A company that sells fastener products such as threaded fasteners, bolts, nuts, and screws may not seem like an exciting investment. If you had purchased 1.000 shares at $9,00 each during Fastenal's IPO in 1987, it would have grown to 192.000 shares valued at $12.435.840 by the end of 2023. It is a gain of approximately 22,2% compounded annually. Furthermore, Fastenal is also a dividend aristocrat, having increased dividends for 25 consecutive years.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of Fastenal. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I do not own any stocks in any of Fastenal's direct competitors either. Thus, I have no personal stake in Fastenal. If you want to purchase shares or fractional shares of Fastenal, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.
The Business
Fastenal was founded in 1967 in Minnesota, United States. Fastenal engages in the wholesale distribution of industrial and construction supplies in the United States, Canada, Mexico, and internationally. Fastenal offers fasteners and related industrial and construction supplies. The company's fastener products include threaded fasteners, bolts, nuts, screws, studs, and related washers. These products are utilized in manufactured goods, construction projects, as well as in the maintenance and repair of machinery. It also offers miscellaneous supplies and hardware, including pins, machinery keys, concrete anchors, metal framing systems, wire ropes, strut products, rivets, and related accessories. The vast majority of Fastenal's sales are business-to-business. Fastenal sells its products through branch and Onsite locations. Branches and Onsites are typically located very close to their customers, often within miles for the former and usually within or near the customers' physical locations for the latter. Fastenal branches are typical stores that serve a wide variety of customers, ranging from the local operations of large national account customers to smaller local businesses. The Onsite network encompasses three main variations: (1) a dedicated business unit with people and inventory primarily placed in the customer's facility, (2) a dedicated business unit with people and inventory primarily placed in a facility located near the customer site, or (3) a dedicated business unit primarily located in the back of an existing Fastenal branch. By the end of 2023, Fastenal had 1.597 branches and 1.822 onsite locations. Fastenal generates 83,6% of its revenue in the United States, 13,4% in Canada and Mexico, and 3,0% in other countries. Fastenal has a moat through its customer relationships and supply chain.
Management
The CEO is Daniel Florness. He joined Fastenal in 1996 and held various positions until becoming the CEO in 2016. Prior to joining Fastenal, Daniel Florness served as a Senior Manager at KPMG LLP. Daniel Florness holds an undergraduate degree in accounting from the University of Wisconsin. He considers frugality key for Fastenal, which emphasizes getting closer to customers and prioritizes its spending accordingly. His famed frugality hasn't slowed the company's growth. Since Daniel Florness became CEO in 2015, sales have doubled, and its international presence has been expanding. He has also been credited for Fastenal shifting its focus from branches to Onsites, resulting in a significant decrease in the number of branches under his leadership. This move has increased Fastenal's Onsite presence, making the company leaner and more profitable. Under Daniel Florness' leadership, Fastenal has made significant progress in digitalization. Approximately 50% of its business is now digital, a percentage that Daniel Florness anticipates will continue to grow rapidly. Daniel Florness earns an employee rating of 75/100 at Comparably, which puts him in the top 20% of similar-sized companies. I am confident in Daniel Florness leading Fastenal in the future due to his experience in the company and industry, his track record, and focus on digitalization.
The Numbers
The first metric we will investigate is the return on invested capital (ROIC). I would like a 10-year history demonstrating a minimum annual growth of 10%. Fastenal has consistently delivered solid financial performance over the years, maintaining a Return on Invested Capital (ROIC) above 20% every year in the past decade, which is impressive. ROIC has reached new heights in the past two years, surpassing 30% in both years. It is also encouraging to see that ROIC has increased in 2023 after reaching its peak in 2022. Not many companies manage to consistently deliver a Return on Invested Capital (ROIC) above 20%. I am very impressed with these numbers.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most significant of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. Fastenal is almost a textbook example of how you would like to see equity evolve, as they have managed to grow their equity every year except for one in the past decade. These numbers are very encouraging; it is rare to see many companies with such consistent growth.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is not surprising to note that Fastenal has consistently generated positive free cash flow every year for the past ten years. Fastenal benefited from the pandemic in 2020, as evidenced by the numbers. However, Fastenal managed to surpass these numbers in 2023 and achieve a record-high free cash flow, which is very encouraging. The levered free cash flow margin has been relatively consistent over the years, except for 2020, which was an outlier. However, Fastenal has managed to achieve its highest levered free cash flow margin in 2023, which is another encouraging sign. The free cash flow yield is higher than the ten-year average, but at 2,9% it suggests that the shares are still trading at a high valuation. However, we will revisit this point later in the analysis.
Debt
Another important aspect to consider is the level of debt. It is crucial to determine if a business has manageable debt that can be repaid within a three-year period. We calculate this by dividing the total long-term debt by earnings. After analyzing Fastenal's financials, I found that the company has 0,13 years' worth of earnings in debt. Hence, debt is not a concern when investing in Fastenal. It is also worth noting that Fastenal has not exceeded 0,22 years' worth of earnings in debt in the past 10 years. This suggests that debt should never be a significant concern when investing in Fastenal.
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Risks
Based on my findings so far, I find Fastenal to be an intriguing company. However, no investment is without risk, and Fastenal also has its fair share of risks. One risk is competition. The industrial, construction, and maintenance supply industry, although slowly consolidating, still remains a large, fragmented, and highly competitive sector. Fastenal's current and future competitors include companies with similar or greater market presence, name recognition, financial, marketing, technological, and other resources. Fastenal believes it will continue to be challenged by these competitors. Furthermore, increased competition from brick-and-mortar retailers could cause Fastenal to lose market share, reduce its prices, or increase its spending. Similarly, the emergence of online retailers, whether as extensions of our traditional competition or in the form of major, non-traditional competitors, could result in easier and quicker price discovery, as well as the adoption of aggressive pricing strategies and sales methods. These pressures could erode Fastenal's gross and/or operating income, as well as its profit margin, over time.
Macroeconomics. By the end of 2023, the U.S. manufacturing PMI had been below 50 for 14 consecutive months, indicating contraction. It hasn't happened since the financial crises in 2008-2009. Management has mentioned that "a sub-50 PMI when you operate very heavily in the industrial space, that's a big deal for you." Furthermore, in their annual report, Fastenal mentions that the primary variable affecting their results in 2023 was a softening in manufacturing sector business conditions. Industrial production has particularly weakened in the machinery and fabricated metal parts sectors, which are relevant areas for Fastenal as a company. Management has mentioned that they expect macroeconomics to continue to affect the business in 2024, as their customers remain cautious and tight with their spending.
Changes in customer and product mix. Changes in Fastenal's customer and product mix have caused its gross profit percentage to decline and could result in future declines. Fastenal has experienced a sustained increase in the proportion of its sales attributable to both non-fastener products and large companies. Non-fastener products typically have a lower gross profit percentage than fasteners. This is often due to the fact that non-fastener products are less technical, have shorter supply chains, and are easier to transport. Similarly, large companies typically have a lower gross profit percentage than smaller customers due to their scale, available business, and broader range of products, which usually have lower gross profit percentages. Thus, customer and product mix have contributed to the decline of Fastenal's gross profit percentage over time. Based on the anticipated sources of Fastenal's future growth, this trend is likely to persist and further reduce its gross profit percentage into the foreseeable future.
Reasons to invest
There are also numerous reasons to invest in Fastenal. One reason is the expansion of Onsites. In his letter to shareholders, CEO Daniel Florness mentions that the evolution of Fastenal's branch and Onsite network (reducing branches and increasing Onsites) frees up time for greater engagement with Fastenal's customers and lowers Fastenal's cost structure. One example is from four of their oldest markets: Minnesota, Wisconsin, Iowa, and Illinois. The revenue in these four markets had a compound annual growth rate (CAGR) of 5,7%, and pre-tax earnings had a CAGR of 5,6%. From 2017 to 2023, the revenue in these four markets expanded at a CAGR of 8,2%, while pre-tax earnings increased by 8,5%. The reason is that Fastenal has been reducing the number of branch locations in these four states by almost 30% compared to a decade ago, while expanding the Onsite location count roughly sevenfold. In these four states, Fastenal's Onsite business grew from approximately 18% of revenue in 2013 to around 46% in 2023. The same pattern exists in other markets. Thus, as Fastenal continues to expand Onsites, it will benefit both the top and bottom lines.
Investing in the supply chain. Fastenal has described itself as a supply chain company. Management has highlighted that their proficiency in supply chain management played a crucial role in ensuring a steady supply of goods to customers. They emphasized, "If you can't get it anywhere else, you come and get it from us." Fastenal has invested in its supply chain and inventory. Management mentioned that "we feel that it's going to take an extra 40 or 45 days to get a container, we'll add 50 days of inventory". These investments in the supply chain and inventory have cost a tremendous amount of cash, but they have positioned Fastenal to gain market share, which is likely to continue in the future. Gaining market share through the supply chain is described by management in this quote: "We had examples where some other suppliers couldn't get stuff to them, and we stepped up to the plate and helped, which always helps our position to be a stronger partner and to gain market share with that customer, because you rely on people you can rely on."
Dividends. Fastenal has just achieved the status of a dividend aristocrat by increasing their dividends for 25 consecutive years. Furthermore, its ten-year dividend growth CAGR is 11,73%, which is above the sector median of 7,90%. Fastenal also has a tradition of paying special dividends to share its cash with investors. Fastenal has paid a special dividend four times. Once was in 2008 during the financial crisis, another was in 2012 when politicians were discussing extra taxes on dividends, once was during the pandemic in 2020, and the last time was in 2023. In all cases, management has mentioned that they had more cash than they needed. Since the cash is owned by its shareholders, they decided to pay a special dividend. I believe this shows that the company is investor-friendly.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 2,02, which is from the year 2023. I have selected a projected future EPS growth rate of 9%. Finbox expects EPS to grow by 8,8% in the next five years. Additionally, I have selected a projected future P/E ratio of 18, which is double the growth rate. This decision is based on Fastenal's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $21,28. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Fastenal at a price of $10,64 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 1.433, and capital expenditures were 173. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 121 in our calculations. The tax provision was 367. We have 571,982 outstanding shares. Hence, the calculation will be as follows: (1.433 – 121 + 367) / 571,982 x 10 = $29,35 in Ten Cap price.
The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Fastenal's free cash flow per share at $2,20 and a growth rate of 9%, if you want to recoup your investment in 8 years, the Payback Time price is $26,45.
Conclusion
I believe that Fastenal is an intriguing company with a good management. Fastenal has delivered some great historical numbers, and more impressively, both Return on Invested Capital (ROIC) and Free Cash Flow have reached their highest levels ever in 2023. Fastenal has also delivered great returns to investors over the years, with a 22,2% compound annual growth rate (CAGR) since its initial public offering (IPO). Fastenal operates in a highly fragmented industry, where competition will always pose a risk. However, Fastenal has historically executed well, and there is no indication that they will not continue to do so in the future. Macroeconomics will affect Fastenal in the short term, but it will eventually improve. The changes in customer and product mix have affected the margins of Fastenal, and management expects this trend to continue in the future. Fastenal is still highly profitable, so I'm not concerned about it, but it is something worth monitoring moving forward. I appreciate Fastenal's focus on expanding its Onsites. It is evident that this strategy is enhancing both the top and bottom lines. I appreciate Fastenal's investment in its supply chain, which has not only helped the company gain market share but also fortified its moat. Finally, Fastenal is increasing its dividend at a rate higher than the sector median. The special dividends and their timing demonstrate that Fastenal is a company that prioritizes its investors. I would like to purchase shares if they drop below $50, which is below the intrinsic value based on two out of three of my calculations.
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