Industrial Distributors Have Report Q3 .. Electrical Industry Sales Leakage?

The past month has been earning season for publicly held companies which provides an opportunity to benchmark the electrical industry, perhaps identify some competitive insights and, hopefully, identify trends looking forward. We’ll start with industrial distributors.

In the distributor environment, many of the companies are industrially-oriented in nature. Let’s take a look at Anixter, Motion Industries, and Grainger to get a sense of the industrial market … which is about 45-50% of electrical spend (and next week we’ll cover the more “core” electrical distributors of Graybar, Rexel and WESCO).

While not all “full-line” electrical, one of the trends we’ve been observing is “electrical leakage” … companies from other industries capturing some electrical spend as 1) they seek growth through diversification 2) customers are willing to migrate “non-critical” purchases to preferred suppliers and 3) manufacturers are willing to authorize alternative channels in pursuit of capturing or retaining sales.

The Earnings:

Anixter

Recall that Anixter purchased HD Supply’s electrical and utility divisions. These now make up Anixter Power Systems, which is part of the Electrical and Electronic Solutions (ESS) business. Anixter is also global, has a security business and its network business (NSS) and WireXpress is part of the overall (but not part of APS).  Its electrical business is a small sub-segment of their business

From their call (and a link to the slides):

• Overall strong performance with a “record” Q3 and organic growth in all segments.
• Quarterly sales increased 8.1% to $2.2B with organic sales up 7.4% after various adjustments, including for copper.
  • Year to date growth is 4.7%
• ESS North America had Q3 sales of $476M, up 11.2% organically.
• Strong growth on the industrial and OEM sides of the business with natural resources (oil, gas, mining) being the strongest. (We’ve also heard from others about renewed growth in the oil, gas and mining space. Have also heard from manufacturers about supporting Anixter for OEM business, which is usually a hard business for distributors to identify, sell and service as it is a niche segment.)
• Utility power segment had sales of $444M, up 8.1%. Growth driven by US investor owned and public power customers.
• Increased their annual growth target by 1%, indicating that they see continued reasonable growth for Q4
  • Estimating Q4, overall, 4.5-5.5%
• Operating expense is 14.9% of sales.
• Freight expense as a % of sales increased 20 basis points although they have taken some actions to reduce this in Q3. (Note to distributors … are you proactively managing this expense issue? Increased fuel costs, driver costs, trucking costs, in-bound freight expense?)
• Investing in technology, which is incurring higher overall operating costs. To continue into 2019.
• Based upon analyst questions
  • It’s been “awhile” since seeing gross margin expansion (which is indicative of most distributors. Many have initiatives to improve, however, as an industry, seems like “running in place” or going backwards from a percentage viewpoint, so the key is increasing GP$ and average order size while managing non-technology and non-employee expenses.)
  • Much of OEM business tied to automotive and chip manufacturing (selling to manufacturers of chip equipment) and Anixter feels it is taking share in the OEM space. Key in this segment, per Anixter, is “services.”
  • Tech investment is “digital marketing” which is a “many year investment”” (and while analysts ask many questions regarding expense management, a question becomes, what is the expected revenue generation, or ROI, on this digital marketing investment. For calling on utilities, OEMs, and for large projects, is the investment to make ordering easier (and hence reduce order placement costs), or to help account penetration, or account “activation / reactivation”, or gain greater sales insights or new account development or further support suppliers???  And, as we’ve said before, “digital investment” is like owning a boat … a continual investment!)
    • Anixter views some, maybe much, of this investment as “necessary to give the type of experience that customers are requiring in the market we’re in today”
    • Hoping for future expense leverage
  • Anixter recognizes it needs to add investment to grow its ESS group

Overall, experienced growth, seems more project-oriented, margins “steady”, making investments to “keep up with the Joneses”. From a competitive viewpoint, seems effective on the OEM side. Manufacturers who seek to diversify their channel support should ask “what’s the ROI” or am I “taking the easy way out?”  From a benchmarking viewpoint, maybe growing with the broad electrical market? Probably exceeding in the OEM segment. Could be a hidden competitor for Rockwell distributors for non-Rockwell opportunities. Overall doesn’t appear to have maximized their entry into the electrical space and could be considered a niche player … although another point of “electrical sales leakage” of traditional electrical distribution business.

Motion Industries

Yes, a little surprising to mention Motion, however, a project we did indicated power transmission distributors, on average, generated 10-15% of sales from electrical materials.  Additionally, there are motors and drive business that some distributors may be able to pursue … and there are some industrial distributors that have power transmission divisions. So, yes, this is a potential “electrical leakage” area. (and, if manufacturers are willing to open them, do you think they’d be willing to accept an industrial lighting order?).  And they’ve been in acquisition mode.

Some insights from Baird Equity Research.

• Company has $5B in revenues
• Organic sales of 7% for Q3, relatively consistent with Q2’s 6.5% (so, industrial market is good)
• Growth in iron / steel customers, chemicals and oil / gas extraction … all double digits!
• Solid margins and an increase in supplier rebate income!
• Elevated freight costs
• Operating margins of 7.6%

Industrial business is good!

Grainger

Grainger is typically a bellweather for the industrial MRO space. And while a target of Amazon, it has endured as its large customers, who represent 90% of sales, value service and “total cost of procurement”. From speaking with Grainger customers, they are very reluctant to trust Amazon Business with any “technical product procurement”.

From Grainger’s call:

• Q3 demand strong, “another solid quarter.”
• Volume growth up 8%, outpacing the market (so, are they taking share or are their large customers having greater MRO needs, which could be the case as the industrial market has had strong growth and these companies may need to meet material given that the US GDP remains very strong … serve growing companies and they need more material that “you” can provide.)
  • US sales up 9% (8% in volume, 1% due to price)
    • Hurricanes reduced sales by 1.6% (affected areas but will probably be made up …. and more)
    • Gross profit increased 20 basis points
  • US medium customer growth up 22%
• Growing faster with mid-size customers (hence an area for taking share? Greater customer engagement (interaction) equates to greater opportunities to close business? Just a thought! – and yes, shameless plug … ask us how!)
• Received strong CSI rating from customer (distributors, ask us about our distribution specific Customer Satisfaction Index process. We also have one for reps to measure their distributors’ satisfaction with them … and manufacturers, we have a tool for measuring satisfaction within chains and groups!)
• Product directly sourced from China, by Grainger, is 20% of COGS with half affected by 301 tariffs. Would increase costs 2%. Are actively seeking alternate sources, or implement price increases to address. (could be an opportunity for “brand” manufacturers to recapture business with “fighting brand” lines or white labeling?)
• Based upon analyst questions
  • Lot’s of questions on tariffs … really no answers other than possible strategies. Reality is too early in the game to determine long-term impact and implement strategy, but companies are getting prepared to “move” business. (and it sounds like Grainger is open to moving private label and sourced business from China … but will evaluate vs current pricing / cost to move … but there may be opportunities for manufacturers to procure business.)
  • Company is very positive on maintaining accelerated growth rate for mid-sized customers. (Which begs the question for distributors, which MRO-related accounts may be seeking to consolidate their purchasing or seeking to purchase online. While Grainger may not be perceived as “electrical, 10-20% of their business, on average, is in this space.  A question to distributors becomes, what other product categories would your customers be willing to purchase from you? French Gerleman carries janitorial and facility maintenance supplies.  Think you could accept and fulfill an order? Have extra space on the truck?)
  • Spot buy business has increased with contract customers (so, the more “realistic” pricing is working on helping Grainger retain / capture this business … shows there is a limit to the margin to charge for “specials”.)
  • Tracking towards the high end of their sales forecasts as well as elements of EPS and EPS itself.
  • Expect Q4 US growth to be 5+%

So ..

• Grainger US up 9%
• Anixter ESS up 11% and utility up 8%
• Motion Industries up 7%

The industrial market remains strong (and perhaps this represents some benefit from the tax cuts and/or is the result of a continuing strong economy … and some confidence going forward?).

There are areas of accelerated growth (oil, gas, mining) and, given that this segment is not reliant on commodities (and the pricing vagaries) as well as lighting, which has its peculiarities, the growth is indicative of above industry growth.  With the electrical industry forecasted to grow 5.8% in 2018 per DISC, assuming these companies’ electrical business performs comparable to overall company performance … these companies are outperforming the market and could be taking share from someone.

So, if you are industrial, how is your performance relative to these companies? What are these companies’ strengths? Why are they performing well for their customers (especially Grainger and Motion)? What could be learned? How does your messaging and value proposition compare to these companies (and yes, we have seen a difference).

And for those that are more construction in nature? We’ll touch on core electrical distributors next.