Updated on February 8th, 2019 by Bob Ciura
The Dividend Aristocrats are a group of 57 companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
We review each of the 57 Dividend Aristocrats once per year. Next up is W.W. Grainger (GWW).
Grainger has increased its dividend for 47 years in a row, including a 6% increase in 2018. Today, the company’s dividend has all the characteristics of a safe income stream for conservative, long-term investors:
Grainger has struggled in the recent past, due to intensifying competition. This has led to price deflation, and lower profit margins.
However, the company has a long history of growth. It 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 pricing environment.
This article will discuss why long-term investors should stick with Grainger for its dividend growth.
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.
Grainger has 3 million business and institutional customers worldwide. The majority of customers are large U.S. businesses.
The company generates annual sales above $10 billion. Over half of revenue is derived from the U.S., but Grainger also has operations in Japan, the U.K., Mexico, and Germany. Grainger operates 700+ branches and 30+ distribution centers in North America.
Source: Investor Presentation
This is a difficult time for Grainger. Competition is heating up in the MRO supply industry. This has caused pricing deflation in the company’s core businesses.
The good news is, Grainger has actively competed on price, and in e-commerce. This has eroded profitability, but volumes are increasing, and Grainger is capturing market share.
The company’s willingness to adapt to a new environment, has helped it secure its competitive position. It has returned to growth, and has a promising future ahead.
W.W. Grainger reported its fourth quarter and full year earnings results on January 24. Fourth-quarter revenue of $2.76 billion increased 5% compared to the prior year’s quarter. Grainger’s revenue growth was driven by a 7% volume increase. Its U.S. operations were able to an achieve above-average revenue growth rate of 6%.
Grainger’s strategic shift – the company aims to sell higher volumes through reduced prices – has impacted its fourth quarter results, as average selling prices declined, which has resulted in a below-average gross profit growth rate.
Source: Investor Presentation
However, the company managed to lower its operating expenses compared to the prior year’s quarter, which allowed it to grow its operating profits by 12% year over year. Grainger’s earnings-per-share growth rate was quite outsized, at 35% during the fourth quarter to $3.96, but this included the one-time impact of a lower tax rate. Investors should not expect this growth rate to last.
Grainger’s guidance for 2019 looks promising, as management forecasts a net sales growth rate of 4% to 8.5%, with earnings-per-share seen in a range of $17.10 to $18.70. At the midpoint of the guidance range, $17.90, Grainger would grow its earnings-per-share by 7.2%.
This is a much slower growth rate than what Grainger has achieved during 2018, but that was expected, as the one-time impact of a lower tax rate has been lapped.
Another growth catalyst is e-commerce. It has various e-commerce platforms, including MonotaRO in Japan, and Zoro in the United States.
Source: Investor Presentation
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 grew its earnings-per-share by 13.7% annually between 2009 and 2018, but this included the impact of the recovery from the financial crisis. Between 2008 and 2018 the earnings-per-share growth rate averaged 10.6%. Backing out the positive one-time impact of a lower tax rate that led to outsized earnings-per-share growth during 2018, the average growth rate declines further.
Grainger’s strategic shift of lowering its pricing, thereby creating higher demand and growing its revenues, seems to have worked well during the most recent quarter, as operating profits grew at an attractive pace.
We believe that growth will moderate somewhat, but Grainger should nevertheless be able to grow its sales as well as its profits further throughout the next couple of years.
Competitive Advantages & Recession Performance
Grainger’s first 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.
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.
Another competitive advantage is scale. Grainger kept operating expenses flat in the U.S. last quarter, despite strong volume growth. This demonstrates leverage and supply-chain efficiency.
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. The company continued to grow after 2010. This indicates a high-quality business model that can withstand recession relatively well.
Valuation & Expected Returns
Based on Grainger’s expected earnings-per-share of $17.90 for 2019, the stock has a price-to-earnings ratio of 16.8. This is below the average 10-year price-to-earnings ratio, which is 18.5.
A breakdown of Grainger’s historical stock valuations can be seen in the table below:
Note: Grainger’s stock price moved since data from the table was collected. The company’s price-to-earnings ratio using expected 2019 earnings-per-share of $17.90 was 16.8 at the time of writing this article.
Our fair value estimate for Grainger is a price-to-earnings ratio of 18.0, which means the stock appears to be undervalued today. Expansion of the valuation multiple to the fair value estimate could yield annual returns of 1.4%. In addition, shareholder returns will be boosted by future earnings growth and dividends.
We expect Grainger to grow its annual earnings-per-share by 7% per year, primarily through revenue growth, modest margin expansion, and share repurchases. The stock also has a current dividend yield of 1.8%. Putting it all together, we expect annual returns of just over 10% per year through 2024.
This is a benefit of investing in highly profitable companies like Grainger; they can continue to grow earnings and pay dividends, even during difficult operating climates.
Grainger is a company managed for the long-term. It has encountered difficulties in recent years, but it has gone through many ups and downs in its history.
These challenges have not stopped Grainger from raising its dividend for more than 40 years. The company still has a profitable business and multiple catalysts for future growth.
The stock appears to be slightly undervalued, with a solid dividend and annual dividend increases. We rate the stock a buy for long-term dividend growth investors.