W.W. Grainger (GWW) and Fastenal Company (FAST) have a lot in common.

They both operate in industrial equipment wholesale. They are both similarly sized, each with a market capitalization of $14 billion.

And, Grainger and Fastenal both have long histories of raising their dividends each year.

Grainger has increased its dividend for 45 years in a row. It is a Dividend Aristocrat, a group of companies in the S&P 500 that have raised dividends for 25+ years.

Fastenal does not quite match Grainger’s track record. It is a Dividend Achiever, a group of 271 stocks with 10+ years of consecutive dividend increases.

Aside from a much longer history of dividend increases, this article will discuss three reasons why I prefer Dividend Aristocrat Grainger, to Dividend Achiever Fastenal.

Reason #1: Business Overview

W.W. Grainger supplies maintenance, repair, and operating products. These include motors, safety products, power tools, test instruments, and more.

It has a very broad customer base, consisting of 3 million business and institutional customers. Annual sales exceed $10 billion.

The company’s revenue breakdown by customer size, is as follows:

• U.S. Large (60% of revenue)
• U.S. Medium (9% of revenue)
• Single Channel (10% of revenue)
• Canada (7% of revenue)
• International (8% of revenue)
• Specialty Brands (6% of revenue)

In the company’s core U.S. large customer segment, total revenue fell 1% in 2016. This weighed Grainger down—overall adjusted earnings-per-share fell 3% for the year.

That said, the company saw strong results from its cost controls. Free cash flow increased 23% in 2016.

This is because Grainger’s operations are highly profitable, thanks to its excellent distribution network. The company’s U.S. Large and U.S. Medium segments generated returns on invested capital of 40%-45% in 2016.

ROIC in the Single Channel business was an even more impressive 50% last year.

When it comes to Fastenal, it has a different product focus. The company takes its name from its core product, which is fastener distribution.

Source: 2016 Annual Report, page 2

Fastenal has been in the fasteners business for nearly 50 years. This is its largest individual product, which makes up more than half of total revenue:

• Fasteners (37% of revenue)
• Non-Fasteners (63% of revenue)

Fastenal fared slightly better than Grainger last year. Fastenal’s revenue increased 2.4%, but earnings-per-share declined 2.3% from 2015.

However, Fastenal’s performance deteriorated throughout the year.

It started off 2016 with a bang; Fastenal’s first-quarter and second-quarter revenue grew 9% and 5%, respectively.

But performance deteriorated in the third and fourth quarters.

Weakness in Fastenal’s end markets led to a disappointing year.

The reason for this was because of weakness among Fastenal’s top 100 customers. Demand from that group, which makes up a significant portion of the company’s total revenue, lagged in 2016.

Source: 4Q Earnings, page 5

Fastenal’s end markets had a better year in 2016 than 2015, but performance still lagged well below 2014 levels.

Specifically, about half of Fastenal’s business comes from customers that are engaged in some form of manufacturing. This market was sluggish for Fastenal last year.

Fastenal’s overall 2016 results were slightly stronger than Grainger, but the drop-off in demand late in the year is a concern.

Grainger’s highly diversified customer base, and excellent returns on capital, give it the stronger business model.

Reason #2: Growth Prospects

Grainger’s main growth priority is e-commerce.

The company has invested heavily in e-commerce, to adapt to changes in the marketplace. For example, Grainger’s e-commerce platforms include Japan-based MonotaRO, and Zoro in the U.S.

This has allowed Grainger to reposition its business model, so that it can better respond to what its customers want.

Source: Raymond James Institutional Investors Conference, page 4

Grainger’s e-commerce operations have had a meaningful impact. Grainger’s ‘Other Businesses’ division generated 34% growth in 2016.

Approximately 60% of Grainger’s sales are now initiated through its digital channels.

This is likely to be Grainger’s most important growth catalyst moving forward.

The company believes its single-channel platforms will generate $2 billion in annual revenue by 2019.

Source: Source: Raymond James Institutional Investors Conference, page 11

Meanwhile, Fastenal’s key growth initiative is to expand its Onsite services.

Slightly less than half of Fastenal’s annual revenue comes from national customer accounts. Today, just one-quarter of these customers are serviced by an Onsite team.

The Onsite service is a ‘store’ within a customer’s facility, or in a facility near the customer. At the end of 2014, there were just over 200 Onsite locations.

Fastenal added 80 Onsite locations in 2015, and another 167 in 2016.

Its goal in 2017 is to add another 275-300 signups.

These locations help deepen customer relationships and strengthen Fastenal’s brand equity. This provides for a high level of customer retention, and a high barrier to entry into Fastenal’s core markets.

Lastly, boosting its vending machine business will be a growth catalyst for Fastenal.

Source: 4Q Earnings, page 3

Vending machines are an important driver for Fastenal. Within its non-fastener business, approximately 25% is distributed through a vending machine.

Similar to the Onsite business, the added vending machines will help boost margins by improving efficiency, and improve financial returns.

Grainger’s growth catalysts hold greater potential than Fastenal, which is likely to continue struggling along with its customers.

Reason #3: Dividend Growth

W.W. Grainger has a current dividend of $4.88 per share, resulting in a 2% dividend yield. Fastenal has a slightly higher yield, of 2.5%.

Fastenal’s dividend yield exceeds the S&P 500 Index average yield by about 50 basis points.

The reason for this is because Fastenal’s most recent dividend increase outpaced Grainger’s.

For example, Fastenal increased its first-quarter 2017 dividend by 6.7%, while Grainger’s most recent dividend increase was 4.3%.

But over the past five years, their dividend growth is very similar–Fastenal and Grainger have increased their dividends by 14% and 13% per year, respectively.

The difference between their two dividend yields is significant, and could make a difference for dividend investors considering which stock to buy.

However, Grainger’s future dividend growth is likely to exceed Fastenal’s. Grainger has done a better job growing free cash flow, and Fastenal is seeing weakness in its core markets to start 2017.

Plus, Grainger has a much lower payout ratio than Fastenal. In the past 12 months, Grainger distributed about half of its earnings, while Fastenal’s payout ratio was 74% in the same period.

This will likely make Grainger the better dividend growth stock.

Final Thoughts

Fastenal stock has a few attractive features when stacked up against Grainger, including a slightly higher dividend yield.

However, Grainger’s track record of annual dividend growth exceeds Fastenal’s, by nearly 30 years.

Grainger ranks very well using The 8 Rules of Dividend Investing, thanks to growth, modest payout ratio, and strong industry position.

Between these two, Grainger is the better dividend stock to buy.