W.W. Grainger Inc., please take your seat at the Victims of Amazon support group. It's time to accept your membership.
The $12 billion industrial-parts distributor reported dismal earnings (again) on Tuesday, sending its stock down as much as 11 percent for the biggest intra-day decline since August 2015. First-quarter adjusted earnings per share fell well short of estimates, as did sales and gross margins. Grainger also had to walk back 2017 EPS guidance that had already been disappointing when it was announced just five months ago; it now expects to earn $10 to $11.30 a share for the year, a reduction of 10 percent at the midpoint. The culprit? Price cuts Grainger is making to keep up with the Amazon.com Inc.'s of the world.
Investors didn't take Grainger's price cuts -- nor its off-base optimism -- well
Much like its displacement of brick-and-mortar stores and uprooting of competitors, Amazon's into the industrial-distribution market in 2012 and the price transparency that came with it has forced traditional operators to rethink their business. Grainger's Amazon vulnerability is particularly acute. With an average order size of about $250, it's more exposed to small- and medium-sized customers and doesn't have as much in the way of specialized or service offerings to insulate it, as RBC's Deane Dray has noted. And yet, Grainger still doesn't seem to fully realize the nature of the battle it’s now fighting.
To try to win back defecting customers, Grainger introduced new market-based prices for online shoppers, negotiated more competitive (aka lower) pricing for large clients on infrequent purchases and made it easier to consolidate orders. The greater-than-expected surge of lower-margin sales sparked by these price cuts are the reason for the first-quarter earnings miss. Because the response was so overwhelming, the company now plans to go ahead and implement price adjustments and marketing efforts planned for 2018 in the third quarter. Hence the lower guidance range.
Down and Out
Grainger's post-earnings drop was the worst in more than a decade. It was the fourth negatively received report in the past five periods.
Grainger tried to spin this as a good thing. Accelerated price cuts will spur faster growth by encouraging existing customers to buy more things while drawing new clients, CEO DG Macpherson said. To be fair, he had to do something, especially in light of his admission that the company hasn’t been able to acquire a customer under the Grainger brand in years (its Zoro and MonotaRO e-commerce businesses have seen more growth). But Grainger also expects to get through all the negative impact on price and gross margins by the end of 2018, and for operating margins to still reach its 12 percent to 13 percent goal by 2019. That seems … optimistic.
I mean, maybe, in Wonderland, this is possible. Grainger expects cost cuts to be a help here, but it appears woefully under-prepared for any competitive response to its strategy. Borders bookstores and Diapers.com operator Quidsi will tell you, the winner of a pricing battle with Amazon is usually Amazon, particularly if it decides something is a priority. Amazon doesn't talk all that much about its industrial-distribution operations (part of Amazon Business), but we got some helpful details out of the Staples-Office Depot merger litigation. Talk of a "land grab" and singling out Grainger as a competitor don't bode particularly well.
Analysts are anticipating a margin squeeze at Grainger over the next few years. Forecasts may move lower as they incorporate Tuesday's results.
What Grainger's accelerated price cuts suggest is that the company is having to become more like Amazon, instead of the other way around, and that the margins of its past are likely to become relics rather than re-runs. The sooner Grainger starts adapting to this reality, the better. Recall that for quite a long time management downplayed Amazon as a pricing threat. On Tuesday, it still maintained that the price cuts weren't a response to competitive changes in the marketplace, but rather based on its own pricing and how its customers buy. Yeah, OK.
On the plus side, Grainger is finally having more regular public conference calls. Management may not have loved certain questions -- like the one from Stifel Financial Corp.'s Rob McCarthy about how they're going to recapture their "spent" credibility -- but having the question-and-answer session allowed analysts and investors to understand the challenges and pricing adjustments in more detail. Now Grainger just needs to get its messaging right.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.