MSC Industrial Direct FY 2Q15 Earnings Call Notes

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We have seen a swift and significant change in demand conditions

“I will now turn to the environment. We’ve seen a significant and swift change in demand conditions since the start of the calendar year. We heard this in a change in tone from many of our customers and saw it in sentiment indicators like the ISM and MBI, both of which trended down through the quarter. Root causes included the impact of the rapid drop in oil prices and softening export demand. As you know, our business has very little direct exposure to the oil and gas sector. There is little doubt, however, that the dislocation in this sector and the resulting uncertainty is currently impacting broader manufacturing activity, particularly in energy producing states. Softening export demand is also impacting manufacturing and heavy manufacturing in particular as exchange rate headwinds have become more severe.”

Weather was a small factor but there was more going on

“In addition, while weather was certainly a factor in the quarter, we believe the broader weakness that we’re seen is more than a temporary disruption. With respective to the pricing environment, conditions remain quite soft due primarily to the lack of commodities inflation. A number of our suppliers did implement small price increases, and we were successful implementing a modest mid-year price adjustment of our own at the beginning of January.”

Growth rates dropped significantly in February

“Turning to our results, the slowing demand environment resulted in lower than expected organic growth which came in at 6.8% for the quarter. As you can see from our monthly numbers, growth rates were solid in December, improved in January, before dropping significantly in February as the environment deteriorated.”

We’re still adding headcount but at a slower pace than previously projected

“As of now, our trajectory is to increase sales headcount by around 6%, a bit below the 8% to 10% range we previously provided and that could change further either up or down as we assess changes to the environment.”

The indirect exposure to oil and gas is larger than we expected

“the direct exposure is 3% or less to the oil and gas sector. Where it gets trickier and what we’re now seeing where the impact is much broader based is all of the tiers of that supply chain and particularly in our core manufacturing base that are actually influenced by oil and gas. So we are seeing pretty pronounced changes in growth rates and in conditions in manufacturing, and particularly when we go to manufacturing and look at our numbers and look at manufacturing activity in states that have an oil and gas influence, it’s really pronounced. So it’s pretty clear to us that while the direct exposure is small, the indirect exposure is pretty broad based.”

In one quarter things moved pretty quickly

“I would say in general if you look at what’s happened with the indices, the sentiment indices, I mean they’ve been trending down. So the drop you’re referencing in Chicago, the ISM in general what’s happened with the MBI I think is indicative of what’s happening on a broader base, less about one area like Chicago more about what’s happening across the board is — look, in one quarter this thing moved pretty quickly where you can tell our tone on this call is quite different from just a quarter ago we see that as pretty broad based and not specific to our region.”

Heavy manufacturing has been particularly hard hit

“manufacturing is a very broad umbrella. We have seen over the past quarter so the slowdown has been broad based on the factors we describe. If there is an area that we call out it would be heavy manufacturing, heavy durables. As you could imagine given our strong metal working position and but that’s a significant percentage of our total company sale, heavy manufacturing has a big influence on our growth rates and you are right, there has been a double whammy in heavy manufacturing because of oil and gas and then being particularly hit hard by the change in the export environment. ”

The inventory build is in fast moving stuff, also higher inventory can be acompetitive advantage if this is a sustained softness

“Few things on the inventory, number one is that, the build is in fast moving inventories that we can turn quickly. We’ve shown — I have complete confidence in our team that it’s been really changed, we can bring inventory levels down quickly. The other thing I’d say is, in times of — if this becomes some sort of sustained softness having inventory on the shelves customers are not going to want keep inventory what will distributors are going to be forced to bleed down inventory levels. This becomes a really big advantage for us and I talked in the prepared remarks about this. Times like this of dislocation being an opportunity for us to accelerate share gains having product in stock and getting it next day is absolutely critical. So I feel very good about our inventory investment.”

We do think long term lower oil prices are good

“whether it’s the back half of ’15 or not or it’s ’16 we don’t know, but longer term we think that what’s happening with energy prices actually bodes quite well for manufacturing in the US. Number one it makes us more competitive and then number two you’re right that lower oil prices that are going to put more dollars in consumers’ pockets and that’s more money, more disposable income to spend.”

We’re hearing more caution than excitement

“I would say the answer is right now no, we are not hearing that, I think we’re hearing more caution than we are excitement for the near term. That said I give a caveat that if I went back a quarter, a quarter and a half ago our customers also weren’t talking about what was coming with oil and gas. So certainly who knows, it’s possible but right now we’re not hearing a lot about a coiled spring for the back half of the calendar year.”

March did not bounce back

“I think the bigger story with March is the fact that growth rates did not bounce back which I think is more supportive of the case that the Q2 factors were a lot deeper than just weather”