Global Debt Markets bring PE deals to a snails pace while B2B distributors continue to post strong results

In the weeks since my last post we have seen the global debt markets grind to halt as the result of increasing concerns about the sub-prime market. The obvious fear is that without an ample supply of cheap debt many leveraged buy-out deals will be delayed or fall apart all together. I am not calling time of death on the LBO market yet but today's announcement by Virgin Media is concerning. The company announced today that they are delaying the auction process for the company so that bidders "can complete their proposals in a more stable debt market environment." The question moving forward is two fold in my mind - first how long will the dark media clouds hang over the debt market? And two, will deals for conservatively leveraged companies with strong cash flows move forward in the interim. This will be an interesting story to follow moving forward particularly as it relates to industrial and B2B distributors.

In other news today Henry Schein posted strong second quarter revenues and raised the lower end of their earnings forecast - further evidence of underlying strength in the economy. Since my last post we have seen a drop in ISM's Manufacturing Index from 56 to 53.8. Despite the drop I remain bullish about the MRO market in the domestic market as long as the index remains above 50.

Grainger's upgraded guidance fails to impress The Street, despite continued strong earnings

Grainger released strong second quarter figures today with 8% revenue growth and a 12% increase in net earnings. In addition Grainger raised their 2007 EPS forecast from $4.70-$4.85 to $4.75-$4.90. Grainger's failure to raise the low end of their EPS forecast caused the stock to crash 4.18% today - which I believe has created an excellent buying opportunity for a stock which should reach $115 by year end.

Grainger's press release detailed progress toward the companies market expansion - with many of the expansion cities experiencing 10-12% growth year over year. The press release also noted that Mexican sales rose 26% with U.S. sales rising 8% (5% related to market expansion efforts and 3% organic growth). 8% revenue growth domestically is impressive and points to good execution of their marketing expansion and underlying strength in the US economy. Historically Grainger's sales have been tied to the health of the U.S. economy but these results reflect the potential for Grainger to grow the business through improved branch locations, targeted advertising and greater cost control. It will be interesting to see if Grainger's numbers will be able to weather any future dips in the ISM Manufacturing Index during the next year or if their sales will continue to move in lock-step with the index.

Strong Profts continue for MRO suppliers

During the last two and half weeks MSC and Fastenal have reported strong quarterly earnings numbers indicating continued strength in the MRO market. MSC's net sales increased 30.7% with approximately 74% of the growth stemming from the 2006 acquisition of J&L. Comments from MSC CEO David Sandler indicate a sense of optimism in the industry noting that "We are especially pleased with our financial performance, despite the prevalent softness of the industry reflected in seven months of weak ISM index reports. Although market conditions have not changed, the two most recent ISM index reports show more optimism in the market. We are not currently seeing that optimism reflected in our ordering rates from customers, however, history shows that if the trend in the ISM continues, we should see improving business conditions in the upcoming months."

The ISM manufacturing report for the last two months stood at 55% and 56% respectively. Figures greater than 50% indicate market expansion.

MSC's gross profit margin of 53% during the most recent quarter also reflects the company's ability to pass along increased prices to customers.

Fastenal was able to grow sales by 13% and profit by 15% in the most recent quarter according to their quarterly report which was released Thursday.

Great M&A articles

A couple of great articles about the state of M&A in the wholesale distribution sector following the sale of HD Supply to a consortium of private equity firms. Adam Fein's post asks - is M&A peaking in this sector? I think the bigger question is whether or not the overall M&A market is peaking? I for one still believe that many private equity groups are just coming around to the idea of wholesale distributors as an attractive sector. That being said as long as private equity firms and strategic buyers continue to have cheap access to capital I think the pace of M&A will continue on the macro level and may intensify within the wholesale distribution sector.

http://www.mdm.com/stories/ma3710.html

http://www.mdm.com/issues/blog/general/4184-1.html

http://www.distributiontrends.com/2007/06/is-m-peaking.html

MRO Supply Fund - A good investment?

This year publicly traded MRO supply companies are up significantly againts the S&P 500 and Dow Industrial averages. Grainger, Fastenal, MSC, and Watsco collectively are up 24.73% YTD compared to 5.94% and 7.20% for the S&P 500 and Dow Industrials respectively. Part of the reason I started this blog is because I think the MRO supply business is a great sector to invest in. I plan to periodically post updates regarding the performance of what I call the MRO Supply Fund (Grainger, Fastenal, MSC, and Watsco). I have also included a small table that tracks the return of these stocks relative to the S&P and Dow at the 1 year, 5 year, and 10 year intervals. Please let me know if you think I should include others companies to the MRO Supply Fund.

	YTD	1 Year	5 Years	10 Years	10,000 Investment after 10 years
GWW	31.46%	29.10%	91.81%	135.74%	23,574
FAST	16.50%	6.25%	116.18%	231.90%	33,190
MSM	33.32%	18.14%	169.21%	149.31%	24,931
WSO	17.67%	-5.12%	207.13%	229.69%	32,969
MRO Fund	24.73%	12.09%	146.08%	186.66%	28,666
S&P 500	5.94%	20.05%	51.79%	21.75%	12,175
Dow Industrials	7.20%	21.30%	66.59%	27.64%	12,764

Home Depot Sells HD Supply - one dumb idea

Home Depot finally pulled the trigger and sold HD Supply to a group of private equity investors for $10.3 Billion. Wall Street may be happy with the decision as they believe that the battered HD can now focus on their retail business. The fact of the matter is that their retail business only has limited growth in the United States as they are beginning to duplicate stores within regional markets - they are clearly nearing saturation in the retail home improvement business.

I was a big fan of Home Depot when they purchased Hughes Supply, the maintsay of their HD Supply franchise. I believed that Home Depot had the name and the know how to build a great MRO/Contractor supply business that could compete with Grainger in the highly fractured $145 billion MRO North American marketplace. However - the HD Supply business has been on the auction block for sometime now as the result of pressure from the street to raise the lagging HD share price.

All I can say is kudos to Bain Capital LLC, Carlyle Group and Clayton Dubilier & Rice - this is solid investment on their part and one that is sure to grow in the coming years. As for HD - if you haven't dumped this stock yet please do so. HD has sold their only growth business...

What percentage of Grainger's revenue growth is domestic? - 8% sales increase in May.

Grainger announced today that their daily sales had increased 8% in May from a year prior. Grainger's sales figures have often be a good indicator for economic activity in the United States given the company's large customer base and broad product offering.

More recently Grainger has made significant investments in foreign markets such as China and Mexico. In the first quarter Grainger indicated that revenues at their Mexican locations had increased 19.5%. It would be interesting to see how much of May's 8% growth was tied to growing business in China and Mexico.