Brian Bernard: Business-to-business, or B2B, distributors play an important role in supply chains across myriad industries. We believe the most successful distributors leverage scale and robust portfolios of value-added services to maintain attractive value propositions for their customers and competitive advantages over smaller competitors. We think cost advantages from economies of scale, and pricing power and customer retention earned through value-added services can contribute to a distributor's ability to earn excess returns.
However, e-commerce is playing an increasingly important role in the distribution industry. Amazon's real or rumored forays into various industries have caused market apprehension around many of the B2B distributors Morningstar covers; however, we think much of this concern has generally been overblown because many of these companies have built differentiated business models or benefit from other factors that discourage new competition.
Specifically, we don't see much of a threat to metal service centers, like Reliance Steel & Aluminum; we see a low threat to pharmaceutical distributors like McKesson, electrical components distributors like Avnet, and auto-parts distributors like Advance Auto; and we see a low-to-moderate threat to food-service distributors like Sysco. That said, we do believe that digital competition poses a very real threat to medical, dental, and veterinarian distributors, like Owens & Minor as well as less specialized industrial distributors, like W.W. Grainger. Except for Grainger, we believe the other industrial distributors we cover are more insulated from digital competition because these firms serve market niches and sell more specialized products that require technical expertise.
In terms of actionable ideas, industrial distributor Anixter International, pharmaceutical distributor McKesson, and auto parts distributor Advance Auto Parts all look undervalued, and we think all three of these companies have low exposure to online competition.