Some bad news can be explained away, and some you just can't ignore.
On Tuesday, W.W. Grainger -- a supplier of motors, fasteners and other industrial parts -- reported second-quarter profit that missed analysts' estimates by the widest margin since at least 2006. It was by all accounts a dismal showing, as operating margins also came up short and Grainger had to cut its full year sales and earnings guidance.
Grainger shares dropped more than 4 percent -- a drop big enough to make it the worst-performing member of the S&P 500 Industrials Index. The measure as a whole fell about 0.3 percent as of early afternoon in New York.
Investors have been willing to give struggling industrial companies the benefit of the doubt this year as they hunt for relatively safe, dividend-paying stocks that will give them some kind of yield in this (apparently never-ending) low-interest rate, slow-growth environment. And not wanting to miss out on an industrial and commodities turnaround that has to come eventually (right??), many have looked past gloomy outlooks and earnings misses and made a bet that things can't get any worse. Grainger's results pop a hole in that optimism.
Bad numbers weren't totally unanticipated out of the industrial supplier. Grainger's rival Fastenal reported earnings last week that also missed analysts' estimates. Despite gains in U.S. manufacturing in the quarter, sales challenges persist at both companies. Grainger dropped 3.8 percent on June 24 after the U.K. voted to leave the European Union and the Commerce Department said demand for durable goods fell more than expected in the month of May as businesses held off on investments. There's also been little in the way of positive commentary from industrial CEOs -- including Grainger leader James Ryan. But analysts presumably knew all of this and still had a more optimistic outlook for Grainger's second-quarter performance than what the company actually delivered.
The fact that Grainger missed so badly should be troubling. The company supplies the construction, industrial and commercial industries, so its results can be a good indicator for the health of the overall economy and a harbinger of what kind of earnings its clients might report. CEO Ryan said last month that ``the overall economic environment doesn't appear to be getting a lot better. It doesn't appear to be getting a lot worse, but an obvious catalyst for a turnaround is still not visible." These latest earnings numbers would seem to suggest the outlook for industrials may in fact get a little bit worse before it gets better, putting that turnaround even further down the road.
It's a wake-up call of sorts, and Grainger's falling stock shows some shareholders are paying attention. At the same time, Grainger is still up about 8 percent this year, outpacing the gains of the broader S&P 500. Even after Tuesday's drop, it's valued at about 10.3 times its projected Ebitda, essentially in line with its historical average over the past five years, according to data compiled by Bloomberg. And Grainger's stock is trading just a few dollars away from analysts' 12-month price target. The company isn't one of the most expensive industrial stocks out there, but it doesn't have a lot of room for error.
That's risky. Drilling down into the numbers, Grainger trimmed its full-year earnings-per-share guidance by about 20 cents at the midpoint. That's despite a second-quarter miss of about 30 cents relative to consensus estimates, 8 cents less of a benefit from clean-energy investments and about 30 cents of negative impact from taxes, notes Raymond James analyst Sam Darkatsh. Could there be more clouds ahead for Grainger? Or for that matter, the industrial sector as a whole? Investors will have to decide whether it's worth sticking around to find out.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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