Make no mistake - Fastenal (Nasdaq:FAST) is a great company, and a good play on the consolidation of the industrial supply market. That said, Fastenal's stock carries a valuation more commonly seen in hot technology stocks than in the industrial sector. Consequently, while I do believe Fastenal has a runway to becoming one of the largest players in a market worth over $150 billion, the stock already seems to be assuming a great future.

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

In-Line Good Enough
Fastenal just barely made the numbers for its third quarter, and ordinarily you might think that would be bad news for a company with a robust valuation. Whisper numbers had been heading lower, however, and I suspect that there was more than a little relief that underlying fundamentals were actually pretty solid this quarter.

Revenue rose a little more than 10% this quarter. Although that was very slightly below expectations, I suspect investors and analysts will be more encouraged by the recovery in daily sales growth - September sales perked up nearly 13% versus 12% in August.

Profits continue to be a mixed bag. Gross margin slid again (down 30 basis points), but is still in the target zone of 51% to 53%. Likewise, the company is still executing well with its operating expenses, as operating income rose 13% and the operating margin expanded another 60 basis points.

SEE: A Look At Corporate Profit Margins

Still Building the Business
Fastenal continues to increase its footprint. The company contracted more than 5,300 vending machines this quarter, bringing its total cumulative installations to over 17,000. At the same time, while the pace of new store openings has slowed, the company has nevertheless opened 73 so far this year.

Both of these remain key metrics for Fastenal and are core to the company's growth plans. While Grainger (NYSE:GWW) and MSC Industrial (NYSE:MSM) are both growing their vending/dispensing businesses, Fastenal has done exceptionally well with it. Elsewhere, while I think some analysts and investors may make too much of the advantages offered by Fastenal's local stores (it's not as though the stores can carry complete inventories), it does offer an immediate sales channel that the delivery-based models of MSC Industrial and Amazon (Nasdaq:AMZN) can't match.

Near-Term Challenges, Long-Term Opportunities
When trying to think about what constitutes fair value for Fastenal, there's always this push and pull between near-term and long-term potential. Right now, the company probably has about 2% share of the huge (and hugely fragmented) industrial supply market. Even if companies like Anixter (NYSE:AXE), Applied Industrial Technologies (NYSE:AIT), MSC Industrial and Amazon try to get into Fastenal's wheelhouse (be it through more focus on fasteners, vending machines or what have you), there's ample room to grow.

On the other hand, fastener sales have been slowing a bit. What's more, it's hard to see how the U.S. industrial sector can just keep on growing if Europe and China don't start seeing better economic health relatively soon. Then again, ISM has been improving a bit and broader economic measures are still basically positive.

The Bottom Line
I have no qualms projecting ongoing strong growth for Fastenal, as I do believe it can more than double its market share over my forecast period. The company is years away from saturating its store base, and that's assuming that the company doesn't try taking the concept outside U.S. borders. Even if the company starts seeing less new store growth potential, it will reap better free cash flow from the lower capex demands.

SEE: 5 Must-Have Metrics For Value Investors

Consequently, I'm comfortable with mid-teens free cash flow growth projections, even though I acknowledge that that's a very demanding goal. Unfortunately, even that level of growth doesn't come close to making these shares cheap. At these valuations, I'd be more inclined to buy shares of MSC Industrial (which I do own) or WESCO (NYSE:WCC), though I'd be in no particular hurry to sell Fastenal shares if I owned them (what makes for a good hold is not always the same as a good buy).

At the time of writing, Stephen D. Simpson owned shares of MSC Industrial since 2006.

Related Articles
  1. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  2. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  3. Mutual Funds & ETFs

    ETF Analysis: iShares Morningstar Small-Cap Value

    Find out about the Shares Morningstar Small-Cap Value ETF, and learn detailed information about this exchange-traded fund that focuses on small-cap equities.
  4. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  7. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  8. Professionals

    What to do During a Market Correction

    The market has what? Here's what you should consider rather than panicking.
  9. Mutual Funds & ETFs

    ETF Analysis: WisdomTree SmallCap Earnings

    Discover the WisdomTree Small Cap Earnings ETF, a fund with a special focus on small-cap and micro-cap stocks with positive earnings.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares US Regional Banks

    Obtain information and analysis of the iShares US Regional Banks ETF for investors seeking particular exposure to regional bank stocks.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  4. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  5. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  6. Net Present Value - NPV

    The difference between the present values of cash inflows and ...
  1. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  4. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  5. What is the difference between the return on total assets and an interest rate?

    Return on total assets (ROTA) represents one of the profitability metrics. It is calculated by taking a company's earnings ... Read Full Answer >>
  6. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!