(GWW) W.W. Grainger Still Neutral

W.W. Grainger Inc.’s (GWW) fiscal first quarter 2011 EPS was a record $2.18, up 58% year over year, while revenues climbed 12.6%, both outperforming the relevant Zacks Consensus Estimates. Results were driven by expanding product lines, investments in eCommerce, and enhancement of sales force.

However, given moderating margin expansion, tougher comparisons from the sale of oil spill clean-up products last year and weakness in government end-markets, we maintain our Neutral recommendation. We currently have a Zacks #3 Rank (short-term Hold recommendation) on the stock.

Based on the upbeat first quarter results, Grainger upped its fiscal 2011 guidance, which it had declared at its analyst meet in November. The company now expects sales growth in the range of 7% to 10% compared with the prior guidance range of 5% to 9%. The company forecasts fiscal 2011 EPS to range between $8.10 and $8.60 in place of its prior expected range of $7.15 to $7.90.

Grainger remains focused on expanding its product offering and growing the share of its private label products. It launched a multi-year product line expansion program in 2006 and has since added approximately 234,000 new products. Grainger’s most recent catalog offers around 350,000 products.

Grainger has a long-term vision to expand the count to 500,000 products. The continued success of this program is expected to drive sales growth in 2011 and beyond. Moreover, Grainger is focused on growing the share of its private label products, which carry higher margins than the national branded products.

Grainger maintains a certain level of debt ratio and liquidity that provides flexibility in funding working capital needs and meeting long-term cash requirements. As of March 31, 2011, its debt-to-capitalization ratio remained low at 17.0%, compared with 17.9% as of December 31, 2010 and 18.0% as of March 31, 2010. This enables Grainger to further invest in growth opportunities, increase dividends and reinvest capital through share repurchases.

Fiscal 2011 marks the 40th consecutive year of increased dividends. The company has approximately 7.7 million shares remaining under the current repurchase authorization. We also expect Grainger to continue to use its strong balance sheet to make strategic, accretive acquisitions both in the U.S. and internationally.

E-commerce is one of Grainger’s most efficient channels both in terms of market growth and profitability. Grainger continues to invest in e-commerce tempting customers to utilize more of this channel and thus increasing the percentage of overall sales. With the e-commerce business constituting 25% of its overall business, there is ample room for growth.

On the flipside, we are disappointed with the slowdown in its recent monthly sales. Grainger recently reported May sales growth of 11%, a drop from the 14% rise in April sales.

May was the first month in 2011 to face tougher year-over-year comparisons emanating from elevated sales, related to the Gulf of Mexico oil spill, in 2010. We are thus anticipating moderation in sales growth in the upcoming quarter as well as the year, with comparisons getting tougher.

Further, we expect some moderation in gross margin expansion over the balance of the year due to a large customer mix and modest price erosion.

The 360-basis point operating margin expansion witnessed in the first quarter is unlikely to recur in the remainder of the year due to several headwinds — tougher sales comparisons due to the Gulf of Mexico oil spill starting in the second quarter, increased investment spending, moderation in gross margin expansion, not having any more additional selling days versus the prior year as in the first quarter and expenses from SAP in Canada. Given these factors, we expect a moderation in margin expansion in the upcoming quarters.

Further, Grainger’s recent sales reflect a weakening in its government end-markets. Given that Grainger derives approximately 20% of its sales from government customers, considering the government’s financially constrained position and tight budgets, we believe this segment will continue to be a drag on revenues in the coming year as well.

Based in Lake Forest, Illinois, Grainger is a distributor of facilities maintenance and other related products and services. The company  competes with Applied Industrial Technologies Inc. (AIT) and WESCO International Inc. (WCC).

APPLD INDL TECH (AIT): Free Stock Analysis Report

GRAINGER W W (GWW): Free Stock Analysis Report

WESCO INTL INC (WCC): Free Stock Analysis Report

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