W.W. Grainger Inc. (GWW) doesn't mind when its customers sharpen their pencils on the cost of what Grainger sells.
Grainger is North America's largest distributor of maintenance and operating supplies to factories, office buildings, hospitals and other institutions. Grainger, Fastenal Co. (FAST), MSC Industrial Direct Co.(MSM) and other large supply companies have been racking up outsized gains in sales and profits lately after the economic recession prompted their customers to take a closer look at how they buy cleaning supplies, screws, light bulbs, safety glasses, step ladders and thousands of other ancillary items.
Companies found they could lower their expenses by trimming their in-house purchasing agents, reducing the number of suppliers they use and shifting more orders to larger supply companies with big product lines and the know-how to manage their customers' inventories of supplies. The move might not merit much notice in other industries. But in the dowdy supply industry where small, regional companies account for about three-quarters of the industry's $140 billion in annual sales, the shift toward larger players has been seismic.
"That behavior change is happening in a way that we haven't seen before," said Grainger Chairman and Chief Executive James Ryan during an interview with Dow Jones Newswires. "As customers consolidate their supplier bases, there are winners and losers. For us, it's been a catalyst for growth. Customers stuck with us during the downturn and we got a lot of new customers."
Grainger's sales last year grew by 15.4% over 2009 to $7.18 billion, more than double the growth rate of the industrial supply sector in North America. The company's net income rose 19% to a record $510.8 million, or $7.05 a share. In 2011, its sales are expected to expand by nearly 10%, compared with about a 7% increase forecast for the industry. Analysts expect profit to rise by 20% from 2010.
Even higher growth rates are anticipated for Fastenal, the industry's second largest company by sales, and MSC, the sector's third largest. Both have more exposure to cyclical manufacturing than Grainger and experienced larger sales declines during the recession.
For the first nine months of MSC's 2011 fiscal year, net income is up 50% from 2010 to $159.3 million, or $2.50 a share. Net sales have grown 21% to $1.49 billion.
"There's still a lot of earnings power left in these businesses," said Ryan Merkel, an analyst with William Blair & Co.
The recession left many small and regional supply shops hurting for the capital to maintain or increase the items they keep in stock. MSC, which specializes in supplies for metalworking, seized on this weakness by increasing its sales force, expanding its product lines and investing in its online sales capacity.
"These investments have enhanced our ability to provide customers with solutions and services that our smaller, less capitalized competitors can't offer," said MSC Chairman and Chief Executive David Sandler during a conference call Friday. "The fragmented nature of our industry … gives us tremendous runway for continued growth."
Grainger also has been adding product lines, increasing the items it stocks to more than 350,000 from 82,000 five years ago. The Illinois-based company also completed the realignment of its 600 branch stores in 2008, adding more than 1 million square feet of floor space. Grainger has improved its online order capabilities and systems for tracking and processing orders.
Grainger estimates companies buy as much as $12 billion a year worth of maintenance and repair supplies--everything from light bulbs to sponges--that never get used. The items languish indefinitely in tool cribs, stock rooms and janitors' closets. While Grainger and other suppliers benefit from that inefficient purchasing, Ryan maintains there's an even bigger opportunity in managing customers' inventories of supplies.
"We can help them get their costs down and they are much more receptive to that," said Ryan, who joined Grainger in 1980 and has been CEO since 2008. "We still have to be competitive on the price [for the items] on the invoice, but more and more customers are looking at their total procurement costs."
David Ronda, operations manager for Micropump Inc., reduced the number of local companies in the Portland, Ore., area he ordered supplies from about two years ago and gave Grainger responsibility for five categories of maintenance, repair and operations supplies, or MRO.
Grainger provides the 100,000-square-foot plant with janitorial supplies; sand paper; gloves and ear plugs; and the components Ronda's employees use to make test benches for the pumps Micropump manufactures. Ronda said the move improved the efficiency of his purchasing and contributed to the nonlabor and noncapital operating costs for the plant falling to $300,000 last year from $1.1 million in 2006. Moreover, Ronda's 12-member staff no longer spends time on filing requisitions because Grainger now manages supply volumes inside the plant.
"To keep them doing what they do best, I can't have them ordering parts," Ronda said. "We're not making MRO. It's an overhead cost."
The test of how much Grainger and other large suppliers have permanently transformed themselves will likely occur when industrial growth starts to slow. Maintenance and operations suppliers are susceptible to the same cyclical downturns as their customers. Idle plants and smaller work forces need fewer supplies. Ryan believes Grainger's ability to manage its customers' supply inventories will make the company more essential to customers during a slump than a company that just distributes mops and buckets.
"Grainger has built a business for exactly what's going on in this industry now," Ryan said.
-By Bob Tita, Dow Jones Newswires; 312-750-4129; email@example.com