THE HEDGEYE EDGE
We had been waiting for an opportunity to re-enter a short position in Industrial Supply, and the recent squeeze/rally in shares of W.W. Grainger (GWW) provided such an opportunity.
While many focus on the competitive threat posed by Amazon Business and its ilk, accelerating competitive intensity from independent suppliers and other larger distributors have principally generated headwinds in the last few years.
We believe the volume ramp at GWW has been misattributed to the company’s sales restructuring and market strategy, with the credibility of turnaround efforts likely to suffer later this year.
Distributors will be comping a strong 2H17, supported by tax reform and hurricanes, with headwinds from a decelerating economic backdrop, delayed pricing, high expectations, and cost pressures.
While valuation of GWW bakes in ongoing favorable growth and performance, data continues to support views that the Industrial Distributor market is being disrupted from many different directions.
From resilient independent distributors, to pricing transparency, to competitive entrants, we doubt that the legacy distributor model will prove relevant in coming years. The traditional industry moats are drying-up as customers see an opportunity to switch to competitors. In short, structural pressures are intensifying competition from all sides, while longs cling to the myth of under-penetration.
We believe that persistent gross margin pressure will preclude equity outperformance, and that recent share price outperformance is an opportunity to enter a well-supported structural short. We expect GWW shares to give back their recent gains and resume long-term underperformance as structural pressures leave the company ‘stuck in the middle’ as margin is wrung from Industrial Supply.
We see greater than 30% downside in GWW shares. Typically, shorting squeezes is an effective strategy in names like GWW. The shares are far from cheap, and cheap usually gets cheaper in broken industries.
ONE-YEAR TRAILING CHART
