Sometimes buying boring businesses can be very profitable for investors. Take Fastenal Company (FAST), which is a distributor of industrial consumables. Its stock keeps hitting 52-week highs, and is up nearly 37% year-to-date.
Fastenal's Modern Business Model
Fastenal operates in 26 countries, but more than 95% of its sales take place in its three main markets of the U.S., Canada and Mexico. Over 70% of its customers are in the manufacturing and non-residential construction sectors.
As its name suggests, Fastenal started out as a provider of fasteners – nails, screws, nuts and bolts, etc. – to customers. It began operations in 1967 with a plan to supply threaded fasteners in small- to medium-sized cities and later expanded its operations to include sites in larger cities.
Since opening its first fasteners store in 1967, Fastenal has built one of the largest industrial distribution businesses in the U.S. For many years, Fastenal’s growth story was driven by its branch count. While this footprint is still an important component of the company’s business model, other strategies — including expanding its product portfolio, its vending and inventory management services, and, most recently, its on-site program — have become increasingly important growth drivers.
Industrial Vending Drives Growth
Fasteners still represent around a third of its business, but Fastenal now sells a much broader range of consumables.
It sells its products at approximately 1,635 stores and 1,728 onsite locations, as well as through vending machines at customer locations, and through e-commerce channels.
The company has been doing very well in the past several years, with sales and operating profit growing at a healthy compound annual rate (CAGR) of 10% over the past five years.
It has scored some big wins, as manufacturers scrambled to secure the components needed to keep production lines moving. In other words, it was a big beneficiary of the pandemic-caused supply chain problems.
First, it was safety equipment during the early stages of the pandemic - then, it was pretty much everything else. The company was able to fund big increases in its own inventory because of its pristine balance sheet. And the fact that Fastenal has its own manufacturing facilities (which make around 4% of the items it sells) to produce hard-to-source or custom parts also helped.
The company offers 10 product lines. The fastener product line, which is primarily sold under the Fastenal product name, represented 34% of net sales in 2022.
In 1993, Fastenal began to add additional product lines, which made up the remaining 66% of sales in 2022. These products tend to move through the same distribution channel, get used by the same customers, and utilize the same logistical capabilities as its fastener product line.
Unlike fasteners, the non-fastener product lines benefit a lot from the development of industrial vending machines. The most significant category of non-fastener products is the safety supplies product line, which accounted for 21% of sales in 2022. This product line has experienced dramatic sales growth in the last 10 years, attributable to Fastenal’s success in industrial vending over that period.
Fastenal’s Future Outlook
The benefits of Fastenal’s vending, inventory management, and on-site services are two-fold.
Not only do these services drive revenues, but more importantly, they embed Fastenal in its customers’ procurement processes, which leads to higher retention rates and pricing power.
Fastenal has a first-mover advantage in both vending and on-site services, introducing the former in 2008 and the latter in 1992. Its cost advantages have allowed it to earn strong returns on invested capital historically (approximately 25% on average over the past two decades).
Today, Fastenal has installed over 100,000 industrial vending machines, up from just 47,000 installed machines in 2014. Its on-site program has also experienced strong growth, expanding from approximately only 200 on-site locations in 2014 to over 1,600 on-site locations today.
I also like the company's focus on digitizing its sales and inventory processes, and expect continued strong growth in digital sales. Fastenal‘s e-commerce business now makes up approximately 25% of total sales, with sales soaring by 41% in the third quarter of 2023.
Over the long term, I expect this industrial company to generate mid-single-digit sales growth and high single-digit earnings per share (EPS) growth.
Fastenal also pays a decent dividend, backed by over two decades of consistent growth. In the first quarter of 2023, the company announced a 13% increase in its regular quarterly dividend to $0.35 per share, or $1.40 annually, for a yield of about 2.5%. I believe the dividend is very secure, and likely to grow - perhaps to $1.60 - in 2024.
Despite serving cyclical end markets, Fastenal’s business model generates strong free cash flow throughout the economic cycle. That makes it unusual in the industrial sector.
That also means FAST can still be bought anywhere in the $60s.
