Updated on February 26th, 2021 by Bob Ciura
Every year, we individually review each of the 65 Dividend Aristocrats. The Dividend Aristocrat we’ll be discussing here is W.W. Grainger, Inc. (GWW).
Grainger has increased its dividend for over 40 years in a row. It is a Dividend Aristocrat, a group of stocks in the S&P 500 Index, with 25+ consecutive years of dividend increases.
You can see our full list of all 65 Dividend Aristocrats, along with important metrics like dividend yields and P/E ratios, by clicking on the link below:
As a manufacturer of industrial products, Grainger’s financial health is tied closely to the broader economy. The company faced a significant challenge last year, as the coronavirus pandemic had a significant impact on global economic growth.
However, the company has a leading position in its core markets, and is investing in new growth initiatives. It has deployed multiple initiatives to continue growing through the difficult environment.
This article will discuss Grainger’s business, growth potential and valuation.
Grainger was founded in 1927. Today, it is a large supplier of maintenance, operating, and repair products, or “MRO” for short. These are products like safety gloves, power tools, ladders, test instruments, and motors. It also offers services such as inventory management. Sales span a wide range of both customers and categories, without a reliance on any one industry in particular.
The company generates annual sales above $11 billion. You can see an overview of Grainger’s business in the image below:
Source: Investor Presentation
Grainger reported its fourth-quarter earnings results on February 3rd, 2020. For the quarter, revenue equaled $2.941 billion, representing a 3.3% increase compared to Q4 2019. Gains were driven by market share gains in the U.S. segment and continued growth in the endless assortment businesses. Adjusted net income equaled $197 million or $3.66 per share, compared to $212 million or $3.88 per share in Q4 2019.
For the year, Grainger reported sales of $11.797 billion, a 2.7% increase compared to 2019. Adjusted net income equaled $877 million or $16.18 per share compared to $17.29 in 2019.
Due to the COVID-19 pandemic Grainger is not providing 2021 guidance at this time. In addition, the company said that it will be changing its reportable segments to High-Touch North America and Endless Assortment beginning this year.
Grainger successfully grew revenue in the fourth quarter and the full year, an impressive feat on its own given the challenge of the coronavirus pandemic. Earnings-per-share declined as the company absorbed higher costs, but we expect revenue and earnings-per-share to grow in 2021 and beyond, assuming normalization of the global economy.
Grainger lays out a number of growth initiatives in the U.S., as a mix between between “foundational” and “incremental” initiatives. In other words, between what the company is already doing to keep market share and what it can do to make further gains.
The company sees multiple avenues to generate future growth, a few of which are detailed in the image below:
Source: Investor Presentation
Grainger will also benefit from the fact that it operates in a large and fragmented market. The company sees the total U.S. business-to-business supply market as a $1.2 trillion market, of which it captures only roughly 7% right now. Grainger sees its addressable U.S. market at roughly $135 billion, with another $225 billion in addressable market opportunity in the international markets.
Therefore, the company sees a large and untapped market opportunity to fuel its long-term growth. Another growth catalyst for Grainger is e-commerce. It has various e-commerce platforms, including MonotaRO in Japan, and Zoro in the United States.
Along with internal investments, Grainger has ramped up its digital platform heavily in recent years. All of these catalysts are likely to help Grainger return to earnings growth over the long-term.
Grainger’s revenue is growing, margins are improving over time and share repurchases will continue to boost earnings-per-share growth over the long term. We are forecasting 6% earnings-per-share growth over the next five years.
Competitive Advantages & Recession Performance
Grainger’s competitive advantage is its vast distribution network. It has the ability to offer services such as next-day ground delivery, which help it retain its competitive position. In addition, the scale of the business allows it to competitively price its products.
Grainger is not active in a high-tech industry, but the services that the company provides are essential for other businesses. This makes Grainger’s business relatively resilient during recessions, providing it with the ability to continue raising its dividend each year.
These competitive advantages helped Grainger stay highly profitable during the Great Recession. Earnings-per-share during the economic downturn are as follows:
- 2007 earnings-per-share of $4.94
- 2008 earnings-per-share of $6.09 (23% increase)
- 2009 earnings-per-share of $5.25 (-14% decline)
- 2010 earnings-per-share of $6.81 (30% increase)
Grainger only had one year of earnings decline during the Great Recession, in-between two very strong years. Moreover, the company continued to grow after 2010. This indicates a high-quality business model that can withstand recessions relatively well.
Grainger continued to generate strong profitability in 2020, despite the coronavirus pandemic weighing on the global economy.
Valuation & Expected Returns
Based on expected earnings-per-share of $18.50 for 2021, and a current share price of ~$380, the stock has a price-to-earnings ratio of 20.5.
While shares have traded hands with an average P/E ratio of 19 during the last decade, this was when the company was growing at a much faster pace. Taking a more conservative view, using 17 times earnings as a fair value baseline, implies the potential for a -3.7% annual valuation headwind.
Weighing this potential decline in valuation multiple against a 6% earnings growth rate and the 1.6% dividend yield, investors might anticipate a total expected return of 3.9% per year.
W.W. Grainger is a company managed for the long-term. It has encountered difficulties as of late, but the business continues to persevere, just as it has done for decades. Moreover, the company remains profitable in good times or bad and has an exceptional record of not only paying but also increasing its dividend for 49 straight years. With one more yearly increase, the company could join the even more exclusive list of Dividend Kings.
While the business strength and potential growth are enviable, the dividend yield and the valuation are not particularly compelling at this time. As such, we view Grainger as a solid business with an average total return potential over the intermediate-term, making the stock a hold and not a buy right now.