-EPS for the quarter came in line with estimates at $0.50, up from $0.42 cents a year ago.

-Revenue came in at $1.8 billion for the quarter, again matching estimates. Revenue came in at $1.4 billion during the same quarter last year.

-Management is worried that cracks are beginning to appear for demand as inflation continues to weigh on the economic outlook.

-Increased prices added around 690 bps to growth.

Fastenal (NASDAQ: FAST) is the largest distributor in North America of industrial safety and construction supplies, and also offers third-party logistics.  The company provides services to a whole range of industries, including auto, airlines, and government, and also supplies products to major companies such as 3M (NYSE: MMM).

Sales and estimates came in strong as demand continued to remain on a strong footing. Construction, OEM, airline, and manufacturing all continued to see strong demand, which translated into another good quarter for the company.

Segment Overview

Onsites had 102 signings and grew by 13.5% y-o-y.  Meanwhile, daily sales for the division grew by 20% y-o-y.  FMI technology grew by 10.6% in terms of revenue and accounted for 35% of total sales. Finally, eCommerce rose by 52% y-o-y representing the quickest increase of all segments. Fastener sales grew by 21% and safety sales grew by 13%, and all other sales grew by 17%.

U.S. PMI and other key indices

The biggest factor that determines whether the company does well or not is the U.S. PMI, which averaged 54.8 for the second quarter. Manufacturing continues to remain robust, as do many other industries across the United States. Other indices that indicate demand for steel, plastics, and transportation remain elevated. Manufacturing is expected to continue to remain robust for the time being, which should translate into positive earnings for the coming quarters.

A key problem in 2021 was shipping. Shipping continues to weigh down on companies and the backlog/ lead times remain elevated, although slightly lower than 2021. Demand being robust, and backlogs being high, are expected to weigh on delivery and lead times in 2022.

Financial overview

2Q operating margins came in at 21.6% and increased by 50 bps for the quarter. Meanwhile, gross margins remained flat at 46.5%. Gross margins may increase if input costs moderate during the second half of the year. Fastenal reduced costs by reducing labor costs, it took advantage of the worker network, but the reduction was slightly offset by higher transportation costs. Transportation costs are higher mainly due to energy costs. But crude prices have started to moderate and energy prices could reduce to much more affordable levels later this year. Natural gas and LNG remain elevated and there is little indication of a major correction in the short term.

Cash flow continued to remain strong as operating cash flow came in at $151 million, up 52% for the year. The company continued to increase CAPEX at a rapid pace, indicating that management, despite short-term issues, is taking a long-term view of the business and continues to reinvest in the business. This strategy clearly revolves around their long-term strategy to increase FMI facilities, which they believe will be key to driving revenue in the future. The company’s balance sheet also remains strong with a debt of 13.7% of capital.

Comparing Fastenal’s stock to its competitors

Fastenal’s stock is down compared to its competitors, who have witnessed far less volatility. Competitors such as WW Grainger (NYSE: GWW) are down only about 14% compared to Fastenal whose stock is down 28% from its 52-week high. Part of the reason the stock is down significantly is because Fastenal’s management has been a lot clearer about their outlook, and secondly, the company has a product mix that is cyclical. Investors fear that as interest rates rise, this could affect some of their key sources of revenue, such as construction.

Fastenal’s valuation

Despite growing at a relatively reasonable pace, investors might look at valuations and reconsider the stock. The stock's price-to-earnings currently stands at 27-28x, and while not expensive, it is still above what investors might consider attractive. Return on equity remains strong at 33%.

Risks

Fastenal’s biggest risk remains construction and OEM divisions, both of which are quite rate sensitive. The latest inflation reading came in stronger than expected at 9.1% and elevated prices could soften demand. Additionally, the Fed is likely to raise interest above 3% as it tries to tame inflation. This will affect OEM sales, and will also affect construction activity. Construction may still be resilient as a backlog of work is expected to continue through 2023, so results could be mixed for the next couple of quarters. On the other hand, energy prices are likely to moderate, and demand for airlines should remain robust, which will provide a bit of a tailwind.