MSC Industrial Direct 3Q15 Earnings Call Notes

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Tough environment but earnings exceeded expectations

“growth rates were in line with guidance, reflecting the challenging demand environment. Second, that gross margin stabilization continued, despite the extremely soft pricing conditions. And third, that strong expense management led to earnings exceeding expectations.”

Drop in oil prices, softening export demand, foreign exchange headwinds

“Root causes for the slowdown included the impact of the rapid drop in oil prices, softening export demand, and foreign exchange headwinds all of which were impacting broader manufacturing activity. At the time, I said that it was unclear as to whether we had moved out of a moderate demand environment and into a low one.”

Low demand environment

“With another few months under our belts and with the same headwinds persisting, it’s now clear that we are in a low demand environment. In speaking with customers, while things have not continued to deteriorate, they have essentially remained at low levels in what is a sluggish environment.”

Activity has at least leveled

“However, most customers are suggesting that their activity has at least leveled, meaning they’ve not seen further significant declines. The macro indices we track confirm what we’re hearing from customers.”

Significant slowdown in metalworking activity

“The ISM has generally trended downward over the past six months, despite a slight improvement in May and June. It remains well below October’s peak, as well as below the 12 month average.

As for the MBI, after an up-tick in March, the index fell below 50 in April, and continued to tick down below 48 in both May and June, suggesting a considerable slowdown in metalworking activity.”

Pricing conditions extremely soft

“With respect to the pricing environment, conditions remain extremely soft, due primarily to the lack of commodities inflation. Supplier pricing activity, which is the primary driver of distribution pricing movement, remains well below historical levels.”

Moderating sales force expansion

“With respect to sales force expansion, we continued moderating as we had started to do last quarter. This is in response to the softening demand environment, as sales force paybacks lengthen when growth rates slow. We now anticipate sales force expansion to be roughly 2% for the fiscal year.”

Things have stabilized but at a very soft level

“I think what we would describe right now is, you hit it on the head. It’s a very sluggish environment, it’s soft demand. What we did want to get across in the prepared remarks is it’s not – we haven’t seen a continued dramatic deterioration within the last couple of months that things have sort of stabilized, but stabilized at a very soft level.”

We look at a few things and triangulate to try to get a sense of where we are in the market

“What we do is we triangulate a number of things. We look at the macro sentiment indices like ISM, like MBI. We look at some of the distribution surveys that are produced by your community. We talk to suppliers, which is a great source for us to get at point of sales growth for distribution, and then we triangulate. I think as we triangulate, the story continues to be that we’re growing well above market.”

Metalworking has been particularly hard hit

“I think you are right to call out the fact that our core business, metalworking, cutting tools, have been particularly hard hit. You could see that evidenced in a number of places, but most notably the MBI has been under 50, indicating contraction for three months in a row.”

You have seen inventory stabilize as a result of changing conditions

“You have since seen that inventory number stabilize. That is the result of certainly changing our approach. As a result, correlating you are seeing free cash flow generation really improve.”

Local distributors are fighting for survival

“what we’re seeing is very typical with what we’ve seen in past cycles, where guys like us, the national players, get hit certainly. We get affected when there’s a slowdown. The local distributors that make up the 70% of the market get disproportionately hit. And what we see in times of slowdown is competition. They will get very – the local distributors will get very competitive.

So I would say price competition is very high right now. And a lot of that, I mean, that’s really being driven off the local distributors doing what they do when things get slow, which is fight for survival. So that’s the biggest headline.”