WESCO Stays On The Growth Path - Analyst Blog

WESCO International (WCC) recently announced fourth quarter earnings that exceeded the Zacks consensus estimate by 7 cents, or 10.8%.

Revenue

WESCO reported revenue of $1.33 billion that beat the Zacks Consensus expectation by 4.4%, increasing 0.5% sequentially and 17.6% year over year.

The average revenue per employee was $783 million, down 9.8% sequentially and up 5.5% year over year.

Acquisitions and currency positively impacted revenue by 1.1% and 0.7%, respectively when compared with the year-ago quarter. Sequential comparisons were impacted by 0.9% positive impact of acquisitions and 0.3% positive impact of currency. Pricing did not impact comparisons in the last quarter.

End Market Update

All six product lines and all four end markets (except utility) served by WESCO grew from the year-ago quarter. Sales to industrial, construction and commercial, institutional & government (“CIG”) customers increased 28%, 15% and 22%, respectively from the year-ago quarter, with the datacom product line expanding 18%. However, utilities remained sluggish, declining 8% on a year-over-year basis.

Industrial marketstrength was broad-based across MRO, OEM and capital projects. Management stated that global bid activity levels remained competitive, possibly because of stability at larger players. Management expressed satisfaction regarding the working of the global account model. The model also includes some construction and utility customers, so some of the bid activity relates to those markets as well. The strength in industrial is expected to moderate but continue through 2011, according to WESCO.

WESCO stated that bidding activity in the Construction market is on an uptrend, with non-residential construction (mainly CIG) market is expected to bottom in 2011 and grow thereafter. Government stimulus funded projects are expected to add to strength in the area.

Unlike Hubbell Inc (HUB.B), which reported on the same day, WESCO continues to see weakness atutilities. Management attributed this to construction markets that still have not picked up sufficiently, resulting in lower occupancy rates. Also, construction markets typically provide the impetus for greater spending by utilities, so any significant growth at utilities is inevitably linked to the construction market. WESCO has been increasing offerings on the transmission side that has held up better during the downturn, although traditionally these products have been sold directly. The distribution side of the business, which is WESCO's primary market, remains depressed, although management expects the business to stabilize this year.

Margins

The gross margin was 19.8%, up 82 basis points (bps) sequentially and 121 bps year over year. The improvement from the year-ago quarter was on account of favorable effect of supplier volume rebates and inventory-related reserves, partially offset by commodity cost increases and increasing competition. Supplier volume rebates and inventory reserves were also favorable to the sequential comparison.

Operating expenses of $204.1 million were up 7.1% sequentially and 21.3% from the year-ago quarter. Operating expenses have been declining for a number of quarters now, mainly due to cost reduction programs initiated by WESCO. A higher commission incentive rate, costs related to the TVC acquisition that WESCO closed in December and two weeks of extra expenses related to the acquisition combined to generate the increase in the last quarter. As a result, the operating margin of 4.5% was an 11 bp decline from the previous quarter, although it remained 74 bps higher than in the year-ago quarter. This marked the second straight quarter of year-over-year expansion in the operating margin since December 2006.

Net Income

WESCO reported net income of $34.8 million, or 2.6% net margin, compared to $33.7 million, or 2.5%, in the previous quarter and $21.8 million, or 1.9% in the year-ago quarter. There were no special items in the last quarter. Therefore, theGAAP EPS was same as the pro forma EPS of 72 cents, down from 74 cents in the September 2010 quarter, but up from 51 cents in the December quarter of 2009.

Balance Sheet

Inventories were up 6.7% sequentially, with inventory turns dropping slightly from 7.8X to 7.3X. DSOs went down a day to around 54. The cash balance at the end of the quarter was $53.6 million, down from $103.1 million at the end of the previous quarter. WESCO generated $51.8 million in cash from operations and spent $5.0 million on capex, resulting in free cash flow of $46.8 million during the quarter. It also spent $251.0 million on the TVC acquisition. The net debt position at quarter-end was $672.3 million, up $291.8 million during the quarter.

Guidance

WESCO expects growth in the industrial, communciation, government and international markets and stability in non-residential construction and utility markets to generate a 2-4% net growth in served markets. Management initiaves are expected to enable the company to exceed the gross margins in 2010 and result in a 50% operating profit pull-through. Interest expenses are expected to be flat to slightly higher, the effective tax rate to come in at 28-30% and capex at $20-25 million. WESCO intends to convert 80% of net income to cash flow in 2011. TVC is expected to add 30 cents to the bottom line.

For the seasonally softer first quarter, WESCO expects year-over-year revenue increase of 16%, gross margin in the high-19% range and higher operating expenses related to a full quarter of TVC operations generating an operating margin of 4.1%. The interest rate will be flat to slightly higher and tax rate in the 28-30% range.

Conclusion

WESCO's business appears to be undergoing a gradual turnaround and we are encouraged by the strong guidance for next quarter (although comps will be easier in the next quarter and get progressively more difficult as we move through the year). Additionally, the company will benefit from the inclusion of TVC.

WESCO has solid strategies, a good operating model, market positon and customer clout. However, results will no doubt be impacted by economic activity, given the company's exposure to core segments, such as industrial, utility, construction and government. The GDP growth rate is a suitable barometer of results. Considering the gradually improving GDP rates and the lack of significant catalysts that could raise share prices, we have a short term Hold recommendation on the shares, as indicated by the Zacks #3 rank.

 
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