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

Good morning. I'm Sam Darkatsh. On behalf of Raymond James, we'd like to welcome you to the Grainger presentation for today. With us today from Grainger, Dee Merriwether, Senior Vice President and Chief Financial Officer; as well as Kyle Bland, Vice President of Investor Relations. Dee, I think you mentioned your prepared remarks are maybe 15, 20 minutes or so, which should give us a little bit of time for the Q&A here, but most of the granular Q&A will be done at the breakout session that will immediately following. I think it's concord over 3, I think. And with that, Dee, welcome back.

Thank you. Thanks, Sam, and good morning, everyone. As a reminder, some of my comments today may include forward-looking statements. Actual results may differ materially as a result of various risks and uncertainties, including those detailed in our SEC filings. Reconciliations of our non-GAAP financial measures with their corresponding GAAP measures are found in the tables at the end of the presentation, and this presentation will be available on the Grainger investor website following the meeting. For those who aren't familiar with Grainger, we exist to fulfill our purpose of keeping the world working. We were founded in 1927 and have since evolved into the largest distributor of maintenance, repair and operating products in North America with nearly 25,000 team members that are energized to support more than 4.6 million customers. With access to more than 35 million unique products across our 3 platforms, we deliver exceptional service in all of the geographies in which we operate. While all MRO customers are looking for B2B partners that can provide a flawless experience and provide them value, how this translates on site is different among customers that have different sizes and have different levels of complexity. For this reason, we operate 2 go-to-market models. One, high touch exists for larger and more complex customers, where we win with deep product knowledge, value-added solutions and strong customer relationships. Here, we create value by helping our customers across North America solve their most challenging problems and challenges. Our best-in-class website helps customers quickly find products for their unique application and our multichannel origination and fulfillment capabilities allow us to serve customers in this preferred way. This is all supported by a team of experts, a curated digital experience that helps us manage our inventory, remove safety risks, assist in achieving their sustainability goals and work to help them improve their operating and procurement productivity. The high-touch model goes to market under the Grainger brand, which most people know, and accounts for 80% of our total company revenue. Our Endless Assortment model is for small and midsized businesses that have simpler needs who want to buy products generally online. They're looking for a distributor that can be a one-stop shop, which is why we have around 13 million SKUs on zoro.com and 29 million SKUs on monotaRO.com in Japan. The Endless Assortment business accounts for about 20% of our total company revenues. We compete with these 2 models in a very large, fragmented and attractive market. Within our high-touch business, we are largely a pure player with only 7% share. We have many competitors in this space who go to market in different and unique ways. We believe if we continue to invest and invest and enhance our capabilities to serve customers better than our competitors, we have a long runway to continue to grow profitably. Our Endless Assortment model offers product categories beyond MRO, allowing us to reach new customers and take advantage of the scope of the small business market in the U.S. In Japan, we've been a pioneer in our space and are committed to investing in innovation to expand our market-leading position with B2B customers. These large TAMs are supported by attractive market characteristics that help insulate us through the cycle. Over the last several years, we've invested heavily in building market-leading data and technology capabilities, including developing proprietary product and customer information systems. These data assets underpin our 5 strategic growth engines noted here, marketing, merchandising, seller coverage and effectiveness and customer solutions and fuel our ability to gain share with our high-touch model. The advantage we've built across the product and customer information scale allows us to unlock ability to tap into new and emerging technologies to better serve customers and extend our leadership position in the MRO industry. We've leveraged the data assets to fuel our artificial intelligence and machine learning strategy, and we look for new ways to increase revenue, drive efficiencies and enhance our service. We've been developing a variety of different capabilities across the business, including homegrown machine learning and AI models to expand our product breadth and depth, improve our marketing return on investment and streamline seller tasks. We feel we're well positioned to accelerate these efforts in the future. The Endless Assortment flywheel is all about creating an endless aisle for our customers, attracting them through organic and paid search opportunities, then driving repeat business by narrowing down the most relevant SKUs based upon their type of business. This flywheel drives sustainable growth and profitability for both zoro.com and monotaro.com. At Zoro, the team is focused on optimizing its assortment, launching Zoro's private brand products and improving customer experience through accurate delivery communication. At MonotaRO, the team remains focused on expanding the enterprise customer landscape, driving repeat business and is playing the future by groundbreaking the new Mito DC outside of Tokyo. Similar to High-Touch, we have progressed AI and ML capabilities across our Endless Assortment businesses as well. It's early innings, but we're using these technologies to drive productivity and accelerate our momentum across the flywheel. We're investing in Gen AI to assist with pricing, customer service and shopping assistance, for example. Underpinning the success of each of our segments is our world-class supply chain, one that is built specifically to serve the needs of business customers. That means having the right products at the right place at the right time. To do this, we invest in capacity, we use demand sensing models and workflow automation to ensure we have the right product in stock and can optimally fulfill orders with high accuracy and efficiency. By doing this, we're able to ship quality products with a high number of orders shipped per day, next day and complete. This is critical for business customers to ensure they can receive what they want when they need it and how they need it and the fewest number of boxes, bill of lading and invoices. And we think our ability to do this now and in the future with our scale makes us a reliable business and amplifies our value proposition to customers. Our supply chain delivers millions of products to millions of customers each day, allowing us to meet the varying needs of our diverse customer base, which spans across industrial, commercial and government end market segments. Our broad assortment of products and deep industry knowledge ensures customers have access to solutions to address any number of challenges they face, helping our customers to keep their operations running and their people safe. The final piece of our foundation that I'd like to highlight today is our purpose-driven culture, which we codify under something we call the Grainger Edge. Grainger has always had a very strong culture, but the Grainger Edge framework has focused and rallied all of our organization around our purpose to keep the world working. The 7 principles captured here under the Edge are at the heart of how we work with one another, with our customers, our suppliers and in the communities in which we serve. Living these principles is foundational to our culture, a culture that I'm proud to say has received several awards around industry leadership, operating responsibly and creating a top place to work. Turning to financials. We performed very well over the last several years, marking a meaningful inflection point in our business. This step change in growth has been fueled by progress by both of our segments. High-Touch has outgrown the broader MRO market by more than 500 basis points over the last decade with its focus on execution and on our strategic growth engines, notably within merchandising and marketing. These growth engines are all supported by a competitive price offer that is relevant for all customer sizes, by our technology and data transformation and by our advantaged supply chain capabilities. In addition, our continued compounding growth from our Endless Assortment segment, which has more than doubled its top line over the last 5 years and is fast approaching $4 billion in total annual revenue. This growth has enabled us to generate strong earnings and cash flow at exceptional returns, all while allowing for a consistent return of cash to shareholders. Flipping to the total company guide for 2026. We laid this out in our most recent earnings call in February. At the total company level, we expect revenue between $18.7 billion and $19.1 billion and daily organic constant currency sales growth between 6.5% to 9%, driven by strong top line performance in both segments. This assumes the High-Touch business continues to drive strong volume outgrowth above a muted U.S. MRO market and that we will benefit from pricing actions taken to help offset tariff-related price pressures. We expect Endless Assortment segment will grow roughly in line with our long-term earnings framework, which is in the low teens. We expect margins to improve meaningfully as we benefit from exiting the U.K. market in late 2025 and as the High-Touch gross margins recover as price/cost improves and we lap prior year LIFO headwinds. This, in addition to core SG&A leverage will result in operating margin expansion between 40 and 90 basis points. We expect EPS for the year between $42.25 and $44.75 per share, up 10% at the midpoint. Overall, we remain confident in our ability to drive strong results in 2026. As we look beyond 2026, the core tenets of our earnings algorithm remain firmly intact. We remain confident we can drive share gain in the U.S., grow the EA business in the teens, stabilize total company gross margins around 39% and grow SG&A slower than sales through process improvements and technology. Combined with our disciplined capital allocation philosophy, we believe this represents a very attractive total shareholder return opportunity. Finally, on this slide, we can see we have a strong balance sheet and a consistent record of prudently allocating capital. This includes investing back in the business at high returns, delivering pretax adjusted ROIC over 39% in 2025 and also includes returning capital to shareholders, which is supported by our 54-year history of consecutive dividend increases and our consistent track record of high-return share repurchases. We think this balanced approach affords us the flexibility needed to ensure we deliver on our commitments, and we can maximize value to shareholders in the future. Summing all this up, our 2 models and the work we've done over the past 5 years have positioned us extremely well for the future to gain share profitably. We play in a large, attractive market. And as the industry leader, we know there is opportunity to continue to grow. We have strong customer value propositions that allow us to serve B2B customers of all shapes and sizes using technology, data and nearly 100 years of know-how. Our supply chain is uniquely designed to serve business customers, and we continue to make investments to strengthen our position. We are strong financially. We are well capitalized and have a consistent track record of returning cash to shareholders. And during -- and driving all of this is our purpose-driven culture, where we emit the importance of doing the right thing for our people, for our customers and the external environment. As a result, customers trust Grainger to support their business. All told, this foundation leaves us well positioned to continue to drive shareholder value for years to come. And with that, I'll turn it back over to Sam to moderate for some questions.

Terrific. Question for Dee. I'll start the public forum. So January was up 10%. Your guidance for -- or at least your implied guidance for the first quarter is up, call it, what, 7.5%. What are your thoughts right now in terms of how the quarter is progressing versus those original anticipations? And what other metrics are you watching right now?

Yes, we still feel good about the guide at 7.5% for Q1. We're continuing to watch what's going on with tariffs, of course. One of our key metrics we look at every day is our order volume as well as our sales volumes. We don't report monthly sales anymore. So I can't share any more about that other than we feel like the quarter is well within the range that we provided.

You typically raise prices couple of times during the year. May is one of them. What were your anticipated pricing actions for May prior to the IEEPA being struck down. Now with Section 122 going into effect at least temporarily, how does that affect the May pricing?

Yes. So our teams are hard at work, as you can imagine, looking at harmonized tariff codes and seeing what is going to go into effect by when. And then those teams are working back with our national product providers to understand what their positioning will be. We can't pass on anything through price until we see the cost. So our main focus is on things that we can actually control. So we're looking at our private label products and understanding how the harmonized tariff codes will change those product costs. That is something that we can control. And based upon the effective date of those changes, those will be bled into our May price changes.

So could you go into that a little bit more? So you have roughly 20% or so of your business is private label. How much of that is -- was IEEPA exposed versus 122? And what's the net effect right now on your private label?

I think what I will point you to is it's probably about half of the 232 is what we're kind of seeing now, but we're still working through all of those details.

Okay. Got you. Question here, yes.

You mentioned that one of your competitive advantages of having the broadest and deepest selection to become a one-stop shop for your customer. Just interested in how you're thinking in how AI changes that competitive advantage and [indiscernible]

Sure. So part of our business is the one-stop shop, which is endless assortment. The Grainger brand is more curated and stocked assortment than the Endless Assortment brand. I will say your question is about how AI will impact, I would say, both of those models, but you started with the Endless Assortment model. What I will say is we've always had price transparency. Will this make prices more easily transparent? Probably. We've been able to compete under those circumstances and believe we will continue to be able to do so. The other thing I will point you to is that even though you may have an AI agent that can help consolidate potentially who to buy from whoever that is, they still need a supply chain. They still need to be able to pick, pack, ship it and they need to be able to deliver it. And that is where we have invested our dollars and continue to do so. So we feel like we are very well positioned to compete in that area. And as it relates to like LLMs, having access to data, we're working really hard to fool proof for that, but making sure that we can compete. So ensuring that the data that we expose to the LLM enables it to drive customers to us just like Google does. Those are the types of things that we are focusing on right now at Grainger in a smart way.

Last few years or so, there have been a number of divestitures, small, but notable. At what point or is there a point where M&A becomes more of a focus for Grainger? And if so, what areas?

So we focus on it. We're just -- we've been pretty quiet, and we've been very selective. So we have established for a number of years and definitely since I've been in this role, the last 5 years, we have filters as it relates to what geographies we believe works well for the High-Touch business as well as the Endless Assortment business. And so we are always looking mostly reactively in that case. But most of our time is spent actively looking and working with each of our functional areas on their strategy. And if there is something out there that could be purchased that we may not want to build, right? So that is where our focus has been is looking at and investing more business development, looking at and investing in areas that we're piloting and making small investments in businesses that could potentially become a larger part of our solution.

Question here, yes.

[indiscernible]

Sure. So we use our product information and our customer information once you land on the site, especially if you're in your account, where we can, based upon how you're searching, help you find the right product for your industry. I know you've heard us use the example of like the metal blue detectable ear plugs if you're a food processor or making sure that you have the right electrical raceway and componentry so that when you go to implement a project, you will not accidentally purchase something that you do not need and requires a return. We have very low returns because we work upfront to help you make sure that you have brought the right solution to solve the problem that you are trying to solve. That is more complicated than just a simple search of a SKU number. We try to actually leave you with a solution. It may be one SKU, but a lot of times could be multiple SKUs to help you solve that problem. I will say, in addition to that, the other services, if you start to bring in our branch network and our sellers, we work with companies to ensure that they could pass OSHA regulations by working with them on safety audits and helping to select the right product to eliminate and mitigate risk, including workers' comp risk in their businesses. And then lastly, from a sustainability perspective, we sell well over $1 billion worth of classified as sustainable products. And so we work with our customers on those products and solutions, and we bring partners to bear to assist them in selecting the right solution.

Other questions in the room? Your margin guidance is 40 to 90 basis points higher in '26 versus '25. Some of that is -- I think, 40 bps of that is because of the absence of the U.K. business, which was divested. The reason why I'm saying all this is, what's an incremental margin expectation, a normal incremental margin expectation for Grainger beyond '26, assuming kind of mid- to upper mid-single-digit growth?

Yes. We don't guide to incremental margins. But as you noted, when you look at our 2026 numbers and you normalize for the U.K. exit, you're at about 20%. And so I will say, generally, high teens to 20% is something that we believe is healthy and we should be able to achieve over time.

And the point at which you leverage margins typically, what kind of organic growth would be needed to...

4 to 5 points. Yes, 4 to 5 points.

Any other -- yes, question here?

[indiscernible]

It appears to be getting improving is what I'd say after some -- a pretty long period of being flat to down. And so we're hopeful like everyone that serves the manufacturing market and market segment that it will continue to accelerate through 2026 since it's been so soft for so long.

Other questions? Grainger is very focused on market outgrowth. It's for years been a KPI at the variable comp level. Why is outgrowth such an important variable for you? And what gives you the confidence that the right outgrowth number is 400 to 500 basis points?

Yes. Great question. So if you go back, I don't know, probably about 20 years, which our economists at Grainger has done, and you look at the market and you break it out between volume growth and price growth, there has been very little volume growth. All of the growth has actually come through price. And so our focus has been if we're going to maintain a market-leading position, it means we have to take share from someone else since the market itself is not growing. And so that became a guidepost for us to figure out and measure ourselves against. We set the -- first it was 3 to 4 a couple -- probably, I don't know, 7 years ago. And then when we went through the pandemic and then the supply chain crisis, we were trying to evaluate what the right target should be. We had done so well during the pandemic and had attempted to rightsize our results for our supply chain advantage. And when we looked at all those and our initiatives and what we were planning to spend over the long range, it looked like 4% to 5% was much more achievable than 3% to 4%. And so we made that change after the pandemic. We still feel confident in that. When you look at our incremental investments, our investments in capacity and then our use of AI to be able to do that over the long term.

Any other final questions? Yes?

[indiscernible]

Yes. When I joined 13 years ago, I will say our Endless Assortment business, it wasn't called that, was more in its infancy. We had created the joint venture with Japan at that time, and they were progressing, not quite profitable yet, but they were hitting their ramp goals. So the Japanese market was -- we were going to create a new market. There were no distributors. There wasn't that segment in the market. There were wholesalers and there were buyers. So that was an opportunity. We thought that, that would also be a great opportunity for the U.S. because when you went back and looked at Grainger's results over a 20-year period, we were growing with extra large customers, large customers, not so well with midsize and not at all with small. And so being able to introduce a go-to-market model that would enable us to grow with all market sizes in the MRO space and be able to do it profitably and scale our supply chain cost, fixed cost, we felt would help us drive incremental margins over a very long period of time as we took share.

And with that, we're out of time. We'll continue this in the breakout in Cordova 3. Thank you all.