Grainger’s Skid Intensifies Earnings Jitters

(Bloomberg Opinion) -- The third quarter was W.W. Grainger Inc.’s chance to prove all the haters wrong. It didn’t deliver.

The distributor of factory-floor basics fell as much as 16 percent on Tuesday morning after reporting third-quarter revenue and gross margin numbers that fell short of analysts’ estimates. It’s the first real verdict on the effectiveness of the draconian price cuts Grainger rolled out last year amid mounting competition from Amazon.com Inc. in the business-to-business marketplace. Grainger had been enjoying outsize sales growth on the back of those cuts, but now it’s lapping tougher comparisons. Revenue increased 7.4 percent in the third quarter; analysts were looking for more like 8 percent growth, which in itself would be a step down from the second quarter.

Grainger’s Skid Intensifies Earnings Jitters

Grainger’s shortfall will add to concerns that we are nearing a peak for industrial earnings as the trade war accelerates an increase in costs and a forced recalibration of supply chains threatens demand dynamics. The company’s report follows a disappointing showing last week for rival Fastenal Co., whose gross margin also fell short of estimates. Grainger said about 20 percent of its U.S. segment is directly sourced from China. The company’s claim that tariff exposure is well-understood and effectively managed contrasts with Fastenal CEO Daniel Florness’s more-believable acknowledgement that price-cost dynamics will be hard to predict in this environment.

On a more company-specific level, Grainger’s revenue miss raises the question of whether it will need to make additional price cuts to meet its volume growth targets. Recall that CEO DG Macpherson was already wishy-washy on Grainger’s goals earlier this year, indicating the 6 percent to 8 percent volume growth the company had previously implied was its 2019 target was actually a collective goal for 2018 and 2019. 

After backing out the impact from currency swings and hurricanes, Grainger’s sales growth still trailed the 13 percent net boost at rival Fastenal. Grainger lacks the kind of service infrastructure and difficult-to-replicate products that help insulate Fastenal from Amazon’s encroachment, so its pain points are more structural. RBC analyst Deane Dray has noted that while Grainger’s products are more competitive after the price cuts, they’re still not the cheapest.

Amazon, meanwhile, is showing no signs of slowing down: In September, the company said its Amazon Business platform hit an annualized rate of $10 billion in global sales. Notably, that includes revenue in the U.K., where Amazon launched a business-to-business offering in 2017. Amazon doesn’t break out specific numbers for the region. But Grainger took a $139 million non-cash impairment charge in the third quarter related to its Cromwell U.K. business to reflect a slower growth trajectory and structural issues including prolonged Brexit uncertainty. I can’t think the extra competition helped anything.

Grainger’s Skid Intensifies Earnings Jitters

Grainger didn’t provide an explicit update to its financial guidance for the full year in either its press release or slide-deck presentation. That is the first time since at least 2013 that the company hasn’t made mention of its annual guidance in an earnings release, even if it’s just a reiteration. The omission isn’t a good sign. For the record, the company in July had forecast sales growth of 5.5 percent to 8.5 percent and a gross margin decline between 50 basis points and 20 basis points after normalizing for revenue recognition accounting changes.

Whether or not management backtracks on these estimates, the earnings jitters are already here.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.

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