W.W. Grainger’s Expected Total Returns
Investors in W.W. Grainger should expect double-digit total returns going forward. The company is targeting revenue growth of between 7% and 12% a year over the next 5 years. This growth will come from a mix of continued organic growth and bolt-on acquisitions, plus e-commerce growth.
The next largest growth driver for W.W. Grainger will be share repurchases. Over the last decade, the company has reduced its share count by 3% a year on average. Over the next three years, W.W. Grainger’s management is committing $3 billion to share repurchases. At current prices, this comes to share repurchases of around 7.5% of shares outstanding a year.
This spectacular level of share repurchases will not occur indefinitely. W.W. Grainger will fund some of these purchases by issuing long-term debt, which it plans to hold permanently. W.W. Grainger is targeting an extremely conservative debt to EBIDTA ratio of 1.0 to 1.5. After the current round of share repurchases is exhausted, I expect W.W. Grainger to continue repurchasing shares at around 3% a year.
On top of revenue growth and share repurchases. W.W. Grainger stock currently has a 2.2% dividend yield.
To summarize, the company will generate 16.7% to 21.7% annualized total returns over the next 3 years from:
– Revenue growth of 7% to 12% a year
– Share repurchases of ~7.5% a year
– Dividends of 2.2% a year
The company could potentially grow even faster if margins continue to expand (as they are expected to). W.W. Grainger’s net profit margin has grown at 3.9% a year over the last decade. Margin expansion is a result of economies of scale generated by the company’s growth. If W.W. Grainger continues to expand its margins at the same rate it has over the last decade, expected annualized returns over the next 3 years are 20.6% to 25.6%. I realize these are almost unbelievable numbers, but this is the economic reality of W.W. Grainger’s expected growth plans.
Bear Case: Recent Weakness & Potential Troubles Ahead
There is a downside to investing in W.W. Grainger (just like any stock). The expected total returns above are only applicable if the global economy doesn’t fall into a deep recession. W.W. Grainger’s earnings-per-share fell by 13.8% in 2009 during the worst of the Great Recession. In 2010, earnings-per-share hit new record highs.
W.W. Grainger’s most recent results were much weaker than expected growth over the next 3 years. The company saw earnings-per-share decline 8% in its most recent quarter. Many of W.W. Grainger’s customers in the oil and gas sector are laying off employees and restructuring their businesses. This is resulting in temporary earnings declines for W.W. Grainger. If oil and gas prices continue to fall, the company will not hit its lofty growth expectations.
Global recessions and falling oil and gas prices will delay W.W. Grainger’s growth, not cancel it all together.
The other threat W.W. Grainger is facing is a new entrant to its market – Amazon.com, Inc. (NASDAQ:AMZN). Amazon’s new business service is targeting business purchases rather than personal purchases. At first glance, Amazon is appealing more to office related purchasers. This will affect the sales of Staples, Inc. (NASDAQ:SPLS) and other office supply companies more than the MRO industry. Still, Amazon’s focus on business customers could slow growth somewhat for W.W. Grainger.
W.W. Grainger Is Trading Around Fair Value
W.W. Grainger has tremendous upside. The bear case for the company’s stock is much weaker than the bull case. The final question for investors looking to start (or add to) a position in W.W. Grainger is:
Is the company fairly valued?
W.W. Grainger is currently trading for a price-to-earnings ratio of 18.4. The S&P 500 currently has a price-to-earnings ratio of 22.0.
W.W. Grainger is an extremely high quality business with excellent long-term growth potential. There is no reason the company should be trading for a price-to-earnings multiple less than that of the S&P 500. At current prices, I believe W.W. Grainger to be undervalued relative to the market.
W W Grainger Inc (NYSE:GWW) is exactly the type of business I look for – a high quality, shareholder friendly business with a strong competitive advantage that has a clear and obvious growth plan. In addition, the company’s stock is likely undervalued. Qualitatively, W.W. Grainger’s upside is much greater than its downside. Quantitatively, it ranks in the Top 10 of 180+ dividend stocks with 25+ years of dividend payments without a reduction using The 8 Rules of Dividend Investing.
Disclosure: None
