At Durable Stocks, our research focuses on wonderful companies with reasonably predictable earnings. Of course, the competitive nature of business and the constant disruption of innovation make it extremely difficult to find such unique businesses. Most companies are mediocre or speculative businesses whose performance is highly unpredictable. It is the rare company that is truly wonderful and predictable. With its wide competitive moat and consistently strong performance, Fastenal is such a company. Fastenal is the leading distributor of fasteners and other industrial and construction products to customers through an extensive network of distribution centers, stores, on-site locations and vending machines that is not easily replicated by competitors. Fastenal's predictability allows us to estimate the intrinsic value of the underlying business with a high degree of confidence and then compare that value to the company's present stock market capitalization. Fastenal's stock price is under pressure largely as the result of current market conditions and cost increases imposed by tariffs.
As an illustration of Fastenal's durable competitive advantages, Fastenal's returns on equity are consistently above 20% and the company operates with little debt. The following table summarizes Fastenal's owner earnings (operating cash flow minus capital expenditures) over the prior ten year span (amounts in millions):
Year 2009 2010 2011 2016 2017 2018
Operating
Cash Flow $224 306 403 520 585 674
CapEx $53 74 120 188 179 174
Owner
Earnings $171 232 283 332 406 500
As shown above, Fastenal generates strong and growing owner earnings. Note that we calculate owner earnings instead of using reported net income, as owner earnings generally illustrates the performance of a company better than reported net income. In the case of Fastenal, its recently reported net earnings were significantly higher than calculated owner earnings. Although the quality of earnings is an important consideration, this appears to be the result of inventory increases to support future growth. Over the last ten years, owner earnings have increased at a compound annual growth rate of 11.33%.
Based on Fastenal's predictable cash flows, one can estimate its intrinsic value as follows. First, we estimate future owner earnings. In view of Fastenal's 11.33% compounded annual growth rate over the past ten years and the likelihood that its wide competitive moat will keep earnings growing at similar rates in the future, we use a 10% compounded annual growth rate. Secondly, we determine the present value of those future owner earnings. In view of persistently low interest rates, we use a 5% discount rate (still well above the current interest rate of the 30-year U.S. treasury bond) to be conservative.
Present Value of Future Owner Earnings for next ten years (amounts in millions):
Future Value $550 605 666 733 806 887 975 1073 1180 1298
Present Value $523 549 575 603 632 662 693 726 760 797
The sum of the above present values for the next ten years of owner earnings is $6.5B. We estimate that the present value of the residual after ten years is $12.5B. The sum of these two values provides an estimated intrinsic value of $19B.
At its previous closing share price of $29.28, Fastenal has a market capitalization of $16.79B. Although $16.79B is not a substantial discount to the estimated intrinsic value of $19B, it does offer a slight margin of safety. Given that the current stock prices of most high quality companies are still generally overvalued (despite the recent fall in the market), Fastenal is a company worth considering.
Disclosures: This is not a recommendation to buy or sell stock. The author owns shares of Fastenal. The author is not being compensated to write this article.
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