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Fastenal's Profits Rise, but Its Core Business Still Hasn't Rebounded

Industrial supply giant Fastenal (NASDAQ: FAST) released its fourth-quarter and full-year 2020 earnings on Wednesday, and in many ways, the quarter and the year collectively represented a success: Revenue and earnings rose over both time periods despite slackening customer demand for fastening and other manufacturing supplies during the pandemic.

But the report also highlighted the questions faced by some industrial companies that have managed to eke out growth over the last 10 months. At what point will creative revenue solutions start to fade, and how long will it take for the manufacturing sector (which has lagged technology, healthcare, and other sectors) to stage an economic recovery?

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A profitable but temporary sales structure

Fastenal achieved a fourth-quarter revenue increase of 6.4% over the prior-year quarter, to $1.36 billion. Management attributed the improvement to increased demand for janitorial and safety products, specifically personal protective equipment (PPE) and sanitizers. These have seen elevated demand over the past three quarters due to the coronavirus pandemic. However, sales of the company's core "fastening" products (industrial supplies), declined relative to the prior-year quarter. Daily sales of fasteners dipped by 2.3% against the fourth quarter of 2019, and represented 30.8% of total net sales, versus 33.6% of total net sales in Q4 2019.

Gross Margin reflected the product shift of the last several months, slipping 135 basis points to 45.6% as the company leaned on revenue from lower-margin PPE equipment and janitorial supplies. Management provided the following commentary on this revenue stream in Fastenal's press release: "Margin pressure remains on a subset of COVID-affected safety products, such as masks and face shields, where an amply supplied market is producing lower margins on sales from our inventory." In a positive sign for future quarters, gross margin improved by 30 basis points from the sequential third quarter of 2020, due to firm pricing actions taken on some PPE and safety supplies.

Net earnings rose 8.6% to $859.1 million, helped by the higher sales level, as well as management's tight rein on overhead expenses. General and administrative expenses as a percentage of the top line declined by 200 basis points year over year, to 25.3% of sales.

Waiting for a return to normalcy

Overall, Fastenal executed admirably in 2020, actively filling demand for pandemic-related merchandise while holding costs steady, and thus maintaining its profit growth. Shareholders certainly endorsed this strategy, as stock in the tools and supplies distribution powerhouse soared 32% last year.

Yet Fastenal finds itself in uncertain territory in 2021. Rightsizing core operations to match sales levels over the last three quarters has meant that the company has curtailed its primary growth engines -- the addition of employee headcount and the addition of in-market locations (i.e., public branch locations and onsite locations within customer premises).

During 2020, Fastenal reduced employees placed at in-market locations by 9.3%, to 12,680. Total headcount fell by 6%, to roughly 17,800 employees. The company closed about 5% of its public branch locations, but managed an increase of 13.6% in active onsite locations -- this helped it eke out a 1.2% increase in total in-market locations, to 3,268. Fastenal was also able to push up the number of industrial vending machines installed at customer locations by 6.4% to 95,733, but this was well below prior annual growth rates, which ranged between 11% and 14%.

The difficult task ahead for Fastenal will be balancing lower-margin pandemic supply sales with the need to invest again in headcount and location growth -- both of which are correlated with revenue expansion -- even in the face of what may be an uneven recovery in the industrial sector.

The company does have some novel and forward-looking initiatives that could help it capitalize on the next pickup in the business cycle. For example, it's accelerating the distribution of its "FAST bin" technology within industrial vending machine installations. FAST bins are Fastenal's newer smart bins, which incorporate radio-frequency identification (RFID), infrared, scale, and other technologies to automate inventory order points and provide operations teams with better supply chain visibility.

Nonetheless, like many other peers in the industrial sector, Fastenal won't be able to resume its most profitable growth equation until the global economy changes a few gears and customer demand awakens. And absent this scenario, investors shouldn't expect the same level of unrestrained share price movement the company enjoyed in 2020.

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Asit Sharma has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.


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