Grainger Beats, Raises Outlook

Zacks

W.W. Grainger Inc. (NYSE:GWW - News) reported net earnings of $170 million in the second quarter of 2011,up 32% from $129 million in the year-ago quarter.

Earnings per share (NYSEArca:EPS - News) increased 35% year over year to $2.34 from $1.73 in 2010.

Reported earnings in the quarter included a benefit of 12 cents per share related to the settlement of tax examinations related to 2007 and 2008, compared with the benefit of 8 cents per share from changes to the company's paid time off policy realized in the prior-year quarter.

Excluding the special items, EPS in the reported quarter stood at $2.22, versus $1.65 in the comparable quarter last year. It also exceeded the Zacks Consensus Estimate of $2.11 per share.

Revenues in the quarter were $2.0 billion, up 12.3% from $1.78 billion in the year-ago period, which was higher than the Zacks Consensus Estimate of $1.97 billion. On a daily basis, sales increased 14% year over year in April, 11% year over year in May and 12% year over year in June.

The improvement in revenue was attributed to volume growth and favorable pricing coupled with favorable foreign exchange rates and acquisitions, partly offset by negative impacts from the oil spill cleanup in the Gulf of Mexico in 2010.

Operating earnings in the quarter improved 23% to $265.3 million from $214.9 million last year, primarily driven by higher gross profit margins. Gross profit rose 15.4% to $862.4 million from $747.1 million a year ago.

Segment Performance            

Revenues from the United States segment increased 9% year over year to $1,625.8 million, driven by favorable volume and price growth, partially offset by negative impacts from the oil spill in the Gulf. On a daily basis, sales increased 10% in April, followed by 8% growth in both May and June.

Operating income for the segment shot up 17% to $270.6 million, mainly due to higher sales and improved gross profit margins from the region.

Revenues from the Acklands-Grainger business in Canada climbed 24% to $256.9 million, which was attributable to the improvements in the oil and gas, heavy manufacturing, retail/wholesale, and agriculture and mining customer end-markets. On a daily basis, sales in the segment increased 16% in April, 15% in May and 17% in June (in local currency).

Operating income in Canada expanded significantly to $29.3 million as a result of strong sales and improvement in gross margins and operating expenses.

Revenues from the Other businesses (which include Japan, Mexico, India, Puerto Rico, China and Panama) were up 49% year over year to $135.6 million, based on strong growth in Japanese, Mexican and Colombian businesses.

Operating earnings also rose significantly to $8.6 million as compared with $1.9 million in the year-ago quarter, primarily driven by strong earnings growth in Japan and Mexico, coupled with lower operating losses in China.

Financial Position

Grainger had cash and cash equivalents of 465.7 million and long-term debt of $200.5 million, as of June 30, 2011. That compares with a cash balance of $388.1 million and long-term debt of $412.7 million, as of June 30, 2010.

The company generated net cash from operating activities of $309.5 million in the first six months of the year, up from $286.3 million in the year-ago period. Capital expenditures for the quarter were $52 million versus $14 million in the prior-year period. Grainger did not repurchase any shares in the quarter although it has approximately 7.7 million shares remaining under its current repurchase authorization. However, the company paid total dividends of $47 million during the quarter.

Outlook

Grainger increased both its sales and earnings estimates for the full year. The company now expects sales growth in the range of 9% to 10% compared with the prior guidance range of 7% to 10%. The company forecasts fiscal 2011 EPS between $8.40 and $8.70 versus its prior expected range of $8.10 to $8.60.

Our Take

Grainger remains focused on expanding its product offering as well as its private label products. The company introduced a multi-year product line expansion program in 2006. Since then, the company has launched approximately 234,000 new products. Grainger expects to roll out almost 500,000 products over a number of years. The continued success of this program is expected to drive sales growth in 2011 and beyond. 

The company’s balance sheet remains strong and, given its strong cash position, we believe the company will further invest in growth opportunities, increase dividends and reinvest capital through share repurchases.

However, Grainger’s recent sales reflect a weakening government end market, which account for 20% of its sales. Considering the financially constrained position of the government and tight budgets, we believe this issue will continue to be an overhang on revenues going forward. Another concern is the seasonal pattern of its gross margins.

Furthermore, increasing competition in the industry may also restrict its progress and the desired business growth. The company’s key competitors include TMS International Corp. (NYSE:TMS - News), Harsco Corporation (NYSE:HSC - News) and ScanSource, Inc. (NasdaqGS:SCSC - News).

Thus, keeping these in mind, shares of W.W. Grainger are maintaining a Zacks #3 Rank, which translates into a short-term Hold rating. The stock also has a Neutral recommendation for the long term.

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