DETTA INLÄGG ÄR ETT UTDRAG UR KVARTALSBREVET JAG SKICKADE TILL PANDIUMS ANDELSÄGARE 29 APRIL 2016.
MSC Industrial Direct (MSM) is a MRO (maintenance, repair and operations) distributor in the US. It means that they sell screws, light bulbs, locks, brooms and another million different products that business customers need to run their daily operations.
Although not often thought about the MRO industry is huge. There are around 150,000 distributors in the US with combined sales of USD 140 billion. The top 50 distributors represent around 30% of the total market. MSM is one of the larger ones. This is great because there are obvious advantages with being large. MSM can afford to keep a large number of products in their inventory and build the distribution system needed to be able to deliver them fast. As an example, MSM sells more than 55,000 different fasteners (screws, nuts, nails and bolts) that they can deliver the next day if the order is made before 20.00. Being big also means that they can serve large national customers from different locations.
The industry itself is more attractive than one might think. When people need a small and cheap component for a machine that does not work without it, price is not the main concern. Getting the missing part quickly is more important. This enables MSM to have gross margins of around 45% and high returns on equity.
Going forward I think it is highly likely that MSM will continue to grow. The market itself grows with the general economy. MSM has a solid base of satisfied customers that likely will stay and potentially increase their spending. Further, they will probably continue to take market share from their smaller competitors, both organically and through acquisitions.
Insiders of MSM owns around a fifth of the company. The CEO, Erik Gershwind, owns stock worth around USD 100 million compared to a salary of USD 2 million. Incentives are clearly aligned with the shareholders.
The share price of MSM has historically followed the development of the manufacturing economy in the US. So when the indicators started to decline at the end of 2014 MSM’s share price went down with them. It is true that MSM’s business is cyclical. But the benefit of being long-term is that if we can be reasonable sure that revenues and profits will bounce back we do not have to be too concerned with it. In MSM’s case each recession has been followed by a period of above average growth. That’s because the products MSM sells are things that wear out and needs to be replaced at some point. Another reason is that MSM’s smaller and less well-managed competitors often go out of business or struggle during recessions, enable MSM to take market share.
The market’s short-term focus enabled us to invest in MSM at a below average valuation, which together with the future growth and capital returns should produce a good return. We paid USD 59 per share.
Let me just make a short comment about the investment process. Most of my time is spent trying to find companies that possess certain features. I’m looking for simple businesses with good prospects that are run by honest and capable managers. Usually these companies are not cheap enough. So what I do is to set a target price and wait. Often the prices don’t go down enough but sometimes, like during the January turbulence, a couple do. If the thesis is still intact we then invest. Sound investing involves a lot of waiting.