During our first quarter portfolio update, we profiled portfolio holding Fastenal (FAST). Below is a replay of our live commentary on the company from our quarterly portfolio update webinar and an excerpt from our QUARTERLY LETTER.

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Fastenal is a supplies distribution service business for industrial manufacturing, non-residential, and other companies in the US. They make it possible to economically and efficiently move lots of daily consumable, high volume products used by employees, manufacturing facilities, and construction sites across vast distances from Asia to the US and from coast to coast.

These include heavy, low value parts like $0.02 screws and rivets (ie, the original “fasteners” business) to supplies employees use to get their jobs done like gloves, masks, safety goggles, and janitorial supplies. Its network of 2,000 free-standing company stores dotted across the country, nearly 1,300 dedicated mini-“stores” on-site at customer factories, and 100,000 vending machines at customer facilities create a vast embedded distribution network that physically maintain the company’s relationship with its customers on a daily basis as a critical and integral part of their manufacturing operations.

In effect, a partnership with Fastenal ensures that the supplies needed by customers, are stocked on a timely and capital efficient basis. And in order to do that job well, Fastenal has to ensure it can be a reliable, efficient, (and what’s now become very clear in the past year), and agile procurement and inventory management partner to its customers.

That is at the heart of its value proposition; that it can get supplies customers need to keep their factories running and employees productive every day without missing a beat, at a cost that is significantly lower than the customer can do in-house while sourcing from a broad and reliable global supplier base.

If the materials needed by factories and their employees to build things aren’t sufficiently stocked in the right distribution outlet, then work stops. This is obviously very disruptive and costly for the customer and would undo the customer’s trust in the Fastenal partnership. Of course, the key to building and delivering on the promise of such an entrusted relationship are the employees that comprise the company’s daily operations and interactions with customers, whom Fastenal constantly talks about and celebrates to show its value and commitment towards them. This is also demonstrated by the importance it places on employee safety, development, decentralized decision making, and internal promotion and compensation policies.

That combination of dedication to its customers’ mission-critical operational needs, empowering its employees, and sourcing and working with a distributed base of quality suppliers around the world has resulted in a business that has grown above industry growth rates and generated durable returns on capital for shareholders over decades.

One thing the pandemic did in the past year was test not just people’s resilience around the world, but also that of companies providing essential products and services. From the start, it tested the distributed global supply chain, especially as it relates to safety supplies like disinfectants, masks, wipes, etc. Every company has been challenged to restructure its safety and health practices to ensure the safety of its employees and customers. A big part of this challenge has been to procure supplies needed to meet these goals to safely continue operations. Fastenal’s globally distributed workforce was able to adapt very quickly to source and deliver needed supplies to both existing customers and many new customers, even in less traditional segments of the company’s business like healthcare, government, and education. In many ways, the pandemic, in retrospect, highlighted and tested Fastenal’s expertise and value proposition – and the company and its employees came through with flying colors. While its normal operations supplies business was obviously disrupted in 2020, its safety supplies business thrived and brought in new customers in new market segments to boot.

It’s instructive to see how Fastenal was able to procure safety supplies to accommodate such a huge spike in growth of over 100% in the second quarter of 2020 when everyone else was also scrambling to source materials in short supply. In its latest annual report, the company published an interesting chart that really speaks to its sourcing agility, scale, and expertise: while 80% of safety supplies were provided by existing primary suppliers in 2019, they only accounted for 40% of the total in 2020. Since safety supplies sales grew 50% y/y in 2020, Fastenal was not only able to source new suppliers for the incremental growth but also backfill shortfalls its primary suppliers had during the year.

That resulted in a year of sales that was actually better overall than the average “benchmark” year, despite disruptions in its main line of work for industrial customers whose factories were shut down or disrupted during the year.

Also interesting is that Fastenal has been able to continue to grow faster than the industrial market over the past decade, probably the most challenging for the industry in recent times. US industrial production has basically been in a recession since the 2009 Great Financial Crisis, having barely grown since its last peak in 2007.

Yet Fastenal grew its revenues 2.6 times from $2 billion to $5.3 billion while maintaining operating margins of roughly 20% and returns on invested capital in the mid 20%. This comes from a combination of growing its customer base, expanding beyond its traditional industrial companies, and increasing the value it provides customers by deepening its relationships and value-added procurement services (onsite stores and factory placed vending machines and bin stocking technologies) thereby taking greater share of customers’ cost wallet. Yet, $5 billion is still a small share of the $100+ billion sourcing opportunity available ahead to grow into for decades to come.

Looking forward, the industrial economy looks poised to accelerate. The combination of unprecedented direct stimulus to consumers, untapped cash in the form of an atypically high savings rate over the last year, a strong pick up in GDP growth, strong growth in the housing economy, and strategic reshoring of manufacturing all could serve to accelerate the industrial economy from its decade long torpor. That would be a big tailwind to Fastenal’s base of existing businesses, even as it continues to grow its share of customers.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

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