Brooke Sutherland

Grainger is weathering competition from Amazon.com Inc. better than some expected it would, but it’s still feeling the pinch.

Amazon’s push into the distribution of factory-floor basics and office supplies has forced incumbents like W.W. Grainger Inc. to cut prices and revamp their online strategy to keep up. The result has been shrinking gross margins and a sales boost that looks temporary, evidence of which was present on Jan. 24 when Grainger reported fourth-quarter results and gave its 2019 outlook. To give the company credit, its gross margin in the fourth quarter of 38.6% was better than analysts expected and surpassed management’s own guidance. But this was still the 21st straight quarterly decline in that profit gauge—and there’s the potential for more slippage in 2019.

Grainger estimated it will retain between $38.10 and $38.70 in gross profit from each dollar of sales in 2019, with the middle of that range implying a drop from a year earlier and falling short of analysts’ estimates. The company had previously vowed to hold its gross margin stable, so this would appear to be a lowering of that target (I will acknowledge, though, that maintaining the goal would have been more challenging, given Grainger’s better-than-expected performance on this metric).

Grainger did reiterate its target of reaching an operating margin of 12.2% to 13% in 2019, a goal that watchers of the company including myself had bashed as unrealistic. Grainger notched an adjusted operating margin of 12% in 2018, a performance that would appear to make the 2019 target less of a stretch.

I will note, however, that the adjustments include $47 million of restructuring expenses and a $139 million non-cash impairment charge related to Grainger’s U.K. Cromwell business. You can debate whether restructuring charges are truly one-time for a company like Grainger that’s facing a structural reset. And the Cromwell business likely faced pressure from Amazon, which introduced its business-to-business offering in the U.K. in 2017. The company’s unadjusted operating margin in 2018 was 10.3%.

Beyond the Amazon threat, the reason these metrics matter so much is that Grainger’s plan for rebuilding its profitability depends on continued growth in sales volume. If it can’t deliver when sales are strong, how is it going to fare when the momentum starts to wane?

That already appears to be happening. The company’s fourth-quarter revenue was lower than expected, and volume growth of 4% made the period the weakest of the year. Grainger expects to deliver 4% to 8.5% sales growth in 2019. It didn’t specify the volume gains baked into that forecast, and it’s notable that Grainger’s previous call for volume growth of 6% to 8% in 2019 doesn’t appear in the earnings materials. Recall that Grainger had already attempted to water down that target by rebranding it as a collective goal for 2018 and 2019. CEO DG Macpherson last week said only that he remains confident in Grainger’s ability to deliver above-market volume growth.

Last week’s batch of industrial earnings provided needed relief for battered investors. United Technologies Corp. soared the most since 2009 after reporting its strongest organic sales growth since before the financial crisis, and as it gave more details around its planned break-up. United Rentals Inc., which reported after the close on Jan. 23, also surged after posting a 20% pop in fourth-quarter sales and reiterating the rosy 2019 outlook it gave in December. It’s proof that there are pockets of continued strength in the industrial sector that counter the slowdown narrative. Grainger just isn’t one of them.

Brooke Sutherland is an industrial and mergers-and-acquisition columnist for Bloomberg Opinion. Follow her on Twitter @blsuth.