Morgan Stanley Downgrades WW Grainger Amid 'Multiple Compression Risk'

• Shares of W W Grainger, Inc. GWW have declined 20.73 percent year-to-date, reaching a low of $201.96 on Monday.
• Morgan Stanley’s Nigel Coe has downgraded the rating on the company from Overweight to Equal-weight, while lowering the price target from $236 to $218.
• Coe expects price and mix pressure to lead to further margin erosion, while the possibility of additional multiple compression, with the stock’s historical premium being difficult to justify.

Analyst Nigel Coe mentioned that he continued to “see the potential for US IP acceleration, once we move beyond inventory and O&G headwinds,” expected in 2H16. However, there seems to be increasing evidence that WW Grainger might not be able to outgrow the underlying MRO market any longer.

“Price pressure feels a good deal more structural and a function of mix as much as it is a function of weak raw materials i.e. we have lost confidence that pricing will stabilize in the near term,” Coe stated.

Coe also expressed concern regarding the company’s investment spending continuing to be sticky, with high investment levels during 4Q15, despite the significant decline in core volume.

In addition, WW Grainger has been aggressive in its capital allocation, although Coe believes that it is insufficient to mitigate downside pressure from the company’s core operations.

“Bottom line, we are cognizant that we are at risk of throwing in the towel at the bottom, but our major concern is continued downside pressure to price and margins, even if volumes do turn,” the Morgan Stanley report said, while adding that it was difficult to “gain sufficient comfort that GWW’s US margins can be supported at such high levels.”

The EPS estimates for FY15 and FY156 have been lowered by 3 percent and 6 percent, respectively.