Thinking of starting a US portfolio (with Fastenal Co)

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Fastenal Co (as the name implies) offers fasteners, and other industrial and construction supplies primarily under the Fastenal name

It is a company I read about in the Little Book that Builds Wealth. It is basically a book that talks about business moat. The author is Pat Dorsey-the Director of Equity Research for leading independent investment research provider Morningstar, Inc.

Extract from the book (pg 141):

Our fourth company isn’t as well-known as the first three, but we can learn a lot about moats from looking at it. The Fastenal Company distributes a wide variety of maintenance, repair, and operations products to manufacturers and contractors around the United States. It does this through a network of about 2,000 stores, and specializes in fasteners, as the company’s name implies. That may sound like a dull business, but let’s check out the numbers to be sure.

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Wow! Whatever you might think of the business, those are not dull numbers. An average return on equity of more than 20 percent over a decade, with minimal financial leverage, is a highly uncommon achievement. In fact, out of the 3,000 stocks in Morningstar’s database with market capitalizations over $500 million, only 50 have similar track records of generating tremendous returns on capital. The question, of course, is whether Fastenal just got lucky or built a competitive advantage that will allow it to maintain such high returns on capital. When you dig into the company, it turns out that Fastenal benefits from location-based scale economies similar to the cement and aggregate companies.

Fasteners, such as screws, anchors, and bolts, are heavy and expensive to ship and they don’t cost very much, which means that Fastenal gets a big cost advantage from having lots of stores close to its customers. Proximity also means that Fastenal usually has a quicker delivery time than competitors, which is an- other big advantage given that manufacturers typically need fasteners when something breaks, and downtime is a very expensive proposition for these firms.

The book may be a bit dated and the information provided are from years ago. But the principle of the business moat I believe is still intact in this company.

A more recent article about this company can be found here. This is probably a company Warren Buffett would like.

If you look at the historical financial performance of Fastenal Co (see below), it is obvious that performance has been consistently good. Gross margin typically is high at more than 50, while operating margin is relatively good and been getting better, approx. 20+.

The consistency can also be seen in the good performance of ROA, ROE and ROIC over the years.

2

Looking at the data from Yahoo Financial, the PE, Price to Book and EV/EBITDA values do not seem to suggest the stock is cheap. However as mentioned earlier operating margin, ROA and ROE are good.

The down part is that total debt is higher than total cash, but Total debt / Equity is not too high, and current ratio (which compares a firm’s current assets to its current liabilities) is a high 4.19.

3

 

1)Trailing PEG

  • P/E: 23.57 (from POEMS 2.0)
  • Dividend Yield (%): 2.9
  • EPS compound growth rate: 21.75% (base on 5 years EPS growth rate )

The trailing PEG will be 23.57/( 21.75 + 2.9) = 0.98. Which is good (< 1).

2)Intrinsic Value

First let’s look at the estimated 5 years earning growth which is 21.75%. Let’s assume a 20% discount, the figure will be 17.4%.

Given EPS and a PE ratio, stock price can easily be calculated for any company. Using the below formula.

F = P(1+R)N where:

  • F = the future EPS
  • P = the starting (present) EPS (1.76)
  • R = compound growth rate (17.4)
  • N = number of years in the future (5)

Estimated future EPS: 3.93

I will be estimating the future PE of Fastenal Co to be 30.96 (See data from Morningstar below) Average of the PE from 2005 to 2014.

1

Future Stock Price

P=EPSxPE

  • P = future stock price
  • EPS = future EPS
  • PE = future PE

Hence future stock price of Fastenal Co is 3.93  x 30.96 = 121.6728

Intrinsic Value

P=F/(1+R)N

  • P = present (intrinsic) value
  • F = future stock price (121.6728)
  • R = MARR (15% or 0.15)
  • N = Number of years (5)

Hence, the intrinsic value of Fastenal Co is 60.5.

Stock price of Fastenal Co on 25 Aug 2015 is 37.40.  There is a margin of safety of approx. 38%.

 

“It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.” Warren Buffett

4

In gist:

Both the calculated intrinsic value and trailing PEG suggests that the stock is under-valued. This company has a very strong business moat and a strong long term financial track record. Price has been trending downwards since 2013 (and of course, with the recent market volatility, its stock price has drop substantially). Price may dip even further in the future, but in the longer term, the company and price should do fine.

Finally, I have initiated a small position in it.

“You never get the high and you never get the low” Walter Schloss

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About apenquotes

Born in 1976. Married with 2 kids (a boy and a girl). A typical Singaporean living in a 4 room HDB flat.
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