Q2 Distributor Performance … WESCO, AD, Graybar, Rexel and Grainger

Over the past couple of weeks a number of manufacturers and some distributors have shared second quarter performance updates. We’ve taken a look at many and will share pertinent, US-related information.  First we’ll do distributors as AD, Graybar, Rexel, WESCO and Grainger have shared their performance results.

WESCO – Pumping Up The Numbers?

Many may remember Hanz and Franz from Saturday Night Live and their infamous phrase “We’re here to pump you up.”

That is the impression we received when reading this analysis from Baird Equity Research in their summary (and they provided a price target):

• “2Q17 operating results below expectations. 2Q17 EPS came in slightly above estimates, though this was mainly driven by a favorable tax rate and lower share count, as sales were in line and gross/operating margins both were below our expectations.
• Operational guidance lowered meaningfully. Although headline EPS guidance was reduced only $0.05 at the midpoint (from $3.60-$4.00 to $3.60-$3.90), this belies a much steeper reduction to operating earnings. Specifically, a lower tax rate (27% vs. 30%) and reduced share count (~0.5mm shares) are significantly buffering EPS, without which, we estimate 2017 guidance would be down $0.30-$0.35, or a midpoint decline of approximately 8-10%.
• Growth on the upswing. Improving trends in Industrial, CIG and Canadian businesses, as well as increasing construction backlog and better (underlying) utility trends, signal a more favorable demand backdrop for WCC. In turn, organic growth accelerated through the quarter (April -2%, May flat, and June +4%), and July is tracking +5%.
• Gross margins remain under pressure, however. Underlying selling margins were -20bps y/y, despite favorable segment mix (industrial +, construction/utility –) and accelerating volume growth. Looking forward, management noted an aggressive competitive environment and signaled that 2H17 gross margins should be similar to 1H17 (19.4-19.5%), implying a -10bps y/y decline near-term (inclusive of what we see as favorable rebate timing, business trends and segment mix).”

Given this summation / overview, is it a surprise that the stock tanked that day?

So, let’s take a look at the earnings report:

• Positive organic growth in the quarter with the comment “WESCO has returned to growth” (The organic growth aspect we’ve heard from everyone and although some inconsistency based upon geographic area and “month to month”. Haven’t spoken to anyone who sounds like they are exhaling saying “finally we’re growing.”)
• Expecting second half accelerated growth (again, hearing similar from many. In some cases they don’t know why other than backlog growing and aspirational.)
• Generated 1% organic growth with sequentially stronger months from May through July
  • Industrial up 6% organically … 4% in US, 10% in Canada
  • Construction sales were down 6% in the US and 4% in Canada.
    • Industrial contractor business down (probably significantly) as commercial contractor partially off-set weakness (even still, surprising that commercial contractor is down as others are reporting up.  Must come down to alignment with customer, the customer sizes they pursue and how active in the lighting market.)
    • Backlog highest since 2012
    • Outlook for non-resi construction is “modestly positive” (which would indicate, from talking with others, underperformance vs the market in most geographies.)
  • Utility up 3% in US, 5% in Canada
    • But this is after “exiting a contract”. (Of course, all salespeople and division management can exclude a large piece of business that did not renew / they lost from their performance and management is accepting?!  Sales managers inevitably say “need to backfill the business!)
  • CIG (essentially commercial MRO, government / institutions) had 7% organic growth
    • 2% US; 30% in Canada
    • Much of growth appears to have been datacom / technology-driven
• Backlog growing … improved by 5%
• Oil and gas is “down” to 6% of sales and evenly split between MRO and capital projects.
• Margins within expectations even with “demand-constrained pricing environment” (this is the ‘new’ norm)  due to “executing cost management and supply chain initiatives” (thank you manufacturers! … hopefully WESCO shares their appreciation with you.)
• Still good free cash flow so monies available for investing into the business and acquisitions and share buy backs … they repurchased $50M in shares last quarter which Baird noted helped improve EPS.
• Reportedly investing in tech expertise, capabilities and service offerings to reignite growth
• Gross margins were 19.2%, down 70 basis points vs last year and 50 basis points from prior quarter.  (could be business mix, product mix, price aggressiveness or other issues.)
  • Also said due to timing of accruals hence an accounting / reporting issue
  • Billing margin was down 20 basis points vs PY (this is the key benchmark for distributors … have your margins decreased by 20 basis points?)
• SG&A down 3%.  Still “closely managing costs”
• Operating margin down to 4.4%, the middle of their range (and this was a company that used to be in the 5’s)
• Overall headcount in the quarter was down year over year (due to changes throughout the year, not necessarily and specifically in the second quarter)
• Q3 Outlook
  • Cautioned that there is 1 fewer day this quarter (so setting up as potential reason for PY comparison)
  • For full-year, narrowing their sales projection to 1-3% growth … a change from 0-4% (The 1-3% is below the DISC annual projection. WESCO may be lower due to Canada and industrial? – DISC does not project Canada.)
  • Decreasing annual EBIT margin range to 41.-4.3% due to planned investments
  • Overall, decreasing EPS projections to $3.60-3.90
  • Q3 projected sales growth of 2-5% and operating margin of 4.2-4.6%
• Planning for “incremental sales and technical personnel growth” in the second half of the year but haven’t done yet.
• On WESCO’s 10-K they provide a range of their expectation for supplier volume rebates as a % of sales (could be a good benchmark for distributors and marketing groups.  May be similar in Grainger and Rexel 10-K’s.)
• Reported that a driver of the margin challenge is margin erosion in their International business which seems to be industrial projects.
• Grew double digits in oil and gas in US and Canada (perhaps as a reflection of increased rig count and oil / gas companies operating better given new price range parameters)
• Seeing MRO and OEM growth in the Industrial side, just not much in capital projects as companies defer these investments (theoretically WESCO could benefit if the Administration is successful in attracting / retaining manufacturing in the US)
• Said that they are slowly increasing inventory to support sales growth (so, some manufacturers should be benefiting)

And interestingly, with so much general market commentary regarding eCommerce, Amazon Business, Grainger (relating to eCommerce and its pricing strategy, especially given their involvement in MRO contracts) and lighting / energy efficiency… no questions on these issues..

Thoughts regarding WESCO’s second quarter performance?

AD – Independents Performing

According to a press release from AD

“AD, the over $30 Billion contractor and industrial products wholesale buying / marketing group, reported sales for all AD members, across ten AD Divisions and three countries grew by 10% during the first six months of 2017 to $17.8 Billion. Purchases from AD Suppliers grew by 16%. Distributions to Members were up 15%.

On a Same Store basis, by industry, Electrical sales were up 10%; PHCP was up 8%; Industrial / PT were up 9%; and Building Materials was up 19%. By country, Same Store sales in the U.S. grew 8%; Canada was up 9% and Mexico grew 6%.

Bill Weisberg, AD’s Chairman and CEO comments on the results, “2017 is exceeding expectations for AD Members and AD overall. Member support for AD Supplier Partners and AD programs are running strong. New Members and Suppliers are joining every Division. There are a lot of great companies in AD. Investments we’ve made to help our Members and Suppliers compete and win are bearing fruit.”

Some interesting aspects:

• AD member electrical sales were up 10%.  AD’s Electrical Supply Division, which is the oldest and largest division, is north of $14B and well diversified.  While an element of growth in inevitably wire / cable, which benefits from copper price increases, these same dynamics are available for non-AD members.  It would suggest that, in aggregate, either AD benefited from many new members (doubtful), AD ESD members are acquiring non-AD members (can’t recall anything “significant” and/or AD members are taking share within the market.
  • And yes, from the information it cannot be determined if the growth is coming from the US, Canada or Mexico but, with the US the largest segment, the US division must still be outperforming many of the US divisions of national distributors.
• AD, according to members, has added significant value with recent meetings for HR personnel (multi-vertical gathering) and its EnergyForce group.  SupplyForce, although a separate organization, but with some affiliation to AD due to the number of its distributors that are in AD, also continues to grow.  AD has also enhanced its product training platform and product content.

Graybar – Chugging Along

Graybar shared it’s second quarter performance and announced:

• Net sales record of $1.7B for the quarter, a 5.1% increase
• They are up 4.8% YTD

Given that Graybar is heavily focused on the contractor market, they are obviously outperforming some!

They also seem to be doing a good job of national marketing with an effort to support product lead generation and  continue to hire based upon postings.

What are you seeing from Graybar in your market?

Rexel – Investing for tomorrow

Rexel posted it’s second quarter performance.  We’ll hit some highlights and focus on North America / US results:

• Worldwide organic growth of 2.4%; part of which is a 1.1% positive benefit from copper. (Interestingly, and perhaps refreshing, is that they broke out this number and are being transparent. Other national chains did not do this. Is it relevant or just “understood”?)
• North America was up 1.6% with improvements in Canada
• Worldwide, gross margins increased slightly to 24.5% with EBITA up to 4.3%
• Investing to support top line growth in US
• Expecting strong second half with US mentioned due to “recovery”
• Confirmed financial targets

North America, which is 36% of Rexel sales,:

• Sales were up 3.3% (including some currency benefits)
• US is 79% of Rexel North America
  • Sales up 1%
    • Faster organic sales growth
      • Challenges in the project business (could be market driven, could be loss of share in selected markets)
        • Oil and gas growing double digits
        • Non-renewal / loss a large wind contract
    • Hearing of branch openings in Florida, Houston, West Coast, selected areas of New England.  Accompanied by hires
  • Gross margin at 22.4%, a 20 basis point improvement that was off-set by 40 bps for operating expenses (investments … new branches, counter resets and personnel where revenue really hasn’t been generated yet.)

Additionally, as it relates to the US, we’re hearing positive feedback on national executive management better understanding of the business vs the recent past, divisions having some more autonomy to grow their business (but they’ll need to perform in late 2017 and 2018), much positive regarding Platt and its eCommerce platform, expanding growth plans and culture / best practices input into the broader organization.

It will be interesting to see what, if any, impact the sale of GE Industrial Solutions may have on Rexel through its Gexpro group.

But they seem to be on an upwards trajectory at least nationally and perhaps even more so in specific markets.

What are you seeing regarding Rexel?

Grainger – Surviving Amazon Business and Pricing to Serve Customers?

Over the past year much has been said and written about the demise of Grainger due to Amazon Business and then its reaction by changing its pricing strategy.  We recently highlighted their Investor Day which shared different strategies to different audiences. From a third party perspective they may have over-reacted to Amazon as anecdotal research shows little Amazon Business penetration into Grainger’s profiled core customers as its value proposition is different than Amazon Business’. Nevertheless, these changes have impacted profitability and hence share price / market cap and therefore their earnings reports take on a new meaning.

Below are highlighted points from the earnings report:

• Had some restructuring charges which impacted results. Closing down a business called Columbia and closed 59 out of 144 locations in Canada
• Total sales up 2%
  • Volume up 7%
  • Price down 3% due to implementation of new pricing model
  • GP declined 110 basis points
  • Zoro and MonotaRO (in Japan) in total were up 23%!
  • Canada sales declined 3%
• US sales were up 1.7%
  • 5% in volume growth
  • Price deflation of 4%
• Large customer volume declined slightly due to government accounts
• Seeing growth from mid-size customers … an effect of the revised pricing strategy (this is an area that distributors need to watch, especially if the customer is MRO. The impact may be more non-electrical, but consider all MRO accounts as “susceptible to Grainger”.)
• Picking up more spot buys from large customers with more competitive pricing (hence share taking from someone.  Since most of these customers are on contracts and are heavily integrated with Grainger, it is expected that pricing could only impact C&D items. These customers also look for TCO benefits and don’t want their staffs doing “hunt and peck” ordering … and since this is MRO business, they order what they need, when they need it.)
• Through 2019, expect US annual growth of 6-8%
• Expect to gain profitable share in US through 2019 due to pricing actions, value proposition and marketing.
• Feel that there has been some growth in the market this year and that they are seeing increased growth when coupled with the pricing initiative in selected markets / customers (this may be a hint to distributors regarding unassigned / house accounts and under-performing accounts.  These accounts typically receive the highest pricing from a distributor because they are “small”. Question is, “are they really small or just small with you?” Could research, marketing, telesales and eCommerce help take share and convert some of these accounts? Does sales account management need to be reconsidered?)
• Some of the remarks emphasized that, in regards to pricing, if you have the right relationship and have the value proposition, the key with pricing is being competitive … especially in the MRO space … not necessarily lowest cost.
• Overall US pricing should be down 6% … impact of price management change … with overall GP down 100-130 basis points. (it’s all about product velocity mix)
• Spend much on SKU specific click-through web advertising. And looking to spend more to acquire customers. (Grainger’s scale helps them in this area.)
  • 25-35% of their 400,000 online SKUs have been repriced to date.  The impact is on medium-sized customers and for large customer spot-buys
• Expecting 6-8% volume growth in second half of the year.
• A key metric is revenue / seller (mostly for outside sales.  Something distributors should consider and then perhaps sharing rankings … peer pressure can drive performance)
• February national sales & service meeting if funded by suppliers and the cost becomes a COGS, not a marketing expense.
• A question was asked “Does Zoro cannibalize purchases at Grainger?” Management responded that
  • they do much analysis and cannabilization is very very small
  • Zoro customers are small businesses that Grainger hasn’t had a relationship with

And here is a link to Grainger’s slides.

So,

• Sorry for the long read but thought it made sense to put all of the distributor reports and analysis into one posting.
• Diverse performance.
  • Grainger slowly improving indicating strength in the large account MRO market; adopting more “traditional” distributor pricing model; having some eCommerce success with Zoro (eventhough they’ve redefined the definition of eCommerce for the remainder of their business); and their US business is prospering.
  • Graybar seemingly chugging along in the contractor market.
  • Rexel having a little growth but investing into the business
  • AD members appear to be performing and growing at a faster rate than the overall market. AD is also investing, and getting member support, for some of its newer initiatives.
  • WESCO appears to still be somewhat challenged and could be said to be the laggard of this group.

But the important question is:

• What are you seeing in your market / dealings with these companies?
• How are they on the competitive front?
• As a supplier, are they helping you grow or are they expecting you to deliver the business for them?

Add your thoughts (even anonymously) or send us your comments and we’ll post for you.