Morningstar | We've Been Impressed With Grainger's Margin Expansion Following Its 2017 Pricing Reset
W.W. Grainger operates in the highly fragmented maintenance, repair, and operating products, or MRO, distribution market, where its over $11 billion of sales represents only 4% global market share (the company has 7% share in the U.S. and 5% in Canada). The growing prevalence of e-commerce has intensified the competitive environment because of better price transparency and increased access to a wider array of vendors (including Amazon Business, which has entered the mix). As consumer preference began to shift to online and electronic purchasing platforms, Grainger invested heavily in improving its e-commerce capabilities and restructuring its distribution network. Grainger is the now the 10th-largest e-commerce site in North America, and the company shrank its U.S. branch network from 423 in 2010 to 283 in 2018 and added distribution centers in the U.S. to support the growing amount of direct-to-customer shipments. Still, the company had work to do on its pricing. Grainger historically relied on a pricing model that applied contractual discounts to high list prices. In recent years, though, this model has made it difficult to win new business. To address this problem, Grainger rolled out a more competitive pricing model. Although lower prices have hurt gross profit margins, management hopes that volume gains, especially among higher-margin spot buys and midsize accounts, will more than offset price reductions and help the company return to 12% to 13% operating margins by 2019. Management's current guidance assumes 12.2% to 13% operating margins in 2019.Given the overall competitive environment and the emergence of Amazon Business into MRO distribution, we think further price reductions are likely. Though our margin outlook may be less rosy, we still think Grainger has distinct competitive advantages, such as its long-standing relationships with large customers and its inventory management solutions, which should help the firm earn excess returns over the next 10 years.W.W. Grainger is a distributor of maintenance, repair and operating (MRO) products and services in North America, Japan and Europe. The company's MRO product offering is grouped under material-handling equipment, safety and security supplies, lighting and electrical products, power and hand tools, pumps and plumbing supplies, cleaning and maintenance supplies and metalworking tools categories. The company's segments are the United States, which provides MRO products and services through its eCommerce platform, catalogs, branches and sales and service representatives; and Canada, which serves Canadian customers through its distribution center and branch network as well as sales and service representatives.
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