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By Brian Bernard, CFA, CPA | 06-12-2017 02:00 PM

4-Star Industrial Distributors That Look Interesting

Anixter International, WESCO International, and HD Supply all trade below our fair value estimates.

Brian Bernard: Industrial distributors play an important role as key middlemen connecting a network of millions of customers and suppliers. Three of the distributors we cover--Anixter International, WESCO International, and HD Supply--currently have a 4-star rating and look interesting to us.

Narrow-moat Anixter and WESCO both specialize in electrical distribution and look cheap based on free cash flow yield. We do prefer Anixter because it utilizes a more shareholder-friendly capital allocation strategy. In our view, Anixter is least exposed to the Amazon Business threat, and we think the company's recent acquisitions have been integrated nicely and should start driving better growth. Also, Anixter's balance sheet is about back to normal, so we should see the company resume returning cash to shareholders.

After announcing first-quarter results and the sale of its Waterworks business, shares of narrow-moat HD Supply have tumbled over 20%. HD Supply is expected to receive $2.5 billion for Waterworks, which we think is about a fair price and the proceeds will be used to pay down debt and repurchase shares. HD Supply's Facilities Maintenance segment, which we think is a bit more exposed to competitive pressure, will represent about 75% of consolidated EBITDA. Although we think the market's reaction has been overblown, HD Supply must prove it can execute on it strategy and improve profitability from here.

We downgraded W.W. Grainger's moat rating and trend to narrow and negative because we think the company is most vulnerable to competitive pressure from Amazon. Still, we do see some upside and think Grainger is an interesting name for contrarian value investors that believe the Amazon threat is exaggerated.

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