Tag: equity

Breaking Down Fastenal’s Moat in 3 Points

Fastenal is a company that sells nuts, bolts, and other industrial and construction supplies. Pretty simple business – and definitely not sexy. How then has Fastenal stock created so much value? In keeping with comparisons to other high-flying stocks on sexier businesses (like my post on NVR) Fastenal stock has beaten both Microsoft and Apple since the 1990s!

FAST Total Return Price Chart

FAST Total Return Price data by YCharts

 It all came down to a certain way they decided to operate – its Competitive Strategy. There probably have been hundreds of fastener businesses that have come and gone over the past 30 years, and many probably never created much value. So what gave Fastenal their competitive advantage? What drove their staying power? And how did they compound earnings so effectively? Clearly, something must be going right to translate into Fastenal stock being such a long-term winner.

One thing I’d like the reader to do is think actually how similar Fastenal’s strategy is to Amazon’s (I think the latter borrowed some things from the former’s playbook).

First, some history to shed a light on the business.


Fastenal was actually dreamt up by its founder, Bob Kierlin when he was just 11 years old.  His father ran an auto supply shop in Wisconsin and Kierlin noticed customers typically drove from store to store looking for fasteners they needed for particular jobs. If a hardware store didn’t have the right nut or bolt, the store would send the customer to Kierlin’s store, and vice-versa. Bob noticed a lot of customers had to resort to buying the part, one-off, via a special order and wait.

Kierlin and four other friends started Fastenal in with $30,000 and rented a store in Winona, Minnesota. They opened a store as a one-stop shop with thousands of fasteners for retail customer needs.

But the idea was a flop and the company almost went bust.

Instead of focusing on the retail customer, Fastenal decided to pivot and focus on the commercial customer. It turned out that price was much less of a factor than timeliness for that market segment — contractors and companies often lost money searching or waiting for a particular part. Kierlin and his partners discovered that there was a great need for a service that could quickly provide the fastener or part that a buyer needed.

In short, Fastenal segmented out its buyer base and identified what their key purchasing criteria was. They focused on industrial and commercial buyers and they realized they didn’t need to be the lowest price, they just needed to have the item in stock.

At the end of the day, you can see why this makes sense.

  1. Fasteners make up a small portion of project costs (e.g. building a home, building a car), but are crucial pieces in the process that can hold up work.
  2. If Fastenal increased price of a particular fastener by 3%, their customer probably wouldn’t even notice in their project and could likely pass it on to the end customer if needed
  3. Fastenal’s customers are many in size but also small in size, so they have limited bargaining power.

Fastenal further segmented based on geographic locations.

Fastenal opened its first branch in Minnesota and continued to target very small towns. Why? By targeting small towns that had healthy construction and manufacturing industries, but were also small towns that were underserved by big distributors, Fastenal could be the only game in town.


Finding New Segments

One thing a business can do to improve its competitive advantage is find new product segments. Think about Arm & Hammer expanding baking soda into a refrigerator deodorant – that was a creative decision to target a market and improved the overall market size.

In some cases, you can find new segments by broadening and you can find new segments by narrowing focus.

Fastenal actually did both.

Narrowing Focus (and Not Being Afraid to Try Something New)

This is from Fastenal’s 1996 10-K. Satellite stores weren’t a major success, but the company did expand to 71 satellite stores opened by 2001. The key was that Fastenal was focused on improving the customer relationship. Fastenal already was getting some business from these customers in smaller areas, but they wanted to make it even easier on the customer to get their Fasteners – and it preemptively did so. Sure, it would cost resources and no one else really saw the returns from doing it, but the customer sure would be loyal. Sound familiar to Amazon?

In fact, do you know what Fastenal says its goal is? “Growth through Customer Service.”

It also reminds me of Dollar General’s strategy of serving rural America. Carve out a niche where you know your customers well and others choose not to serve and that can payoff well.

In 2014, Fastenal identified a new growth driver: Onsite locations. These are sites that are not open to the public, or a wide variety of customers, but instead serve one customer at their location.

In essence, the customer (typically a very large one) might consume enough fasteners that it could source them themselves, but they’d rather benefit from Fastenal’s scale and expertise so they hire them to serve all their needs.

Fastenal had locations like these since the 1990s, but they expanded following 2014 – growing from 214 locations to over 1,100 by 2019 and represents roughly 30% of the company now.

The company really started to build a vending solution in 2011, choosing to do so while industrial activity was still weak from the Financial Crisis.

They would give a customer a vending machine, essentially for free (estimated to be a $10,000 value), but in return it would essentially become a “mini-branch” at the customer’s site. The machines were also available to the customer 24/7 – not just when a supply room is staffed. It also helped the customer track consumption data, in some cases improving their ability to see which of their plants were consuming more or less of certain parts.

Early on, Fastenal learned that it actually cut customer consumption (2011 conference call):

As we talked about on the Amazon review, if I were to distill differentiation with a buyer into two factors it would be: cut their cost and/or improve performance.

In this case, Fastenal cut the costs for its customers buy reducing spend, but it also differentiated Fastenal as a solutions provider. It also resulted in a share shift as customers looked favorably at the vending machines (quid pro quo) and Fastenal “locked” the customer into purchasing from them.

The company now has 105,000 vending devices in the field and generate $1.1BN of revenue.

Expanding Breadth

Fastenal decided in the mid-90s to test out new products. If a customer came into the store for fasteners, they might want to pick up something else why they are in the store. Convenience outweighs price.

In 1995, threaded fasteners were ~70% of sales. By 2000, it was just 51% of sales. Now, Fastenal has 9 different product categories it sells and targeting further product diversity:

The company also decided that in some cases, it made sense to manufacture tools for a customer. This would be rare, but in some cases it would pay off royally (and gain customer loyalty).

In one instance, a Ford plant’s assembly line was shut down by a breakdown that required a few dozen special bolts. Ford’s regular supplier told the company it would have to wait until Monday—three days later. “Meanwhile, it’s costing them something like $50,000 an hour to have this line not operating,” Slaggie [one of Fastenal’s founders] said in the March 11, 1992, Successful Business. “They called us and the part is an oddball, something we don’t have in stock. We had them fax us the blueprint for the machine and we determined we could make it…. We had them finished Sunday afternoon.”

Doing some simple math, $50,000 a day is $1.2MM in cost… for 3 days that would cost the company $3.6MM. Fastenal could make a part and charge $50,000 for it, and I’m sure Ford would pay for that all day…  I have no idea what Fastenal charged in this case, but you can see why Fastenal created differentiation here as a service provider.


Decentralized. By the time Fastenal stock became public, they put out some interesting color on how they decided to manage new branch openings:

By reading the company’s filings, you can tell they first want to train their employees to understand the business and industry and then give them the power to make decisions on their own.

I’m a relatively cynical person, so I wonder to myself how the employees could possibly know more about what to stock than people who have been operating the business for 20+ years. Two words: Smile & Dial.


Putting it together

I could go on about Fastenal — there is a lot I didn’t touch on about how frugal the company chooses to be — but its performance as “just a fastener distributor” has been truly amazing.

I opened this series saying that I was tired of the terms “asset light” or “high margins” being used to say why a business is “good”… instead, you need to understand what the company has done to make its business sustainable and why they will create above average shareholder value in the long run.

Here are some summary financial metrics for Fastenal compared to other distributor peers.

What jumps off the page to me is (i) its gross margins for a distributor, (ii) its EBITDA margins and (iii) EBITA / Assets (a proxy for ROIC).

High Gross Margins: Its high gross margins relay to me that they truly have targeted their customer in a way that isn’t just based on price – otherwise I think the margins would be much lower.

EBITDA margins: Its EBITDA margins are high, which makes sense given the gross margins. But the delta between gross margins and EBITDA margins is nearly 23% of sales — meaning they spend 23% of sales on selling costs and general and administrative expenses. That’s definitely in the upper half of the group and tells me that they are spending a lot on service for the customer.

EBITA / Assets: One might look at this comp set and say, “hmmm, Fastenal’s metrics are good, but its FCF conversion (rough proxy using EBITDA – Capex over EBITDA) isn’t great because capex is so high.” That’s ok for me – when I look at EBITA / Assets, what Fastenal earns on every dollar of capex it spends is much higher than what I could go out and earn! It also will likely lead to above-average sales growth.


I hope you’ve seen from what I’ve outlined above that Fastenal is very similar to Amazon – relentless focus on the customer. But Kierlen also appreciated hiring the right people and giving autonomy, as shown in this interview I found with some hard-hitting reporters.

“I admit things I never knew how to do well – I admit I was never a good sales person, so I hired a good salesperson.” In some ways it reminds me of Steve Jobs (though it was later learned he had a tendency to micromanage), he did have a great quote:

“It doesn’t make sense to hire smart people and tell them what to do; we hire smart people so they can tell us what to do.”

When Buybacks Fail… IBM Buybacks and Stock Performance

I typically look for underappreciated, high FCF businesses that are shareholder friendly. As I was screening for new ideas, an old giant popped up – IBM. IBM is famous for buybacks. This is a personal opinion, but with so much focus on Google, Facebook, Amazon, Microsoft and Apple it seems as though no one even discusses IBM anymore.

Could this be a Microsoft-in-2011 moment? At that time, MSFT was trading at a P/E of 9-10x and was viewed as a slow, lagging behemoth, and certainly not exciting anymore… just a dividend paying stock. They got a new CEO after many years of Balmer and reignited excitement and ingenuity at the company. The rest is history.

IBM currently trades with a 4.8% dividend yield, 9.5x 2020e EBITDA and 10.1x 2020e EPS. And with IBM buybacks staying strong – it is essentially returning all cash to shareholders.

The business in total has not grown much, but does have some exciting segments like Watson (“Cognitive Solutions”) which is wildly profitable – in 2018, Cognitive Solutions had nearly 68% gross profit margins and 38% EBITDA margins…

Should we compare Microsoft then to IBM? Clearly over the same time frame as Microsoft, IBM has been floundering.

Cognitive Solutions is clearly an exciting segment, but at the end of 2014 the company did $93BN in revenue and $24.6BN in EBITDA. In the past 12 month, the company did $77BN in revenue and $16.6BN in EBITDA. Moreover, if we go back to the end of 2003, the company’s market cap was $161BN. When they reported Q3’19 results, IBM’s market cap was $120BN. Meaning after nearly 16 years, no real value had been created.

So what happened? What were the drivers of these abysmal returns?

Clearly, a significant driver is the changing technology landscape. Over this time period, IBMs standing as a leader in tech has been eroded by competition. Over this time period, net income is up only $1.2BN, from $6.5BN to $7.7BN, which is a 1% CAGR.

With its changing position, investors no longer valued the company as an exciting leader. At the end of 2003, IBM was trading at 24.5x LTM earnings. By the end of Q3’19, it is trading at 15.5x LTM earnings. That de-rating of 10x had a significant impact on its stock performance.

Secondly, I think the company made some really poor investments. What investments you ask? Buying its own stock in large amounts. Admittedly, without these buybacks, the price performance of IBM would have been abysmal.

I pulled the company’s cash flow statement over these ~16 years and analyzed what it did with cash. While we have hindsight bias, the company deployed too much into its own stock instead of trying to strengthen its position in a changing climate. You could even argue that they should have done more acquisitions. Excluding the recent RedHat acquisition, which was $33BN, the company did not actually spend that much on acquisitions over this time frame.

Outside of acquisitions, you could even argue that they should have just distributed cash to shareholders with special dividends. Again in hindsight, that would have allowed investors to purchase other businesses that are allocating capital for growth.

Let me be clear, I am a huge fan of buybacks and not trying to beat the drum that politicians like to use (buybacks aren’t an efficient use of resources and stifle growth etc.). It is a return of capital though. One might say its a return of capital to selling shareholders (because the buybacks would create a new buyer in the market to lift the price) but I view it as a return to existing shareholders – my proportional share of each new sale increases. 

One of my favorite companies is LyondellBasel (ticker LYB). While it is a cyclical, commodity chemical company operating near peak, they’re capital allocation decisions make sense. First, invest in their equipment for safety. Second, ensure that they are well prepared in an evolving landscape. Third, return cash to shareholders while managing a prudent balance sheet. They have bought back 10% of their outstanding shares each year for the past few years.

In this case, however, it seems like IBM bought back shares just to buyback shares.


I wouldn’t be surprised if we see an activist approach IBM. Following Elliot’s success with AT&T, it seems like an activist could approach IBM regarding a spin-off or sale of its Cognitive Solutions business. I think a split of “old business” and “new business” similar to what happened at HP could be very interesting.

CorePoint Q1’19 Recap: Asset sales are the real story $CPLG

CorePoint reported Q1’19 EBITDA of $43MM compared to $40MM estimates and $37MM last year.

Net/net this was an OK result. Obviously, EBITDA beat expectations. RevPar was up 3% according to the company, which is ahead of their 0-2% growth guidance. Unfortunately,  though, excluding the hurricane-impacted hotels of last year RevPar would’ve been down ~1%. EBITDA improved due to these hotels coming back online, but that was to be expected.

April was also looking slightly weak due to oil related market which the company noted was softer than Q1’19 as well as an outage at their call center.

Fortunately, the outlook was also left largely unchanged. The company filed an 8-K that shows they are taking steps to lower G&A (reducing headcount which should save 7% of G&A or $1.5MM).

As I noted in my prior post, the real developing story, Core Point is looking to divest “non-core” hotel assets. They had conducted 2 sales at very attractive multiples when they initially announced this.

They also announced 3 more hotel sales. The hotels carried an average hotel RevPar that was 25% lower than the portfolio average and the average hotel EBITDA margin was 700bps below the portfolio average.

Therefore the implied valuation for these 15x at EBITDAre or 2.5x revenue multiple, per the company disclosure. This is a great result. Let’s take a look at what that means so far for the five hotels sold:

We know from this chart below that there is still a lot of wood left to chop.

Since the 76 non-core hotels were already excluding the 2 asset sales sold for $4.5MM, there are still 73 hotels left worth $132MM of sales and $11MM of EBITDA.

This is important because the sales proceeds / multiples thus far have come well in excess of where CPLG is trading. CPLG currently trades at 9.9x 2019 EBITDA… If it can continue to divest non-core assets at multiples above where it trades, this could be very incremental to the stock, as shown below:

More than likely, the company will probably sell these assets for 2.0x Sales as they move forward, meaning CPLG would be trading at 8.4x on a PF basis. If the stock were to trade at 10x, this would mean it is worth $18.7/share, or 35% upside.

That said, I think that would still be too cheap given multiple ways to look at it, whether it be cap rate, book value, EV/EBITDA, etc. CPLG is too cheap.  Imagine if CPLG just traded at book value… the stock would be worth $21/share.

It seems to me that the reported book value as well as the JP Morgan valuation is looking more and more accurate.

The company has also started to buy back some stock. Per the earnings call, “Our priority has been on paying down debt and opportunistically repurchasing our shares accretively at a discount to NAV.”

Is Uber or Lyft stock a Buy?

Should you buy Uber stock following the IPO? Both Uber and Lyft have caught a lot of attention in the wave of tech IPO’s that have hit the market this spring. Lyft already IPO’d and surged initially, but has since fallen 33%, which in turn hurt Uber’s expected valuation. Uber priced its IPO at $45 – the low end of its valuation range

I’ll try to help provide some insights into the businesses and “what you need to believe” to invest in these companies. The bull case for Uber stock and Lyft stock is that “transportation-as-a-service” or “TaaS” is a new market. While Uber and Lyft are fiercely competitive today, and unprofitable, the market is really 2 players (in the US) and that should ease over time (“think of the great duopoly’s of Visa and Mastercard” the bulls will tell you).

So let’s rehash the investment case:

  • “TaaS” is a large market and growing
  • Upside possible from the “end” of car ownership (and entry of autonomous cars)
  • These are “platform businesses” that can leverage their user base to expand into adjacent markets (UberFreight, UberEats, third-party delivery, scooters, bikes etc.)
  • Only two players today. Now that they are public, competitive behavior should cool as the CEOs will be beholden to new investors
  • This isn’t priced in to Uber or Lyft stock yet because investors don’t realize the potential

I struggle with the last point for several reasons. Uber and Lyft are not actually the only two players – taxi’s do still exist. While you may not take one every time to the airport, they wait for you when you arrive in a new city as the marginal provider of transportation. When the Uber wait is too long or there is surge pricing, yellow cab is still there… My point is that pricing for Uber and Lyft can only go so high. And who knows if the companies that have succeeded in China and elsewhere are waiting in the wings to enter the US market (and drive down prices). 

If Uber and Lyft can’t raise the the price of your ride, maybe they take more of the driver’s fare. That’s possible, but they also have to incentize the drivers to drive and beat the hell out of their car. As I calculated in my post on what driver’s might make, it is a decent wage, but if you squeeze that too much, they just won’t drive anymore.

Do I think Uber is the Facebook of transportation? No. Facebook increased the return on investment for all advertisers and increased the total pie. Uber drove down the price of taxi medallions because it added significant supply to the market (everyone can now be a driver) and drove down prices.


The other bull case for Uber or Lyft stock is that they will win the race to autonomy. The reason why this would be so important to the stocks is that autonomy is viewed as a winner-take-all business (think google maps – do you really need another provider?).

There again, I struggle. Calling the winner in autonomy is anyone’s guess. Why would I bet on Uber or Lyft winning vs. Google? I can’t, I can only speculate. And to speculate, I would have to bet that others are not pricing it into the stock. Google spends over $1bn on Waymo a year. I have no insight into this market


Next, to the notion of Uber reducing car ownership. There have been anecdotes of people forgoing car ownership, but that doesn’t seem to be impacting car purchases yet. Car sales, measured by units, are at all-time highs. It’s slowing, but its because we are selling nearly 17MM cars per year and have been for ~5 years. 

Prices too have marched up since the Great Recession. In December 2018, the average price paid for a car was $37.5k, up from $30K in 2013. If Uber and Lyft are having an impact, it is hard to decipher this from the data.


Indeed, while Uber is growing bookings significantly and reported revenue, their growth rates have slowed dramatically. As shown below, Q1’19 adj. rideshare revenue growth is only +9%.

That is materially different than the +21% for the reported bookings. This is revenue that is adjusted to reflect driver earnings as well as incentive comp. An example is provided below: 

As you can see, the driver pay and incentives matter materially here. “Excess” incentives are defined as “payments, including incentives but excluding Driver Referrals, to a Driver that exceed the cumulative revenue that we recognize from a Driver with no future guarantee of additional revenue.” 

Is this number improving for the Company? Hmmm…

Granted, this does include incentives for UberEats and Rideshare incentives are expected to improve for Q1’18 compared Q1’19, but hard to see that the conditions overall are less competitive.

As an aside, I recently had an Uber driver tell me he was going to buy the Uber IPO (he admitted he didn’t study it much, just knew they were growing). That actually could be an interesting employment hedge… if the drivers are hurting, Uber may be doing well – and vice versa!


There are two players so we should compare what they look like. For starters, Uber is much bigger than Lyft and is global. How has that scale played out on the financials? Still a bit too early to see benefits. It’s clear you can see Uber expanding into other markets, while Lyft is focused on the core. 

Clearly, they both burn cash. This actually surprised me a bit. Before the financials were released, I would have viewed the companies as platforms and apps, or asset-light businesses, whereas all the asset-heavy stuff is left to the drivers. Similar to AirBNB, where the homeowner faces the cost of serving the guest and the platform just takes a fee. 

Clearly, that is not the case. They spend a lot on data centers and other infrastructure (more on cash flow at the bottom of this post

We should compare and contrast the two players as well (feel free to add anything in the comments):

Pros of Uber:

  • Larger scale – ride sharing is 5x the size of Lyft.
  • More diverse business with options – UberEats, UberFreight, autonomous… with the added scale. You could argue Lyft is also entering these, but Uber appears to have the lead
  • Valuation seems less demanding – basing that only on Lyft’s valuation and other travel comps

Cons of Uber:

  • Clearly losing share to Lyft
  • Operates in highly competitive markets – as if ride sharing wasn’t competitive enough, Uber got into UberEats (a zero barrier to entry business, but I get why they did it), and freight brokerage

Pros of Lyft:

  • Singular Focus – nothing other than “transportation-as-a-service”. There is some support of companies that focus on one goal tend to execute on that rather than be stretched in all directions
  • Increasing Share – overthe past 2 years, Lyft’s share has grown from 22% to 39%, taking advantage of Uber’s PR mishaps while also being competitive
  • More Upside in Core Market – Similar to the bullet above, if Lyft continues to take share, it seems clear that it will be at the expense of Uber. Given Lyft is 1/5 the size of Uber, there is plenty of share to give

Cons of Lyft:

  • Smaller company / less scale
  • No “other bets” – Similar to google’s “other bets” segment, Uber benefits from its core delivery business, cross-synergies with UberEats, and other bets.  Lyft has autonomous capability, but its anyone’s guess on who wins the war here.
  • Entering more capital intensive businesses – with the entry into scooters and bikes in scale, it appears Lyft is going to now be reinvesting in that business.  (Funny enough, I saw a piece that said Bird Scooters last less than a month)

Perhaps Uber should trade at a significant premium to Lyft due to scale, global presence, and “Amazon” view of transportation. Jeff Bezos wanted the everything store, Uber will be the transportation store. Conquer all, forget profits in the near term, it is all about the next 10+ years…

At $45/share, that means Uber is valued at $82.4BN while Lyft is valued at $15.7BN at $55/share. That places them both at exactly 7.3x 2018 sales…

Perhaps investors are saying Lyft will grow core earnings faster. Perhaps they like the market share gains. Perhaps they view Uber’s other ventures as dilutive. Maybe there is negative view on autonomous given Otto was caught stealing trade secrets and that put them behind. Either way, I am a bit surprised to see Uber trading for the same price (long UBER stock / short LYFT stock anyone?).

I will be passing on both Uber stock and Lyft stock. I just don’t see this as a great market and I think it will be forever competitive. It seems like a race to the bottom for both attempts to gain and retain riders and drivers. Yet, there is nothing binding one to either. Therefore, I don’t see much pricing power here, as noted above.

Interesting Insurance Dynamic Not Discussed Often

One last thing — as I was building the cash flow statement for these companies, I noticed working capital changes were an inflow of cash, largely due to changes in an insurance reserve.

At first, it seems that Uber and Lyft are negative working capital businesses (i.e. the more sales grow, they actually get cash in the door like an insurance company that they can reinvest). That could possibly be a great thing. Lo and behold, I learned Lyft and Uber actually have self-insurance.

In other words, when a driver accepts a rider on Lyft, up until the ride is finished, Lyft is responsible for insuring the trip. This is a huge cost.

In fact, cost of revenue is really made up of two main items: Insurance costs and payment processing charges. Payment processing is the merchant fees that credit cards charge. Insurance costs include estimated losses and allocated lost adjustment expense on claims that occurred in the quarter. It also includes changes to the insurance reserves. These latter two items make up the bulk of COGS.

Lyft says in its S-1 that, “By leveraging our data and technology, we are seeking to reduce cycle times, improve settlement results, provide a better user experience, drive down our cost of claims and have fewer accidents by drivers on our platform.”

Clearly, this would be great. But insurance is also one of the items that can be gamed in the future. By reserving less, Lyft and Uber and report higher earnings. This often happens in good times for banks, where they reserve less for bad loans to boots EPS until a recession hits and they realize they didn’t reserve enough.

Analysts typically are wrong in their expectations, but this could be something where they are especially wrong. If analysts think they can leverage COGS more than reality, the forward estimates people are baking in could be too high.

Mohawk posts another ugly quarter… its stock is still not cheap enough yet…

In early November, I wrote that Mohawk stock (the leading carpet and tile manufacturer) had more pain to come… the stock was down some 55%, but was not reflecting this yet.

Fast forward a bit following that article, and Mohawk stock went down another ~10% post-article, but now is up 8%. So what happened? Did something encouraging come from its latest earnings report?

Well, do you call a 20% year-over-year decline in EBITDA good?

I didn’t either. The company called out similar factors as it did in the last call. “The period was affected by significant inflation, slowing markets and LVT impacting sales of other products.”

Unfortunately, I don’t these headwinds are abating any time soon. As I noted in my last post, MHK has gotten a massive margin uplift from a decline in raw materials. That’s starting to normalize.

Here’s the trend on LTM EBITDA margins over time.

MHK Margins_dec2018

Contrarian investors might say, “well, what if it snaps back? Then the stock is cheap”. That may be true, but I doubt it. The street is currently expecting 17% EBITDA margins for next year and 18.5% the following year. So essentially they are expecting a snap back. As such, I think the company is trading more at around 8.0x+ 2020 EBITDA, instead of 7.3x it would suggest.

Are the forgetting before the commodity collapse, Mohawk had ~13-14% EBITDA margins??

MHK Margins

I think Mohawk stock is still too expensive considering these expected headwinds. More importantly, I think sentiment has room to fall, which we all know can be a larger driver of stock performance.