019 framework is an improvement over the 2018 version, which guided to full-year operating margin ranging between 12.8% and 13.9%. We're forecasting MSC's operating margin to improve to 13.5% in fiscal 2019 from 13.1% in 2018.

Regarding tariffs, management estimates that less than 5% of cost of goods sold is exposed to Chinese tariffs, so MSC has limited exposure. However, management noted that tariffs could fuel an increasingly inflationary environment, which could be beneficial to MSC's profitability if end market demand holds up and the firm is able to pass on higher prices to its customer base. While MSC has historically realized strong price realization during periods of inflation, a pessimistic view envisions a scenario where price realization is more difficult amid greater price transparency and a more competitive environment.

MSC maintained its balanced capital allocation strategy in fiscal 2018. Free cash flow grew 47% year over year to $295 million, of which, the company spent $87 million to acquire All Integrated Solutions, $82 million to repurchase 972,000 shares, and $125 million to fund its quarterly dividend, which increased from $1.80 per share in fiscal 2017 to $2.22 per share in 2018.