This Company's 'Picks and Shovels' Business Model Is Thriving
Regular readers know that we like to invest in companies that sell "picks and shovels"...
These businesses provide goods and services for entire industries – like Levi Strauss' namesake company did for miners during the California Gold Rush.
So, even if their customers didn't "strike gold," the companies selling them the industry tools typically won out.
More than 165 years later, the picks-and-shovels business model is still going strong.
Just look at companies that supply parts to multiple automakers...
These businesses come out on top no matter which automaker ends up leading the market... That's because they supply all the major players.
Today's company uses a similar approach to support the industrial sector...
W.W. Grainger (NYSE: GWW) collects $13 billion in annual revenue selling maintenance, repair, and operating supplies, or "MRO."
Yes, you can get motors... belt-drive, direct-current, and condenser-fan motors. In fact, there are 64 pages of motors to choose from in the company catalog.
But you can also buy laboratory tools, janitorial supplies, packaging, hydraulics, pneumatics, pumps, and abrasives.
This is a business-to-business operation, so you likely won't purchase Grainger products as an individual. But if you work in any industry that uses physical equipment, you have probably been a customer.
The company sells the parts, tools, and supplies needed to keep industrial equipment on the move. And it reaches across different areas of the U.S. economy.
Keep in mind that Grainger doesn't manufacture a single product... It's a distributor. The company's 1.5-million-plus item inventory comes from more than 5,000 suppliers. Grainger simply warehouses the products and helps get them to customers.
The key to this business is expertise...
If you've ever tried to find replacement parts for an appliance on your own, you know how hard it is to pin down compatibility, availability, and price. Buying industrial parts gets even more complicated.
Most customers need some help to get the right products quickly. That's why about 80% of Grainger's revenue comes from its High-Touch Solutions model, which fosters a high level of client interaction.
Grainger has more than 4,000 sales representatives who know the products and can work through different problems. Customers can also browse a carefully curated website to find solutions.
This approach serves mainly mid-sized and large businesses. The largest customers have already integrated Grainger's systems into their own operations...
For example, many facilities have embedded Grainger's ordering system and installed its "KeepStock" system. The latter allows the company to manage and supply inventory on site. So, a technician can just walk to a Grainger "vending machine" and grab the tool or part he needs.
Grainger's distribution model translates into a fantastic business... You take your cut as a middleman without making huge investments in product development or manufacturing.
Of course, you need warehouses, logistics capabilities, and the right inventory. But Grainger has spent more than 60 years creating an efficient system... ever since founder William W. "Bill" Grainger revamped how the company sold its products.
Grainger has also earned an operating margin in the double-digit range for decades now. And that leads to returns on capital well above 10% – and often more than 20%.
What's more, Grainger loves to reward its shareholders...
The company has paid and raised its dividends for 51 consecutive years. That's more than double the time frame of the "Dividend Aristocrats" – companies that have raised dividends for 25 years in a row. Grainger now qualifies as one of the ultra-rare "Dividend Kings" – those with 50 straight years of dividend hikes. (There are only 44 Dividend Kings out there.)
In today's market, what would you expect to pay for such a company? Let's break it down in terms of return on equity ("ROE") and price-to-earnings ("P/E") ratio...
The median company in the S&P 500 Index has an ROE of 20.2% and a P/E of 20 times. Now, consider Grainger's far-superior 56% ROE and 26 times earnings. Grainger's impressive ROE warrants that higher-than-average valuation.
If investors were less concerned about competition from online marketplaces, Grainger's shares would likely trade for even higher valuations.
The point is this... When you pair the company's profitable distribution model with a highly fragmented MRO market, Grainger's businesses have room to keep growing.
Considering Grainger's dividend history, strong balance sheet, low-capital requirement, and the opportunity to continue share repurchases, Grainger is the kind of business that will continue rewarding long-term shareholders for years to come.
Sometimes investing is simple.