Here comes the trade war, and that isn’t good news for Fastenal (NASDAQ:FAST) which dropped nearly 4% on news that U.S. President Donald Trump will impose a 10% tariff on $300 billion worth of Chinese goods at the start of September. Don’t count Fastenal stock out just yet, though.
The logic here is simple enough. Fastenal is the world’s largest fastener distributor in North America. As the largest fastener distributor in North America, Fastenal sells heavily to North American industrial and manufacturing companies. They also source a ton of product from Asia, particularly China. Consequently, the company has been hit hard by a double headwind of slowing demand and rising costs amid escalating trade tensions.
Revenue growth has slowed. Margins have compressed. Profits have fallen flat. FAST stock has dropped, falling close to bear market territory (almost 20% off recent highs), while the S&P 500 is just 3% off its all-time highs.
This new round of tariffs is more bad news for FAST stock. It’s basically confirmation that things won’t get much better anytime soon, and that Fastenal stock will likely remain depressed for the foreseeable future.
But, this trade war isn’t a permanent thing. Eventually, it will stop. Nobody really knows when. But, it will, because the global economy is so connected that neither side can fight with the other forever. Once the trade war does get resolved, Fastenal’s headwinds will disappear. Revenue growth will pace higher. Margins will rise. Profits will rebound.
So will FAST stock.
As such, patience will be rewarded here. FAST sock won’t turn things around right away. But, in a multi-year window, this stock does have tremendous upside in the likely scenario that a trade resolution is struck within the next few years.
Fastenal Stock Won’t Turnaround Just Yet
The first important thing to note about Fastenal stock is that it’s depressed for a reason (the trade war) and that reason isn’t going away anytime soon.
There are two things here: supply and demand. On the supply side, Fastenal sources a ton of product from Asia, particularly China, so as Trump has continued to impose more and more tariffs on Chinese imports, it has resulted in rising costs for a healthy portion of Fastenal’s products.
Fastenal has tried to hike prices to offset these rising costs. But, such efforts have fallen short thus far. Consequently, gross margins are getting squeezed. Last quarter, Fastenal reported nearly 200 basis points of year-over-year gross margin compression.
On the demand side, Fastenal sells a ton of product to North American manufacturing and industrial companies. Those companies are being hit hard by the trade war. Because prices are going up, business operations are being disrupted, and everyone in the industry is uncertain about what’s going to happen next.
The result is, capex and investment levels are dropping. Indeed, by many metrics, U.S. manufacturing activity has plunged in 2019 to a nine-year low.
As U.S. manufacturing activity has slowed, so has demand for Fastenal’s products. Daily sales growth, the important revenue metric for this business, was 8%. It was the first sub-10% reading since the first quarter of 2017.
Overall, then, the trade war is creating a huge drag on Fastenal’s business. That drag isn’t going away anytime soon. So long as it remains, FAST stock will remain depressed.
Huge Upside Potential, Eventually
The second important thing to note about Fastenal stock is that near term weakness isn’t here to stay forever, and it’s ultimately creating a compelling long term buying opportunity.
Zooming out, the big picture fundamentals here are very good. Since 2010, U.S. manufacturing sales have grown at a ~2.5% compounded annual growth rate. Fastenal, due to its expansion and growth drivers, has significantly outpaced the industry, growing revenues at a 10%-plus compounded annual growth rate since 2010.
This outperformance persists today, even in a time of turbulence. U.S. manufacturing sales have fallen flat in 2019. Fastenal reported first-quarter sales growth of 12% and second-quarter sales growth of 8%. That’s impressive.
Thus, Fastenal is a winning company in a long-term stable industry that’s going through a rough patch right now. But, this rough patch won’t last forever. Because their two economies are so connected and dependent upon one another, the U.S. and China are unlikely to fight on trade forever.
Instead, Trump will keep upping the ante, China will be forced into a position to make a more meaningful deal, and a resolution will likely be reached within the next few quarters or years.
Once that resolution is reached, FAST stock should jump.
The math here is easy to follow. Even accounting for the trade war, Fastenal still projects as a mid-single-digit revenue grower over the next several years. Gross margins should rebound as Fastenal more consistently and optimally leverages price hikes to offset rising costs. The opex rate should keep falling since management sounded a big cost savings tone on the last call.
Putting all that together, profit growth should run around 10% over the next several years. That puts 2025 EPS at around $2.50. Based on a historically average 20-times forward multiple, that implies a 2024 price target of $50. Discounted back by 7% per year (3 points below 10% to account for the yield), which equates to a 2019 price target of ~$35.
Bottom Line on Fastenal Stock
According to the long term fundamentals, FAST stock is materially undervalued at the current moment. But, this undervaluation promises to hang around so long as the trade war persists. As such, patience is key here, and it will ultimately be rewarded long term once trade disputes fade into the rear-view mirror.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.