W.W. Grainger, Inc. (GWW) Earnings Call Transcript & Summary

Good morning. There you are. I'm Sam Darkatsh, and on behalf of Raymond James, I'd like to welcome you to the Grainger presentation for today. With us today from Grainger, Dee Merriwether, Chief Financial Officer; as well as Kyle Bland and Irene Holman, Vice Presidents of Investor Relations. For those unaware, Grainger is the largest domestic broad line distributor of MRO products with operations primarily in North America, Japan and Europe. Dee, I think your prepared remarks, maybe your 10 minutes or so. We should leave a few minutes for Q&A from the room. And then we'll follow this with a breakout session downstairs. So with that, Dee, welcome.

Thank you. Is this on? Well, hello, everybody, and it's really great to be here in-person after not being in-person for so long. So welcome. So of course, I'll start with just some forward-looking statements, so please take a look at that before I get started. Sam basically did my first slide, but it's okay. So we are a leading broad liner in distribution of products and services in the MRO space. We're very focused on keeping the world working by providing innovative solutions to help solve our customers' problems and building customer relationships at the ground floor with our customers better than anyone else. We are a global company as we -- sorry, I'm going ahead -- we are a global company, as I noted. We operate primarily out of North America, Japan and the U.K. We do that with a very broad assortment, over 30 million SKUs, and we service close to 5 million customers across those geographies. And we do that in a highly digital way, as you see. Most of our transactions go through our digital channel, over 75% of them. We service the market with 24,000 employees, a broad distribution network of branches and DCs. And we're very focused on changing with our customers' buying behavior as we go to market. So to talk about that a little bit. We go to market in 2 distinct and competitively advantaged ways. We've named them High-Touch, and we focus on customers in North America with our High-Touch model and Endless Assortment. So the High-Touch model, we typically are working with large entities that may be single-site or have multisite locations. These customers expect deep product assortment and deep product knowledge, and they also expect services, someone to actually come in and help them solve their customer problems as well as help them take cost out. We call that reducing their total cost of ownership. What's important to them, really that assortment, distinct services, nowadays how can we help them with energy management solutions, help them achieve their ESG targets, how can we assist them with safety, making their workplace a more safe workplace and how can we connect them better with suppliers to help them look at innovative products and solutions. We do that by focusing on advantaged MRO solutions. We get a lot of questions about what does that mean. For us, that means having the best assortment, having the best language and search to make it easy for them to find those products online. And when they need assistance, having in-person sales associates does that differentiated sales and service, but also having a live person they could talk to technically on the phone about those highly technical issues. So we value our technical support and then also providing on-site inventory solutions and other service offerings like roofing and things like that, wastewater management that actually help them take costs out. They also are looking for no-hassle payments, invoicing and returns. So it's a key focus for us. If you're a very large business or we worked in one, having to work through requisitions, purchase orders and payments and making sure you can find your product when it's delivered to your dot. We are very focused on providing the right technology and embedding in their purchasing processes so we can do that better and more seamlessly than anyone else. If I move to Endless Assortment, this is a very broad market for us across North America. It's the biggest part of the MRO market. It's smaller businesses. They have more simple needs, more simple purchasing processes in their business. They're looking for a straight for search capability online and a very broad assortment of products, some in the MRO space and some outside of the MRO space. And they're also looking for very transparent pricing. We call these customers the highest order of shoppers. They are really shopping and quoting and price checking every day and significantly all day. We service them by providing a very broad assortment. You saw on the other page 30 million SKUs. 20 million SKUs we provide to these customers in Japan through MonotaRO and over 9 million SKUs in the U.S. with Zoro. Those SKUs are competitively priced. Our online search capability within that market is less curated, very much intuitive. We use analytics and a lot of reporting to help them understand their spend and is very customer-centric. So that's what we focus, and that's how we embed with our Endless Assortment customers. So I just want to cover some of our financial highlights for 2021. We delivered top line sales of $13 billion. On a daily basis that's about 12.4%. We outgrew the market versus 2019, which we believe is a much more comparable benchmark for our performance. And we outgrew the market by -- on average, 450 basis points. That was delivered by strong growth, both in the High-Touch segment as well as in the Endless Assortment segment. Endless Assortment segment has consistently grown at high teens. In this case, ended the year above 20% on a constant currency basis. We continue to focus on achieving SG&A leverage over the long term, and as a result, deliver operating margin at the order of 11.9%, which was a 65 basis points improvement over prior year. In line with our capital allocation strategy, we returned over $1 billion to shareholders through dividends and share repurchases. And of course, we continue to maintain a very strong ROIC north of 30%, 31%, 31.9%, specifically for a total company level. As we look to this year, last year, we feel like we were advantaged in dealing with a lot of the supply chain challenges that you hear about in the market, utilizing our scale and our supplier and merchandising prowess. And we continue to do so into 2022. So we expect sales to land at a range between $14.1 billion and $14.5 billion. On a daily sales basis, that's between 7.5% and 10.5%. That is supported by both strong growth in the High-Touch segment as well as in the Endless Assortment segment. And from a GP perspective, we intend to continue to expand margins. Our High-Touch segment is getting back to GP levels pre-pandemic, which is the focus. During the pandemic, our product mix skewed to pandemic or some of those items like mass hand sanitizers that we're pretty happy to get out of and getting back to our core assortment, that core assortment is much more profitable for us, and that's going to help us get back there. Again, we're maintaining and investing in the business. We continue to invest in marketing to help us drive demand. We're going to be investing in future capacity, specifically in the DC -- in the Japanese market as well as in our owned DC network to help us achieve our personal ESG targets, our corporate targets as well as to gain back some efficiency. We intend to expand margins between 65 and 125 basis points. And our top line targets, our profitability targets and continuing to execute on our capital allocation strategy, we intend to deliver EPS between $23.50 and $25.50 this year, which is north of 20% growth, almost 30% growth year-over-year. So that ends my prepared remarks. Sam, I don't know if you have any questions for me, but happy to take any at this time as well.

Sure. Thank you. Questions for Dee from the room. In the back, yes, ma'am. Supply chain update.

So well, I will say, we've been working very diligently with our supply partners to maintain relatively high availability of our core products. We've been investing along the entire pandemic cycle to get in line first with our suppliers to get back in stock. In addition to that, we've utilized our entire network to maintain high availability. Prior to the pandemic, we were very focused on DC optimization. So the majority of our products came out of the DC, direct-to-customer. We are actually sourcing product wherever it is in our network, if it's closest to the customer. So we've changed our allocation calculations to actually pull product out of the branches as well, which has served us well with customers. As it relates to general import and transportation, we're not immune to some of the dynamics that are going on in the marketplace. But we feel with our strong partnerships that we're doing better, better than most.

What are you seeing trend wise with respect to vendor lead times, fill rates, container rates? What specifically are you seeing here in the first quarter versus the last 6 months of last year?

So our fill rates have improved from 2020 to 2022, and they're still continuing to improve slightly here.

Your fill rates or your vendor fill rates?

Our vendor fill rates have improved and continue to improve. And we're seeing some challenges with containers, especially those coming over from China. However, our container backlog is actually down in Q1 versus Q4. So we're trending in the right direction. Now of course, with fuel increases, we haven't seen a lot of that flow through yet, but we're starting to have more conversations with our transportation partners about that right now.

Yes, sir.

How should we think about the business model in an environment of sustained [indiscernible], we are called core buyers and inflation of 3 or 4 or 5 years, how does that affect the business?

Well, our focus is to pass on cost inflation to our customers. That's the way our model works. And so we will continue to do that. Even if it starts to impact volume a bit. However, we believe we've built really great relationships based upon our availability over the pandemic, and we've continued to be able to take share. So we will be focused on passing on all inflation to customers even if it's sustained over a period of time. That helps us from a GP perspective, as long as we continue to target neutrality or slightly north of neutrality and continue to gain SG&A leverage. So we feel it will assist us with growing operating margins over the period.

Any questions? Talk about what you're seeing with demand this year so far. Fastenal, as an example, noted that January and February was still running a couple of points above historical seasonality. What sort of trends are you seeing?

So we did report January. We don't report February publicly, but our January results were similar. So we exceeded our plan in January as well as we saw increase in trend month-over-month from December to January, much higher than what we traditionally see. So demand remains strong in the business.

You are projecting 300 to 400 basis points of market outgrowth over the long term, which is similar to the outgrowth that you've seen post COVID. Why -- I would think that Grainger has been advantaged during COVID at a minimum because of your supply availability versus your less well-capitalized peers. Once inventories normalize in the channel, why would you expect that same 300 to 400-basis-point outgrowth to continue that you've seen over the past year or 2?

Well, our focus is 300 to 400 basis points of outgrowth over the long term. So we can have some years where we're significantly higher like we saw in 2020. And then in 2021, we're, based upon the year-over-year impact, may be a little bit lower. That's why in my prepared remarks, I noted that on a 2-year average, we outgrew the market by 450. So over the long term, we plan to have a steady march of 300 to 400 basis points of outgrowth. And just to remind everyone, prior to some of our changes related to pricing, our strategy and resegmentation focusing on High-Touch and Endless Assortment, we were not able to consistently do that. So this is an actual change in our strategy and our ability to execute well. And we have been on the right path. We believe we have the right initiatives in order to do that and to consistently execute.

And when you're talking about market outgrowth just for the sake of level setting the room, you're talking from a market standpoint, it's typically industrial production plus PPI, that sort of thing?

Correct.

Endless Assortment, is clearly one of the primary growth drivers of the business growing 20% or so, and it has for years and is expected to continue to grow that for years. What's interesting is that -- first off, both of your businesses within Endless Assortment should grow at a similar level, whether it's MonotaRO or Zoro. So talk about each's value proposition, relative value proposition versus their peers. MonotaRO is maybe the #4 or #5 player in Japan, yet is the only one growing or at least has demonstrated growth. And then Zoro, what's the relative value proposition versus perhaps an Amazon business, which we're all familiar with.

Sure. So I'll start with MonotaRO. And so we feel like we're probably 1 or 2 there, but are somewhat unique, I will say, because their model is a wholesaler model. And so we've actually, I will say, created a new channel in the Japanese market for MRO products. And so they're very focused on new customer acquisition, and now more recently, in the last couple of years having very strong growth with enterprise customers. So we expect that to continue. What enterprise customers stop to find it is more large corporations there. And so they are actually setting up relationships with large corporations to go after more of their tailspin. And MRO space, they have been doing that quite well and very successfully. As you look at Zoro, we had to brand-build over a period of time. That was a new business start-up for us. No one knew who Zoro was. We had to build up infrastructure even though they utilized the U.S. supply chain primarily, up until the last couple of years. Now they've expanded their assortment from about 700,000 core items that they were purchasing through the Grainger supply chain to now close to $9 million. They're doing that through other distributor and OEM partnerships. And that model, that flywheel model basically is, have a broad assortment, have strong marketing and key search online, attract new customers to the website, use analytics to actually analyze what customers need and what those signals are, add more of those products and types of products and go into segments that generally Grainger has not gone into and in some cases, don't necessarily include MRO to serve the broadest needs of the small customer. So they've been doing that for about 5 to 7 years really well. Now it's all about a frequency game. So we're looking to figure out how we gain more share of wallet of those customers now that they have become more loyal Zoro customers. So how do we increase this frequency of their purchases? How do we expand the share of wallet with those customers? And we're doing that by using information, providing reporting and information up to them and actually being at the right place online via Google search -- when they're looking for products and needs and marketing to them.

You mentioned in your prepared remarks how price sensitive or at least price conscious the Zoro customer is. And you have to be mindful of that when determining pricing. How do you manage potential pricing conflicts then, between Zoro and the base High-Touch business, especially knowing that High-Touch has a lot of national accounts that would want favorable pricing.

Sure. Since their onset, we've seen some crossover but fairly immaterial crossover. And if you think about it, most large corporations don't source their MRO products to one provider anyway. Our share within some of those providers is somewhat small. So there's a lot of room for growth and a lot of room for even Zoro, as an example. So we run pricing completely independent. So High-Touch pricing is completely independent of the Zoro pricing team. They do use -- both use great technology. Both have a pricing algorithm that they've built that is attuned to those 2 models. So we really don't collaborate on what the price of the product should be. I will say the one commonality is, cost. Since a lot of their products still comes from the supply -- the U.S. supply chain, their pricing becomes part of the base -- their costing becomes part of the baseline for their pricing algorithm, just like it is on High-Touch.

How does MonotaRO fit within the portfolio long term? It's obviously very richly valued, at least as a public entity over in Japan. And so there might be a significant monetization opportunity for Grainger at least theoretically. So how does it fit into the portfolio strategically? Or does it long term?

Sure. So I will say right now, the Endless Assortment business is being managed by Masaya Suzuki who is also the CEO of MonotaRO. And we were deliberate about that combination. Zoro really needs to figure out the frequency game that I talked about to be successful long term and to take advantage and improve their customer lifetime value, which is really the model that we execute within Zoro. So Masaya is really helping with the best practice sharing between MonotaRO and Zoro, and it goes both ways. So really trying to understand the frequency game, how you market to end segments that you want to grow with, where you have no salespeople, you have no branches and how you do that. MonotaRO has done that for close to 20 years now. And so we're trying to get Zoro on that glide path. So that is the initial and the most immediate requirement that we need from Zoro before we can think about any type of monetization of that asset or the MonotaRO asset. Our CEO, D.G. Macpherson, has said though that we agree that maybe in 3-plus years, depending on where we get with customers in the U.S., there may be opportunity there for monetization. So that's our evaluation period and time line, but our first focus is really getting Zoro what we would kind of say battle-ready for the U.S. market.

Other questions here from the room? With respect to your High-Touch, you've got a, what, 7% or 8% share or so of a $130 billion industry. What's the biggest opportunity for High-Touch from a market share standpoint? Is it growing existing customer share of wallet? Is it convincing new customers to use Grainger and talk about that both from a large customer and a medium-sized customer standpoint.

Yes. So I'll start with large customer. We have good share with large or we classify extra-large, largest of the large, large customers in the U.S. or across North America. So of course, if you're in sales, you know the easiest thing to do is to sell more to who you work with today. So that is definitely a focus because there's more share to be gained there. But we are still looking for new large customer and the ability to embed in those customers, where we have low single-digit share, and we're trying to get to high teens share. So new customer acquisition is not really new because they do business with us, but really trying to embed and expand is an opportunity, and we feel like that's easier to do then to go out and get brand-new customers. Medium customers is where we feel like our new acquisition model can really help us from a profitability perspective as well as a growth perspective. Prior to 2017, we were losing share with those customers at a clip of about 10 -- down 10% a year for 10 years. We've been up high teens since 2017 with that segment of the business and again, a very profitable segment of the business for us. So our focus there is acquisition, acquiring more medium customers. And just like Zoro, figuring out how we can build loyalty and affinity with the Grainger brand over a longer period of time. I feel like we're doing pretty well since we've been delivering in the high teens, call it, 25% as we exited 2021 with that customer. So a little bit of balance of both for us, is the biggest opportunity.

So your share of wallet with your large-size customers, I'm guessing, it's clearly going to be higher than your overall market share. I'm going to be guessing it's around 20%, 25% or so.

Fair enough.

Where do you find -- I mean you're going to have certain customers that you're going to be representing the lion's share of what they're spending. But where do you find typically the cap is for when a large-size customer is comfortable giving a supplier that much share? In other words, how much head space is there between where you are share of wallet and where you start to get some pushback?

We have some pretty large customers where our share of wallet is north of 40%. I think it starts to get challenging both ways. Then they have a lot of leverage over you from pricing, which doesn't feel good to us. And then their procurement departments generally start to get uncomfortable that if anything went wrong or south with the relationship, then it would be hard for them to switch. So I will say, around that point is when we start to feel some discomfort, probably on both ends, but we do have some very solid, what we call strategic relationships with very high share, and they've worked well for a number of years. But I would say it becomes probably a little bit more challenging when you get to that level.

Which would suggest at least 10-plus years or...

Absolutely...

So of pretty comfortable outgrowth before you start to reach that ceiling?

Yes. Yes.

Any other questions? I think we'll continue this in the breakout. Dee, thank you very much. Appreciate it.

Thank you. Thank you.