Not So FAST! Fastenal Drops on Solid Earnings

Fastenal (FAST) reported second quarter earnings of 47 cents per share on revenue of $571 million, which topped analysts’ forecasts of 44 cents on sales of $568.7 million.  In addition to topping Wall Street’s expectations, the company also easily exceeded last year’s second quarter results of 29 cents per share in earnings with revenue growth of 20% since that period.  The maker of nuts, bolts and other fastening devices and equipment saw net income rise 59%, but comparisons are still quite favorable as business fell off sharply during the recession.

Demand from both manufacturing and non-residential customers improved in the quarter, which is a welcome sign after a long streak of declines.  Fastenal’s gains in non-residential construction, while modest (up .5%), showed the first increase in more than a year.  Prompted by the stronger than expected rebound in demand, the company said it plans to open 80 to 95 new stores during the second half of the year in hopes of being prepared to take advantage of continued improvements in the construction sector.  The company declined to update their guidance for the rest of the year, but at least earnings are trending the right way.  The company has now topped analysts’ expectations after missing them in each quarter of fiscal 2009.

With Fastenal showing positive momentum and topping expectations it might surprise some that the stock is actually trading 3% lower on heavy volume, especially considering the rest of the market is roaring higher.  At Ockham, we became concerned about Fastenal’s valuation in mid-April as the stock reached a new 52-week high at nearly $57.  It was at that time that we downgraded FAST to Overvalued and have maintained that stance ever since.  The stock is very near the high end of its historically normal ranges of both price-to-cash earnings and price-to-sales, which suggests the market has already priced in quite a bit of fundamental improvement.  For example, historically FAST has traded between 21x and 35x times cash earnings per share, and Fastenal closed yesterday trading for a multiple of 31x.  Similarly, with price-to-sales per share around 3.5x, it is near the historical high end of the range at 2.2x to 3.6x.

While Fastenal is clearly experiencing fundamental improvement and starting to see growth return, it is clear to us that some of that has already been priced in.  At Ockham, we are value-oriented and try to find stocks that are fundamentally strong and appear priced attractive compared to historical norms.  The stock has appreciated 63% over the last twelve months, and we think value investors should look elsewhere for ways to play a recovery in construction and manufacturing.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

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