W.W. Grainger – Not Out of The Woods

GWW - W. W. Grainger, Inc.

In the industrial sector, W.W. Grainger ranks the highest within the Dividend Aristocrats. It highlights GWW as the best opportunity out of 10 industrial companies from the Dividend Aristocrats list,

GWW – Business Overview

W.W. Grainger, Inc., with 2016 sales of $10.1 billion, is North America’s leading broad line supplier of maintenance, repair and operating products (MRO), with operations also in Europe, Asia, and Latin America.

More than 3.2 million businesses and institutions worldwide rely on Grainger for products such as safety gloves, ladders, motors and janitorial supplies, along with services like inventory management and technical support. These customers represent a broad collection of industries including commercial, government, healthcare, and manufacturing.

GWW – Today’s Numbers

Ticker:NYSE:GWW
Stock:$162.58
P/E: 18.71
Annual Dividend:$5.12
Dividend Yield:3.15%
Payout Ratio:58.92%
Market Cap:9.46B
Sector:Industrials
Industry:Industrial Distribution
Technicals:Market Trend

GWW – Analysis Summary

There are 4 quantitative rules in the stock selection filtering I use to support my 7 Rules of Dividend Investing. As an investor, once you have mastered the Wealth Triangle, you must then master the Dividend Triangle and finally establish your Stock Selection Process.

The rules covered are outlined below as a summary of the reasoning followed by the company’s analysis for each rule.

Dividend RuleSustainability RuleAccounting RuleQuality Rule
Snapshot - PassSnapshot - FailSnapshot - FailSnapshot - Fail

 

Dividend Rule - Dividend Growth

Dividend growth is expected when a business makes money but since not all dividend growth is equal, we must establish thresholds that work for our investing goals. In the accumulation years, I aim for a 10% CAGR dividend growth and in the income years, 5% CAGR growth is acceptable. A dividend drop should be an immediate sell unless there are special circumstances out of control by management.
If you aren’t thinking about owning a stock for 10 years, don’t even think about owning it for 10 minutes.
– Warren Buffett

Sustainability Rule – Revenue Growth

A company without growing revenue cannot sustain paying back shareholders for too long. It’s normal to see variation from year to year but over a longer period of time, there should be growth.
It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.
– Warren Buffett

Accounting Rule - Payout Ratio Stability

The payout ratio validation over a 10-year period really highlights how the company’s bottom line can sustain the dividend it pays. Investors should be cautious when the payout ratio increases faster than the bottom line as growing revenue is not the source of dividend growth.
The secret of sound investment in 3 words; margin of safety.
– Benjamin Graham

Quality Rule - Business Quality

The business quality is an important factor to consider to ensure your investment is viable for the long term. A strong business that has been around for a long time and is expected to be around for a lot longer is a good business.
Know what you own, and know why you own it.
– Peter Lynch
Value Rule is a potential 5th qualitative rule you can add on your own. It’s not based on numbers as it requires a more intricate knowledge of the company, its business and the markets. Consider how many analysts are following companies and how many are wrong in predicting stock price movement. Not to mention how difficult it can be for some companies to have accurate forward guidance when you take into account currency exchange and world economies. I have opted to not predict entry level. I have done as good buying at the 52-week high.
Twenty years in this business convinces me that any normal person using the customary three percent of the brain can pick stocks just as well, if not better, than the average Wall Street expert.
– Peter Lynch

Dividend Rule – GWW Dividend Growth

As a Dividend Aristocrat with 25+ years of dividend growth, W. W. Grainger has established itself as a dividend grower. With that said, GWW is also a Dividend Ambassador with over 10% dividend growth over the past 10 years.

The dividend growth trend over the past 10 years is as follow:

  • 3-year: 10.40%
  • 5-year: 13.90%
  • 10-year: 15.84%

W. Grainger has a decent dividend yield of 3.12% (higher due to the current 52-week low).

GWW - Performance Numbers
Source: 2016 Annual Report

The current dividend yield and dividend growth for GWW meet the dividend rule requirements. The Chowder Rule score is 13.52% which is also above my 12% target.

Sustainability Rule – GWW Revenue Growth

While the dividend yield and growth is excellent, it’s important to make sure it can be sustained over time. The EPS trend is not very good from a growth perspective and it struggles to have growth.

  • 3-year: -4.21%
  • 5-year: 1.43%
  • 10-year: 8.59%

The hiccups come from the most recent years where the growth is down and it has driven the dividend payout ratio up above the trend.

Unfortunately, I would fail this rule since the decline in EPS is too pronounced and repeated over the past 2 years. There is clearly a challenge that needs to be overcome and investors have spoken by driving the stock price to 52-week lows.

GWW - Dividend vs EPS
Source: GWW Annual Reports

Accounting Rule – GWW Dividend Payout Ratio

Based on the graph above, a healthy payout should be below 40% to stay within the trend. With a 59% dividend payout ratio, GWW now pays out more than other Dividend Aristocrats industrial stocks where the average payout ratio is 51%.

It’s two data points that are not good. Above the historical trend and above the average peers. I can foresee a slower dividend growth which has been the trend when you look at the 3, 5 and 10-year dividend growth. I don’t believe growth is at risk but 10% growth may be too much if the top line doesn’t improve.

The S&P Global rating gives Hormel Foods an ‘A+’ rating which means:

Strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances

Moody’s Rating classifies GWW as an investment grade with an ‘A2’ rating. The balance sheet is strong considering banks and a minority of other companies receive a higher rating.

However, it’s not enough for the runaway payout ratio. To rein in the payout ratio, the company either needs to reduce the dividend growth or grow the bottom line (hopefully through top line growth) but that’s easier said than done.

Quality Rule – GWW Business Quality

At first glance, the company’s business is difficult to figure out. They have channels to place orders for service but it all seems very complicated. I honestly could not easily explain to my teenager what the company does.

It has such a wide array of products that it seems too diversified and without synergy. From HVAC to furniture to food service. Any of these channels could be challenged by companies wanting to specialize in those areas. I realize that the company can specialize internally and have strength but it doesn’t speak to having an oligopoly or a competitive advantage. I like to invest in companies that have a competitive advantage and while it’s not a small company, it’s not a conglomerate either.

If you’re prepared to invest in a company, then you ought to be able to explain why in simple language that a fifth grader could understand, and quickly enough so the fifth grader won’t get bored.
– Peter Lynch

GWW – Snapshot Opportunity Score

Following the Snapshot Opportunity Score, W.W. Grainger NYSE:GWW has a score of 72% (the higher, the better) for being an investing opportunity. Above 60% is a good range to pay attention to an opportunity. Anything around 80% would have a short window of opportunity unless the stock got beaten down for other qualitative reasons. See my Easy Stock Selection Process for more details on selecting stocks.

So far, the dividend growth and the low stock price are the only attractive qualities for GWW. With the stock hitting the 52-week lows, is it a bargain or a trap? I presume the dividend growth will be there but will it slow down? If you are looking for an industrial stock for your portfolio, there are 10 Dividend Aristocrats in the industrial sector and 5 of them are Dividend Ambassadors. There are other opportunities but the low price and higher yield may be of interest for some investors while they wait for the company to sort out their issues.

Don’t get me wrong, the company is not in trouble but while the 10-year numbers are good, the short-term challenges cannot be overlooked. A turn around could take another 3 to 5 years depending on the challenges they are facing to grow the top line.

Based on the announced 2017 goals and the 2016 challenges highlighted in their 2016 annual report, there is no rush to load up on GWW for now. There are many goals, all independent, that must work together to fix the top and bottom line. Margin pressure for online competition may also have an impact on restructures in the short term. Most companies go through some challenges when transitioning to digital as they invest and adjust the workforce.

In 2017, Grainger will focus on the following initiatives:

• Execute the pricing changes in the United States to attract and acquire new customers to Grainger and capture a higher share of wallet with existing customers.

• Accelerate share gain with large customers in the United States, leveraging changes made to the sales organization in 2016.

• Regain share with medium-sized customers in the United States through our inside sales team and innovative digital solutions.

• Accelerate the rapid growth in revenue and earnings through our single channel online businesses MonotaRO, Zoro and Cromwell Direct.

• Reverse the decline in our Canadian business by improving service, adjusting the cost structure and continuing to diversify our customer base.

• Reduce our cost base everywhere throughout the company. • Improve our team member experience through focused development and improved processes.

I don’t think GWW is out of the woods and would review the stock in a few quarters to assess their progress.

DISCLOSURE: Please note that I may have a position in one or many of the holdings listed. For a complete list of my holdings, please see my Dividend Portfolio.

DISCLAIMER: Please note that this blog post represents my opinion and not an advice/recommendation. I am not a financial adviser, I am not qualified to give financial advice. Before you buy any stocks/funds consult with a qualified financial planner. Make your investment decisions at your own risk – see my full disclaimer for more details.