An HD Supply Refocused On Facilities MRO, And More Reasonably Valued, Is A More Interesting Story

HD Supply (HDS) is, I believe, another example of how sooner or later valuation always matters. While this is a well-run industrial distributor with a lot of positive attributes, the valuation has historically been quite generous, as the Street was all-in on the “growth by M&A/consolidation” story, as well as improved margin leverage through scale. While the company has done pretty well operationally, the shares have sported only a mid-single-digit return (annualized) over the last five years due to what I believe was an inflated starting point.

There’s still a lot to like about this business. I previously worried that the company was too much of an M&A-driven “magpie”, assembling a collection of businesses that didn’t really make much sense together, but the company has since streamlined down to just its quality, relatively less-cyclical, facilities management maintenance, repair, and overhaul (or MRO) business. I do see opportunities for more consolidation-through-M&A, as well as opportunities to leverage advantages of scale to gain share and margin leverage over time. Valuation is now more reasonable, with the shares priced for a high single-digit to low double-digit return, albeit with a noticeable divergence between my cash flow-based fair value and my multiples-based fair value.

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An HD Supply Refocused On Facilities MRO, And More Reasonably Valued, Is A More Interesting Story

Wolseley Needs To Focus On What It Does Best (U.S. Distribution)

It's hard to find fault with Wolseley's (OTCQX:WOSYY) (WOS.LN) recent performance. The UK shares are up more than 30% over the past year, outdoing peers like HD Supply (NASDAQ:HDS) (up almost 28%), Home Depot (NYSE:HD) (up around 13%), Lowe's (NYSE:LOW) (up about 11%), and Watsco (NYSE:WSO) (also up about 11%), not to mention others like Travis Perkins (OTCQX:TPRKY). Helping the cause has been strong growth in the U.S. business, with like-for-like growth steadily in the mid-single digits despite deflationary pressures, as the company continues to grow share.

There are certainly more ways for Wolseley to improve. Fixing, or better still selling, the businesses outside North America would likely be a good long-term move, and give the company some extra capital with which to pursue growth initiatives in the U.S. like expansion into adjacent distribution/MRO markets. What's more, the remodeling market should continue to support growth while a recovery in the industrial sector will be a welcome tailwind. The hang-up, as is so often the case, is with valuation. While the shares don't seem unreasonably priced on an EV/EBITDA basis, the free cash flow outlook is not as strong, and it's hard for me to regard this as much more than a hold.

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Wolseley Needs To Focus On What It Does Best (U.S. Distribution)

HD Supply Looking To Potentially Play Multiple Trump

While the recent downturn hammered industrial-exposed distributors like MSC Industrial (NYSE:MSM), Fastenal (NASDAQ:FAST), and Grainger (NYSE:GWW), HD Supply (NASDAQ:HDS) was more or less able to go about its business and continue growing. Due to its much different end-market exposures (facilities maintenance, water, and construction), HD Supply has continued to grow revenue and expand its margins, leading to a meaningful outperformance over the last three years relative to the likes of MSC, Fastenal, Grainger, and Wolseley (OTCQX:WOSYY) (with which it shares more in common).

Looking ahead, even though non-residential construction seems to be slowing and water infrastructure spending continues to click along at a slow pace that frustrates its bulls, I think HD Supply could still have potential catalysts to drive higher revenue and earnings. HD Supply would be a meaningful beneficiary of a lower corporate tax rate and would likewise be well-placed to benefit from the incoming administration's pledges to significantly increase federal spending on infrastructure. Projecting real numbers on the basis of campaign pledges is always a tricky business, and I haven't changed my tax rate assumptions yet, but if this administration delivers, it could support a fair value of $50 or higher for this distributor.

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HD Supply Looking To Potentially Play Multiple Trump

Mueller Looks Hard-Pressed To Reward The Market's Rediscovered Optimism

One of the ongoing mysteries of the market that I have yet to solve is the almost evergreen enthusiasm that investors have for water-related companies. While stocks like Mueller Water Products (NYSE:MWA) and Xylem (NYSE:XYL) do have their periods of relative underperformance, it seems like there's a strong "will to believe" behind this sector that doesn't seem related to the actual underlying long-term free cash flow growth or ROIC prospects.

Be that as it may, I'm not going to look a gift horse in the mouth - I thought Mueller looked undervalued earlier this year and the 50% move in the stock since then is definitely more than I'd expected. It's also more than I think is merited by the fundamentals. I understand that housing activity and municipal spending are both looking better, and this company has been doing well with margins in its core business, but even my expectations for almost a decade of sustained double-digit FCF margins (something the company hasn't achieved before) and solid mid-single-digit revenue growth isn't enough to generate a fair value above today's stock price.

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Mueller Looks Hard-Pressed To Reward The Market's Rediscovered Optimism

WESCO's Whipsaw Seems To Have Over-Corrected

When I last wrote about WESCO (NYSE:WCC) in January of this year, I thought the Street was too negative on the shares. I was concerned about the prospect for lingering weakness in the Industrial and Construction sectors, as well as the likelihood of gross margin leverage, but I thought the gap between the share price in the mid-$30's and my fair value in the low $50's was too wide.

I didn't expect that the shares were going to shoot up more than 70% in the interim, but that's what has happened - despite the fact that the company's earnings haven't been that much better than expected. Then again, January of this year was at or near a point of peak pessimism in the market and it seems as though a lot of investors are back to thinking that WESCO is somehow going to deliver on pretty aggressive guidance for the next three to four years.

I'm not so bullish, although I have nudged my revenue estimates up a little bit, and my fair value as well. I believe distributors like WESCO, Rexel (OTCPK:RXEEY), HD Supply (NASDAQ:HDS), Grainger (NYSE:GWW) and so on are going to have a much harder time achieving gross margin leverage in the years to come, and I don't know that that's really reflected in expectations.

Although I do think WESCO has some strong competitive attributes, including a well-tested M&A strategy and a strong service component, I'd be cautious expecting large-scale changes from a company whose financials have been pretty consistent for many years now.

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WESCO's Whipsaw Seems To Have Over-Corrected

Seeking Alpha: WESCO Hammered Down, But Margin Questions Linger

Finding a beaten down industrial stock takes no effort these days, and WESCO (NYSE:WCC) certainly qualifies. These shares have fallen about 45% over the past year, surpassing the declines in other distributors like Grainger (NYSE:GWW), Rexel, HD Supply (NASDAQ:HDS), and Anixter (NYSE:AXE). Given the company's higher exposure to energy, perhaps it is not entirely unfair that WESCO would see a sharper drop, but I find it interesting that WESCO is also the only name on that short list that is expected to see revenue declines in both 2015 and 2016.

The North American industrial sector has weakened a lot more than I expected back in May of 2015, and that has led me to reduce my fair value estimate by about 25%. While I do believe that WESCO's core markets will recover in time, I still have concerns about the company's long-term margin leverage. Although WESCO is very efficiently-run from an SG&A perspective, I think gross margin leverage will likely disappoint the bulls and I don't see what will shake WESCO out of its long-term status as an average grower. So while WESCO does look undervalued today and should have more leverage to an industrial recovery, it wouldn't be first pick for a long-term holding.

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WESCO Hammered Down, But Margin Questions Linger

Seeking Alpha: Mueller Water Still Waiting For Orders To Really Flow

Construction activity has been getting better in the U.S., but you wouldn't really know it by looking at the performance of water infrastructure supplier Mueller Water Products (NYSE:MWA), nor other related stocks like HD Supply (NASDAQ:HDS) and Rexnord (NYSE:RXN). On the other hand, it's hard to say that Mueller's shares ought to be outperforming as the company has racked up three straight quarterly revenue misses and sell-side estimates have been moving lower.

I'm still optimistic that municipal spending will pick up, but it's not all going to materialize in 2016 for Mueller. What's more, investors are still concerned about the impact of the profound weakness in the oil/gas markets and the lack of traction in Mueller's water technology businesses. Mid-single digit revenue growth and operating leverage-driven margin improvements can still support a double-digit fair value, but the shares definitely need to see some beat-and-raise quarterly performances.

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Mueller Water Still Waiting For Orders To Really Flow

Seeking Alpha: Fastenal Battered Down By The Industrial Recession

Something is definitely wrong in the U.S. manufacturing sector, and it is showing up in the results of Grainger (NYSE:GWW), MSC Industrial (NYSE:MSM), and Fastenal (NASDAQ:FAST). While Fastenal hasn't fared too badly on a relative basis since my last report on the company, the shares nevertheless have fallen about 12% in the last six months. As is par for the course, Fastenal seen its growth rate hold up better than those of Grainger and MSC Industrial, but expectations have come down pretty significantly in response to slowing manufacturing activity.

Fastenal isn't exactly cheap, but it's about as close as the stock ever gets. Further weakness in industrial activity could push these shares down even further in 2016, but I like the company's prospects for high single-digit long-term revenue growth. I expect the company to continue to gain share in the industrial distribution space through its extensive store base, its vending efforts, and its growing efforts in onsite management and e-commerce.

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Fastenal Battered Down By The Industrial Recession

Seeking Alpha: Margin Leverage Limiting WESCO's Potential

None of the major industrial distributors have been doing especially well of late (other than HD Supply (NASDAQ:HDS)), but WESCO (NYSE:WCC) has had a rough time of it as industrial spending has weakened and the company has struggled to generate meaningful margin leverage. WESCO's steady-eddy performance is one of its strong points during the tough times, but the company's going to be hard-pressed to generate substantial margin upside without some underlying inflation as rivals compete hard for business and customers push back on pricing.

I like WESCO as a company, but I think management has a tough challenge in front of them - very lean SG&A spending doesn't leave much room for meaningful cost-cutting, pricing power limits the gross margin potential that I see, and breaking out of the company's long-term average revenue growth rate range in the mid-single digits may well require M&A at the cost of risk and leverage.

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Margin Leverage Limiting WESCO's Potential

Seeking Alpha: WESCO Still Waiting

WESCO (NYSE:WCC) hasn't exactly distinguished itself in the six months since I last wrote about the company. Admittedly, not many distributors have done well over that time, as HD Supply (NASDAQ:HDS), Grainger (NYSE:GWW), Fastenal (NASDAQ:FAST) and several others are in the red, but it is nevertheless frustrating that WESCO has paired a frustratingly slow recovery in key markets with shortfalls in its reported margins.

Pushing out some of the expected improvements in financial performance does take some upside out of my price target, but with a fair value in the mid-$80s, I still believe WESCO is a worthwhile name to consider as a play on a non-residential construction recovery. Management needs to show that it can deliver real results from its "One WESCO" strategy, but I do see a path for the company to generate better margins and asset turnover as it continues to integrate acquisitions and leverage end-market recoveries.

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WESCO Still Waiting

Seeking Alpha: HD Supply Outgrowing Its Markets At An Accelerating Rate

I liked HD Supply (NASDAQ:HDS) as a play on recovering construction and infrastructure markets back in March, but I wasn't expecting a nearly 25% move in the shares over the next six months. This was not just a "rising tide lifts all boats" sort of move either - industrial distributor MSC Industrial (NYSE:MSM) and electrical distributor WESCO (NYSE:WCC) are both up over that period as well, but only by about 3% and 5%, while Rexel (OTCPK:RXEEY), Wolseley (OTCQX:WOSYY), and Fastenal (NASDAQ:FAST) are in the red over that stretch. What has helped HD Supply greatly is that management is delivering on its guidance and establishing credibility with its plans to outgrow its underlying markets by a meaningful amount over the next few years.

I still believe that HD Supply is more of a momentum play than a value story. Even with expectations of a construction/infrastructure recovery and internal growth initiatives supporting double-digit growth over the next five years and long-term sales growth of 8%, I can't really get to an attractive discounted cash flow number. I don't expect that to matter much, though, so long as the company can continue to deliver above-market growth and ongoing margin leverage.

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HD Supply Outgrowing Its Markets At An Accelerating Rate

Seeking Alpha: MSC Industrial Continues To See An Early Cyclical Recovery

While the bad winter weather early this year certainly had an impact on some businesses, it doesn't seem to have hurt the industrial distribution businesses as much feared. MSC Industrial (MSM) didn't see the same level of growth in its most recent quarter that HD Supply (HDS) did, and the company did miss the published average sell-side revenue target, but many analysts had this stock's earnings pegged as a likely disappointment.

Instead of disappointing the Street, MSC Industrial gave a relatively encouraging update regarding the U.S. manufacturing sector and its business. Business still is far from rampant recovery levels, but the company's efforts to add sales associates and SKUs seem to be progressing on plan, as is the integration of the large BDNA deal. The expected returns here are looking increasingly ordinary, though, so I can't really pound the table as hard on this stock today as in past articles.

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MSC Industrial Continues To See An Early Cyclical Recovery

Seeking Alpha: WESCO Offers Another Way To Play Familiar Themes

I was lukewarm to positive on WESCO (WCC) six months ago (you can read that article here), and the stock has more or less matched the S&P 500 in the time since, rising about 10%. That's not too bad, particularly as two of the company's largest markets, industrial and construction, have yet to really rebound all that much. HD Supply (HDS) offers a lot of the same underlying exposures and market leverage, with an operational improvement kicker, but WESCO may hold more appeal for investors less inclined to gamble on an internal improvement story.

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WESCO Offers Another Way To Play Familiar Themes

Seeking Alpha: HD Supply Seeing A Turn In Non-Residential Construction

It may yet be early for all-clear on HD Supply (HDS), as "green shoots" could easily get trampled, but the company does seem to have its guidance dialed in better and underlying results are looking better. There's still some comp-group noise that has me questioning the sell-side's apparent love for this stock, but the valuation and opportunity seem in reasonable alignment these days.

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HD Supply Seeing A Turn In Non-Residential Construction

Seeking Alpha: Wall Street Slow To Abandon HD Supply's Long-Term Story

Covering HD Supply's (HDS) first quarter, I thought that the company was a solid collection of assets with real upside to a recovery in construction and internal operating margin improvement, but I thought the valuation was a little rich. I remarked that the shares would be more interesting at $20, and sure enough investors had a couple of days in which they could have bought below that level.

Since then the shares are up 10% even though the company is not doing particularly well staying on target with respect to sell-side estimates. Even though the company reset revenue expectations lower once again, and a change in CFOs so soon after an IPO is alarming, it looks like investors are more focused on the EBITDA margin improvement and the long-term prospects. I still believe that there are better options in the distribution sector, but I'll also acknowledge that Wall Street *wants* to like this story and there's room for both operating results and multiples to head higher.

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Wall Street Slow To Abandon HD Supply's Long-Term Story

Seeking Alpha: MSC Industrial Comes Through In A Tough Quarter

Maybe the best shine I can put on MSC Industrial's (MSM) fiscal fourth quarter is that it was one of the better results in an industry that has disappointed investors due to a slowdown in manufacturing, the sequestration, and the stubborn lack of recovery in construction. While MSC's organic revenue growth was weaker than that reported by large rivals like Grainger (GWW) and Fastenal (FAST), at least some of that can be attributed to the company's greater focus on small manufacturing companies.

I'm not looking for 2014 to be a banner year for industrial distributors, but I believe MSC Industrial is still meaningfully undervalued. The company is definitely vulnerable to further slowing in manufacturing and more activity from Fastenal in areas like metalworking, but the market's worries about MSC Industrial's cyclicality (worries that are harder to dismiss given the company's relative performance) means that investors can still take advantage of an undervalued stock.

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MSC Industrial Comes Through In A Tough Quarter

Seeking Alpha: Even With The Debt, WESCO Is Interesting

I'm well aware that not everyone uses discounted cash flow to analyze and value stocks, and that's perfectly fine. Not only is there no such thing as "one right way", but using different methods in tandem can tell you some interesting things about a stock. Along those lines, WESCO (WCC) looks like a pretty interesting value if you compare its EV/EBITDA multiple to other distributors and perhaps even cheap if you go with a PEG-based approach.

The problem I have with earnings/PE approaches, though, is that I happen to think that debt matters. And WESCO has a lot of that. So I'm torn - WESCO has more than enough cash flow and operating income to cover its interest expense and debt service, and the company's debt load is not likely to undermine its leverage to a rebound in commercial construction or utility spending. Given that Wall Street often just ignores debt when there is revenue growth and margin leverage to focus on, I'm not going to rule out the possibility of further gains in WESCO's share price, even though netting out the debt would normally generate an uninspiring fair value target.

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Even With The Debt, WESCO Is Interesting

Seeking Alpha: HD Supply An Expensive Play On Construction And MRO

Admittedly, I have a thing for the industrial/MRO distribution sector - I own MSC Industrial (MSM) and follow others like Fastenal (FAST), Grainger (GWW), and WESCO (WCC) pretty closely. Although it's a very competitive space with a strong cyclical component, it's a fragmented market where companies with a good business plan (e.g. MSC Industrial and Fastenal) can really make a name for themselves.

Into this mix comes one of the bigger dogs in the yard - HD Supply (HDS). Once part of Home Depot (HD) and then sold to private equity, HD Supply has already enjoyed a pretty good post-IPO run, rising about one-third since its debut. Although I do appreciate the leverage that HD Supply offers to a U.S. construction rebound, not to mention margin improvement and consolidation potential, I think the multiple today is demanding unless you are really bullish on the company's growth plans and the recovery potential of the U.S. construction market.

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HD Supply An Expensive Play On Construction And MRO

Seeking Alpha: Weak Metalworking Corroding MSC Industrial's Growth

When I last wrote on MSC Industrial (MSM) about a month ago, I suggested that the solid average daily sales growth being reported by Grainger (GWW) and Fastenal (FAST) on a monthly basis was threatening to put the company in the penalty box with some investors. See, the challenge for MSC Industrial has long been in proving that it's more than a cyclical industrial supplier and that it can grow consistently, albeit even if not on the same level as Fastenal.

Unfortunately for investors, MSC Industrial's fiscal third quarter earnings were decidedly mediocre in that respect. Although the company did as it said it would in terms of revenue and exceeded its own guidance for operating efficiency, the relatively weak daily growth highlights the challenges of the company's focus on the metalworking industry and puts even more pressure on management to exploit the BNDA acquisition for all its worth in terms of broadening its addressed markets.

The question for investors now is one of time horizon and patience. I do believe the company is making considerable investments today that will underpin above-average growth in the coming years (likely starting around the second half of 2014). I likewise believe that U.S. manufacturing (and particularly metalworking businesses) can and will recover in 2014. So while I continue to find MSC Industrial undervalued on a long-term basis, the exposure to the clearly underperforming metalworking industry could make it harder for these shares to outperform in the meantime.

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Weak Metalworking Corroding MSC Industrial's Growth