Fastenal: Expensive Despite Strong Growth Drivers (NASDAQ:FAST)

Overview

Fastenal Company (NASDAQ:FAST) is a company that sells industrial and construction supplies, including fasteners, tools, and other related products. The company operates a network of retail stores and sells products online through its website. Fastenal also provides on-site inventory and supply chain management services to its customers. The company does business in the United States, Canada, Mexico, North America, and internationally.

FAST’s business model is based on serving customers’ needs in the manufacturing, construction, and other industries by providing them with a wide range of products and services. The company aims to be a one-stop shop for its customers’ industrial and construction supply needs.

In addition to its retail stores and online sales, FAST also operates a distribution network that efficiently delivers products to its customers. As a result, the company has a large inventory of products and can quickly fill orders and get them shipped out to customers.

FAST was founded in 1967 by Bob Kierlin in Winona, Minnesota. The company initially focused on selling fasteners, such as screws and bolts, to local customers in the Winona area. Over the years, FAST has expanded significantly in terms of its products and the geographical regions it serves. As a result, it has become a major player in the industrial and construction supply industry.

Overall, FAST business model focuses on providing a wide range of products and services to its customers conveniently and efficiently to build long-term relationships with them.

Track Record

FAST has experienced management, led by CEO and President Daniel Florness, a post he’s held since 2016. Florness joined Fastenal in 1992 and served in several leadership roles within the company before being appointed CEO. He has been instrumental in helping Fastenal expand its product offerings and customer base during his tenure as CEO.

Under Florness’s leadership, Fastenal has focused on providing high-quality products and services to its customers and building solid relationships with them. He has also led efforts to expand the company’s distribution network and enter new markets worldwide.

Since Florness took over as CEO in January 2016, FAST’s revenue has been up an impressive 76%. Even before Florness’s tenure, FAST has achieved steady revenue growth over the past decade. The company doubled its revenue without a single year of decline.

The company’s free cash flow growth over the past decade has been equally impressive, albeit a little bumpier. Overall, FAST’s free cash flow has grown 146% since 2012.

FAST has also maintained exceptionally high levels of return on equity, averaging 29.79% return on equity over the last decade without a year under 25% and the past five years over 30%.

Investors may want to pay attention to FAST’s rising debt levels. The company had no debt in 2013, but total debt has been growing ever since. Management explained in the 3Q22 earnings call that the recent rising debt is attributed to increasing working capital needs and share repurchases. Though FAST’s total debt is rising quickly, the debt is manageable. FAST has a total debt-to-equity ratio of 0.26 and an interest coverage ratio of 121.54.

Overall, FAST has an experienced leadership team that has established an impressive track record of growth and profitability. While total debt is snowballing, FAST debt remains manageable at current levels.

Growth Drivers

There are several growth drivers for FAST that investors should consider. One of the most significant growth drivers for the business is signing new onsite locations, which are dedicated sales and service locations provided from within or near a customer’s facility.

In the third quarter of 2022, the company signed 86 new locations for its Onsite sales and service program. This brings the total number of recent Onsite locations marked this year to 294. As of September 30, 2022, the company had 1,567 active Onsite locations, representing a 14.6% increase from the previous year.

During the third quarter of 2022, daily sales at Onsite locations saw more than 20% growth compared to the same period in the previous year. This growth is attributed to increased business activity from Onsite customers and, to a lesser extent, the increase in the number of Onsite locations. The company had initially anticipated signing 375 to 400 Onsite locations in 2022 but now expects to be in the lower half of this range, given the year-to-date signings.

Another important growth driver is FAST’s signings, installations, and sales through its FMI devices. FAST’s FMI Technology consists of three different offerings: FASTStock℠, FASTBin®, and FASTVend®. FASTStock℠ is a scanned stocking location system that utilizes proprietary mobility technology and is flexible in its application. FASTBin and FASTVend both incorporate embedded data tracking and fulfillment processing technologies, which are highly efficient and powerful.

FASTBin and FASTVend are equipped with various technologies, including infrared, RFID, and scales. The benefits of this technology are increased visibility, a significant reduction in stock-outs, and allowing the FAST branch to right-size its customer’s inventory. The table below summarizes FAST’s FMI device’s performance from 3Q22.

A final growth driver to consider is FAST’s rapidly growing ecommerce business. The company’s eCommerce business includes sales made through technical interfaces such as EDI and its online platforms. In the third quarter of 2022, daily sales through eCommerce increased by 50.2%, making up 18.0% of the company’s total revenues.

Overall, these results, particularly in FMI devices, are slightly lower than management would like, and this trend is expected to continue as management expects a soft 2023. CEO Daniel Florness had this to say on the 3Q22 earnings call:

The most important feedback that we focus on is what are our regional and district leaders hearing from their customers as far as their confidence going into 2023? And I will be honest with the group. That confidence isn’t strong. It’s not, hey, the sky is falling, but the confidence is very, very cautious and we are preparing for that type of environment. And that means that you are very thoughtful about where you invest. You are very thoughtful about not getting ahead of yourself.

Valuation

We will run comparative and discounted cash flow (“DCF”) analyses to estimate the intrinsic value of FAST. To begin, we’ll start with the comparative analysis and look at the highest, lowest, and average price-to-earnings ratios the market has paid for FAST over the past five years. We’ll also look at the sector median P/E, which is 18.49. Finally, we’ll multiply these ratios by the average analyst estimate of 2023 earnings, which is $1.92.

Scenario	P/E	2023 Earnings Estimate	Intrinsic Value Estimate	% Change from Current price
Bear Case	20.43 – 2018 PE	$1.92	$39.22	-16.41%
Average	28.77 – 5-year average	$1.92	$55.23	17.71%
Bull Case	41.60 – 2021 P/E	$1.92	$79.87	70.22%
Sector Median Valuation	18.49	$1.92	$35.50	-24.33%

Click to enlarge

On a comparative analysis, FAST has slightly more upside than downside. Investors would realize an excellent 70.22% return if the market were bullish and applied the 41.60 multiple, seen in 2021, to next year’s earnings estimate. However, suppose the market would value FAST at the bearish multiple seen in 2018 or even worse. In that case, if the market valued FAST at the sector median multiple, investors could see as much as a -24.33% return on their investment.

Turning to the discounted cash flow analysis, we will begin by taking the average of the last five years of free cash flows, which is $662 million. Then we will apply a 7% growth rate for the next ten years based on rule 72, which states a 7% growth rate will double the original value in ten years. We will follow rule 72 for this DCF because it’s challenging to forecast accurately free cash flow growth rates multiple years into the future. Still, I am confident that FAST will be able to double its free cash flow over the next decade because of the growth drivers previously mentioned.

Following the 10th year, we will use a 2.5% growth rate into perpetuity to determine the terminal value. We will then use a discount rate of 10% based. I use this discount rate because it’s my personal required rate of return. With these inputs, the DCF analysis gives us an intrinsic value of $21.85, representing a downside of -53.42% from FAST’s current share price.

If you believe a 7% growth rate over the next 10 years is too conservative, consider that FAST would need over a 17% growth rate for the current share price to match the estimated intrinsic value from this DCF.

Takeaway

Current Fastenal Company management has established an impressive track record for growth and profitability. Powered by FAST’s Onsite sales and service program, sales of FMI devices and ecommerce growth, FAST’s strong track record of growth and profitability should continue in the future despite expectations of a soft 2023. Unfortunately, at 25.30 times earnings, Fastenal Company’s current share price is too high for investors to expect an adequate return, but if you disagree, please let me know in the comments section below.

Thank you for reading!