MSC Industrial Direct : Full Of Value, Lacking In Popularity – MSC Industrial Direct Co., Inc. (NYSE:MSM)

MSC Industrial Direct Company, Inc. (MSM) appears to be enjoying a strong performance based on its dividend activity. On December 17, 2019, the company declared a special dividend of $5.00 for shareholders, in addition to its regular dividend payment of $0.75. This special dividend was paid on February 5, 2020 to all shareholders owning stock prior to January 21, 2020. Special dividends are generally paid after a specific windfall event, such as the sale of an asset, or after periods exceptionally strong company earnings. This suggests that MSM is performing well and expects to continue this performance in the future.

It was also announced in December that Executive Vice President and Chief Financial Officer of MSC Industrial Direct, Rustom Jilla, would be stepping down effective January 17, 2020. This was not due to any illegal or improper activity within the company, but rather so that Jilla could become CFO of a public global manufacturing company. In relation to the special dividend declaration, it is interesting to note that other reasons for the declaration to occur are when a company wishes to make changes to its financial structure or spin off a subsidiary company to its shareholders. It will be worth keeping an eye on in the upcoming months to see if significant changes are made following Jilla’s departure.

While current news stories, good or bad, can sway our opinion about investing in a company, it’s good to analyze the fundamentals of the company and to see where it’s been in the past and in which direction it’s heading.

This article will focus on the long-term fundamentals of the company, which tend to give us a better picture of the company as a viable investment. I also analyze the value of the company versus the price and help you to determine if MSM is currently trading at a bargain price. I provide various situations which help estimate the company’s future returns. In closing, I will tell you my personal opinion about whether I’m interested in taking a position in this company and why.

Snapshot of the Company

A fast way for me to get an overall understanding of the condition of the business is to use the BTMA Stock Analyzer’s company rating score. It shows a score of around 81/100. Therefore, MSC Industrial Direct Company, Inc. is considered to be a good company to invest in since 70 is the lowest good company score. MSM has high scores for 10-year price per share, ROE, earnings per share, ability to recover from a market crash or downturn, and gross margin percent. It has mediocre scores for ROIC. It has a low score for PEG ratio. A low PEG ratio score indicates that the company may not be experiencing high growth consistently over the past 5 years. In summary, these findings show us that MSM seems to have above average fundamentals since the majority of categories produce good scores.

Before jumping to conclusions, we’ll have to look closer into individual categories to see what’s going on.

(Source: BTMA Stock Analyzer )

Fundamentals

Let’s examine the price per share history first. In the chart below, we can see that price per share has been inconsistent over the last 10 years, with price per share increasing in the first 4 years before experiencing a drop in year 5, followed by price per share increases over the next 3 years and then declining in the remaining years. Overall, share price average has grown by about 14.7% over the past 10 years or a compound annual growth rate of 1.54%. This is an abysmal return.

(Source: BTMA Stock Analyzer – Price Per Share History)

Earnings

Looking closer at earnings history, we see that earnings have increased overall during the past 9 years. However, increases have not been consistent. It appears that this company experiences periods of accelerated growth, then periods of stagnancy. This indicates that shareholders might have years of great returns followed by periods of little to no returns. Inconsistent earnings make it more difficult to accurately estimate the future growth and value of the company. So, in this regard, MSM is not a good candidate of a stock to accurately estimate future growth or current value.

(Source: BTMA Stock Analyzer – EPS History)

Since earnings and price per share don’t always give the whole picture, it’s good to look at other factors like the gross margins, return on equity, and return on invested capital.

Return on Equity

The return on equity has increased overall, which is good. However, the most recent year saw a decline in ROE. Five-year average ROE is in good standing at around 20%. For return on equity (ROE), I look for a 5-year average of 16% or more. So MSM has a five-year average that meets my requirements.

(Source: BTMA Stock Analyzer – ROE History)

Let’s compare the ROE of this company to its industry. The average ROE of 120 Machinery companies is 20.03%.

Therefore, MSC Industrial Direct Company, Inc.’s 5-year average of 20.2% and current ROE of 20.16% are about average for its industry.

Return on Invested Capital

The return on invested capital has fluctuated over the past five years, remaining stable over the first three years before peaking and then declining. Five-year average ROIC is slightly low at around 15%. For return on invested capital (ROIC), I also look for a 5-year average of 16% or more. So MSM fails to meet my requirements on this test.

(Source: BTMA Stock Analyzer – Return on Invested Capital History)

Gross Margin Percent

The gross margin percent (GMP) has steadily declined over the last five years. Five-year GMP is good at around 44%. I typically look for companies with gross margin percent consistently above 30%. So MSM has proven that it has the ability to maintain acceptable margins over a long period; however, the trend should be watched to see if it continues to decline.

(Source: BTMA Stock Analyzer – Gross Margin Percent History)

Looking at other fundamentals involving the balance sheet, we can see that the debt-to-equity is less than 1. This is a good indicator, telling us that the company owns more than it owes.

MSM’s current ratio of 2.9 is good, indicating that it has a good ability to use its assets to pay its short-term debt. Ideally, we want to see a current ratio of more than 1, so MSM exceeds this amount.

According to the balance sheet, the company seems to be in good financial health. In the long term, the company seems fine in regard to its debt-to-equity. In the short term, the company’s financial situation meets requirements.

The Price-Earnings ratio of 14.2 indicates that MSM might be selling at a low price when comparing MSM’s PE ratio to a long-term market average PE ratio of 15. The 10-year and 5-year average PE ratio of MSM has typically been between 19.2 and 17.6, so this indicates that MSM could be currently trading at a low price when comparing to MSM’s average historical PE ratio range.

MSM currently pays a dividend of 4.23% (or 4.10% over the last 12 months).

(Source: BTMA Stock Analyzer – Misc. Fundamentals)

The Story Behind The Dividend

In regards to dividend history, I’m first interested in knowing if the payout ratio is sustainable. At this time, it’s around 43%, which means that there is still room to grow the dividend. Also, notice that MSM has a regular history of buying back shares, which contributes to higher payout ratios.

If we look only at the dividend yield, we see a range of 1.88% to 4.06%. This stock pays out a decent dividend. Dividend yields have increased overall during the 5-year period, but not consistently. Therefore, this stock may not be desirable for some dividend investors.

Although MSM participates in share buybacks, sometimes buybacks don’t make sense, as according to Warren Buffett: “There is only one combination of facts that makes it advisable for a company to repurchase its shares: First, the company has available funds – cash plus sensible borrowing capacity – beyond the near-term needs of the business and, second, finds its stock selling in the market below its intrinsic value, conservatively calculated.”

In the example of MSM, the company appears to have ample equity as indicated by its satisfactory debt-to-equity ratio and its short-term cash is also sufficient according to its current ratio. Now let’s consider its borrowing capacity.

A good check for borrowing capacity is to see if earnings before interest and tax (EBIT) covers net interest by at least three times. MSM’s ratio is 31.39x, indicating that interest is comfortably covered. Hence, lenders will likely be willing to provide more funding since MSM interest coverage is conservative and safe.

Now to see if the buyback timing made sense. From the view of a share price chart over the past 5 years, the best times to do share buybacks would have been when MSM was near its lowest share price. This would have been in 2015 and 2016. Coincidentally, in 2016 was a time when MSM was buying back a huge amount of shares. This makes sense if the company is effectively trying to return value back to shareholders. Therefore, it seems like MSM has done a satisfactory job of strategically buying back stocks.

If I were currently interested in buying MSM now for the dividend, I would be trying to buy when the dividend yield was highest relative to its past. From the chart below, we can see that the dividend yield is near a high point relative to the past 10 years. Therefore, it’s an ideal time to buy now if my priority is a better than average return through dividends.

Overall, the dividend situation with MSM is better than average. On the positive side, the stock pays a decent and consistent dividend. The payout ratio leaves room to continue increasing the dividend. The dividend yield has been increasing over the years. MSC Industrial also aims to regularly return value back to shareholders through buybacks. Finally, the dividend yield is near a high level when compared with the past 10 years.

On the negative side, the dividend yields haven’t been increasing consistently year-over-year.

This analysis wouldn’t be complete without considering the value of the company vs. share price.

Value Vs. Price

For valuation purposes, I will be using a conservative diluted EPS of 5.05. I’ve used various past averages of growth rates and PE ratios to calculate different scenarios of valuation ranges from low to average values. The valuations compare growth rates of EPS, book value, and total equity.

In the table below, you can see the different scenarios, and in the chart, you will see vertical valuation lines that correspond to the table valuation ranges. The dots on the lines represent the current stock price. If the dot is towards the bottom of the valuation range, this would indicate that the stock is undervalued. If the dot is near the top of the valuation line, this would show an overvalued stock.

(Source: BTMA Wealth Builders Club)

According to this valuation analysis, MSM is undervalued.

  • If MSM continues with a growth average similar to its past 10 years earnings growth, then the stock is undervalued at this time.
  • If MSM continues with a growth average similar to its past 5 years earnings growth, then the stock is undervalued at this time.
  • If MSM continues with a growth average similar to its past 10 years book value growth, then the stock is undervalued at this time.
  • If MSM continues with a growth average similar to its past 5 years book value growth, then the stock is undervalued at this time.
  • If MSM continues with a growth average similar to its past 5 years total equity growth, then the stock is undervalued at this time.
  • According to MSM’s typical PE ratio relation to the S&P 500’s PE ratio, MSM is undervalued.
  • If MSM continues with a growth average as forecasted by analysts, then the stock is overpriced.

This analysis shows an average valuation of around $84 per share versus its current price of about $72; this would indicate that MSC Industrial Direct is undervalued.

Forward-Looking Conclusion

According to the facts, MSC Industrial Direct is financially healthy in a long-term sense in having enough equity as compared with debt, and in the short term because the current ratio indicates that it has enough cash to cover current liabilities.

Other fundamentals are solid, including ROE, gross margin percent, and EPS. Although, gross margins should be watched since they have been on a declining trend over the past 5 years.

The dividend situation is very good as the company pays a decent dividend with a yield that has been increasing over the past 5 years. Plus the yield is at a high point when compared to the past 10 years.

Lastly, this analysis shows that the stock is undervalued.

The big drawback of this stock seems to be with its share price performance. Since 2014, the share price has failed to show consistent and increasing performance. As I said before, the fundamentals of the company seem strong; it is financially solid and earnings have been increasing over the years. But still these positives have not been reflected in the share price. This could be a combination of factors. Possibly because it’s a smaller company that’s not so popular. Therefore, it receives less coverage by news and analysts and doesn’t receive the price recognition it deserves. There may also be an issue with its industry or possibly its products are losing perceived value. This could definitely be the case since forecasts for the company and its industry are often showing negative growth. Stronger competition and pessimism about MSM could also be a reason why the company’s stock price has struggled.

The chart below compares MSM versus the S&P 500 through the economic recession of 2008 until 2020. Both MSM and the S&P 500 saw significant declines during 2008, but MSM was able to recover and grow faster than the index in subsequent years. But as mentioned above, the stock has failed to show consistent stock price performance since 2014.

Predicted Growth

Over the next five years, the analysts that follow this company are expecting it to grow earnings at an average annual rate of 15%. This year, analysts are forecasting earnings decrease of -8.18% over last year. Analysts expect earnings growth next year of 5.58% over this year’s forecasted earnings.” (Source: Forecast Earnings Growth)

If you invest today, with analysts’ forecasts, you might expect about -8.18% growth per year. Plus we’ll add the current 4.23% forward dividend, which gives us a return of -3.95%.

Here is an alternative scenario based on MSM’s past earnings growth. During the past 10- and 5-year periods, the average EPS growth rate was about 7.8% and 6.1%, respectively. Plus the average 5-year dividend yield was about 2.55%. So we’re at a total return of 10.35 % to 8.65%.

But when considering cash flow growth over the past 10 and 5 years, the growth has been 8.7% and 6.9%, respectively. Plus the average 5-year dividend yield would give us a total return of 11.25% to 9.45 %. Therefore, if MSM performed in line with past growth rates, we could expect our annual return to be around 9%-10%. But if considering forecasted growth, our expected returns could actually be negative around -4%.

If considering actual past results of MSC Industrial, which includes affected share prices, and long-term dividend yields, the story is a bit different. Here are the actual 10- and 5-year return results.

______________

10-Year Return Results if Invested in MSM:

Initial Investment Date: 2/12/2010

End Date: 2/12/2020

Cost per Share: $44.90

End Date Price: $71.88

Total Dividends Received: $16.30

Total Return: 96.39%

Compound Annualized Growth Rate: 7%

_______________

5-Year Return Results if Invested in MSM:

Initial Investment Date: 2/12/2015

End Date: 2/12/2020

Cost per Share: $76.33

End Date Price: $71.88

Total Dividends Received: $10.68

Total Return: 8.16%

Compound Annualized Growth Rate: 2%

_________________

From these scenarios, we have produced results from 2% to 7%. This is certainly not too reassuring for hopeful investors. Especially, since you could invest in a low-cost S&P 500 index fund and easily outperform this with long-term returns of around 10% with more diversification and less risk.

The value investor in me likes the fundamentals and value of this company versus the share price. However, I realize that for a stock to make favorable returns requires more than just buying undervalued stocks. The company and industry need to have some positive perception by the market and general public. It seems that MSM has the value, but lacks the latter. I can’t invest in a value play simply with long-shot hopes of a solid return. I’ll put my money in other investments that I’m more confident about.

If you want to find good companies at bargain prices that will provide you with long-term returns and dividends or monthly swing trade profits, then my Seeking Alpha Marketplace service (Good Stocks@Bargain Prices) is a good match for you. I combine the proven methods of Warren Buffett’s and Benjamin Graham’s value investing with a practical system to apply these methods into today’s market.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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