Supply chain issues force creative solutions for companies like Fastenal, Donaldson

Winona-based Fastenal supplies factories and construction companies across the country with equipment and hardware such as fasteners.

And like most large companies right now, it was hit with supply chain issues over the summer.

"The product and shipping cost inflation is not just high, it's brutally high," Dan Florness, Fastenal's president and chief executive, said on the company's earnings call. "The chaos and the impact, not just from a financial perspective but from a toll it takes on our human capital, is immense."

The company's size allows it to carry a lot of inventory across its branch and Onsite locations, and allowed managers to be creative in sustaining service levels to customers.

As a result, Fastenal reported third quarter sales of $1.55 billion, up 10% from the same quarter a year ago of 2020 and up 13% from the pre-pandemic third quarter of 2019. The results met or slightly exceeded analyst expectations.

Because it supplies big industrial customers and reports toward the beginning of the earnings cycle, Fastenal is considered a bellwether for what's to come.

During the second quarter earnings season, it was rare that a publicly traded manufacturing company didn't have a comment about their supply chain struggles. Analysts expect companies this month to lay out how external factors, which also include inflation and worker shortages, affected growth as Fastenal did.

Deane Dray, an analyst with RBC Capital Markets, covers several manufacturing and industrial companies including Minnesota-based 3M, Graco, nVent and Pentair.

"The risk this quarter is that the severity of the ongoing inflation/supply chain pressures and labor shortages has reached a breaking point," Dray wrote in his third quarter earnings preview. "We expect more companies to trim [second half of 2021] earnings expectations."

The economy continues to recover, and most companies have plenty of demand for their goods and services, but rising costs for raw materials and transportation and continued supply chain struggles threaten company margins.

Florness told analysts deliveries of branded products from domestic suppliers and elsewhere were less of an issue, but commodity-type fastener products that have long been sourced from overseas have seen weeks added to delivery schedules due to the shortage of shipping containers, backups at West Coast ports and labor issues.

The continued rebound in demand for construction and manufacturing materials helped Fastenal post third-quarter earnings of $243.5 million, or 42 cents a share — a 10% increase over last year and a 14% bump over the same quarter in 2019.

Shares were up 3% in afternoon trading.

Last summer Fastenal had a pandemic-fueled surge in safety and sanitation orders from government and healthcare customers but product mix moved back to more normal levels, evidence that the manufacturing and construction sectors continue to bounce back.

Daily sales of fasteners rose 20.2% over the same quarter last year and represented almost the same percentage of net sales as in 2019.

Sales of safety and sanitation supplies also increased in the third quarter but not nearly as much as in the same period a year ago, in the height of the pandemic. Fastenal said the markets for those products have stabilized, and prices have dropped.

However, near-term pressures on customers from inflation, supply disruption, labor shortages and the pandemic meant Fastenal's new contract signings for its high-growth options, including Onsite and vending, did not meet the company's expectations.

COVID-19 continues to be an issue for staffing and productions at smaller suppliers. And the backlogs at ports were exacerbated by severe weather events over the summer.

"COVID-19 is still playing a major role, and I don't see that going away soon," said Kingshuk Sinha, professor of sustainable supply chain at the University of Minnesota's Carlson School of Business.

Sinha predicts that eventually some level of equilibrium will emerge. But he cautioned that long-term risks from climate change and increasing weather events, plus geopolitical instabilities and national security issues, will remain.

Rich Lewis, as senior vice president of global operations for Donaldson Inc., keeps tabs on the Bloomington-based company's chessboard of moving pieces.

Donaldson and other companies started seeing demand pick up toward the end of last year, and then started seeing extraordinary supply chain issues appear in late 2020 and early this year, Lewis said.

He and others began to realize the supply chain situation was different than when the economy pulled out of the last recession.

"As we got deeper into the recovery we could see they were vastly different, and going to be deeper and wider than probably what we had seen in prior recessions," Lewis said.

Donaldson's supply chain network has about 3,200 materials vendors from 60 countries, and 1,000 indirect suppliers of services and miscellaneous items. The filtration company also has manufacturing facilities spread across the globe, so the supply chain issues are not spread evenly throughout the system, Lewis said.

Donaldson's region for region manufacturing strategy shortens and simplifies the supply chain for each region and gave Lewis the ability to move some capacity around.

Three broad issues appear to be driving most supply chain woes: global logistics problems; labor shortagesin the U.S.; and low supplies of steel, petrochemical products and the media used in Donaldson filters, he said.

"It's as widespread as probably any supply chain event in my career," Lewis said. "It really is permeating every industry, manufacturing and otherwise."

That's forced many companies to get creative in addressing the problems. Donaldson has augmented its corporate supply chain team, in some cases calling back recent retirees to help smaller suppliers with scheduling and logistics, Lewis said.

Modest wage increases and incentives also were put on the table to address labor issues.

Lewis regularly checks in with his peers at various industry conferences to confirm the widespread nature of the supply chain struggles.

"I think we are in for a fairly long normalization process," Lewis said. "The common read from everyone I've spoken to, and what I'm hearing from other industry folks is certainly into the middle of calendar year 2022."