We expect W.W. Grainger, Inc. (GWW) to report second quarter EPS of $1.46, up 20.7% from the year-ago level of $1.21, amid sales growth, profitability from market expansion initiative, product line expansion, and share buybacks. New product offerings, market expansion, SAP initiatives and share repurchases are expected to boost profitability over the next few quarters. However, organic growth in the Lab Safety Supply segment remains weak.

In our view, the company's premium P/E multiple over its average peer group multiple reflects that the stock has factored in the earnings improvement expected this year. We recommend investors to hold shares of GWW in their portfolio. Our target price is $87.50, which values the stock at 15x our FY08 EPS estimate of $5.85.

In the first quarter, the segment's revenue increased 5.9%, underpinned by revenue growth of 6% in the U.S. and 17% in Mexico. The Acklands-Grainger Branch-based division's Q108 revenue grew 24.8%. The company's market expansion program is progressing beyond expectations. In 2008, it is expected to produce operating earnings of $50-$60 million. By 2013, the expansion program is expected to result in incremental sales of more than $1.1 billion and operating earnings of over $200 million.

Going forward, GWW's strategy of developing a world-class logistics network and growing its small customer base makes business sense. In the first quarter, Grainger opened five new full-service branches and closed one in the U.S., and opened one will-call express branch in China. For 2008, management plans to open nine branches in Mexico.

However, organic growth in the Lab Safety Supply segment remains weak and the lawsuit relating to the United States General Services Administration contract might hurt the confidence of the customers and undermine investors' sentiment if GWW is found guilty.