Rating Update: Stock Rating C-Low Neutral (10/17/19)-Grainger (W.W.) Inc (GWW).

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BUSINESS

W.W. Grainger, Inc. distributes maintenance, repair, and operating (MRO) supplies; and other related products and services that are used by businesses and institutions in the United States, Canada, Europe, Asia, and Latin America. The company offers material handling equipment, safety and security supplies, lighting and electrical products, power and hand tools, pumps and plumbing supplies, cleaning and maintenance supplies, metalworking tools, and various other products. It also offers inventory management solutions; and distributes fasteners, gloves, ladders, motors, and janitorial supplies. The company serves small and mid-sized businesses, large corporations, government entities, and other institutions. It offers its products through various branches, sales and service representatives, contact centers, distribution centers, and catalogs, as well as through Websites. W.W.
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INVESTMENT RATING

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Reflecting future returns on capital that are forecasted to be above the cost of capital, GWW is expected to continue to be a major Value Builder.

Grainger (W.W.) has a current Value Trend Rating of C (Low Neutral).
With this rating, PTR’s two proprietary measures of a stock’s current attractiveness are providing consistent signals. Grainger (W.W.) has a neutral Appreciation Score of 51 and a slightly negative Power Rating of 39, leading to the Low Neutral Value Trend Rating.

Grainger (W.W.)’s stock is selling below targeted value. The current stock price of $310.74 compares to targeted value 12 months forward of $373.
This neutral appreciation potential results in an appreciation score of 51 (49% of the universe has greater appreciation potential.)
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Grainger (W.W.) has a Power Rating of 39. (This slightly negative Power Rating indicates that GWW’s chances of enjoying attractive investment performance over the near to intermediate term are only average.)
Factors contributing to this slightly negative Power Rating include: recent price action has been neutral; earnings estimate behavior for GWW has been slightly negative recently; and is in a slightly weakened position current.

INVESTMENT PROFILE

GWW’s financial strength is high. Financial strength rating is 80.
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Relative to the S&P 500 Composite, Grainger (W.W.) Inc has moderate Growth characteristics; its appeal is likely to be to Capital Gain-oriented investors; the perception is that GWW is normal risk. Low historical growth is a relative weakness for GWW. GWW’s valuation is moderate: moderate dividend yield, moderate P/E ratio, and high price/book ratio. GWW has low market capitalization.

CURRENT SIGNALS

Grainger (W.W.)’s current operations are strong. Return on equity is rising, reflecting: improving asset utilization; widening pretax margins; rising tax keep rate; and rising leverage.

Grainger (W.W.)’s current technical position is mixed. The stock price is in a 9.1 month down move. The stock has declined 22.6% from its prior high. The 200 day moving average is in an uptrend. The stock price is below its 200 day moving average. The stock has just risen above its 200 day moving average.

ALERTS

Grainger (W.W.) Inc (NYSE: GWW). Extremely significant positive changes in investment behavior have recently occurred: positive upside/downside volume developed, the stock’s recent price rise disrupted its longer term downtrend, and its shorter term price trend turned up.
Recent marginal positive changes in fundamentals have benefitted Grainger (W.W.) Inc (NYSE: GWW): significant quarterly earnings acceleration occurred.
The stock is currently rated C.
On 10/17/19, Grainger (W.W.) Inc (NYSE: GWW) stock enjoyed a major increase of 14.3%, closing at $0.16. However, this advance was accompanied by unusually low trading volume at 64% of normal. The stock has performed in line with the market over the last nine months and has risen 9.4% during the last week.

CASH FLOW

In 2018, Grainger (W.W.) generated a very significant increase in cash of +$211 million (+65%). Sources of cash were much larger than uses. Cash generated from 2018 EBITDA totalled +$1,598 million. Non-operating uses consumed -$206 million (-13% of EBITDA). Cash taxes consumed -$259 million (-16% of EBITDA). Re-investment in the business amounted to -$150 million (-9% of EBITDA). On a net basis, debt investors received -$220 million (-14% of EBITDA) while equity investors removed -$551 million (-34% of EBITDA).
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Grainger (W.W.)’s Non-operating Income, %EBITDA has experienced a minor downtrend over the period. This downtrend was accompanied by stability for the Grainger (w.W.) Inc Peer Group. In most years, Grainger (W.W.) was in the lower quartile and top quartile. Currently, Grainger (W.W.) is lower quartile at -13% of EBITDA (-$206 million).

Grainger (W.W.)’s Cash Taxes, %EBITDA has exhibited a very small overall uptrend over the period. This improvement was accompanied by stability for the Grainger (w.W.) Inc Peer Group. (Since 2016 Cash Taxes, %EBITDA has accelerated.) In most years, Grainger (W.W.) was in the lower quartile and second quartile. Currently, Grainger (W.W.) is at median at -16% of EBITDA (-$259 million).

Grainger (W.W.)’s Business Re-investment, %EBITDA has enjoyed a strong overall uptrend over the period. This improvement was accompanied by an opposite trend for the Grainger (w.W.) Inc Peer Group. In most years, Grainger (W.W.) was in the third quartile and top quartile. Currently, Grainger (W.W.) is upper quartile at -9% of EBITDA (-$150 million).

Grainger (W.W.)’s Debt Investors, %EBITDA has exhibited a volatile overall uptrend over the period. This improvement was accompanied by a similar trend for the Grainger (w.W.) Inc Peer Group. (Since 2015 Debt Investors, %EBITDA has experienced a very sharp decline.) In most years, Grainger (W.W.) was in the second quartile and top quartile. Currently, Grainger (W.W.) is lower quartile at -14% of EBITDA (-$220 million).

Grainger (W.W.)’s Equity Investors, %EBITDA has suffered a volatile overall downtrend over the period. This downtrend was accompanied by a similar trend for the Grainger (w.W.) Inc Peer Group. (Since 2015 Equity Investors, %EBITDA has experienced a very sharp recovery.) In most years, Grainger (W.W.) was in the second quartile and top quartile. Currently, Grainger (W.W.) is upper quartile at -34% of EBITDA (-$551 million).

Grainger (W.W.)’s Change in Cash, %EBITDA has exhibited a volatile overall uptrend over the period. This improvement was accompanied by an opposite trend for the Grainger (w.W.) Inc Peer Group. (Since 2016 Change in Cash, %EBITDA has sharply accelerated.) In most years, Grainger (W.W.) was in the third quartile and top quartile. Currently, Grainger (W.W.) is upper quartile at +13% of EBITDA (+$211 million).
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Grainger (W.W.)’s Cash, %Revenue has exhibited little to no overall change over the period. This stability was accompanied by a downtrend for the Grainger (w.W.) Inc Peer Group. In most years, Grainger (W.W.) was in the third quartile. Currently, Grainger (W.W.) is at median at +5%.

PROFITABILITY

Grainger (W.W.)’s return on equity has improved very significantly since 2009.
Grainger (W.W.)’s minor negative trend in pretax operating return significantly offset by a very strong positive trend in non-operating factors is a major performance consideration.
The productivity of Grainger (W.W.)’s assets rose over the full period 2009-2019: asset turnover has exhibited a small overall uptrend.
More than offsetting this trend, however, pretax margin experienced a strong overall downtrend that acccelerated very sharply from the 2013 level.
Non-operating factors (income taxes and financial leverage) had a very significant positive influence on return on equity.
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Grainger (W.W.)’s return on equity is at the upper quartile (43.0%) for the four quarters ended June, 2019.
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Operating performance (pretax return on assets) is at the upper quartile (19.5%) reflecting asset turnover that is above median (1.88X) and at median pretax margin (10.3%).
Tax “keep” rate (income tax management) is lower quartile (70.8%) resulting in after tax return on assets that is above median.
Financial leverage (leverage) is below median (3.12X).

GROWTH RATES

Overall, Grainger (W.W.)’s growth rate has slowed considerably in recent years.
Grainger (W.W.)’s historical income statement growth and balance sheet growth have diverged. Revenue growth has paralleled asset growth; earnings growth has exceeded equity growth.

Annual revenue growth has been 8.6% per year.

Total asset growth has been 7.8% per year.

Annual E.P.S. growth has been 8.2% per year.

Equity growth has been -0.6% per year. (More recently it has been -5.1%.)

Grainger (W.W.)’s consensus growth rate forecast (average of Wall Street analysts) is 11.5% — substantially above the average of the historical growth measures.
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Relative to the Grainger (w.W.) Inc Peer Group, Grainger (W.W.)’s historical growth measures are erratic. Revenue growth (8.6%) has been above median. Total asset growth (7.8%) has been substantially above median. E.P.S. growth (8.2%) has been below median. Equity growth (-0.6%) has been substantially below median.

Consensus growth forecast (11.5%) is above median.
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PRICE HISTORY

Over the full time period, Grainger (W.W.)’s stock price performance has been good. Between December, 2008 and October, 2019, Grainger (W.W.)’s stock price rose +294%; relative to the market, this was a +19% gain. Significant price moves during the period: 1) August, 2017 – September, 2018: +120%; and 2) February, 2009 – October, 2013: +307%.
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TOTAL INVESTMENT RETURNS

Current annual total return performance of -15.2% is lower quartile relative to the S&P 500 Composite.
In addition to being lower quartile relative to S&P 500 Composite, current annual total return performance through September, 2019 of -15.2% is lower quartile relative to Grainger (W.W.) Inc Peer Group.

Current 5-year total return performance of 5.6% is substantially below median relative to the S&P 500 Composite.
Through September, 2019, with substantially below median current 5-year total return of 5.6% relative to S&P 500 Composite, Grainger (W.W.)’s total return performance is lower quartile relative to Grainger (W.W.) Inc Peer Group.
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VALUATION BENCHMARKS

Relative to S&P 500 Composite, GWW’s overall valuation is normal. The highest factor, the price/equity ratio, is upper quartile. Ratio of enterprise value/assets is upper quartile. Price/earnings ratio is at median. Ratio of enterprise value/earnings before interest and taxes is below median. The lowest factor, the ratio of enterprise value/revenue, is at the lower quartile.

Relative to Grainger (W.W.) Inc Peer Group, GWW’s overall valuation is normal. The highest factor, the price/equity ratio, is above median. Ratio of enterprise value/assets is at median. Price/earnings ratio is at median. Ratio of enterprise value/revenue is at median. The lowest factor, the ratio of enterprise value/earnings before interest and taxes, is lower quartile.
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Grainger (W.W.) has a minor value gap compared to the median valuation. For GWW to rise to median valuation, its current ratio of enterprise value/revenue would have to rise from the current level of 1.69X to 1.71X. If GWW’s ratio of enterprise value/revenue were to rise to 1.71X, its stock price would be lower by $4 to $314.
For GWW to hit lower quartile valuation relative to the Grainger (W.W.) Inc Peer Group, its current ratio of enterprise value/revenue would have to fall from the current level of 1.69X to 1.22X. If GWW’s ratio of enterprise value/revenue were to fall to 1.22X, its stock price would decline by $-96 from the current level of $311.

VALUE TARGETS

Reflecting future returns on capital that are forecasted to be above the cost of capital, GWW is expected to continue to be a major Value Builder.
Grainger (W.W.)’s current Price Target of $383 represents a +23% change from the current price of $310.74.
This neutral appreciation potential results in an appreciation score of 51 (49% of the universe has greater appreciation potential.)
Reinforcing this neutral Appreciation Score of 51, the moderately low Power Rating of 39 contributes to an Value Trend Rating of C.
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Grainger (W.W.)’s current Price Target is $383 (+35% from the 2018 Target of $283 and +23% from the 10/17/19 price of $310.74). This dramatic rise in the Target is the result of a +8% increase in the equity base and a +25% increase in the price/equity multiple. The forecasted increase in growth has a very large positive impact on the price/equity multiple and the forecasted increase in return on equity has a slight positive impact as well. Partially offsetting these Drivers, the forecasted increase in cost of equity has a slight negative impact.
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PTR’s return on equity forecast is 49.7% — in line with our recent forecasts. Forecasted return on equity enjoyed a dramatic, steady increase between 2010 and 2018. The current forecast is significantly above the 2010 low of 22%.

PTR’s growth forecast is 7.0% — slightly above our recent forecasts. Forecasted growth suffered a dramatic, variable decline between 2010 and 2018. The current forecast is below the 2013 peak of 10%.

PTR’s cost of equity forecast is 10.1% — in line with recent levels. Forecasted cost of equity exhibited a slight, erratic decline between 2010 and 2018. The current forecast is steady at the 2010 peak of 9.9%.
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At Grainger (W.W.)’s current price of $310.74, investors are placing a positive value of $123 on its future investments. This view is consistent with the company’s most recent performance that reflected a growth rate of 4.0% per year, and a return on equity of 47.8% versus a cost of equity of 9.6%.
PTR’s 2020 Price Target of $383 is based on these forecasts and reflects an estimated value of existing assets of $202 and a value of future investments of $181.

About John Lafferty 58018 Articles
During his career, John has developed valuation and stock rating methodologies, managed institutional portfolios and mutual funds, and provided equity research to institutional investors on thousands of companies. He has been Director of Research at PTR since its inception in 2004.

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