How Amazon.com, Inc. (AMZN)’s Amazon Business Could Impact Margins Of Fastenal Company (FAST) And W W Grainger Inc (GWW)?

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Whenever a big company enters into other areas of business there is bound to be a multiplicity of problems for the existing players in that particular sector. Therefore, it is no exception for Fastenal Company (NASDAQ:FAST) and W W Grainger Inc (NYSE:GWW). Both are well established, as well as well-run, industrial distributors. Also, both of them have delivered tremendous return on capital to investors historically. That is mainly because of the customers, who relied on these two firms for speedy delivery. Their customers also believed that their services offered product breadth, as well as good prices. However, the entry of Amazon.com, Inc. (NASDAQ:AMZN)’s Amazon Business could alter the scenario in a dramatic turn of events, According to a recent shareholders letter by Steve Romick of FPA Investors first.

Strong Margins

Fastenal Company (NASDAQ:FAST) and W W Grainger Inc (NYSE:GWW) have enjoyed the confidence of both the customers and investors. The two firms were regarded as middlemen engaged in distribution of products manufactured by their customers. Distribution of business delivered strong returns to its shareholders by way of strong performance of their stocks on the bourses. Besides, there is a projection of price/earnings ratio of 20x. Significantly, both the companies enjoyed strong and high gross margins in the past.

For the trailing twelve-month period, Fastenal Company (NASDAQ:FAST)’s gross margin was 50.7%, while the estimated profit earnings ratio is 23.1% for the year 2015. Similarly, the gross margin for the trailing 12-month period of W W Grainger Inc (NYSE:GWW) was 43.2%, whereas the estimated profit/earnings ratio is 19.3% for the current year. In comparison, the average gross margin of others in the business is only 19.2%. That is more than 50% less than the top two companies, primarily due to Amazon.com, Inc. (NASDAQ:AMZN)’s Amazon Business. The online retailer could wreck any competitor with its infrastructure and availability of funds. That might be heady for the existing companies.

Ruthless Competition

When the online retailer enters the space, it becomes a merciless competition. Amazon started Amazon Supply with more than 2M Stock Keeping Units (SKU), that is transformed to Amazon Business now. Currently, the business can manage hundreds of millions of products for the purpose of sales. Obviously, commercial customers started asking them to do shopping for their business. Now it has become a reality. The company has never bothered about short-term perspective.

The online retailer always looked at the long-term gains and was always ready to accept short-term pain. Therefore, the company has been more than willing to sacrifice profits to extend its lead in business to gain market share. The company has already demonstrated its power in attaching, as well as entrenching, the once successful businesses. For instance, Borders has gone into bankruptcy in the book business. Similarly, there is no respite in the operating income of Barnes & Noble. That is because its operating income remained at half of its peak level witnessed a decade back. In the process, it also earned the ire of investors in the past.

Margins Pressure

Still Amazon.com, Inc. (NASDAQ:AMZN)’s Amazon Business is only at a nascent stage. However, the company has provided a wider product line. Those apart, lower prices, as well as free shipping on orders of more than $49, remain attractive for the customers. It is but natural to raise a question whether Fastenal Company (NASDAQ:FAST) and W W Grainger Inc (NYSE:GWW) will be able to maintain their gross margins and still face the onslaught of the online retailer. The answer is naturally a tough one to maintain. The fact that the two firms were well-managed will not help them to escape from the pressures of margins.

It is an inevitable thing for both the companies that the tough competition will drive these two companies to settle for lower margins to retain market share. However, retaining the market share will also be a big question mark, given the scale of operations of Amazon.com, Inc. (NASDAQ:AMZN)’s Amazon Business. It is a fact that Amazon has got nothing to lose in the business but everything to gain. On the other hand, mounting pressures will cause damage to the margins, as well as the market share. The online retailer is also said to be enjoying a better power of buying and leverage with the United Parcel Service, Inc. (NYSE:UPS).

Valuations Questioned

Fastenal Company (NASDAQ:FAST) and W W Grainger Inc (NYSE:GWW) together are said to be enjoying below 10% market share. The entry of Amazon Business might probably drive smaller players to oblivion. However, the two companies will find it tough to stabilize their margins. That means the erosion of profit is in the cards. For instance, one percentage of change in gross margin will translate into a fall of 7% in earnings for Grainer and 4% for Fastenal. Therefore, the valuation of Fastenal Company (NASDAQ:FAST) and W W Grainger Inc (NYSE:GWW) are questioned, since valuation reflects future earnings.

The ground realities suggest the possible scenarios. Either Amazon.com, Inc. (NASDAQ:AMZN)’s Amazon Business wins or the two firms. Any loss will not have a big impact on Amazon, since it has other businesses to compensate them. However, the same cannot be said in respect of the other two companies.

Conclusion

There is no doubt that Fastenal Company (NASDAQ:FAST) and W W Grainger Inc (NYSE:GWW) will face pressures on their margins. That will result in dragging down of their profits. Stability of margins cannot be seen in the near term and might take some more time than one might imagine. These two do not have any other major business to offset any loss from margins. That is the advantage Amazon.com, Inc. (NASDAQ:AMZN) has and allows the firm to continue to explore different options.

Disclaimer: The opinions and data expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisory capacity, nor is this an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the company or companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.

Viraj Shah

Viraj Shah has completed M.Com (Finance) and is currently pursuing his CFP. He tracks US markets along with other global markets like India very closely. He is very passionate about stocks, real estate, and technology. He also believes that money can always be made in the market.

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