Fastenal

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

A leading industrial distributor, Fastenal supplies a wide array of fasteners, tools, and industrial supplies, primarily through a vast network of branches in North America and internationally.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Fastenal operates as a distributor, procuring a variety of fasteners, tools, and industrial supplies from multiple manufacturers and then selling these products to its customers. These sales are made through a vast branch network and a direct sales force. Its customer base consists mainly of the manufacturing, construction, and maintenance industries, and Fastenal provides a wide range of solutions that address these industries’ needs. Their main focus is the manufacturing sector, and they make a significant portion of their revenues from them. In addition, they serve other end markets, such as heavy construction, and they are increasingly expanding in markets like the healthcare sector.

Their products can be divided into two main groups:

Fasteners, which are things such as screws, bolts, nuts, and other types of hardware.
Non-fasteners, which are things like tools, safety equipment, and maintenance and repair supplies. Fasteners are a commodity product, while non-fasteners are differentiated products. The company wants to grow its non-fastener products since those products are of better margin, and there’s room for growth there. They aim to reach more customers with more non-fastener products. They are also aggressively expanding their onsite distribution, or “in-plant” business, which is a small-size full-service branch located at the customer’s site. A typical branch is big and has a lot of inventory, an onsite location doesn’t need that. This means a lower initial cost and a closer relation to their clients. This is how they make their customers dependent on them, by integrating themselves into their customer’s supply chain.

Moat Analysis

Fastenal’s moat is primarily based on its extensive distribution network, which is its scale advantage and high switching costs, and which gives it a significant competitive edge. The company has around 2,000 branches all over North America, mostly serving smaller geographical areas, that cannot support a competitor’s business. With its vast distribution network and its willingness to open branches in smaller markets that competitors find unprofitable, Fastenal is able to maintain a strong hold of its market. They also try to establish close ties with their clients to create loyalty, and make it hard for a competitor to swoop in and take market share. A large part of their revenues come from its National Accounts, so they have had time to develop close relationships with them. They are also doing very good at winning new national contracts since they have improved their product offering. In addition, the company has a huge catalog, allowing customers to find the products they need. It has a lot of logistics experience with its own truck fleet and distribution network, that have taken many years to develop. The company provides tailored customer services as well, which gives them more customer loyalty. Fastenal’s moat is a narrow moat, as it could erode over time. I would rate their moat a 3 out of 5 because of the factors above and the fact that it is a commodity industry that relies heavily on price as the main factor, though their customers can be sticky.

Risks to the Moat and Business Resilience

Despite having a moat, Fastenal does face a few risks that can erode it or make it more difficult for the company to compete effectively, and it is important to analyze them.

1. Economic Downturns and Cyclicality: The company’s revenue is tied to the health of the general economy, since the manufacturing and construction sectors are highly sensitive to it. - Resilience: The company has historically managed to remain profitable during downturns, but its ROIC is significantly affected. For example, their sales decreased by 2% in 2020. Their wide offering of products helps a lot, since they can offer the necessary products needed no matter the cycle.

2. Competition: Fastenal is still exposed to competitors like Grainger and Amazon Business, that can easily gain market share in the long term due to pricing, distribution, or other factors. - Resilience: They need to stay ahead of their competition by improving their product offerings, increasing their locations, or providing more tailored services. By making themselves vital for their customers, they are able to withstand competition.

3. Raw Material Prices: Fastenal buys its goods from different companies, therefore rising raw material costs could cause their own costs to increase and, if they can not pass them to customers, decrease their margins. - Resilience: By having a strong supply chain, they can get better prices from suppliers, and by raising their own prices in tandem with the market, they can avoid losses.

4. Technological Disruption: The industry is rapidly changing, and new technologies are emerging. If the company is slow to adapt or it does not implement those changes in time, the company might be left behind. - Resilience: The company has already started with e-commerce, but should improve that section of its business and implement the newest technologies to keep in line with their customer’s changing demands and expectations.

5. Dependence on Key Suppliers: Since Fastenal is a distributor of other companies, their revenue is dependent on their production and availability of raw materials. - Resilience: They are diversified in terms of product suppliers and the ability to source from anywhere in the world. It is unlikely that a single supplier would have a major impact on their performance, however, they should maintain good relationships with their supply chain.

Financial Analysis

Fastenal has a strong history of revenues and earnings, and a good financial standing.

Revenues: Fastenal generates its revenues mostly from the sale of fasteners, tools, and industrial products to different industries.

Their revenues have grown steadily in the past few years, averaging high single-digit growth, as of the latest reports. For the full year, net sales growth was 9.2% in 2023 and 15.9% in 2022.
Their growth is primarily in the North America market, but they are expanding internationally.
They are transitioning towards more non-fastener sales to further increase their margins.
The company does not provide too much information about the individual contribution from each market, since they are so intertwined.

Margins: Fastenal has seen gross margins fluctuate somewhat, but they remain high in the industry.

Gross margins have been around 46-47% as of the latest reports.
Operating income has improved, although slightly, because of some operating leverage.
Net margins for 2023 were 16.2%
Due to the high competition in their industry, maintaining their margins will always be a challenge.

Profitability: The company has a strong return on invested capital.

They have a return on equity of around 22% and a ROIC around 17% which is good for the industry.
However, these numbers can decrease in a bad economy, and it is something to watch.
They aim to improve return on capital in the long term by driving productivity, scale, customer growth, and supply-chain optimization,
The fact that they don’t pay dividends allows for more profits to be reinvested and thus, achieve a higher return on capital.

Balance Sheet: The company has a relatively conservative balance sheet with a mix of equity and debt.

Their debt has mostly stayed stable, and they can easily repay their financial commitments.
They do not have very much long-term debt, and they have shown no problem at all in covering their short-term obligations. They are easily able to deal with downturns.
They have a healthy current ratio of around 4, which means a solid position in terms of liquidity and solvency.

Cash Flow: The company’s free cash flow has been growing well and has been increasing in the past few years.

Their free cash flow allows them to finance growth without resorting to debt, or returning it to shareholders through buybacks.
They do not pay dividends.
Management has also said that the company has a strong balance sheet, giving them the ability to acquire other businesses, which is something they are actively looking at.

Recent Financial Performance: Fastenal has had good financial results in the last few years, with growing revenues, great profitability, and strong cash flow, and their expansion to smaller markets and to new products have been successful.

Even so, as the company has mentioned in their latest reports, growth is normalizing, and the company is having a hard time achieving those high numbers of before, even with the tailwinds the industry is presenting.
Despite that, they still expect continued growth in the next years.
Their expansion into their national accounts has been successful and it will only grow more important for their business.

Understandability Rating

I give Fastenal a 2 out of 5 for understandability. While the basic business of distributing industrial supplies is straightforward, their business model has a few layers of complexities like the importance of national accounts, the vastness of their branch network, logistics, and all the intricacies that come from a commodity industry. It is a difficult business to manage successfully, and it is necessary to study deeply to understand them fully.

Balance Sheet Health Rating

I give Fastenal a 4 out of 5 in terms of balance sheet health. It has a good balance of debt and equity, they have more than enough cash to face their obligations, and their current assets are substantially greater than current liabilities. Overall, their financial position is very strong.

Recent Concerns and Controversies

In the latest earnings calls, executives have mentioned that growth rates are slowly normalizing and the company is not achieving the high numbers of the recent past. That is an important concern since, if they fail to grow enough, they might start losing their market share to more aggressive players, like Amazon. Management has noted, though, that they have started the expansion towards non-fasteners, and they have a lot of opportunities to grow in new markets, which is where they are investing a lot of resources and efforts. The effects of inflation are also starting to be noticeable, but the company has managed to stay ahead by focusing on high-quality and well-needed products. Overall, the company seems prepared to face upcoming challenges, and has the ability to leverage their advantages, so the future should be good.