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Morningstar | Grainger Enjoyed Strong First-Quarter Margin Expansion Despite Softer-Than-Expected Revenue Growth

Shares of W.W. Grainger traded down over 5% on April 22 following the release of  first-quarter results. The narrow-moat rated industrial distributor's first-quarter sales grew a paltry 1% year over year to approximately $2.8 billion, which missed the consensus estimate by about 3%. Management acknowledged during the earnings call that the United States market was "choppy," and sales came in lighter than they had expected. Grainger's first-quarter sales were negatively affected by one less business day and foreign currency translation. After adjusting for these items, Grainger's daily revenue growth came in at a more respectable 4%. However, considering peer Fastenal's 12.2% first-quarter daily sales growth, we suspect many investors were expecting stronger growth from Grainger that it was unable to deliver. Still, we were impressed with Grainger's strong operating leverage during the quarter. Adjusted operating income grew 6% on a 1% increase in revenue, which resulted in adjusted operating margin expanding 65 basis points to 13%. Adjusted EPS grew an even faster 8% year over year to $4.51, which beat the consensus estimate by $0.05. The valuation impact of our lower sales growth expectations for 2019 and 2020 was offset by our stronger margin assumptions and the time value of money since our last update. As such, we've maintained our $288 per share fair value estimate.

Despite slower-than-expected first-quarter sales growth, management maintained its full-year guidance, which projects sales to grow 4% to 8.5%, adjusted operating margin to expand 20 to 100 basis points (12.2% to 13%), and EPS ranging between $17.10 to $18.70. We're now assuming just over 5.5% sales growth and a 12.5% operating margin in 2019 versus our previous assumptions of over 7% sales growth and a 12.4% operating margin.

U.S. revenue increased 2% (4.5% after adjusting for business days and a prior year accounting estimate change). The 4.5% adjusted sales growth was driven by a 2.5% increase in volume, a 1.5% increase in price, and a 0.5% increase in intercompany sales. U.S. adjusted operating margin expanded 30 basis points to 17%.

The Canada segment, which is still in turnaround mode, lost $5 million during the quarter compared with a $20 million loss last year (both GAAP figures that include restructuring costs). Management continues to expect this segment to be profitable in 2019.

Grainger's other businesses, which include MonotaRO, Zoro, Cromwell, and Fabory, grew revenue 8% year over year (12% adjusting for business days and currency), but adjusted operating margin contracted 160 basis points to 4.8% due to Zoro-related investments and Cromwell's weak performance.