Interesting Takeaways From Global Industrial's Competitors

This post is more of a follow up to my writeup about Global Industrial. It will not be an in depth writeup about a specific business. These were takeaways that I happened to notice by chance while doing research on Global Industrial. In their 10-K’s, Global Industrial lists their competitors in the MRO and industrial product distribution market as Uline, Grainger, MSC Industrial, Fastenal and Amazon. Uline is private so I cannot see their financials. Per the Milwaukee Business News link here, which I found on Uline’s Wikipedia page, the business generated $5.8 billion in yearly revenue and had 6,700 employees as of February 2020. Per their corporate website, the business claims to now have over 8,200 employees in North America. If I had to guess, I’d say that business is pretty good for Uline. Amazon offers industrial products through Amazon Business. I was not able to find any specific information on Amazon Business in Amazon’s annual report, via a Google search or via an EBSCOhost database search so I am not going to include it in this writeup. My focus will be on Grainger, MSC Industrial and Fastenal.

So what are the interesting takeaways that I noticed about these companies? There were two specifically. The first is that all three operate in the same MRO and industrial product distribution market as Global Industrial, yet they all have pretty good to excellent returns on capital. I got to thinking about how this could be the case. It doesn’t make sense that there are thousands of MRO and industrial parts distributors and yet these three plus Global Industrial all have high returns on capital. What I ended up learning is the second takeaway, which is that each business differentiates themselves inside of the MRO and industrial product distribution market. Each business and what differentiates them are discussed below. Please note that these are my own takeaways and opinions from what I’ve read about each business and that I could be missing something which differentiates them further.

Grainger (NYSE: GWW)

Grainger’s first source of differentiation is to be very customer focused. What does this mean though? Grainger offers their customers several ways of ordering and receiving whatever supplies they need to run their business as shown in the second screencap below. They break their customers in to two segments: High Touch which makes up 77+% of their sales and Endless Assortment which makes up the remain 22+%. High Touch customers are typically larger business with complex supply requirements while Endless Assortment customers are typically smaller businesses with less complex supply issues that are focused more on price. The screencaps below shows how they service each business segment. It is taken from pp. 3-4 from Grainger’s Corporate Profile PDF which is linked here.

In the middle of the second screencap you can see the KeepStock inventory management system shown as one of the ways that Grainger originates and fulfills orders. In my opinion, Grainger’s KeepStock system is the most interesting and effective way that they help their customers and drive value for the business. Through their KeepStock system, Grainger goes as far as having industrial vending machines on site for their customers to have immediate access to and manage their MRO and industrial product supplies more efficiently. I think that this is an excellent way to integrate with their customer’s operations and deepen their relationship with them. The Keepstock system currently makes up 15% of Grainger’s sales. The linked video below gives a full breakdown of their Keepstock system services. It is only 3 minutes long and explains the entirety of the system way better than I ever could.

The second source of differentiation for Grainger is that they have a more diversified mix of product sales. Unlike the two other businesses which will be profiled, Grainger has less concentration of sales throughout their product mix meaning that one or two segments don’t make up most of the sales for the business. The screencap below is taken from p. 2 of their Corporate Profile which is linked above.

So what and who cares about how they differentiate themselves? My answer to that would be to look at the screencap below which I got from TIKR. Grainger’s returns on assets, capital, equity and common equity since 2005 have been exceptional. I used 2005 as the starting year because that’s as far back as TIKR’s data goes. On top of these metrics, revenues have gone up every year except for 2009. Grainger has clearly figured something out, in my opinion. Most impressive have been their returns on invested capital which TIKR calculates as EBIT / (Total Debt + Total Equity + Total Deferred Tax Liabilities). They have not gone below 22.5% since 2005.

MSC Industrial (NYSE: MSM)

The biggest differentiator that I could find about MSC Industrial is their focus on metalworking products. I mentioned this because they discuss it repeatedly in their 10-K’s. Taken from p. 4 of the fiscal 2021 10-K, “MSC differentiates itself in the industry by being a leading distributor of metalworking products. We have continued to expand technical support and enhance supplier relationships, especially with our metalworking products. Our associates share their deep expertise and knowledge of metalworking and MRO products to help our customers achieve their goals.” Also taken from p. 4 of the same 10-K regarding their technical expertise and support under the “Business Strategy” section of the document, “We provide technical support and one-on-one service through our field and customer care center representatives. We have a dedicated team of more than 100 metalworking specialists who work with customers to improve their manufacturing processes and efficiency, as well as a technical support team that provides assistance to our sales teams and customers via phone and email. These metalworking specialists are customer-facing and work side-by-side with our customers. We utilize our Application Optimization proprietary software to capture the application data and to deliver documented cost savings to our customers. Our exclusive service, MSC Millmax®, focuses on maximizing milling productivity and lowering cost by reducing the milling optimization process to a fraction of the time. Our customers recognize the value of a distributor that can provide technical support to improve their operations and productivity.” MSC Industrial’s discusses their growth strategy on p. 5 of the same document. The first initiative that the business mentions is “Expanding and enhancing our metalworking capabilities to aggressively penetrate customers in heavy and light manufacturing.” Quoting p. 5 of the 2021 10-K directly, “MSC is a leading distributor of metalworking products in North America. We have continued to expand technical support and enhance supplier relationships. We are continuing to develop high-performance metalworking products marketed under MSC exclusive brands, providing high-value product alternatives for our customers. Our metalworking field specialists and centralized technical support team members have diverse backgrounds in machining, programming, management and engineering. They help our customers select the right tool for the job from our deep supplier base and exclusive brands.” For as much as I’ve harped on this, the business does not provide how much revenue metalworking products generate versus the other MRO products that they offer. They only segment their customer end-markets. I looked at their most recent investor presentation which is linked here. Slide 6 of that presentation is screencapped below. Based off the “MSC Fiscal Year 2021 Sales” pie chart, I would venture to guess that metalworking products make up approximately 40-45% of total sales.

Again, so what and who cares about focusing on metalworking products? Again, I would refer you to the data below which I got from TIKR. MSC Industrial’s returns on assets, capital, equity and common equity since 2005 have been really good. I used 2005 as the starting year because that’s as far back as TIKR’s data goes. In my opinion, MSC Industrial, like Grainger, has figured out their niche. If you notice over the last few years, MSC Industrial’s returns on invested capital has ticked down from 21.2% in fiscal 2018 to 17.6% in fiscal 2021. During that same time their sales have essentially been flat with revenues in fiscal 2018 being $3.203 billion and revenues in 2021 being 3.243 billion. That is an increase of only ~$40 million. Management has acknowledged this and launched what they called their “Mission Critical” initiative. Per p. 21 of their fiscal 2021 10-K, the business launched their Mission Critical initiative to “accelerate market share capture and improve profitability over the period through fiscal year 2023. Among the Mission Critical initiatives to realize growth, we began and expect to continue investing in our market-leading metalworking business by adding to our metalworking specialist team, introducing value-added services to our customers, expanding our vending, VMI and in-plant solutions programs, building out our sales force, and diversifying our customers and end markets. We also are focused on critical structural cost reductions in order to improve return on invested capital. We anticipate that these cost reductions will be comprised of savings in the areas of sales and service, supply chain and general and administrative expenses, and include initiatives to optimize our distribution center network and real estate footprint, renegotiate supplier contracts, and redesign our talent acquisition and retention approach.” How the “Mission Critical” initiative will work out is too tough to call, but at least management is aware that they aren’t growing the business and are doing something about it. I wouldn’t mind if their returns on invested capital went back to above 20% either.

Fastenal (NASDAQ: FAST)

I only knew two things about Fastenal before I started reading about them. The first thing that came to my mind is the business has been a multidecade compounder. The stock price is up almost 1000x since the late 1980’s. The second thing that I knew is that they sell their products in bland and unassuming locations throughout the country. Very weird thing to pop into my head. What I didn’t know is that they’ve changed their branch locations and have moved even closer to their customers operations. These are the first two ways that Fastenal differentiates itself. Per p. 4 of the 2021 10-K, “A 'traditional branch' typically services a wide variety of customers, including our larger national and regional accounts as well as retail customers. Locations are selected primarily based on their proximity to our distribution network, population statistics, and employment data for manufacturing and non-residential construction companies. We stock all branches with inventory drawn from all of our product lines, and over time, where appropriate, our district and branch personnel may tailor the inventory offering to the needs of the local customer base.” So how have they changed? An increasing number of their branch locations operate as Customer Fulfillment Centers (CFCs). CFCs, quoting again from p. 4 of the 2021 10-K, “tend to feature a limited showroom, reduced hours of access to the public, greater usage of will-call, and stock customer-specific inventory. These tend to appear and function more like an industrial supply house and stocking location and tend not to have transactions with non-account or retail like customers unless it is a will call arrangement related to an online transaction.” As of 2021 year-end, 65% of Fastenal’s branches operated as a CFC. The other 35% operate as Customer Service Branches (CSBs). Quoting from the same page above, CFCs “tend to feature a showroom, regular hours during which it is open to the public, and our standard stocking model of products designed for contractors. CSBs are similar in function to a hardware store and they often conduct some business with non-account or retail-like customers. However, this customer set typically represents less than 10% of sales at this type of location.”

Fastenal has moved closer to their customers via their Onsite locations. An Onsite is literally a Fastenal store inside of a manufacturing facility with a customized product offering strictly for that location. The Onsite has a dedicated Fastenal team working to manage and resupply the products so that the business owner or facility manager doesn’t have to. Onsite currently has 1,416 locations worldwide. An interesting comment from the company regarding Onsite and why it makes sense as part of their overall strategy is taken from p. 4 of the 2021 10-K, “In many cases, we are shifting revenue with the customer from an existing branch location, though we are beginning to see more new customer opportunities arise as a result of our Onsite capabilities. The model is best suited to larger companies, though we believe we can provide a higher degree of service at a lower level of revenue than most of our competitors. It has been our experience that sales mix at our Onsite locations produces a lower gross profit percentage than at our branch locations, but we gain revenue with the customer and our cost to serve is lower.” This comment made me wonder how Fastenal gains revenue at a lower cost. The answer is in the video linked below. It’s from 2016, but provides a ton of insight. In the video, Dan Florness, the CEO, talks about how Onsite saves Fastenal money through a reduction in labor, occupancy and transportation costs. He claims that Onsite labor costs are reduced by 40% versus a traditional branch location. Occupancy costs typically go to zero implying that the Onsite locations operate rent free. I’m not sure if Fastenal is still getting free rent for their Onsite locations. Transportation costs are reduced because the Onsite reduces a stop between the business it operates in and a traditional Fastenal branch location. These three Onsite dynamics allows Fastenal to offer their customers a lower markup on their products. In addition to lower markups, it allows their customers to save on labor because Fastenal employees are handling at least some of their supplies. The customer’s transportation costs are reduced because less trips are made to Fastenal branches. The customer’s inventory costs are reduced because, again, Fastenal is handling that for you.

A fascinating aspect related to Onsite’s are Fastenal’s Managed Inventory (FMI) solutions. If you watched the video above about Grainger’s Keepstock program, you would’ve have seen that they offer a restocking service where the customer scans a barcode and it creates an order ticket for Grainger to come and resupply the item. Fastenal’s FMI solution is one step ahead of Grainger’s because it offers an automatic restocking program via their FASTStock, FASTBin and FASTVend programs. FASTstock is the same thing as Grainger’s Keepstock program in that it relies on barcodes to be physically scanned to create an order ticket. Fastenal’s FASTBin technology takes this up a notch. Per p. 6 of the 2021 10-K, “FASTBin is the evolution of FASTStock into a set of electronic inventory management solutions that automate process controls by providing 24/7 continuous inventory monitoring, real-time inventory visibility, and more efficient replenishment of bin stock parts. These technologies come in three forms: (1) Scales utilize a high-precision weight sensor system to measure the exact quantity on hand in real time, automatically sending an order to Fastenal when inventory hits an established minimum. (2) Infrared uses infrared sensors lining individual bins to provide real-time visibility of approximate quantity and inventory values, automatically sending an order to Fastenal when inventory hits an established minimum threshold. (3) RFID is a Kanban system that utilizes RFID tags so that when an empty bin is removed from the rack and placed in a replenishment zone (also part of the same racking system) an automatic refill order is generated. These technologies provide superior monitoring capabilities and immediate visibility to consumption changes, allowing for a lean supply chain, reducing risk of stock-outs, and providing a more efficient labor model for both the customer and the supplier.” The business also describes their FASTVend program on p. 6 of the 2021 10-K. It states that FASTVend “was introduced in 2008 to provide our customers with improved product monitoring and control. Benefits include reduced consumption, reduced purchase orders, reduced product handling, and 24-hour product availability, and we believe our company has a market advantage by virtue of our extensive in-market network of inventory and local personnel.” Bringing Fastenal stores and products directly to the customer is a brilliant move. It deepens the customer relationship and makes Fastenal almost a necessity for their business operations. This customer service and product availability model is just better than Grainger’s. Fastenal will be attached to their customers’ hips if they move any closer to them.

The third way that Fastenal differentiates itself is through their product offering. It is less brilliant than their OnSite locations and FMI solutions, but still effective. Their product offering in the past was focused on fasteners which still make up over 33% of sales. Their safety supplies segment has experienced rapid growth over the last several years. Per the 2019 10-K, safety supplies made up 16.3% of sales in 2017. This was the first time Fastenal separated safety supplies out from their “other product lines”. Per the 2021 10-K, safety supplies made up 21.2% of sales. The business states on p. 9 of the 2021 10-K, “The most significant category of non-fastener products is our safety supplies product line, which accounted for 21.2% of our consolidated sales in 2021. This product line has enjoyed dramatic sales growth in the last ten years which we believe is directly attributable to our success in industrial vending over that period.” Adding the two together gives you over 54% of sales from only two product lines.

Fastenal differentiates itself further through its online capabilities/resources, distribution network and incentive structure, but those are a little too in depth for this writeup. I can tell you that they matter, but they just don’t make the cut for this writeup. Feel free to read about them in Fastenal’s 10-K’s.

I’m beating a dead horse with this question, but so what and who cares about their differentiation strategy? If you look at the data below which I got from TIKR, Fastenal’s returns on assets, capital, equity and common equity since 2005 have been stellar. I used 2005 as the starting year because that’s as far back as TIKR’s data goes. Fastenal, like Grainger and MSC Industrial, has figured their niche out and dominated it. Sales have increased every year except in 2009. Most impressive, like Grainger, have been their returns on invested capital. They have gone below 30% onetime which was in 2009. Last thing about Fastenal, I know that I wrote a lot more about it than I did about Grainger and MSC Industrial. That is due to Fastenal providing more information about their business in their annual reports, on their corporate website and on their YouTube channel. It made writing about the business much easier than the other two.

Conclusion

Hopefully I’ve done a decent job of explaining showing how Grainger, MSC Industrial and Fastenal differentiate themselves. This differentiation is what I believe leads to their high returns on capital. This leads me to another question. Since they all differentiate themselves within the MRO and industrial product distribution market and all have high returns on capital, does this mean that they are rational businesses? What I mean by “rational businesses” are those which are concerned more with themselves and their niche rather than trying to gain market share from competitors or engage in empire building. Perhaps the MRO and industrial product distribution market is like the cereal market that Charlie Munger commented on many years ago? You can find the speech here or in the Expanded Third Edition of Poor Charlie’s Almanack (the edition that I own) on pp. 185-187. Mr. Munger states that some businesses like airlines made very little money for their shareholders, but any halfway decent cereal company at that point in time made at least mid-teen returns on their capital and there seems to be no specific rhyme or reason as to why this is the case. Maybe that is what’s happening with GIC and their competitors that I’ve written about? The answer remains uncertain, but I thought learning more about Global Industrial’s competitors and the MRO and industrial product distribution market was interesting. I’m always willing to receive feedback or talk about this writeup in further detail. Thanks again as always for reading. Feel free to reach out to me via email at possiblevalueresarch@gmail.com, on Twitter @PossibleValue or on Microcap Club @Heshy. Tell someone that you love them and have a stellar day.