Two Herds of Cautious Bulls

Feb. 1, 2011
Distributors and their customers are feeling more comfortable with market conditions for 2011.

Conditions for the electrical distribution industry continued to improve through the final quarter of 2010, according to a recent survey by KeyBanc Capital Markets, Cleveland, in partnership with Electrical Wholesaling magazine. Based on survey results, electrical distributors reported end demand continued to improve through the final quarter of 2010, led by utility, institutional construction, industrial MRO and enterprise IT markets. In addition, many distributors now have more pricing latitude to offset input costs as demand has improved and channel inventories remain in line with demand. This improved demand and pricing environment seems to have helped distributors become more bullish for 2011.

KeyBanc and EW recently completed the second in a planned series of quarterly surveys of conditions in the U.S. electrical distribution market. All responses were anonymous and have been aggregated in order to compose what should be a clear and up-to-date picture of trends in demand, pricing, inventory levels and economic conditions in the electrical distribution market. Below are the results of the quarterly survey for October through December 2010, based on more than 80 responses.

Sequential demand trends for 4Q10 show modest growth. Quarter-to-quarter (from June-September 2010 to October-December 2010) demand trends were flat to slightly higher in the fourth quarter of 2010 (4Q10) when compared to 2Q10. While the overall percentage of respondents (74 percent) who indicated quarter-over-quarter volume growth remained unchanged from 3Q10 survey results, the distribution of growth in 4Q10 relative to 3Q10 indicates a larger number of respondents generated volume gains at the upper end of the growth spectrum (Figure 1). Average volumes in all but three end markets showed an improvement on a sequential basis, with those serving the markets of utility, institutional construction, industrial MRO and enterprise IT realizing the greatest growth during the quarter (Figure 2). Distributors exposed to utility markets should benefit in the future as it appears utility spending remained healthy through 4Q10. The improvement in near-term spending trends is the result of a build-up in end user inventory levels following improving electricity demand and several years of utilities' underinvestment in infrastructure. In addition, the improvement in customer quoting activity further supports overall future demand trends, as 32 percent of respondents noted greater quoting activity than the normal seasonal rate thus far in January versus 29 percent who noted lower activity.

Pricing remains a challenge. While demand remains relatively stable, it appears some pricing pressure is still a reality that distributors had to confront during the fourth quarter. Overall, about 66 percent of the respondents indicated a negative price/cost dynamic, suggesting suppliers have been able to combat commodity inflation more effectively than distributors (Figure 3). That said, most distributors have been able to at least pass along some of the commodity inflation to end users — only 19 percent of distributors stated they were unable to pass along any of the cost increase. Consistent with what we would have expected, participants noted copper is the largest component of raw material costs. On average, copper has risen 19 percent sequentially in the 4Q10, but recent spot prices at press time of approximately $4.40/pound would represent another 10 percent sequential increase from the 4Q10 average.

Therefore, it comes as little surprise that of all major commodities used in products that are sold through distribution, more than 50 percent of respondents believe copper will advance the most in 2011 from current levels. While a steady inflationary environment for the price of copper is generally positive in the long run (especially for distributors), rapid acceleration in copper price can make it difficult for manufacturers and distributors to recapture selling costs as we are under the impression these price increases typically lag the copper increase by three to six months.

Inventory levels appear balanced. For the second consecutive quarter, respondents noted channel inventories were mostly in line with demand as approximately 53 percent of respondents anticipate maintaining inventory levels in line with normal seasonality in 1Q11 (Figure 4). This is slightly less than forward looking expectations for 4Q10 (59 percent) noted in the last survey with the variance weighted toward reducing current inventory levels.

While expectations for a near-term reduction in inventory levels compels us to have a somewhat cautious approach for future demand expectations, we believe the expected inventory reduction is largely a function of smaller, less financially sound distributors adjusting inventory levels due to competitive pressures from larger, more well-established distributors. As end-user demand has modestly improved, we believe well-established electrical distributors had increased inventory spending to support service levels and gain market share from less financially sound competitors.

2011 outlook appears cautiously optimistic. Based on responses to several of our forward-looking questions, we see a more bullish sentiment with electrical distributors and their customers. More than half of respondents said their customers' mind-set was “cautiously optimistic” with another 13 percent termed “optimistic.”

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