Q4 Industrial Insights from WESCO and Grainger Reports

Last week WESCO and Grainger released their fourth quarter reports and shared some comments looking forward. As the two seem to be a barometer for the industrial market (overall, not always from a company performance side), we looked to see what they are saying:

WESCO

Let’s look at WESCO’s Q4 report, with comments in italics:

• Q4 overall, down 3.6% but saw improvement from prior quarters.  This is an aggregate number that includes US electrical (contractor and industrial), utility, non-electrical distribution, Canada and the benefits of their contractor acquisitions from last year … so not a number that US electrical distributors should benchmark themselves against.
• “Took additional actions to reduce our cost” (code for cost savings! More personnel “trimming”?)
• January 2017 started with “low single digit growth” (which is expected and in the electrical space DISC is projecting the year being up 5%, in aggregate, with higher in construction, lower in industrial, so, depending upon WESCO’s mix and account penetration, will determine if they grow greater than the industry which is what they profess is their expectation.)
• Their US business was down 5% in Q4, Canada was down 14%.  (The US decline, if all electrical, would be “worse” than the market, but need to dig into the business split … electrical vs utility vs non-electrical.)
• Feel that customers are becoming more optimistic (we are hearing this from distributors across the country. (The question for WESCO will be can they capture this business? Have they retained the relationships at these accounts to participate in the upside or will they have to buy the business?)
• Can someone define “workday adjusted organic sales”? They were up 2% sequentially for the quarter (and wouldn’t most people have the same workday adjustment?)
• Construction sales down 3% in the US (this is a greater decline than the overall market, however, since WESCO typically focuses on large contractors, could mean that projects were completed.  Could also mean that others, and growth, is coming from small and medium-sized contractors who may be less impacted by labor challenges.  Regardless, this could mean that WESCO lost share in the construction market last quarter.)  Canada was flat for a net of -2%.
  • More of their decline is with industrial contractors and reportedly some growth with commercial contractors.  DISC’s projections, and history, is for overall “contractors”, hence is an appropriate comparison.
  • Their commercial construction business benefited from a 2% growth from Needham Electric and AED (in other words they would have been down more)
  • WESCO’s 2017 outlook for the non-residential construction contractor market is “modestly positive.”
    • Feel that this will benefit them due to their project management expertise (note: many distributors have strong project management departments, albeit WESCO may have a differentiation for very very large projects)
• Utility was up 3% in US
• CIG (commercial, institutional and government) sales in the US were down 10%.
• Seeing some success in broadband . data centers, retrofit cloud technology projects and cyber / physical security for infrastructure … specialized markets.
• Backlog down 3% (which they say is typical for season)
• Over past couple of years have eliminated over 950 jobs!
• Operating margin on low end of projections at 4.6% (range was 4.5-4.8%) and that is with the benefit of a lower tax rate vs PY
• Their leverage ratio is back down to a desired 3.5x EBITDA with a generated $282M of free cash flow (which also means that they are no back to ratios where they would consider acquisitions.)
• 2017 … expect flat to +4% (which is below DISCs overall market projection and below their industrial projection.  WESCO’s number may be reduced due to Canada or non-electrical performance.)
  • For Q1 expect to be flat to -3% overall (this doesn’t correlate with what we are currently hearing from distributors and manufacturers but could be some projects that were large last year so comps create a challenge.)
• Industrial global accounts bidding level is up (which can also infer there is a risk to losing business and we know that SupplyForce has had success – don’t know whom they have taken business from – and can presume others are bidding for the business.  The question also becomes, “will margins be reduced or will customers value service and technical support and make decisions based upon these plus competitive pricing?”)

And for those distributors who compete with WESCO for contractor business, they are continuing their contractor trip program … to where?

So, overall, it would appear to be a more challenging quarter for WESCO than market forecasts from DISC project and more so than what we’ve heard from other distributors.  It is also interesting that WESCO didn’t use the word “lighting” or “LED” at all as we’ve seen a correlation between distributor performance and their level of being proactive in promoting, and capturing, lighting business.  Perhaps this area isn’t a strength of WESCO’s?

But, as a more industrially-focused electrical distributor, it appears they continue to under perform the market and are projecting slightly lower performance than industry sources are projecting.

Grainger

So, now let’s look at Grainger which is known more for MRO although do some CapEx whereas WESCO is, according to them, more reverse (more CapEx and less MRO):

• Q4 met sales and earnings expectations.
• US business performed slightly better than expected with strong in December (different than WESCO.  Customers spending budget at end of year? Customers preparing for 2017 by conducting some maintenance?)
  • Overall flat for quarter (which is outperforming WESCO and Grainger says only 1 less selling day vs last year)
  • 73% of business is US, which was -1% vs PY and flat on a daily basis.
    • December was up 4% in US
• Grainger’s Zoro business, which operates in the US and Japan, is continues to grow. The combined business represents $1B in sales and grew 35%.  Zoro is $403M in the US with an operating margin of 7.4%. The remainder of the business is in Japan, and with an operating margin of 13.1%! (According to some distributors that compete in the industrial supplies space, Zoro also competes with Grainger in the sense of the same / similar product mix, albeit they could be targeting a slightly different type of buyer, hence niching themselves.)
• Have developed an inside sales team (200 people calling on 100,000 customers) to focus on medium-sized customers with a different sales organization for larger customers (the concept of segmenting the sales force is something for distributors to consider … and this could involve a telesales group or a different type of outside sales group with a different comp model)
  • Plan to add more inside salespeople to call on an additional 50,000 customers. (question for distributors … are you buying from Grainger? If so, should you be buying from a competitor or supporting other local distributors?)
• New pricing model in the US that results in lower pricing for mid-sized customers in a bid to capture incremental business.  Program is called Red Pass Plus.
• Closed 69 locations in US and Canada (can’t determine if in quarter or for year).  Grainger currently has 252 branches in the US, down from 420.
• Don’t expect significant supplier price increases in 2017
• Grainger’s oil & gas exposure in the US is <5% … about 30% in Canada
• Margins down slightly (an indication of the competitiveness of the market)
• December growth came from commercial, government and heavy manufacturing due to some holiday timing and year-end buying.
• 2017 sales guidance is to be up 2-6% (high and low ends of range are higher than WESCO.  Could be due to product mix? Perhaps sales effectiveness? Perhaps winning national accounts? Penetrating small / medium customers?)
• For the year, Grainger cracked the $10B mark, ending with $10.1B in total sales.

So, again, Grainger, to a degree, is echoing WESCO by showing that the MRO market is flat.  Both report customer optimism for 2017 but it’s early to see results (only 1 month).  The takeaway … flat for industrial in 2017 might be good (but DISC is projecting higher … more like 4%).  Anything north of that is excellent.  Both companies reported nominal margin erosion, which independents may be realizing also,

How is your industrial business?