WESCO Q3 Outperforms Many, Provides Greater Transparency

WESCO was the final national distributor to report Q3 earnings this week. Overall they performed well and, surprisingly, the tone of this quarterly called seemed to be more “open” and a little more transparent.

From their call and presentation:

• “Record sales, in all end-markets in a more challenging economic and market environment.” (all of the major distributors share that the market is slowing, albeit still growing)
• Shared that they are reducing inventory, which improved free cash flow. (We had heard rumblings from manufacturers that they were seeing some uptick in returns or, as distributors say “inventory management / inventory right-sizing”.  A word of caution to distributors, in slower times, those who have “the right inventory” – breadth and depth – typically perform better as, in the terms of the customer “they have it in stock for me now.”)
• Sales
  • Up 3.9% with US up 4% and Canada up 1%
  • US performance by segment
    • Construction up 4% (pretty good, especially since Graybar is more construction focused and was up almost 6%)
    • Industrial up 3% (given performance saw from Grainger , albeit with a broader product mix, and Anixter, WESCO’s industrial performance was better)
    • Utility up 6% (better performance in utility than Anixter, which has a good size utility business)
    • CIG up 2%
  • Canada performance by segment
    • Industrial up 7%
    • CIG up 6%
    • Construction up 1%
• Overall gross margin was 18.6%, down 60 basis points.  Lower due to mix an price costs (may infer that they couldn’t pass on some price increases due to contract pricing on the industrial side or committed projects … or perhaps timing.  The mix issue is greater growth in construction and utility which have lower margins for WESCO.  Utility typically has lower margin; construction can be profitable. The construction issue could also be large projects, which would be positive from a GM$ / invoice viewpoint and potentially net profitability.)
  • Later in the report WESCO mentions direct sales grew
• SG&A is 13.5% for quarter, 14.1% through 9 months (distributors can use as a benchmark)
• Price increases, inclusive of tariffs, have exceeded 2018 AND are averaged high single digits in Q3.
• Some color regarding global accounts
  • Petrochem, metals and mining and food processing were up
  • OEM is down (which others have reported, much due to the global economic slowdown)
• Reinforced that the “macroeconomic indicators are moderating”
• RFPs / bidding levels still “strong” and up mid-single digits
• Commented on contractor labor shortages
• 2^nd highest backlog in company history with backlog representing a higher gross margin.
• CapEx up $9M with monies going to digitizing business – much into IT and digital (both are areas were WESCO has been perceived to be “behind”.)
• Rest of year outlook
  • Expect Industrial, Construction and CIG markets to be up low single digits for the year
  • Utility to be up low to mid-single digits
  • US overall to be up low single digits
  • Canada to be up low to mid-single digits
  • Overall, up 1-3%
• 2020 Outlook
  • “macroeconomic uncertainties” (which mirrors our projections of “cloudy”)
  • Expect “current soft demand” to continue into 2020 with stronger growth potential in the utility & CIG segments due to longer-term electrification and digitization efforts (data com market)
  • Sales growth of 0-4% (wide margin, which highlights the current uncertainty of 2020)
  • The sales outlook also assumes 1-2% of “market out-performance”. If the perform a la Q3, possible.

Analyst questions

• Would like to acquire a “large core electrical distributor”, or multiple, to be “transformational.  Alternatively, expand into adjacent product and service categories. (the large electrical opportunity may be a challenge to fit the current WESCO perceived model, but would be an interesting “what if” exercise that presumably some manufacturers have done … how would such a deal change the competitive environment? A manufacturer’s channel strategy? Impact Eaton?)
• OEM, on average, has a higher gross margin that WESCO’s overall industrial business.
• Growth was across most regions, expect in Western Canada
• Opportunity pipeline has improved with information being gathered from some of their digital sales tools that they’ve deployed.
• Seeing slowness in the machine builder market and industrial automation & control … down mid-high single digits
• After increasing inventories in the first half of the year, WESCO reduced overall inventories in Q3 by about $40 million.

Overall it appears that WESCO performed well in Q3, especially with its performance on the construction side of the business in the US. While analysts may not like the gross margin decline, given that growth came from projects, electrical distributors recognize that “this is the way the business is grown.” A key distributor metric is GM$ / invoice and projects drive this. Additionally, profitable projects drive the bottom line as “less touching” of the order occurs (assuming the project goes somewhat smoothly.)

A good Q3 for WESCO … and the openness (perhaps a little candor) was refreshing.