Fastenal

Strong growth with industrial supplies

Before I decide to invest in a stock, I take a thorough look at the founders and the company's history. I'm firmly convinced that this helps me better understand the company and its business model. It also helps me invest in companies and not just in some securities - and that, in turn, is exactly what helps me stay calm and level-headed in times of crisis.

Today, once again, I've brought along an interesting origin story with an equally remarkable founding father. I'm talking about Robert A. Kierlin, who was once considered "The cheapest CEO in America" and who built the industrial distribution company Fastenal. Even though he can look back on a huge fortune, he lives a totally down-to-earth life and donates most of his money. Where this attitude toward money came from and how he built an international billion-dollar business with screws, nuts and nails is what we'll look at below.

The history and business model of the Fastenal Company

Robert "Bob" A. Kierlin was born on June 1, 1939, in Winona, Minnesota. He was the youngest of 5 children and was raised to be frugal from an early age. He remembered that his family never ate out and was very careful with its spending. The Kierlins never traveled either; instead, the children played in the local park. Bob's father Edmund ran an auto supply store, where Bob was already helping out at age 7, sweeping the floors of the small-parts storeroom, among other things. At 11 he was assisting his father behind the counter. Back then he noticed that customers were often looking for special fasteners, such as screws and nuts. If they didn't have the requested parts in stock, they regularly sent their customers to other hardware stores, and vice versa. In many cases, the customers didn't find them there either, and the parts had to be made as a special order, which of course meant a long wait. Little by little, the idea took shape in Bob's mind of one day opening his own store with all the different fasteners.

After graduating from high school, Bob studied mechanical engineering at the University of Minnesota and then took a job at IBM. He worked there for 10 years as a financial analyst. He was very good at his job and was even supposed to take on an international position. But when he missed the interview because of a delayed flight and therefore didn't get the promotion, he remembered his childhood dream. Without further ado, he teamed up with his IBM colleague Jack Remick and his former high school friends Michael Gostomski, Dan McConnon and Steve Slaggie to open a store for all kinds of fasteners together. The 5 business partners put up the starting capital of 30,000 dollars and rented their first location. Since not everyone was happy with the name Lightning Bolts, they ultimately settled on Fastenal ("fasten all kind of things").

Since the founders were still working full-time at that point, they planned their business strategy on weekends. They agreed to open a store for consumers where you could buy screws and nuts in all sorts of designs. No sooner said than done: in 1967 they opened the doors of the first Fastenal store in Winona. However, business was very sluggish. Sales were miserable, and a second store in the neighboring town didn't change that either. Slowly they realized that their strategy had failed. Consumers weren't the right target group for the company; it was industrial and construction companies that had a big need for precise fasteners. Their production regularly ground to a halt while they searched for suitable parts. From then on, the Fastenal Company focused on commercial customers and became very successful with that.

Today the company sells its products in over 3,200 locations, which include both public stores and on-site locations at large customers. It's exactly this closeness to customers with a tailored product range that drives the strong growth. Fastenal also expanded its product portfolio considerably. Today it sells not only fasteners but all kinds of industrial supplies (tools, electrical equipment, safety gear and much more).

How do I assess Fastenal's future prospects?

Let's first take a look at the most recently published figures for Q2 2020. There we can see that Fastenal increased its revenue by an impressive 10.3 percent compared to the prior-year quarter. That was due in part to strong sales in the safety segment. In total, the company generated over 1.5 billion US dollars and realized a profit of 671 million US dollars on it (an increase of 4.7% over Q2 2019). I also found the statistics on the regular branches and the so-called Onsites (an individual shop at the customer's location) very interesting. Here we've seen a steady reduction of public stores since 2014 and, over the same period, a massive increase in Onsites. At the time of publication, Fastenal was still operating 2,060 stores and already 1,212 Onsites. In addition, the company has over 105,000 vending machines in operation. Here employees can quickly and easily get things like safety gloves, tools or various work supplies as needed.

The Onsites and the many vending machines create especially strong customer loyalty, which can definitely be interpreted as a small moat effect. Satisfied customers who already have their own Fastenal shops in the building won't switch suppliers that quickly. They'll also try to source their various needs through Fastenal. You can also see that Fastenal has been able to increase its margins with its new strategy. The net margin here is a solid 15 percent.

But where is this headed in the long run?

The fact is that the market and the demand are huge. The company estimates domestic demand for its products alone at more than 140 billion US dollars per year. Of that, Fastenal currently only has a small piece of the pie - so there's definitely growth potential. Management also has two more topics at the top of the agenda: expanding the e-commerce business and globalization and expansion into more countries. Fastenal is currently present in 25 countries, so there's still room to grow here too.

What are the risks?

For one thing, it has to be said that Fastenal's business is definitely cyclical. If the economy goes downhill, they'll feel it too. However, it has already shown in earlier crises that it was well prepared and usually even emerged from the crisis stronger. Another risk, of course, is increasing automation. If more and more work steps are taken over by robots, fewer workers are needed, which in turn would mean lower sales for Fastenal. Last but not least, you also have to admit that the parts Fastenal makes usually aren't really complicated - meaning they can easily be copied. In the long run, 3D printers could also come into play, for example.

All in all, though, I'm firmly convinced that Fastenal is more than aware of the current risks and is already working hard on solutions. It has shown many times that it can adapt quickly to new circumstances and can thus also be successful as a long-term partner to industry.

And what about the dividend?

Fastenal began giving its shareholders a share of the company's success in the form of profit distributions in 1991. Up until 1998 there were only 2 dividend increases, but from 1999 on, the industrial distributor has managed to deliver exemplary dividend growth. The dividend growth rate over the last 10 years is 12.75 percent - and trending upward. The current dividend yield of 2.2 percent is also respectable. The only thing I find a bit high is the payout ratio of 66.9 percent - but it has to be said that Fastenal has an established business model that doesn't require much investment.

Conclusion:
Together with his colleagues, Bob Kierlin built a very successful industrial distribution company. With its Onsites and the many vending machines, Fastenal is already very well positioned today - nevertheless, the company offers great growth opportunities. For long-term-oriented dividend investors, this is surely a real find.