National sales forecasts by DISC Corp. and Electrical Wholesaling's Market Planning Guide look similar for 2006. For this year, both EW and DISC forecast growth of more than 10 percent.
According to DISC numbers, industry sales will grow 12.8 percent in 2006, with double-digit gains in the distributor-served contractor and industrial market segments. I believe 2006 will go down in history as the best year in this decade. It doesn't get any better in 2008 or 2009. Led by strength in the distributor-served contractor market, look for a continuation of the industry growth cycle in 2007 that's not quite as robust as this year. The distributor-served industrial market will cool to an 8-percent growth rate in 2007 after topping a 13-percent rate this year.
This phase of the distributor business cycle took off in 2004 when the distributor-served industrial market ratcheted up more than 8 percent. In the fourth quarter of 2004, industrial sales grew by an exceptionally strong 13 percent. By the fourth quarter of 2005, industrial sales surged again, hitting a 15-percent pace. Now the distributor-served contractor market is leading all market segments and is up nearly 16 percent in 2006. This growth is driven by nonresidential construction spending, which was up 8 percent in the second quarter of 2006. Since mid-year, nonresidential spending is averaging better than 15-percent growth in deflated dollars.
Sizing the Residential Market
Meanwhile, the growth rate for spending on residential construction peaked in the third quarter of 2005 and has been weakening through 2006. DISC forecasts that residential construction spending for the second half of this year will decline more than 10 percent from the same period a year ago.
You may ask yourself: If the residential market is weakening, how can total distributor sales grow nearly 13 percent and contractor sales grow nearly 16 percent this year? In terms of total construction dollars spent, the residential piece (in deflated dollars) is $581 billion; the nonresidential segment is $277 billion. That's a ratio of more than 2 to 1. In terms of growth, the residential construction market will decrease about 4 percent this year while the nonresidential construction market will increase more than 10 percent this year, in real terms.
Distributors are enjoying the strongest distributor-served contractor market in more than five years. It's happening despite negative growth in residential construction spending. That can only happen if the distributor market is more tied to nonresidential construction than to residential construction. Of course, this market grows the most when residential and nonresidential construction spending grow at a good clip in tandem, but that doesn't happen too often.
We are witnessing a fairly substantial growth differential between residential construction and nonresidential construction spending. For example, for the fourth quarter of this year, DISC forecasts residential construction will be down 13 percent and nonresidential construction spending will increase 15 percent. That's a 28-point spread and it's quite significant.
Yet we are looking for an 18-percent gain in the distributor-served contractor market in this year's fourth quarter over the fourth quarter of 2006. An 18-percent increase in the face of a 28-point spread indicates the residential market, while very important to many distributors and manufacturers, is not the critical driver in overall industry performance.
According to the responses from electrical distributors that Electrical Wholesaling receives to its Market Planning Guide (MPG) survey, the residential market accounts for more than 20 percent of total distributor sales. Twenty percent of total industry sales, according to DISC's numbers, amounts to about $14.5 billion. This makes the residential component just about half of the distributor-served contractor market, which is a $29 billion market.
If the overall distributor-served contractor market is split equally between residential and nonresidential construction spending, it seems we would have experienced a better industry performance since 2003, because residential construction spending has increased more than 8.5 percent annually (until this year).
To extend the logic, let's use 2002 as a base because that was the low point during the current cycle. The distributor-served contractor market decreased 13.3 percent in 2002. In deflated dollars it declined 10.7 percent. Residential construction spending increased 3.9 percent, while nonresidential construction spending decreased 16.4 percent in deflated dollars in 2002. The combination of residential and nonresidential construction spending in deflated dollars decreased 4.5 percent.
If residential construction spending constituted half of the distributor-served contractor market, we would have seen a much better performance, something closer to a 4.5 percent decrease rather than the 10.7 percent decrease actually observed.
So what's the point? Simply that at best there is uncertainty as to the size of the distributor-served residential market. This is an important gap in our understanding of the electrical wholesaling industry, and it would help if a better residential market number was available. The only way that can be done is if a greater representation of electrical distributors — large, medium and small — reported their sales mix to EW in the annual survey it uses to develop its sales forecast for the Market Planning Guide each November.
Comparing the DISC Numbers and EW Numbers
EW's MPG forecast for 2006 total industry sales differs by approximately 15 percent from DISC's forecast for total industry sales. EW forecasts industry sales in 2006 at $84 billion while DISC reports sales of $72 billion.
Although Electrical Wholesaling has forecasted double-digit sales growth for electrical distributors in its Market Planning Guide for the last few years, DISC Corp. hasn't forecasted double-digit gains since 2000. See “Industry Sales Forecasts 2003-2006” on the adjacent page.
As a basis for sales forecasts, EW and DISC both begin projections with the Census Bureau's Census of Wholesale Trade, which is conducted every five years, but our methodologies diverge there. DISC updates the census numbers based on economic models and economic indicators. EW forecasts are based upon consensus predictions of electrical distributors via its annual MPG survey.
It's also quite possible that the difference in the EW and DISC total industry sales number could in some way be related to differences in sizing the residential market. The “Growth in Deflated Dollars” chart shows how industry sales have grown since 2002 as calculated by EW and by DISC. I have deflated both EW and DISC sales and compared them with deflated residential and nonresidential construction spending.
Although the relationship is not perfect, it seems that the EW total growth is closer to the behavior of residential construction spending while DISC is closer to nonresidential construction spending. Both EW and DISC forecasts are more in line with the nonresidential growth in 2006, but EW's growth is not as strong as DISC's. This may be because the participants in the EW survey are more oriented to serving the residential market.
Put another way, when DISC compares its growth forecast with EW's forecast for the period between 2003 and 2006, EW's growth outpaces DISC growth. These differential rates account for the 15-percent difference in total industry sales between EW and the DISC forecasts for 2006.
Outlook for 2007
The DISC forecast for 2007 looks for continued strength, led by the contractor market and followed by the distributor-served industrial market. From 2003 through 2005, growth in the industrial market led industry sales.
The DISC forecast in the chart on this page takes into account the behavior of three key economic indicators for the electrical industry. The two most powerful drivers of industry sales, investment in machinery and nonresidential construction outlays, are largely responsible for the solid overall industry growth beginning in 2006.
With real growth up a solid 7 percent this year and 4.5 percent next year, order backlogs are high and rising. The electrical industry is challenged to manage its scarce resources efficiently and improve productivity to maintain profit margins.
Herm Isenstein is president of DISC Corp., Orange, Conn., a market analysis and forecasting company for electrical 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.