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2 Wide-Moat Companies That Deliver the Goods

Thu, 31 Jul 2014

With over a million products stocked, these firms enjoy long-lasting competitive positions through cost advantages and the network effect.

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Video Transcript

Kwame Webb: Today, I'd like to highlight Grainger and Fastenal, two wide moat-rated industrial distribution companies. Industrial distributors are similar to general merchandise stores, except they sell exclusively to businesses and manufacturers. These companies sell everything from welding masks to gloves that are used in metalworking shops to mops and buckets used to clean the shop floor. In fact, both companies stock well in excess of one million products to satisfy their customers' wide array of diverse needs.

Over the last decade, many customers have realized that it's far more efficient to use an industrial distributor than to maintain relationships with thousands of suppliers. Grainger and Fastenal have both been beneficiaries of this secular trend. As we think about these companies, they enjoy two moat sources, the first of which is a cost advantage. As the two largest players, they have scales of economy on both procurement and transportation that allow them to be more cost-efficient than their 150,000 suppliers.

The second moat source comes from a network effect. As they become larger, many customers have realized that they don't need a procurement department and that it's far more efficient to use an industrial distributor. Additionally, many suppliers have realized that they don't need a salesforce; instead, they use Grainger or Fastenal. Currently, both stocks have a 3-star rating [from the Morningstar Rating for stocks]. However, Grainger trades at the larger discount to our fair value estimate. And at this time, we believe it's more attractively valued.

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