Grainger's Q3 2025: Contradictions Emerge on Pricing Strategies, Government Shutdown, Margins, and Tariff Impacts

Date of Call: None provided

Financials Results

• Revenue: $4.7B, up 6.1% reported / up 5.4% daily constant currency
• EPS: $10.21 diluted, up $0.34 (3.4% YOY)
• Gross Margin: 38.6%, down 60 basis points YOY (LIFO and mix headwinds)
• Operating Margin: 15.2%, down 40 basis points YOY

Guidance:

• Full-year adjusted diluted EPS narrowed to $39.00–$39.75.
• Daily organic constant-currency sales growth expected 4.4%–5.1% for 2025.
• Implied Q4 daily organic growth ~4% at the midpoint (assumes >3 pts price contribution in high-touch).
• Total-company gross margin expected to stabilize around ~39% (subject to seasonality).
• Q4 operating margin implied around ~14.5% at the midpoint.
• LIFO inventory headwinds expected to persist for the next couple quarters; further inflationary pressure is anticipated into 2026.
• Guidance assumes government shutdown resolved by mid-November.

Business Commentary:

• Strong Financial Performance:
• Grainger reported sales of nearly $4.7 billion for Q3 2025, up 6.1% on a reported basis and 5.4% on a daily constant currency basis.
• The company's gross margin was 38.6%, operating margin was 15.2%, and diluted EPS was $10.21.

• This solid performance was driven by consistently strong execution and increased efficiency from the team, despite external uncertainties.

• Segment Performance and Price Cost Dynamics:

• The High-Touch Solutions segment delivered solid growth with sales up 3.4% on both a reported and daily constant currency basis.
• Gross profit margin for this segment finished at 41.1%, down 50 basis points from the prior year, reflecting negative price cost spreads.
• The Endless Assortment segment saw sales increase by 18.2% on a reported basis and 14.6% on a daily constant currency basis.

• The growth was driven by efficiency improvements in marketing spending and customer experience enhancements, particularly in Zoro U.S and MonotaRO.

• Tariff Impacts and Pricing Strategies:

• Grainger experienced tariff-related LIFO inventory valuation headwinds, which were less than expected.
• The company implemented price increases in September and November to offset continued cost pressure, aligning prices with market conditions.

• Despite these challenges, Grainger anticipates gross margins to stabilize around 39%, subject to normal seasonality and changes in the tariff landscape.

• Strategic Exits and Market Focus:

• Grainger announced the exit from the UK market by selling its UK-based Cromwell business and Zoro UK, expecting to close the deal by early December.
• This strategic move aims to focus resources on growing the North American and Japanese businesses, where Grainger sees greater long-term impact.
• As a result of these divestitures, the company anticipates an annualized operating margin improvement of approximately 20 basis points.

Sentiment Analysis:

Overall Tone: Positive

• Management described results as a "solid performance," highlighted gross margin outperformance versus the August guide, returned $399M to shareholders, and reiterated confidence in execution and long-term framework (stabilize gross margins ~39%, grow endless assortment in the teens). They acknowledged LIFO/tariff noise but emphasized underlying business momentum and digital/AI investments.

Q&A:

• Question from David Manthey (Baird): Clarify Cromwell impact on 2025 guidance and whether recent pricing actions are in endless assortment or high-touch (and next contract repricing timing).
  Response: Cromwell and Zoro UK are held for sale and removed from guidance, totaling about $40M of revenue in Q4; September and November price increases were high-touch actions and flow into Q4 and contracts.

• Question from Christopher Snyder (Morgan Stanley): If current LIFO headwinds (~70 bps implied) ease, would the 39% target move closer to 40%?
  Response: As LIFO eases and price is passed, gross margin should improve, but other factors (mix, freight) limit visibility, so management maintains the ~39% stabilization target.

• Question from Jacob Levenson (Melius Research): Any consideration to move from LIFO to FIFO? Also, would demand catch up after a government shutdown?
  Response: Converting to FIFO was evaluated but would trigger a material one-time cash tax payment, so no change now.

• Question from Ryan Merkel (William Blair): How large is the government shutdown impact in Q4 and why an off-cycle price increase?
  Response: Shutdown reduces daily sales by roughly ≈1 point (six weeks ≈0.5 point; full duration ≥1 point); the off-cycle November price matches realized supplier cost increases rather than being speculative.

• Question from Steven Volkman (Jefferies): Was the November price increase speculative and how are private-label competitive pressures managed?
  Response: November price was not speculative—it's responsive to realized cost increases; private-label pressure is limited to a subset where private vs national brand price gaps tightened and is being managed case-by-case.

• Question from Christopher Glynn (Oppenheimer): How will AI/technology be applied commercially vs. cost-to-serve and status of large-bid pipeline?
  Response: AI investments target both back-end operations and commercial capabilities, with commercial/data-driven solutions expected to create differentiated customer value; large-bid pipeline is healthy but conversion/local execution matters.

• Question from Ken Newman (KeyBanc): How will exiting the UK affect operating margin and what drove mid-size customer growth?
  Response: Exiting the UK should improve consolidated operating margin by roughly 20 basis points annualized; mid-size customer improvement reflects product/comp dynamics and softer prior-year comps rather than solely price.

• Question from Sabrina Abrams (Bank of America): Why was the LIFO charge lighter than expected—inventory burn, suppliers eating increases, or timing?
  Response: LIFO was lighter primarily because supplier negotiations pushed some cost increases into later periods, combined with price-cost improvements and favorable mix/freight.

• Question from Neil Burke (UBS): Are suppliers fully passing costs or only partially, and what are key margin drivers for 2026?
  Response: Supplier pass-through varies widely (many passed partial costs); main 2026 margin drivers are ongoing LIFO dynamics and the UK exit, plus future pricing cycles.

• Question from Deane Dray (RBC Capital Markets): Lessons from Cromwell/Europe and impact across federal/state/local government demand?
  Response: Post-Brexit economics made the UK opportunity less attractive; Grainger will refocus on North America and Japan; government slowdown impact is mainly federal/military with limited state/local ripple beyond hurricane comps.

• Question from Nigel Cove (Wolfe Research): We estimated a ~$52M LIFO reserve change this quarter—should we expect more moderate LIFO impact in H1 2026?
  Response: More LIFO impact is expected into 2026 as the cost cycle continues; normalization is likely toward the back half of next year after multiple pricing cycles.

• Question from Tommy Moll (Stephens Inc.): Confirm $40M Q4 sales impact and the 20-basis-point operating margin improvement from exiting the UK; thoughts on 2026 pricing wrap.
  Response: Yes—$40M is the Q4 revenue impact (Cromwell + Zoro UK) and exiting the UK should improve consolidated operating margin by ~20 bps annualized; high-touch pricing wrap is estimated near 3% and likely north of 3% into 2026.

• Question from Guy Hardwick (Barclays): Why was warehousing demand down mid-teens in high-touch U.S.?
  Response: The decline was driven by a single customer's contract adjustment, not broader market weakness.

• Question from Patrick Baumann (JPMorgan): What did MRO market volume do in Q3 and are share-gain investments delivering returns?
  Response: Market volume was down roughly 2% in Q3; investments are delivering strong returns with ROIC north of 40%, though slightly lower than prior year as capacity assets were built.

• Question from Chris Danker (Loop Capital Markets): What is driving endless assortment (EA) momentum—selection, acquisition, or larger order sizes?
  Response: EA strength (notably Zoro US) is driven by higher-quality customer acquisition and increased order frequency/repeat rates; average order size is largely unchanged.

Contradiction Point 1

Price Increase Strategy

It involves the company's pricing strategy and the timing of price increases, which directly impacts financial performance and market competitiveness.

Was the November price increase speculative, and how do you address competitive headwinds in private label? - Steven Volkman (Jefferies)

2025Q3: The price increase was not speculative but based on market conditions. - Dee Merriwether(CFO)

What factors led to the decision to maintain price increases on a regular schedule rather than real-time adjustments? - Thomas Allen Moll (Stephens Inc., Research Division)

2025Q2: We considered various approaches. Keeping prices on the normal schedule provides customer stability, while we manage to be slightly upside down on price/cost. - Donald G. Macpherson(CEO)

Contradiction Point 2

Impact of Government Shutdown

It involves the assessment of the impact of a government shutdown on sales, which could affect revenue forecasts and operational planning.

Can you quantify the government shutdown's impact on Q4? What caused the off-cycle price increase? - Ryan Merkel (William Blair)

2025Q3: The impact of the government shutdown is estimated to be a point or more in daily sales if it lasts six weeks. - Dee Merriwether(CFO)

Are you confident prices can be maintained without volume declines? - Chris Danker (Loop Capital Markets)

2025Q2: The government shutdown, if it persists beyond the present 2 weeks, by itself would likely be a 2% negative factor for us. - Donald G. Macpherson(CEO)

Contradiction Point 3

Gross Margin Recovery Expectations

It involves expectations regarding gross margin recovery, which is crucial for financial projections and investor expectations.

Would gross margin have increased year-over-year if LIFO were excluded? What does a 39% gross margin imply after excluding LIFO? - Christopher Snyder (Morgan Stanley)

2025Q3: Gross margin may not normalize to 40% post-LIFO due to other factors like product mix and freight. The stable gross margin of 39% is not projected to increase significantly. - Dee Merriwether(CFO)

Will Blackwell's Q4 revenue be additive, and what is the expected exit rate for gross margins? - Stacy Rasgon (Bernstein Research)

2025Q2: Gross margins for Q3 are expected around 75%, with full-year guidance in the mid-70s. - Deidra Cheeks Merriwether(CFO)

Contradiction Point 4

Impact of Tariffs on Pricing and Demand

It involves differing perspectives on the impact of tariffs on pricing and customer demand, which are crucial for strategic decision-making and financial forecasting.

How did the government shutdown affect Q4 results? What caused the off-cycle price increase? - Ryan Merkel (William Blair)

2025Q3: The impact of the government shutdown is estimated to be a point or more in daily sales if it lasts six weeks. - Dee Merriwether(CFO)

Do you see any impact from tariffs on customer demand, and what concerns do customers have? - Ryan Merkel (William Blair)

2025Q1: No significant impact on demand from tariffs yet. Customers are focused on running their operations and keeping people safe, not regarding tariffs as a major challenge. - Donald Macpherson(CEO)

Contradiction Point 5

Price Expectations and Margin Impact

It involves the company's expectations for price increases and their impact on gross margins, which directly affect financial forecasts and investor expectations.

Can you clarify the Cromwell impact on Q4 revenue and operating income? Also, were the recent Q4 price increases related to endless assortment or high-touch customers? - David Manthey (Baird)

2025Q3: We expect another price increase in November, which will include both high-touch contract and non-contract business. - Dee Merriwether(CFO)

Does the company expect 2025 minimal price expectations to be below market expectations, and can it push incremental pricing if needed? - Christopher Snyder (Morgan Stanley)

2024Q4: We think if there is price in the market, we can certainly pass price. If there's not, passing price probably isn't the right thing to do. - Donald Macpherson(CEO)