Electrical distributors reported that demand was flat to slightly improved in the third quarter of 2010, compared with the previous quarter, that prices were sustainable or declining slightly and that inventory levels were essentially equal to demand, according to a new quarterly survey by KeyBanc Capital Markets, Cleveland, in partnership with Electrical Wholesaling magazine. Distributors' outlook for the final quarter of the year had almost half of the respondents slightly worried about new project opportunities — an outlook that may be tied to the industry's customary dip in early-winter demand — but many were cautiously optimistic.
KeyBanc and EW conducted the first in a planned series of quarterly surveys of conditions in the U.S. electrical distribution market. All responses were anonymous and have been aggregated in order to comprise what should be a clear and up-to-date picture of trends in demand, pricing, inventory levels and a sense of where things are headed overall in the electrical distribution market. Below are the results of the quarterly survey for June through September 2010, based on more than 200 responses.
Sequential Demand Trends for 3Q10
Quarter-to-quarter (sequential) demand trends were flat to slightly improved in the third quarter of 2010 (3Q10) compared to 2Q10. Overall, about one third of respondents indicated demand was sequentially flat while just over 40% indicated demand improved during 3Q10 (Figure 1). For those citing improving conditions, over half said the improvement was relatively modest (up 5%-9%). From an end-market perspective, it should come as no surprise that the most commonly cited end markets characterized as “weak” were residential and non-residential construction. On average, just over 70% of respondents who participate in those markets indicated weak conditions. Meanwhile end markets most commonly cited as “strong” were institutional, utility and industrial. On average, about 20% of respondents who participate in those markets indicated strong conditions. All other markets were generally stable.
Pricing Remains a Concern
While demand remains relatively stable, it appears some pricing pressure is still a reality that respondents had to confront throughout third quarter. Overall, about 38% of the participants indicated the need to lower prices during the 3Q10 while about 56% were able to hold price and about 6% actually raised prices (Figure 2). In an environment where demand has not rebounded as sharply as it had declined in 2009, we believe competition among smaller electrical distributors is still relatively strong. We think it's likely contractors are aggressively bidding on project-related business and are turning to distributors for price concessions to help defray their own lower pricing. Further supporting this inflationary theme is the advancement in the pricing component of the Institute for Supply Management's Purchasing Managers Index (ISM PMI), which rose again in September, its 15th consecutive month of increase.
Inventory Levels Appear Balanced
Channel inventories are mostly in line with demand trends (Figure 3). An almost equal proportion of respondents described inventories as “too high” and “too low.” As end-user demand has modestly improved, we think well-established distributors had increased inventory spending to support service levels and gain market share from fragmented and less financially sound competitors. However, based on 2Q10 commentary from public companies we follow, we get the sense healthy demand trends that drove inventory restocking toward the end of 2009 and into the first half of 2010 are mostly complete and we are not expecting material tailwinds from this dynamic going forward.
Outlook Beyond 3Q10
Based on responses to several of our forward-looking questions, we believe sentiment among electrical distributors has turned toward a negative bias. Our survey included a general question about what customers of each distributor were anticipating for the balance of 2010 and also included two questions on hiring practices, which we view as another leading indicator (Figures 4 and 5). About one-third of respondents characterized their customers' mindset as “cautiously optimistic” with another 4% “optimistic.” However, almost 47% selected the phrase “worried about new project opportunities” and another 17% were “very pessimistic” about new projects.
Normal seasonality for the industry points to a sequential decline into the December quarter and, without the benefit of historical survey data (this is our first survey), we think some of the pessimism about the near term outlook could be attributed to this normal seasonal slowdown. However, looking further at distributors themselves, most (53%) do not expect to add or cut headcount in the near future and only a slightly higher percentage plan on lowering staffing hours (29%) versus those who plan on adding resources (25%).
Respondents indicated a slightly more negative outlook for their customers' (contractors) plans for hiring with about 47% indicating they either plan on reducing the number of hours worked or reducing employee headcount. For this same question, about 43% expect no change while about 18% plan to add resources.