Electrical distributors can expect a mixed bag of economic results in 2007. Almost everything came up roses last year, especially if you were not deeply embedded in the distributor-served residential market.
By every measure, total industry sales in 2006 were up at double-digit rates. The distributor-served contractor market led this surge and was followed closely by the distributor-served industrial market, with both segments up 10 percent to 15 percent. In the fourth quarter of 2006, sales were strong, but they did not keep pace with the string of double-digit sales increases that began in the fourth quarter of 2005. We saw a little weakening in the fourth quarter of 2006.
Industry sales did not start as fast in 2007 as they did last year, and they won't finish as strong as last year, either. This is a reflection of an economy making a number of adjustments and the continuing steep slide in housing. Residential spending is a whopping 70 percent of total private construction, and the ripple effect of the housing market's woes throughout the economy is huge.
Electrical Wholesaling estimates the distributor-served residential market to be between 15 percent and 20 percent of total industry sales. While that's a significant chunk of the market, that leaves 80 percent to 85 percent of industry sales dedicated to other sectors, including the commercial and institutional markets. Make no mistake about it — the dog still wags the tail.
However, changes in residential construction will impact nonresidential construction. My concern is how badly the housing market will affect this year's expectations for a reasonably solid year for nonresidential spending. I believe that's the fly in the ointment in the economic fortunes of 2007.
Global Insight, Waltham, Mass., expects residential construction spending to decrease nearly 16 percent this year after a 4-percent slide last year. This economic research firm also expects nonresidential construction to increase more than 7 percent this year after an 8-percent increase in 2006. This means the steep declines in residential construction will not extract a heavy toll from the expected growth in the nonresidential market. This is reassuring and it's the best analysis around, but it's not a guaranteed outcome.
When we look at the key economic drivers of the electrical industry, they are clearly residential and nonresidential construction spending. They are global drivers and fit nicely into our framework of economic models that explain industry behavior and growth.
Alas, the devil is in the details. It's one thing to look at this in the aggregate, but wouldn't you be more comfortable if you had greater insight into how changes in the residential sector affect the specific nonresidential segments? Every electrical distributor's business doesn't behave like the industry in the aggregate. Each electrical supply house has its own niche indicators that drive the business. Distributors in the aggregate are a diversified group serving many different customer types. When you add them all up, you have an industry whose performance is dictated by broad economic indicators. For instance, electrical distributors that depend on large projects in the construction market could have a very different experience this year if large projects are more adversely affected by the decline in residential construction than is overall nonresidential construction.
Your performance is measured against the whole industry in the aggregate. After all, those opportunities are available to you, and it is up to you to select the ones that make the most sense for your company. To get a feel for how you are doing specifically against your set of narrow drivers, you must look at those narrow drivers. However, you must still explore the broader range of industry drivers and figure out what you can do to enhance your own business performance and increase revenues and profitability.
Many electrical distributors view commercial and industrial construction as their core business. Commercial and health-care construction was up almost 7 percent last year, and industrial construction increased a solid 12 percent. Both increases are after inflation so it's pure physical volume. Global Insight is not forecasting much of a change for this year — a bit less for the combination, but not materially so.
The question remains, with a huge downturn in residential spending, when will the nonresidential sector take the hit? Fortunately, the hit is not concentrated in one quarter. The largest effect takes place as we move through this year, with the rate of growth in total industry sales decreasing by a third between the first quarter and the fourth quarter. While sales dollars will not change much, the year-over-year growth rate will change. By the first quarter of next year, expect industry growth of approximately 2 percent. I believe the electrical wholesaling industry will be stuck at that 2 percent growth rate throughout 2008 and into 2009.
DISC Corp.'s outlook for total industry sales for this year is growth of 7.5 percent. As an alternative forecast, I can envision a scenario where we could be a point or two shy of the 7.5 percent forecast, but I don't see a scenario with much upside potential.
I still see the distributor-served contractor market as the segment leader, at least through the first quarter of 2008. Growth in the distributor-served industrial market, according to our latest analysis, is expected to be less than half what it was last year — about 6 percent.
Bottom line: I don't think the drop in residential construction will devastate the overall electrical distribution market this year, but it's clear that manufacturers and distributors serving the residential market are hurting. The real challenge for the electrical industry overall comes next year when both residential and nonresidential construction are expected to be weak, driving industry sales to low single-digit gains.
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.