Share prices increased more than 20% this year at the distributor of business and industrial products, as investors have responded favorably to its more competitive pricing strategy.

(Bloomberg) Investors seemed to have left W.W. Grainger Inc. for dead last year as a perceived threat from Amazon.com Inc. pushed the industrial distributor’s stock to a six-year low in August.

Justin Bergner

Industrial distributors, and particularly Grainger, are affected by Amazon, and we are now seeing these companies reassert themselves.
Justin Bergner, investment analyst
Gabelli & Co.

Now the price-cutting strategy that the 90-year-old company adopted to better compete in the 21st century marketplace has brought new life to the shares, which have gained 21% in 2018. The turnaround comes as the S&P 500 Industrials Index, a key gauge of industrial companies and Grainger’s customer base, is up 0.2% for the year after falling from its January high.

Grainger sells maintenance, repair and operations (MRO) equipment and supplies to businesses across the manufacturing, hospitality, transportation and retail industries. The company and its competitors had already been struggling with tepid demand as the growth in the U.S. industrial sector slowed over the past few years. Then came the Amazon.com scare.

The e-commerce giant’s foray into industrial distribution triggered a sharp selloff in the shares of the traditional players last year, with Grainger hit the hardest. Amazon sells business and industrial products on Amazon.com under the Business, Industrial & Scientific category, and through its B2B brand, Amazon Business.

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Investors were further shaken when Grainger decided to lower prices in a bid to gain market share. Short interest climbed to 21% of free float in October, from just below 10% six months earlier, according to IHS Markit.

“Close to $2.5 billion of their revenue, out of their total $10 billion, was uncompetitively priced, so they cut their price to be more in line with the market,” Macquarie analyst Hamzah Mazari said in a phone interview. “Last year, people did not have enough confidence as it was a complicated strategy, but in the fourth quarter they showed volumes were up double digits.”

The focus during the first-quarter results, due to be reported before Thursday’s market open, will be on whether the volume surge was a fluke or if it marked an inflection point for the Lake Forest, Ill.-based company.

“If it turns out to be a one- or two-quarter pop, I think we will see investors beginning to short the stock again in the second half of the year, on the secular thesis that Amazon is going to take over the business,” said Mazari, who rates Grainger neutral, with a $270 price target.

Analysts’ on average have increased their estimates for Grainger’s first-quarter earnings per share by more than 11% over the past three months, according to data compiled by Bloomberg. Its two biggest rivals, Fastenal Co. and MSC Industrial Direct Co., have already reported mixed results. While MSC—which often goes by the name of its primary unit, MSC Industrial Supply Co.—posted better-than-expected margins helped by higher pricing and a lower mix of government sales, Fastenal’s margins disappointed, triggering a sharp selloff in the group on April 11.

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‘Margin Reset’

Grainger is seen as being in a more direct line of fire from Amazon than its competitors. Fewer of its products need technical support compared to MSC, whose customer base is largely made up of metalworking and heavy manufacturing companies. Nor does Grainger have the kind of business model that gives Fastenal a big chunk of revenue from fasteners, which are mostly uneconomical to ship. On top of that, Grainger’s products were priced at a premium.

As pricing information became more widely available online, customers more clearly saw the degree to which some of Grainger’s products were materially ahead of the general market, leaving the company little choice but to adjust, according to Gabelli & Co. analyst Justin Bergner. While the move triggered fear among investors that it may have a ripple effect and hurt the whole group by starting a price war, so far those concerns seem unfounded, he said.

“Industrial distributors, and particularly Grainger, are part of a group of companies across industries that are affected by Amazon, and we are now seeing these companies reassert themselves,” said Bergner, who recommends buying the stock. “We are seeing these stocks return to life as people realized that the Amazon effect for now is a margin reset from increased price transparency.”

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