WESCO International (WCC) recently announced second quarter earnings that missed the Zacks Consensus estimate by 6 cents, or 5.0%. Despite revenue growth and margin expansion, the higher tax rate worked against it in the last quarter.
Revenue
WESCO reported revenue of $1.67 billion, increasing 4.2% sequentially and 9.7% year over year.
The average revenue per employee was $892 million, up 1.4% sequentially and down 0.5% year over year.
Acquisitions and currency positively impacted revenue by 2.2% and 0.7%, respectively when compared with the year-ago quarter. Additionally, pricing had a positive impact of 1% on organic sales.
End Market Update
WESCO continued to see improving trends across all end markets. Organic sales to utility and commercial, institutional & government (“CIG”) customers were up double-digits, while sales to construction and industrial markets increased mid-to-high single-digits. The trend also reversed in the datacom market, where WESCO saw low single-digit growth after several quarters of decline.
Growth in the industrial marketwas across MRO, OEM and capital project categories. The global account model appears to be yielding positive results. The model also includes some construction and utility customers, so the benefit is split between all these markets. WESCO’s acquisitions (particularly the recently-acquired Conney Safety Products) is also helping the higher-margin MRO segment of the industrial business.
WESCO stated business in the Construction market remains on an uptrend in both the U.S. and Canada, with non-residential construction (mainly CIG) market now bottoming out as we move through the year. Despite some leading indicators pointing to persistent challenges in the market, WESCO’s optimism in this respect shows that the company is outdoing the market. Therefore, execution remains solid.
The utilities business is expected to grow through the end of the year, with WESCO’s pickup relatively slow, since a lot of the spending remains on the transmission side, while the company’s focus has always been on the distribution side. 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.
Margins
The gross margin was 19.6%, up 16 basis points (bps) sequentially and down 6 bps year over year. The sequential improvement in the gross margin was due to a better execution and mix of business. While the decline in copper prices meant that WESCO could not recover a higher margin from customers, it did lower raw material and therefore, inventory costs.
Operating expenses of $231.2 million were up 1.4% sequentially and 7.9% from the year-ago quarter. Despite recent acquisitions that drove up operating costs and employee merit increases that amounted to $4 million in the last quarter, operating expenses continued to decline as a percentage of sales. This is mainly due to cost reduction programs initiated by WESCO. As a result, the operating margin of 5.7% was a 54 bp increase from the previous quarter and 16 bp increase from the year-ago quarter.
Net Income
WESCO reported net income of $58.9 million, or a 3.5% net margin, compared to $52.9 million, or 3.3%, in the previous quarter and $50.2 million, or 3.3% in the year-ago quarter. There were no special items in the last quarter. Therefore, the GAAP EPS was same as the pro forma EPS of $1.15, up from $1.03 in the March 2012 quarter and $1.00 in the June quarter of 2011.
Balance Sheet
Inventories were up 2.7% sequentially, with inventory turns increasing slightly from 8.2X to 8.3X. DSOs went down from 57 to around 55. The cash balance at the end of the quarter was $72.2 million, up from $63.6 million at the end of the previous quarter.
WESCO generated $56.9 million in cash from operations and spent $7.8 million on capex, resulting in free cash flow of $49.1 million during the quarter. The net debt position at quarter-end was $511.9 million, down $43.0 million during the quarter.
Guidance
WESCO expects the industrial and utility markets to continue growing this year and construction to bottom out, which should lead to a year-over-year revenue growth of 9-11%. Of this, acquisition-related growth is expected to be 4%. The gross margin is expected to be at or above 20%, operating margin at least 6%, operating profit pull-through of 50% and an effective tax rate of 30-32%.
Full-year revenue growth including acquisitions is expected to be 7-11% over 2011 levels. The Conney and Trydor acquisitions are expected to raise earnings by 15 cents.
Conclusion
WESCO’s business appears to be undergoing a gradual turnaround and we are encouraged by the strong guidance for next quarter, as well as for the year.
WESCO has solid strategies, a good operating model, market position and customer clout. However, results are impacted by economic activity, given the company’s exposure to core segments, such as industrial, utility, construction and government. The GDP growth rate is therefore a suitable barometer of the company’s performance, both in the past and the future.
Given moderate market conditions and WESCO’s performance trends, we think that the company will see gradual improvement in its business right through the year. Therefore, similar to other distributors, such as Anixter International (AXE), Arrow Electronics (ARW) and Avnet Inc (AVT) that also have broad exposure to core segments, WESCO shares have a Zacks Rank of #3, implying a Hold recommendation in the next 1-3 months.
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