When looking at a potential investment, investors want to know if the stock they are purchasing is a strong investment choice. To qualify as such an investment, the underlying company should be an industry leader with a proven track record of growing both revenue and earnings. The company should also be financially sound. Income investors would likely want the company to have a history of paying and raising a dividend and that the yield is likely safe.
This analysis will examine why I believe Fastenal Co. (FAST, Financial) meets the definition of a strong investment.
Fastenal: An overview and recent earnings highlights
Fastenal provides industrial and construction supplies to customers in North America and around the world. The company began by selling nuts and bolts through vending machines, but has transformed to a wholesale distributor of the equipment needed for its customers to perform their basic operations. Fastenal has more hundreds of thousands of individual parts in its portfolio.
The company has more than 1,600 public branches, but has focused more recently on its active on-site locations to drive growth. On-site locations are dedicated sales and services that are located near a customer’s facility. Fastenal is valued at just over $32 billion and generates annual revenue approaching $7 billion. The company surpassed $1 billion of international sales in 2022.
Fastenal reported second-quarter earnings results on July 13. Revenue grew 6% to $1.9 billion, though this was a slight miss of analysts’ estimates. Earnings per share totaled 52 cents, which was in line with estimates, but a 4.6% improvement from the prior year. Impressively, Fastenal has met or exceeded analysts’ estimates for 15 consecutive quarters, demonstrating a very consistent track record of outperforming expectations.
For the first six months of the year, revenue and earnings per share increased 7.5% and 7.4%.
Growth driven by on-site locations
Revenue growth for the quarter was primarily driven by gains in the company’s on-site locations. Revenue for this aspect of the business grew at a high-teens percentage, with locations open at least two years performing especially well. Fastenal signed 86 new on-site locations during the quarter, bringing the year-to-date total to 175. The addition of these new agreements will likely further lift results in the future.
The recent results are essentially a continuation of a long-term trend of growth for Fastenal. Revenue for the company has a compound annual growth rate of 8.6% for the last decade, while earnings per share growth has been even better at 10.7%.
Fastenal's strong cash flow generation
A very consistent business has resulted in high level of cash flow generation. Remarkably, much of the operating cash flow has translated to free cash flow. For example, Fastenal has produced operating cash flow of $1.25 billion over the last year, with free cash flow totaling $1.07 billion.
Again, this is not a one-off occurrence, as the business has regularly generated robust free cash flow for a very long period.
As a result, Fastenal is in the envious position to be able to use its free cash flow a variety of purposes. Perhaps most important is that the company carries very little debt, just $618 million as of the last quarter, relative to its size. About $202 million of this debt is due within the next year, but this should not present much of an issue for the company. Factoring in cash on its balance sheet as of the end of the June quarter, the net debt position is just $106 million.
Shareholder returns
With very little debt to worry about, Fastenal can instead direct its ample cash flow to shareholder returns. The dividend is the primary way the company returns capital. It has paid and raised its dividend for 24 consecutive years. The dividend has more than tripled over the last decade as the company has aggressively increased its distributions, including a 13% raise last January.
Shares of the company yield 2.6%, more than a full percentage point better than the average yield of the S&P 500 Index. This is also slightly ahead of the stock’s average yield of 2.4% since 2013.
The dividend is likely secure as well. Fastenal has distributed $754 million of dividends over the last 12 months, leading to a free cash flow payout ratio of 71%. This payout ratio is high, but considerably better than the free cash flow payout ratio of 91% the company has averaged since 2019. Normally, such a high payout ratio would be concerning, but I am less worried in this case given the recent lower payout ratio and the fact so little free cash flow must be earmarked for debt repayment. This is a major benefit of carrying so little debt on the balance sheet.
Share repurchases have been less of a primary focus, but the share count has been reduced by approximately 18 million shares, or 3%, since 2013. This small amount of buybacks has not gone to waste either as the company does not dilute its share count with stock-based compensation.
Financial health and industry ranking
In comparison to its peer group, Fastenal ranks very high on most metrics, so much so that the GF Score is a very impressive 98 out of 100. There are very few companies in the entire marketplace with a a higher score. This implies the possibility of significant returns going forward.
Contributing factors include the company’s profitability rank, which receives a perfect 10 out of 10 from GuruFocus. It should not be surprising that Fastenal’s underlying business metrics are the best in its industry given its historical performance.
On nearly every metric that is measured, such as net margin, return on invested capital and return on assets, Fastenal tops at least 95% of companies in the industrial distribution industry. Many of these scores are also at the high end of the 10-year range for the company.
Fastenal also received a perfect score for momentum, due to industry-leading relative strength, but also for growth, which has high expectations for earnings growth over the next three to five years.
Financial strength is solid, scoring an 8 out 10 as most metrics related to debt are near the high end of the peer group given that debt levels are so low. The Piotroski F-Score shows that Fastenal is stable and the Altman Z-Score points to a company that is highly unlikely to go out of business.
Valuation analysis
Fastenal has traditionally traded with a premium multiple as more than a decade of consistently high growth rates usually leads to an elevated valuation. The average price-earnings ratio has been 27 since 2013. Currently, shares trade at this exact valuation based on estimates for the year. Therefore, shares are fairly valued on a historical basis.
However, the stock appears to be trading at a discount to its intrinsic value according to the GF Value chart. With shares trading at $54.50, Fastenal has a price-to-GF Value ratio of 0.87. Investors could be looking at a 14.3% gain if shares were to reach its GF Value before factoring in the Fastenal’s dividend yield.
Final thoughts
Fastenal has all the makings of a strong investment. The company leads its industry on most metrics and the results for more than a decade have been very good. The company also carries very little debt, which allows it to use its free cash flow to generously raise its dividend. At the same time, the share price is materially below its intrinsic value, suggesting mid-double-digit returns could be possible. Therefore, Fastenal could be an excellent name for investors to add to their watchlist.
