Mixed Messages

Oct. 1, 2012
Distributors and their customers appeared to be more cautious and less optimistic about future business conditions in 2Q 2012, according to the results of this Electrical Wholesaling/KeyBanc survey.

To gauge near term trends for the second quarter, we have again conducted our proprietary KeyBanc Capital Markets Electrical Distributor survey in association with Electrical Wholesaling magazine. This is our eighth quarterly survey of North American electrical distributors in partnership with the magazine, and we received over 45 responses detailing trends in sequential demand, pricing, inventories and outlook going forward. Following are some key takeaways from our survey.

In the 2Q 2012, sequential demand trends came in weaker than the historic seasonal pattern. Based on the conditions cited in the survey, we estimate end demand rose 3.9% sequentially in 2Q 2012. The overall sequential performance is considerably lower than the historical average of up 9.9% noted by participants and is a significant deceleration from the year-ago period (Fig. 2). It's likely the lower than average demand trends in the 2Q 2012 are a direct result of a better-than-expected 1Q 2012, which could have benefitted from an unusually warm winter. While one quarter doesn't signify a trend, we will remain vigilant for any additional signs of weakening, as recent domestic macroeconomic indicators continue to indicate a demand environment that's sluggish at best. Despite the lower sequential rate of growth, a similar mix of respondents in 2Q 2012 (64%) realized some sequential growth as in 2Q 2011 (65%), which validates the seasonal trend.

Inventories are stable. Survey respondents indicated that inventory levels have leveled out as it appears distributors are seeking to maintain a normal level after last year's large build-up. Heading into 3Q 2012, it appears most distributors will be maintaining their current levels (Fig. 3) with a smaller percentage of respondents increasing inventories when compared to 2011 (44% in 3Q12 versus 37% in 3Q11). We think this points to a measure of caution from distributors who seem less willing to expand inventory levels for the third quarter ending in September, given the sluggish demand trends and an uncertain political environment.

The construction market seems the most price sensitive. The strongest pricing concessions for distributors came in the residential/non-residential construction markets, which is likely due in part to recent weakness in the U.S. construction market. It appears this stagnant trend underlies the competitive pricing environment as residential construction does not seem to enjoy much pricing latitude. Despite this, results from our survey indicated products sold into the industrial MRO and industrial OEM markets were able to realize the least amount of pricing concessions during the quarter

Hiring improved from 1Q 2012 but the outlook for the balance of 2012 is incrementally pessimistic. It appears the employment situation indicates a consistency of hiring practices since last quarter with an equal amount of respondents (66%) noting their customers (i.e., contractors) have largely retained existing levels of employment, added hours to existing employee workload or hired new employees due to high capacity. These results are in line with 1Q 2012 (67% of respondents).

Looking at distributors themselves, the employment situation has slightly improved on a sequential basis as approximately 91% retained employees, added employee hours or hired new associates. While this is up from 86% in 1Q 2012 and 85% in 4Q 2012, the percentage of new hires showed more improvement on a sequential basis (23% versus 5% in 1Q 2012). We find it to be interesting that the distributors' customers have an incrementally pessimistic view of the 2Q 2012 with customers feeling more pessimistic and worried — 53% vs. 38% in 1Q 2012.

The authors are equity research analysts for KeyBanc Capital Markets Inc. in Cleveland and can be reached at either [email protected] or [email protected].

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