End market trends for the electrical wholesaling industry remained strong through the second quarter of 2011, according to a recent survey by KeyBanc Capital Markets, Cleveland, in partnership with Electrical Wholesaling magazine. Survey results indicated sequential improvement in demand for the fourth quarter in a row, but demand actually trended slightly behind normal seasonal trends.
From an end-market perspective, nearly all end markets posted sequential improvement in 2Q11 with residential construction as the only laggard. Inventories at the distributor level appear in line with normal seasonality, which are most likely being influenced by the construction cycle, customers building safety stock levels amid uncertainty surrounding supply chain disruptions, and future material price increases. A less favorable employment situation and pricing environment has led to a more muted, less optimistic outlook for the balance of the year. We think the survey results validate a moderate recovery from the most recent recession.
This survey by KeyBanc and EW is the fourth in a series of quarterly surveys of conditions in the U.S. electrical distribution market. The analysis provided in this article comes from more than 60 responses to our survey on market conditions for April through June 2011. 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 future outlook in the electrical distribution market.
Sequential demand trends for 2Q11 show moderation from historical norms
According to survey results, end demand improved sequentially in 2Q11, but demand actually trended slightly behind normal seasonal trends when compared to the “normal” seasonal uptick associated with the construction season. Approximately 65 percent of respondents noted 2Q11 demand levels grew quarter-over-quarter (Figure 1), compared to 85 percent of respondents that stated positive growth was characteristic for the 2Q. While most of the ranges of growth were in line with historical norms at the high end, there was a substantial disparity in the +1% to 9% range for 2Q11, where only 16 percent indicated growth versus the historical norm of 33 percent. That said, participants noted 2Q11 represented the fourth consecutive quarter of sequential demand improvement. By end market, respondents cited notable strength in industrial OEM and MRO, institutional construction and utility markets (Figure 2). Residential construction continued to lag on a sequential basis for the third quarter in a row. All in all, we think the data validates what appears to be the commonly held belief of a slow-growth recovery from the most recent recession.
Inventory levels suggest continued optimism for future demand
It appears forward-looking sentiment on future inventory builds is in line with expectations from the end of 1Q11, as about an equal portion of respondents (38 percent in 2Q11 versus 37 percent in 1Q11) are anticipating expanding inventories during the quarter. In addition, approximately 35 percent of respondents noted they are investing the normal portion of capital towards inventory for the upcoming quarter (3Q11), up from 29 percent in 1Q11 and 15 percent in 4Q10. However, only three percent of respondents said they are building inventory faster than normal seasonality would dictate, down from eight percent of respondents in 1Q11. The survey did not take into account the dollar value of inventory, which increased during the 2Q11 as commodity costs have remained elevated at high levels. Our survey is consistent with the most current data available from the Institute for Supply Management's Purchasing Managers Index, which suggests inventories in the channel remain slightly higher than in previous months. We believe the higher inventory levels at the distributor level are being influenced by the construction cycle, customers building safety stock levels amid uncertainty surrounding supply chain disruptions and future material price increases. Overall, we think the data suggest modest optimism from survey respondents that current demand momentum will continue into the second half of this year.
Price/cost dynamic remains a risk
We are under the impression distributors have generally been able to pass through raw material costs, although to a smaller degree since 1Q11. According to our survey results, smaller distributors have not been successful in equally offsetting manufacturers' announced price increases. About 74 percent of respondents indicated some level of negative price/cost spread, up from 65 percent in 1Q11. Of those that were able to pass along some of the commodity inflation, respondents were less likely to capture the full amount through price increases to end customers. On average, results from our survey indicated industrial MRO and OEM markets were able to realize the most pricing latitude during the quarter, while residential and non-residential construction markets were forced to concede the most price. On balance, a steady inflationary environment for commodities is generally positive for distributors in the long run. However, rapid acceleration can make it difficult for distributors to keep pace as we are under the impression price pass-throughs generally lag manufacturer increases. At this point, this dynamic appears to be in check.
2011 outlook becoming more clouded
Commensurate with relatively soft private-sector hiring, it appears the employment situation points to a lower degree of confidence about the sustainability of a near-term recovery. Approximately 37 percent of respondents in 2Q11 suggested their customers are either laying off current employees or suffering from idle capacity by being forced to reduce hours to existing employee workload. This is up from 26 percent in 1Q11 and 29 percent in 4Q10 (Figure 3). That said, there remains a large percentage of respondents (20 percent) that noted their customers are adding employee hours. Looking at electrical distributors, most did not add or cut headcount during the 2Q11 (61 percent in 2Q11 versus 45 percent in 1Q11). However, those who added employee hours or hired additional employees (22 percent) exceeded those who reduced employee hours or laid off employees (16 percent). We believe prospects for increased hiring at the distributor level are particularly illustrative of the channel's confidence level, as we are under the impression distributors are typically one of the last players in the value chain to hire in an up-cycle. Given a slightly less positive outlook on customers' employee situations, it's no surprise that respondents believed their customers' outlook for 2011 turned more pessimistic in the 2Q11 (Figure 4).