MSC Industrial (MSM) and the rest of the manufacturing sector should be watched for signs of where our economy is headed.
People look to various companies as indicators of the health of the overall economy, and those big-cap names can certainly tell us a lot. However, I look at other, less popular companies because I think they provide a more comprehensive view. I never take just one company and derive a theory from it, but always in context with other reports.
For example, Q1’s retail numbers were miserable, and I suspected that would lead to a weak GDP. I did not expect revised GDP to be -2.9%, but the retail numbers certainly telegraphed it. So I’ll be watching for Q2 retail information.
But in the meantime, that means I’m also going to be looking at companies like MSC Industrial Direct (MSM).
Manufacturing Companies and the Economy
MSC Industrial truly is the most boring company you can find, which means it comes from the manufacturing sector. However, it is one of the largest marketers and distributors of metalworking and maintenance, repair and operations (MRO) products. It has 760,000 stock-keeping units (SKUs), which it sells to everyone from machine shops up to Fortune 1000 companies, including the government and the Department of Defense. As a distributor, MSC locates its warehouses near major cities so it can ship items to arrive the next day.
Competitors include Applied Industrial Technologies (AIT) Grainger (GWW), Wesco (WCC) and Anixter (AXE), and they’re all important to keep tabs on.
Why? Because manufacturing is a big part of the U.S. economy. Parts are something that are in constant demand because machinery always breaks down or needs maintenance.
If these distributors see a decline in average order size or a decline in revenue, it might suggest that manufacturers are either slowing down, or they are waiting before ordering parts because they want to conserve cash.
MSC’s earnings came in Wednesday, and the results were mixed. EPS only grew 1%. Revenue grew 13% to $720.5 million, but fell just shy of expectations. MSC also lowered next quarter’s guidance from $1.07 to a range of 98 cents to $1.02.
Those are not good signs.
MSC Industrial CEO Erik Gershwind said the quarter reflected “firmer demand environment, more robust order flows, and some talk of order backlogs…That said, despite these encouraging signs and significant improvement over prior year, we would still characterize the current environment as one of moderate growth. Customers remain slightly more confident, but they also remain appropriately cautious with their spending and capital investments.”
The subtext is that things are mixed out there. We’ll have to see what MSC’s peers report. However, I think this is a “blinking yellow” light on my call that Q2 will yield a negative GDP, meaning we are in a recession again.
Bottom Line
As for the company itself, MSC has $45 million in cash and only $246 million in debt. It is paying next to nothing on that interest, a mere $3.3 million per year. Meanwhile, MSC generated $175 million in free cash flow over the past nine months.
However, MSM stock trades at 22 times FY14 estimates. Meanwhile, this year’s EPS isn’t going to be much over last year’s, and FY15 is expected to grow 14% — the same growth expected over the next five years.
Thus, MSC seems quite overvalued, maybe as much as 50%.
If the economy is getting worse, as I fear it is, I don’t think you want to be in this stock, or this sector, right now.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at pdlcapital66@gmail.com and follow his tweets at @ichabodscranium.
