What Happened to Grainger’s Margins in 4Q?

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What Happened to Grainger’s Margins in 4Q?

“Disappointing” was how one analyst described the industrial distributor’s gross margin performance (down 290bps) in the period, but such a plunge was all too familiar for many companies in these pandemic-plagued times.
2022 Grainger Show in Orlando

W.W. Grainger Inc. was among the success stories of distribution throughout the pandemic-riddled year of 2020.

Bolstered by a strong pivot to PPE and other COVID-related products, the Chicago-based industrial and MRO distributor routinely beat revenue and earnings estimates even as its traditional product mix was flat.

And as MDM reported earlier Wednesday, Grainger reported 2020 sales increased 2.7%, or 3.5% on an organic basis, to $11.8 billion, while the company’s profit decreased 18.1% to $695 million for the year.

In the fourth quarter, Grainger’s sales of $2.9 billion were up 3.3%, or 5.6% on an organic daily basis, compared to 4Q 2019 (excluding divestitures and foreign exchange) and ahead of analysts’ expectations by $20 million. Profit in the quarter increased 63% to $168 million, while diluted earnings per share of $3.12 were up from $1.88 in 4Q 2019, missing analysts’ estimates by 75 cents.

But while Grainger saw revenue improve in 4Q and the entire year, however meager relative to its usual growth, the final quarter of 2020 proved to be a bump in the road with regard to gross margins.

Even if it winds up being a temporary obstacle, the company’s softening gross margin performance and its flat guidance for 2021 were the key takeaways this week for investment bank Baird, whose industrial distribution analyst Dave Manthey wrote in a note to clients that Grainger’s 4Q performance “disappointed … due entirely to gross margin.”

And while Manthey was also disappointed that Grainger again didn’t provide guidance for 2021 (more on that below), he remains upbeat about the company’s moves amid the ongoing challenges of COVID-19.

“Net, 4Q20 results disappointed but the outlook seemingly implies our/Street 2021 estimates could be moving higher, and the upcoming re-segmenting (high-touch vs. endless assortment vs. other) could also be a positive catalyst,” he wrote.

The Pandemic Strikes (Again)

On Wednesday morning’s earnings call with analysts, Grainger said gross margin of 35.7% was down 290 basis points compared to the fourth quarter of 2019. But there was one clear factor in that decline that has been pressuring margins for most companies since about last March.

“The unfavorable variance in gross margin was driven most notably by pandemic-related headwinds, which accounted for nearly 90% of the GP decline,” said Grainger’s new CFO, Deidra “Dee” Merriwether, who was making her debut earnings call after being appointed to the company’s top financial post on Jan. 12. “The pandemic impact was driven by continued product and customer mix and mark-to-market inventory adjustments.”

Earlier on that call with analysts, Grainger Chairman and CEO DG Macpherson had provided some additional color of Grainger’s pandemic-driven gross profit and gross margin problems.

“The pandemic has also had a big impact on gross profit, driven by two main factors,” he said. “First, we were impacted by product and customer mix. Pandemic products are generally lower-margin, and we sold large quantities to health care and government customers, which typically receive more favorable pricing. This was exasperated early on as we initially prioritized product allocation to those most in need like health systems and those on the front lines. So sell-through margins have been negatively affected by these mix impacts.

“The second driver is that we have been aggressive in supporting our customers by trying to anticipate the needs they might have. As a result, we placed large orders for certain products in Q2 of last year. As we have gone through the pandemic surges, the supply-demand picture has changed rapidly for some products and we had to revalue our inventory to reflect this reality. The vast majority of our purchases have worked well, a few have not. We have reverted to our normal purchasing processes, and we’ll continue to monitor market dynamics as the situation unfolds.”

Grainger’s Outlook for 2021

While the year presented plenty of challenges for Grainger — as it did for almost all businesses, even those who benefited from COVID-driven product sales — the company made some key strides in 2020 that bode well for the future.

For one, Merriwether noted (and Grainger had discussed on its 3Q earnings call), the company has found success in attracting new customers who arrived at grainger.com or in a branch for some PPE and safety gear but has come back for other product needs.

“We’ve also seen a significant uptick in new customer acquisitions month-over-month with encouraging signs of repeat buying,” Merriwether said. “From a customer perspective, we see improved growth with both large and midsized customers, with the latter growing about 6% in the quarter, continuing to show signs of improvement from earlier in the year.”

And while the company continued to not provide guidance due to the uncertainty surrounding the pandemic — including the various lockdowns, slowdowns and quarantines — executives on the earnings call shed some light on what Grainger expects in 2021.

For one, though January is off to a strong start with 9% year-over-year growth, look for sales improvement to dwindle during the rest of the quarter due to an unfavorable comp with February and March of 2020, when the pandemic hadn’t fully taken hold. But they do project improvement in that gross margin and gross profit category, which had been disappointing in 4Q.

“From a gross margin perspective, we expect GP improvement of around 50 to 100 basis points sequentially versus Q4 2020,” Merriwether said. “This anticipated lift is underpinned by a slowdown in pandemic product demand, continued price cost recovery and the lapping of freight headwinds experienced in Q4 2020.”

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