Ensemble Capital Client Call Transcript: Fastenal Co. Update

15 July 2019 | by Ensemble Capital

We recently hosted our quarterly client conference call. You can read a full transcript HERE.

Below is an excerpt from the call discussing our investment in Fastenal Co. (FAST)

Excerpt (Todd Wenning speaking):

Fastenal is a company that most people have never heard of, yet it touches nearly everything we see around us.

Fastenal specializes in the curation, management, and logistics of moving billions of low value parts like nuts, bolts, screws, rivets (collectively known as fasteners) and other products from their point of origin around the world to their destination at or near the factory floor in a timely and cost-effective manner.

Fastenal’s customers are manufacturers of end products we use every day, like cars, airplanes, furniture, appliances, electronics and so on.

While each of the parts Fastenal moves is low value, their role is essential in the manufacturing of high value products and the health of the manufacturers’ operations. Delays in their supplies or having the wrong type of fastener in inventory can mean millions of dollars in costs for the manufacturers in the form of slowdowns, shutdowns, or poor product quality, safety, and recalls.

Fastenal’s business is focused on making sure its customers have the right parts at the right time in the right place. If you’re missing one type of screw on a $10K or $100MM machine, you’re not shipping the product out today. At the same time having too many parts laying around can be costly and wasteful. Fastenal’s role is to provide the mission-critical but low value products efficiently and reliably to their customers’ factories.

Fastenal’s services therefore cater to customers who value its ability to deliver both reliably and cost effectively because it aggregates the demand of its customers to extract higher volume discounts from suppliers. As a result, customers see compounded savings across their procurement chain.

In many cases, Fastenal is so deeply tied into customers’ operations that it manages the real-time stock of inventory for their plants and takes on the burden of inventory costs on their behalf, helping them not only run their plants smoothly but also in managing their working capital more efficiently.

Over time, Fastenal has also expanded on the types of materials it provides on the factory floor beyond fasteners to include things like safety goggles, tools, metal suppliers, janitorial supplies, and other consumables that have similar distribution benefits and leverage Fastenal’s expertise and infrastructure. And in fact, these other materials now account for most of its revenue with traditional fasteners accounting for less than 40%.

In return customers have rewarded Fastenal with a healthy premium above the cost of supplied parts, which is what’s driven the 20% return on invested capital that’s underpinned the stock’s return over time. Since it went public in 1987, Fastenal’s stock has returned a compounded 23% per year.

While most people have never heard of the company, Wall Street certainly has. In 2012, BusinessWeek ran a story highlighting the fact that in the prior 25 years since the crash of 1987, Fastenal had appreciated by 38,600% making it the best performing stock during that time period. But it wasn’t just great fundamental performance that had driven the returns, there was also the fact that in 2012 the stock was trading near its all time high valuation, with a PE ratio of 37.

We took note of the company at that time but passed due to the valuation. Since then, the company has continued to execute very well, doubling earnings. However, from the time of the BusinessWeek article to our first purchases of the stock last summer, the stock only returned 40% (or 5% per year) while the S&P 500 returned 140% (or 15% per year). With rising earnings and a lagging stock price, we ended up being able to buy the stock last year at one of its lowest ever valuations, setting up what we hope will be a return to strong outperformance.

Fastenal’s growth is heavily tied to North American manufacturing growth, where its customers predominantly operate. It also grows by increasing its share of spend penetration by winning over more customer plants and selling adjacent consumables for the factory or its workers to keep the plants running smoothly. This also further entrenches Fastenal with its national accounts by getting even deeper into customers’ operations with tens of thousands of vending machines it directly manages in factories and hundreds of dedicated on-site stores within them. All of these bring Fastenal closer to its customers and deepens and expands its relationships, making Fastenal hard to displace.

Over the past decade, Fastenal has grown revenue by about 9% per year, with several points of that growth coming from market share gains. With only $5B in revenue in 2018, Fastenal still has a long growth runway available to continue increasing its share of a very fragmented market, estimated to be about $140B in the US alone.

 

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