Grainger’s 1Q Earnings Fall Short of Expectations

CHICAGO — Grainger reported results for the 2017 first quarter ended March 31, 2017. Sales of $2.5 billion increased 1 percent versus $2.5 billion in the first quarter of 2016. There were 64 selling days in the 2017 first quarter, the same as the 2016 first quarter. Net earnings for the quarter of $175 million were down 6 percent versus $187 million in 2016. Earnings per share of $2.93 declined 2 percent versus $2.98 in 2016. 

“Overall, the first quarter clearly fell short of our expectations, driven primarily by the stronger than anticipated customer response to our U.S. strategic pricing actions, with a greater volume of products sold at more competitive prices,” said Chief Executive Officer DG Macpherson. “Based on the positive customer response thus far, we are pulling forward the remaining pricing actions originally scheduled for 2018 into the third quarter of this year. This decision requires a significant change to our earnings per share guidance for the year but should enable us to accelerate growth with existing customers and attract new customers sooner than planned.     

“Our Zoro and MonotaRO businesses continued to perform very well. We continue to be challenged in Canada, although our service has improved. We will continue to aggressively take action to improve gross margins and reduce our cost structure in Canada with the expectation of hitting break-even by the end of 2017,” Macpherson concluded.

Grainger’s pricing actions, first described in November 2016, were primarily implemented in January and February of this year. The actions included:

• Adjusting list prices across the board to make it easier for large customers to consolidate their purchases;
• Introducing new web prices on about 450,000 SKUs to drive medium and large noncontract customer acquisition and growth;
• Negotiating large customer contracts with more competitive pricing for infrequently purchased items. Most large customers already receive very competitive pricing on routine items through their contracts.

Results from the first quarter pricing actions showed that customers with access to lower pricing bought more than company expectations. Although it is early, the data provided confidence that the pricing actions were successful.  The decision to accelerate the pricing actions is expected to enable faster growth through share gain with existing customers and acquisition of new customers.  Web pricing will be available on all SKUs in the 2017 third quarter.

The company lowered its 2017 sales and earnings per share guidance for the year and now expects sales growth of 1 to 4 percent and earnings per share of $10.00 to $11.30, which incorporates the effect of the pricing acceleration and a 1 percent reduction in sales from foreign exchange. The company’s previous 2017 guidance, communicated on January 25, 2017, was sales growth of 2 to 6 percent and earnings per share of $11.30 to $12.40.

Company 
Sales increased 1 percent in the 2017 first quarter versus the prior year, driven by a 5 percentage point increase from volume growth, partially offset by a 3 percentage point decline in price and a 1 percentage point decline from lower sales of seasonal products.

Company operating earnings of $295 million for the 2017 first quarter declined 7 percent versus $317 million in the 2016 quarter. The decline was driven primarily by lower gross profit from the strategic pricing initiatives in the United States.

The first quarter contained the following restructuring items:

The company has two reportable business segments, the United States and Canada, which represented approximately 80 percent of company sales for the quarter. The remaining operating businesses are located in Europe, Asia and Latin America. The single channel online businesses are included in Other Businesses and are not reportable segments. 

United States
Sales for the U.S. segment were down 1 percent versus the 2016 first quarter. The decrease was driven by a 4 percentage point decline in price and a 1 percentage point decline from lower sales of seasonal products, partially offset by a 4 percentage point increase from volume growth. Sales to customers in the Government and Heavy Manufacturing end markets led the sales performance in the quarter.   

Operating earnings for the U.S. segment declined 6 percent in the quarter driven by lower gross profit. Gross profit margins for the quarter declined 1.7 percentage points driven by the strategic price initiatives. In the 2017 first quarter, operating expenses were down 4 percent, which included a $9 million benefit from the gain on sale of branches and $3 million of restructuring costs. Excluding restructuring costs and the gain on sale of assets, operating expenses were flat and operating earnings were down 12 percent.   

Canada
First quarter 2017 sales for the Canada segment increased 4 percent in U.S. dollars and 1 percent in local currency. The 1 percent increase consisted of 4 percentage points from volume, partially offset by 2 percentage points from lower price and a 1 percentage point decline from unfavorable holiday timing.  

The business in Canada posted a $17 million operating loss in the 2017 first quarter versus a $12 million operating loss in the prior year, primarily driven by a lower gross profit margin and negative expense leverage. The gross profit margin in Canada declined 2.7 percentage points versus the prior year largely due to price deflation and higher freight costs. The business in Canada increased prices to offset foreign exchange-related cost of goods sold inflation in the first quarter, but most customers are under contract and will not experience price increases until later in the year.  Freight costs increased year-over-year as the business shifts to direct-to-customer shipping. Operating expenses increased 3 percent, driven by the re-establishment of the national sales meeting and the unfavorable comparison to the 2016 gain from the sale of the former Toronto distribution center, partially offset by lower IT expenses.

Other Businesses
Sales for the Other Businesses increased 12 percent versus the prior year, consisting of 15 percentage points of growth from volume and price, partially offset by a 3 percentage point decline from foreign exchange, primarily attributable to weakness in the British pound. The performance was driven primarily by 23 percent sales growth for the single channel online businesses.

Operating earnings for the Other Businesses were $32 million in the 2017 first quarter versus $22 million in the prior year. This performance included strong results from Zoro in the United States and MonotaRO in Japan.    

Other
Other income and expense was a net expense of $25 million in the 2017 first quarter versus a net expense of $20 million in the 2016 first quarter. This increase was primarily due to interest expense from the additional debt the company issued in 2016 and expected losses from the company’s investments in clean energy. For the quarter, the effective tax rate in 2017 was 32.4 percent versus 35.6 percent in 2016. The decrease was primarily due to the adoption of Financial Accounting Standards Board Update No. 2016-09 (“ASU 2016-09”), which recognizes the excess tax benefits of stock-based awards as a reduction to income tax expense instead of the previous methodology which recorded the benefit on the balance sheet.  The adoption of this standard generated a $0.13 benefit to earnings per share in the quarter. The company is currently projecting an effective tax rate of 35.0 to 36.0 percent for the year 2017.

Cash Flow
Operating cash flow was $181 million in the 2017 first quarter versus $161 million in the 2016 first quarter. The $161 million for the prior year reflects a reclassification from $154 million based on the adoption of ASU 2016-09, which retrospectively reclassified $7 million from operating activities to financing activities. The reclassification relates to employee taxes paid as a part of the exercise of stock options. The company used the cash generated during the quarter along with short term borrowings to invest in the business and return cash to shareholders through share repurchase and dividends. Capital expenditures were $79 million in the 2017 first quarter versus $52 million in the first quarter of 2016. In the 2017 first quarter, Grainger returned $231 million to shareholders through $72 million in dividends and $159 million to buy back 646,000 shares of stock.