MSC Industrial Direct FY 1Q17 Earnings Call Notes

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Erik Gershwind – President and CEO

Environment stabilizing

” I’ll begin this morning’s discussion by covering the environment which is showing potential signs of stabilizing. We’ve also seen increased optimism from our customers over the past couple of months.”

Return to growth in December

“While conditions remain difficult throughout the quarter we did see a better than expected November as well as a return to growth in December, the start of our second quarter. The improvement in growth rate was across all of our customer types. MDI readings that had risen above 48 back in August continued above the 48 level through October and then ticked up to 49.7 in November and 49.8 in December bringing the rolling 12 month average to 47.2. The most current readings imply essentially stable metal working end markets, and are a significant improvement over the trends of the past year. Remember that December of last year was at a reading of 44.”

Marked improvement in optimism driven by

” there is also a market improvement in optimism about what the future may bring. This optimism is being driven by a couple of things, first there is an expectation that increases in infrastructure spending, lower corporate tax rates, and a more business friendly regulatory environment will provide a stimulus to the industrial econom”

Still need to see sustained increased optimism

” All of that said we caution that these are not yet sustained trends and increased optimism will need to translate into sustained increases in demand and order activity before we declare that the environment has turned.”

Price activity is not yet broad based

“I’ll now turn to the pricing environment where it remained soft in the fiscal first quarter and continues to be so. Commodity prices are still fairly low relative to historical levels despite improving over the past year. While we have seen some supplier price increase activity, we characterize it as selective and not broad based. That said any activity at all is more than we’ve seen over the past couple of years. If we continue to see increases we anticipate taking a very modest price increase sometime in the next month or two.”

Potential for a spring loaded effect when the economy returns to a stronger foot

“Many of our customers businesses have been depressed by the difficult environment. And this has created the potential for a spring loaded effect when the industrial economy returns to stronger foot. ”

If the recovery comes we have a great earnings leverage story

” we are now seeing signs that a potential recovery could be coming. If in fact it becomes a reality we will benefit from a tremendous earnings leverage story.”

Distribution is winning in the marketplace

“. I would say we are seeing a trend among some of our suppliers with many already do all or virtually all of their sales through distribution. I would say there is more of a trend of laid towards putting more of sales through distribution. And I think the reason that’s the case is because distribution is winning as a channel in the marketplace. So I think it’s a response to what’s happening with customers making choices about where they want to buy and that’s through well performing distributors. ”

We are seeing a clear improvement in growth rate

“look no question when you hold back. We are seeing an improvement in the growth rate in the business, okay plain and simple because you’re right you point to its start in November being better than expectations, December certainly better. What we wanted to do though is give you a realistic picture that I would say in terms of December it was a pretty strong month across the Board obviously.”

We did see capital related purchases

“Now our belief there Matt is we did see a spike in what we call Capital related purchases. So these — it could be a machine. It could be a tool holder, it could be a tooling package, let’s think of that like a start up kit of cutting tools when a customer purchases a machine. Or all of those things tend to imply optimism about the future obviously if they are investing in the business.”

Optimistic end of year buying probably wont continue into January and February

“Our assumption right now and again Rustom mentioned limited visibility, we’re sitting here very early in the month of January is that a lot of what we saw was end of the year buying because customers are more optimistic and that won’t continue in January and February. Which kind of gets us to more or less flatter January and February.”

It’s been at least three years since we’ve seen anything resembling this

” it is at least three years because the last two years there’s been really low confidence among our customer base. It has been at least three years since we’ve seen anything resembling this””

The stabilization has been pretty broad based

” This stabilization has been pretty broad based Adam. So across most of our core customer types that we referred to was our typical core customer types of the machine and equipment folks, primary metals, metal fabrication. All of those are seeing an improvement over the last couple of months. I think some of that is driven by oil and gas, no question Adam because we’ve said the indirect effect on all these job shops. And again what we’re hearing is more stabilization than it is a strong rebound even with oil and gas

Rustom Jilla

Probaby 40% of our goods are ultimately foreign sourced

“Look, I mean yes, our federal tax rate is pretty much we pay our full federal tax so any reduction whether it’s 20% to 25% to 15% any reduction will be a positive for us, right. The ultimate EPS benefit to us and we definitely expect it will depend on what the offsets are and whether there are any offsets. I mean that could be with foreign tariff, cross border taxes, interest, a whole bunch of different factors which might or might not come into play. So it’s hard to quantify. I mean since you did ask the question it was foreign tax related but I will sort of make the point on the — on our cost of goods sold as well in there and that is that remember that about 12% to 15% of our cost of goods sold comes directly from outside the U.S. And we believe that — and we believe, we don’t have the exact number with the U.S. purchases that are actually foreign source it’s roughly about 40%.”

We are ultimately expecting a net benefit

“So remember many suppliers have multiple countries of origin and alternatives as we do also. And in any case inflation is historically good for distributors but it’s a bunch of different factors here that mean it’s hard to quantify exactly how much of the benefit will flow through but we clearly are expecting a benefit. ”

What we would do with extra cash: dividends and M&A

” Now part B of your question is what will we do with that. So I mean, look I mean in general we believe in steadily increasing our ongoing ordinary dividends. I mean we’re very, very Erik and I have been very consistent in terms of communicating that. There’s no reason to think that will change. And we have also demonstrated over the years that if we do have excess cash flow over and above requirements, we are balanced and opportunistic in terms of capital management and if we do have excess cash at the end of the day that we can’t deploy in the business, that we can’t deploy you know for ordinary dividend increases, and if we don’t have attractive M&A we are absolutely not averse to returning it by way of open market by banks or even tender type things.”