Fastenal

Fastenal reported second-quarter sales growth of 14.7% year over year, outpacing its selling, general, and administrative expense growth, resulting in nearly 16% year-over-year growth in net income per share.

Why it matters: Fastenal's top-line growth has reaccelerated. The company tends to outgrow its manufacturing-centered end markets by achieving significant wallet-share gains and winning new customers. Fastenal grew its sales by double digits for all of its product lines and end markets. Notably, its heavy manufacturing and nonresidential construction businesses grew in the high teens. The firm continues to prioritize larger customer accounts in favor of smaller ones. We like this strategy because we believe switching costs are considerably greater for its larger national customers.

The bottom line: We maintain our $40 fair value estimate for wide-moat Fastenal. Shares trade slightly overheated in 2-star territory. Fastenal's vending device count grew 8%, and Fastenal Managed Inventory, or FMI, now represents around 45% of consolidated revenue, up 60 basis points from a year ago. These sales tend to be sticky and give Fastenal increased visibility into customer inventory usage patterns. We view any pullback toward Fastenal's fair value estimate as a great entry point into the stock, given that Fastenal tends to compound its earnings per share in the midteens.

We maintain Fastenal's fair value estimate at $39.90, which equates to about 33 times our estimate of 2026 adjusted earnings. Fastenal’s value is underpinned by its wide economic moat rating through which we believe the firm can outearn its cost of capital over the next 20 years.

Fastenal primarily serves the manufacturing industry, which has historically grown around GDP. However, the firm's organic growth has greatly outpaced GDP from a number of factors that we expect to continue. For one, Fastenal has done a great job at identifying new products and services to expand its wallet share of existing customers. It grows with the customer, often starting with an off-site relationship and moving operations on-site once the customer’s sales volume justifies it. Fastenal’s on-site program encourages customers to outsource more supply chain functions to the firm than its traditional branch model, expanding Fastenal’s wallet share faster and beyond its off-site equilibrium penetration rate.

Companies are opting to outsource noncore functions to experts like Fastenal for the first time amid rising regulations and skilled labor shortages, which is driving new customer growth for the firm. Although Fastenal has a long runway for organic growth in the US, overseas expansion is yet another growth driver, as full-service supply chain outsourcing remains relatively nascent in most countries. Fastenal generates just under one-fifth of its revenue from countries outside the US, but this cohort has grown meaningfully faster than Fastenal’s US business. Considering each growth driver, we model top-line growth in the high single digits over our explicit forecast.

Because Fastenal’s sales mix is skewing toward large national accounts, on-site programs, and more price-competitive MRO products, the company’s gross margins are likely to come under pressure. However, the combination of higher sales volume and containment of operating costs provides Fastenal with the opportunity to realize volume leverage and expand operating margins. We expect Fastenal's operating margin to eclipse 20% over our explicit forecast.

Even if economic activity weakens, we find comfort in Fastenal’s free cash flow resiliency through the cycle. During downturns, free cash flow as a percentage of sales tends to increase due to reduced working capital requirements.

We assign Fastenal a wide economic moat rating carved through a scale-based cost advantage and switching costs. The firm generates average returns on invested capital inclusive of goodwill in the low thirties and we expect returns to improve going forward. Importantly, Fastenal’s returns did not fall below 15% during the last two global economic crises in 2009 and 2020. It has also been able to maintain its 20% operating margin goal through recent downturns, well above the margins of its close peers Grainger and MSC Industrial.

Fastenal distributes maintenance, repair, and operations supplies to industrial customers through on-site vending machines and nearby branches. It owns one of the densest networks of MRO distribution centers and branches, akin to a hub-and-spoke model. Even after the conversion of hundreds of branches into on-site locations, 93% of the US population is within a 30-minute drive from a Fastenal branch. We suspect Fastenal’s branches sit considerably closer to its customers than Grainger’s, on average, allowing Fastenal to more quickly distribute supplies. We think customers greatly value this proximate service and rapid product delivery given the time-sensitive and mission-critical nature of maintenance products. As the aggregate cost of MRO supplies is typically less than 10% of the total cost to run a manufacturing plant, we believe the customer’s focus is shifted away from price. This pricing power is evidenced by Fastenal’s ability to charge premium pricing and generate higher margins than peers.

Indeed, Fastenal holds dominant share of the fastener distribution market in North America. Fasteners, the firm’s largest product category by revenue, have a low value/weight ratio and are thus economically unfeasible to transport long distances. With its expansive store network, dense supplier base, dominant purchasing scale, and captive shipping fleet that handles over 95% of orders, Fastenal has built a cost-effective distribution system that makes fastener distribution not only feasible, but highly profitable. Fastenal’s wide portfolio of MRO products, national presence, and flexible on-site model also allow it to service two difficult cohorts: small, rural customers in underserved areas and large, complex customers with bargaining power. Moreover, Fastenal’s scale and deep supplier relationships enable it to receive preferential access to supplies during supply chain disruptions. For example, the firm was able to utilize its global supplier network throughout the covid-19 pandemic to build inventory and maintain speedy, on-time deliveries.

We believe Fastenal wins customers based on offering the lowest total cost of ownership. Costs to manage inventory include sourcing, transporting, tracking, storage, and disposal. On top of reducing costs associated with these complex functions, Fastenal acts as an advisor to the customer, reconfiguring manufacturing plants, providing inventory data analytics, and recommending additional outsourced services to save more time and money. In aggregate, Fastenal estimates that it saves the average customer over 20% on overhead expenses by outsourcing inventory management to the firm. We expect Fastenal’s value proposition to grow as the skilled labor shortage worsens and meeting regulations becomes more costly.

We suspect Fastenal also benefits from switching costs, especially once it has an on-site presence. For a customer to change supply chain partners, a competing offering would have to save the customer 20% on overhead plus the costs and risks associated with plant redesign, operational downtime, on-site installations, software migration, and employee retraining. We think Fastenal’s bespoke inventory management solutions significantly increase such switching costs; its on-site inventory cages, bin stocks, vending machines, and accompanying software cannot simply be ripped out of a customer’s operations.

Customers tend to adopt more of Fastenal’s services as their value is borne out, raising switching costs over time. For example, take a larger customer that initially trials Fastenal to deliver nuts and bolts from a nearby Fastenal branch to a single site. The customer may quickly see the value of outsourcing and elect Fastenal to deliver safety, janitorial, and metalworking supplies to multiple sites. Eventually, the customer may generate enough revenue for Fastenal to justify the installation of custom on-site vending solutions. It offers larger customers dedicated personnel that attend internal customer meetings and stay on top of all supply chain needs. Underpinning each of these services is Fastenal’s software that becomes integrated into customer workflows. The distributor has worked diligently to develop sophisticated digital tools such as its Fastenal Managed Inventory suite and Fast 360, its inventory management dashboard, that generate proprietary analytical reports.

Lastly, Fastenal derives around 5% of revenue from designing, manufacturing, and repairing custom, low-volume fasteners and tools that require special alloys or nonstandard sizes. Although these services are a trivial percentage of revenue, we believe they raise Fastenal’s value proposition and the friction to change supply chain partners.

Fastenal measurably reduces its customers’ supply chain costs, an attractive value proposition regardless of the macro environment.

Largely due to share gains, Fastenal has handily outgrown the overall manufacturing sector even during global economic slowdowns.

The firm owns one of the densest distribution networks in the US, making it a preferred partner for both local and national customers.

A continued mix shift toward nonfastener products could dilute the firm’s differentiation and further hamper its gross margin.

Amazon Business remains an ever-present threat and could bring greater price transparency that pressures industry profit margins.

We believe some competitors have already copied Fastenal’s on-site distribution model, which could result in faster market saturation.