With the year's second quarter recently completed, it's clear distributor sales are not what they were just four quarters ago. According to forecast data from DISC Corp., Orange, Conn., distributors and vendors were flying high early last year, with total sales in the first quarter up 13 percent. Of course, all the stars were aligned just right, as every single important economic indicator directly impacting sales in the electrical wholesaling industry was in plus territory.
In fact, the first half of 2006 was the peak growth period in the industry's business cycle, up 13 percent compared with the first half of 2005. While 2006 was a very good year overall for the electrical industry, the growth curve was decelerating, and by the fourth quarter industry sales were advancing at barely 7 percent.
At the same time, the distributor-served contractor market was advancing at a strong 11 percent rate. The basis for the contractor growth was positive gains in the residential and nonresidential construction markets. However, by year-end, the residential and nonresidential construction markets were growing in opposite directions. The nonresidential market finally took off, with a solid gain of 11 percent. On the flip side, the residential market slumped, with a loss of more than 12 percent in 2006's last quarter.
Although distributor sales to the industrial market surged by over 18 percent from the year-earlier quarter, the distributor-served industrial market was winding down as the electrical industry moved through 2006. From a growth of better than 18 percent in the first quarter, industrial market sales gained just 6 percent in the last quarter of the year.
We are now at the point in the electrical market's business cycle when the key economic indicators are beginning to move in different directions. This means the cycle has peaked and slower industry growth is sure to follow. However, it's important to recognize that although the key indicators are slowing, they are not all slowing at the same rate. Therefore, some distributors and vendors will feel very differently about industry performance.
Contractors still quite busy
This is the year of the contractor market, residential construction notwithstanding. Here's why. Overall, the distributor-served contractor market will increase about 9 percent this year because of strength in nonresidential construction.
That's really fine growth, when you think about the huge downturn in the residential market. When you dig into what's happening in the residential market, you will see that its impact on distributors is an eye-opener. In the first quarter of this year, residential construction was down 17 percent from the year-ago quarter.
However, the drag is in single-family homes, off nearly 30 percent from a year earlier. Meanwhile, multi-family construction is actually up 1 percent in the first quarter. The density of electrical content in multi-family building is much greater than in single-family building. For this industry, the percentage change in single-family construction is not a good indicator of distributor sales to the overall residential market, unless a company doesn't go after the multi-family residential construction market.
I believe 2007 is the bottom for distributors and vendors serving the residential market. According to DISC analysis of U.S. Census data, electrical contractors will increase their purchases of electrical supplies from electrical distributors in 2008 for residential applications by approximately 5 percent.
Getting a handle on the size of the residential market for the electrical industry is very difficult, and to my knowledge, it has not been done very well. However, I can share a bit of information about the residential market focused on single-family homebuilders. In DISC's MarketTrack database, we have two four-digit SIC (Standard Industrial Classification) industries: SIC 1521 for single-family homebuilders, and SIC 1522, residential construction not elsewhere classified. At the national level taken together, we expect these two SIC industries to buy 18 percent less electrical supplies from distributors in 2007. So this is roughly in line with the residential construction spending in the first quarter.
Another piece to the puzzle is determining how much residential business goes through electrical contractors. I don't know the answer and don't think it's worth speculating on. I do think this year is the bottom for distributors and vendors serving the residential market. In 2008, the SIC code industries 1521 and 1522 are expected to buy 5.5 percent more supplies and apparatus from distributors compared with this year.
Nonresidential construction tells the tale
Let's take a look at performance in the nonresidential market, because that's the most important driver of industry sales this year. Just about every one of the major components of nonresidential construction spending in the first quarter is pointing up at double-digit rates.
Total nonresidential construction increased 9.4 percent in the first quarter compared to a year earlier. Commercial/health care was up 12.3 percent, and multi-merchandise shopping was up 11.2 percent. Meanwhile, construction expenditures for manufacturing plants were up a solid 13 percent. However, some of these components will eventually be hit directly by the downturn in the residential construction market. Multi-merchandising shopping is one example. I expect the downturn in nonresidential construction to hit as we close out 2007.
I believe 2007 is the beginning of a slowdown in industry sales, coming off a very strong 2006. In DISC's current forecast cycle, I don't see any growth as high as 5 percent through 2011. I am not suggesting a recession in the electrical industry, but I do expect to start seeing low single-digit growth across the major segments served by distributors and vendors.
What does this sales forecast mean to distributors? I think they should look very carefully at the kind of productivity they are getting out of their employees. The average electrical distributor should be getting approximately $500,000 per employee. This is the industry average that DISC has calculated. If electrical distributors can hit this number, it will contribute significantly to an overall efficient cost structure and decent productivity.
Herm Isenstein is president of DISC Corp., Orange, Conn., a market analysis and forecasting company for distributors and manufacturers, and a frequent contributor to Electrical Wholesaling. You can reach him at (203) 799-3673 or [email protected]. Web site: www.disccorp.com.