A Different Model Has Made A Difference For Lawson Products

Nearly four years ago, I was cautious (if not outright skeptical) about the prospects for Lawson Products (NASDAQ:LAWS) leveraging a change in its operating model to drive meaningfully better operating results. Management has delivered, though, with gross margins up more than three points, operating margins in the black, free cash flow in the black, and the company well-positioned in its core service-driven MRO space.

The market has noticed, with Lawson shares significantly outperforming MSC Industrial (NYSE:MSM), W.W. Grainger (NYSE:GWW), and Fastenal (NASDAQ:FAST) since that last report on Lawson, though it took about a year or so for the Street to come around to the positive implications of Lawson's changes. While the shares don't look radically undervalued today, there are still above-average growth opportunities for Lawson to pursue and the company is not well-covered nor over-owned by institutions. What's more, Lawson should be relatively well-placed to benefit from improvements in industrial production in the U.S., should those take place.

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A Different Model Has Made A Difference For Lawson Products

MSC Industrial Paddling Hard Just To Stay In Place

I was cautious on MSC Industrial (NYSE:MSM) a quarter ago, and the stock's slightly negative performance since then (down about 1%) is better than I'd expected - not to mention better than what other distributors like Grainger (NYSE:GWW), Fastenal (NASDAQ:FAST), and Lawson (NASDAQ:LAWS) have managed over the same time.

And yet, the operating environment remains severely challenged - the metalworking index remains in contraction, industrial production is soft, and MSC's core heavy manufacturing sector is still struggling, not to mention ongoing pressure on industrial distributors as a group.

While MSC Industrial did get a bump after fiscal fourth quarter earnings, I think a lot of that was relief and the shares look more or less fairly priced right now. I'm still looking for mid single-digit revenue growth and high single-digit FCF growth, and I do expect an eventual recovery in manufacturing and industrial MRO demand, but I still also believe that distributors are looking at a more challenging future.

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MSC Industrial Paddling Hard Just To Stay In Place

Seeking Alpha: MSC Industrial Suffering From Weakening Markets And Execution Issues

I have been a shareholder of MSC Industrial (NYSE:MSM) for a long time, and with that comes the risk of papering over problems and telling myself "oh, it's not that bad" in the interest of holding on to a position that has done pretty well for me. To be sure, I still think that MSC Industrial has a lot of potential - I think the company's combination of e-commerce, vending, catalog, and vendor-managed inventory channels can drive meaningful share gains in what is still a fragmented (but essential) industrial wholesaling market.

The problem is that management's recent execution has not been sharp and the company may be in the midst of a one-two punch of self-inflicted disappointment and weakening core markets. I still believe that MSC Industrial can outgrow the industrial MRO market and generate mid-single digit revenue growth (and double-digit FCF growth), supporting a low-to-mid $80's fair value. I also acknowledge, though, that this stock may have further to fall before hitting bottom and investors looking here for value today may want to think carefully about what the next few quarters could look like.

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MSC Industrial Suffering From Weakening Markets And Execution Issues

Seeking Alpha: MSC Industrial Slowly Coiling The Spring

As I have written previously, I had no particular expectations that fiscal 2014 was going to be an excellent growth year for MSC Industrial (MSM). Not only is the company dealing with the same sluggishness in the industrial sector that has been showing up in the results at Grainger (GWW) and Fastenal (FAST), but the company has committed to making a series of investments this year that are designed to drive and support growth in future years.

I continue to believe that MSC is a good stock to buy during this "reloading" phase. Management here is consistently conservative in its outlook/communications and its approach to the business - running the business for long-term success and not to please the Street's short-term growth obsessions. I also believe that the Street overestimates the potential impact of Amazon (AMZN), Fastenal, and Grainger encroaching on MSC Industrial's turf, while underestimating the company's ability to leverage the BDNA deal into significant cross-selling and entries into new markets.

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MSC Industrial Slowly Coiling The Spring

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

Investopedia: Slowing Sales At Fastenal Not Denting Investor Enthusiasm ... Yet

It's an unfortunate reality of financial writing today that you can't express concern about a stock's valuation and/or investor expectations without reaping a whirlwind of angry readers claiming you hate the company (while in secret many are shorting the stock). Be that as it may, only a fool wouldn't appreciate the business that Fastenal (Nasdaq:FAST) has built in the industrial distribution market, but that doesn't mean that the shares are cheap – particularly with growth becoming more of a concern than at any time before in this latest post-recession recovery.

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Seeking Alpha: Lawson Products Toils Away In Obscurity

I would never say that the industrial maintenance, repair, and operations (MRO) space is wildly popular with investors, but analyst coverage for Grainger (GWW), Fastenal (FAST), Applied Industrial Technologies (AIT), and MSC Industrial (MSM) does at least stretch into the double-digits. By comparison, Lawson Products (LAWS) is barely covered at all.

It takes more than obscurity to make a bargain, though. To that end, I'm concerned about the long history of uninspired financial performance from Lawson, as well as a business model that appears to overlap with many better-positioned rivals without a true, strong core of specialization. On the other hand, management is relatively new here and the MRO market is still scattered enough to let a company like Lawson grow.

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Lawson Products Toils Away In Obscurity

Seeking Alpha: MSC Industrial Makes A Bold Bid For Scale

The North American MRO market is ripe for consolidation and MSC Industrial (MSM) has made it clear that it intends to be one of the consolidators. On Friday morning MSC Industrial announced a large transaction - an agreement to buy the North American distribution business of Barnes (B). This deal will not only add incremental revenue to MSC Industrial, but it also adds entire new lines of product distribution and customer categories.

The Deal To Be
Assuming that the deal goes through as planned, MSC Industrial will acquire the Barnes Distribution North America (BDNA) business of Barnes for $550 million in cash. MSC Industrial will pay for the deal with cash on hand and a credit facility/term loan that it later intends to refinance long term. All told, about $400 million of the purchase price will likely be borrowed at a long-term interest rate below 3%.

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MSC Industrial Makes A Bold Bid For Scale

Seeking Alpha: MSC Industrial - Good Growth, Great Returns, And Rich Valuation

Sooner or later, every investor will find a company that challenges his or her beliefs on the proper trade-off between quality and value. For me, that company is MSC Industrial Direct (NYSE: MSM). This industrial supply company has posted excellent growth over the past decade and boasts full-cycle returns that many far larger companies in less cyclical businesses never approach. While this company has ample potential to grow its footprint and top line, as well as expand those margins even further, today's valuation seems already predicated on those assumptions.

Carving A Niche In A Huge Market
Figuring out MSC Industrial's market potential is no easy task; my first job on the Street was with an analyst team that covered this company and that was a constant struggle. A good estimate, though, is probably in the $140 billion neighborhood – suggesting that MSC has less than 2% share.

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MSC Industrial - Good Growth, Great Returns And Rich Valuation