Electrical manufacturers, reps and distributors know they're facing rough times ahead. In an exclusive EW survey, they also expressed teh determination to get through it.
It's ugly out there and it's getting uglier.
Electrical distributors and reps are keeping a watchful eye on the continuing decline in the vitality of the U.S. economy and taking a variety of steps to keep their businesses on solid footings while they wait for the market to turn around.
When that turnaround will come is anyone's guess. Predictions from those willing to venture such a guess in an outlook survey last month by Electrical Wholesaling and Electrical Marketing varied over a wide range. None expected the picture to brighten much before the third quarter of next year, and some put the turnaround a year further out, in the second or third quarter of 2010.
When asked about “the single scariest thing about 2009,” many survey respondents raised concerns about customer credit-worthiness and a slow recovery.
Ralph Bliquez, principal of Ewing-Foley Inc., a rep agency based in Tigard, Ore., and current president of the National Electrical Manufacturers Representatives Association (NEMRA), Armonk, N.Y., said the scariest thing is, “Reading the paper; listening to radio; watching television: in other words, media hyperbole.” In other words, articles such as this one.
But most widespread were comments about fears of the unknown.
More questions than answers
“How far do we cut cost when we really have no idea just how bad or good next year will be?” Barry Oliver of Electro Link Sales, Albuquerque, N.M., asked. “I think without a doubt next year is going to be scary just trying to stay on top of changes as they occur. It seems that in normal conditions we can budget and plan, because we have a sense of what to expect. 2009 is starting to look like we have no idea what to expect, but we'd better be ready for something almost certainly not good.”
The sense of uncertainty appeared to have been spurred by the sudden drop in sales over the previous month. After several months of hearing and reading about how horrible the economy was, but seeing just mild overall sluggishness in sales of electrical products, “New business seemed to fall off a cliff in November,” said Henry Bergson, recently retired president and CEO of NEMRA. “October sales were fine, and then November plunged dramatically,” said one rep who asked to remain anonymous.
“No one knows how bad it is or how bad it will get,” said a distributor. “Even the best minds in the financial and business world cannot agree to the breadth and depth of the problem, nor how to solve the problem. It is flat-out scary. On top of that, some people in the work force are oblivious to what is going on. High earners are going to be shocked when their paychecks are cut in half next year.”
“If we were able to predict that we were going to be down 10 percent, we could adjust our businesses accordingly, but some reports are suggesting business off as much as 30 percent. It is very difficult to plan with a range this large,” says Greg Reynolds, president of Flynn & Reynolds Agency, Tewksbury, Mass. “A 10 percent scale-back is much different from a 30 percent scale-back and just makes it very difficult to plan. We are seeing more and more construction being placed on hold, adding to this uncertainty. To date we have had a very strong 2008, outperforming last year in single digits. This makes it very confusing, with all the indications that we are seeing that next year will be down.”
More specific to the electrical industry, many respondents pointed in different ways to concerns about business failures within the supply chain. Eric Haines, Haines Sales Corp., Syracuse, N.Y., “It's one thing to read about recently robust financial institutions tanking and being bought by others, but some of the same is bound to happen in the electrical market — probably, with as little notice.”
In the broader perspective of the electrical industry's business cycles over time, economic downturns are nothing new. In fact, they're perfectly normal. But comparing the present situation to previous economic downturns is difficult. Many industry executives are bracing themselves for the worst recession they've ever seen.
“I've been through several downturns, and this one does not compare,” Reynolds of Flynn & Reynolds said. “We've never seen the Fed rate go to zero and treasury bills selling for negative interest rates. There is across-the-board halting of building, including the medical, educational and institutional sectors, which traditionally have been recession-proof. With the publicity that the Wall Street debacle has received consumer sentiment is one of desperation or catatonic, causing everyone to stop spending.”
Even for seasoned economists, this downturn looks unusually severe. “This may well turn out to be the worst since World War II,” said Don Leavens, vice president and chief economist for the National Electrical Manufacturers Association (NEMA), Rosslyn, Va. “The origins of this recession are manifold and include a housing market implosion, a severe financial shock and related drastic credit crunch and stock market crash, an energy price shock, a raw materials price shock … all while fighting two wars. The U.S. economy is extraordinarily flexible and able to withstand an occasional shock or two. But the combination of so many negative forces has overwhelmed consumer and investor confidence and created a strong and widespread aversion to risk that has rendered the Federal Reserve's monetary policy about as useful as pushing on a string.”
Some cautioned against relying on the tactics that saw the industry through the last downturn.
“I don't think I can compare what we may see in the next several years to any other experience in my lifetime,” said Vic Jury Jr., Summit Electric Supply, Albuquerque. “The economic indicators continue to degrade, the world is flatter than ever (in Friedman terms) and our industry is in something of a ‘perfect storm’, with the potential for significant commodity deflation, soft demand and tight capital markets constraining investment in projects that would otherwise be funded. I think companies that attempt to use a playbook from a previous recession may be far too optimistic for the good of their employees, investors and suppliers.”
All the same, the options for managing a business through a severe recession don't change all that much. Veteran reps such as Gary Brusacroam, AJB Sales, Minneapolis, will be focusing on essentials and attitude. “The economy is what it is, though disconcerting,” Brusacoram said. “We have to deal in business realities, which means we have to adapt, close the sale on the present potentials and then go disrupt the marketplace. Find and get what's there. These are the times when leadership becomes an art form…we have to pull out some old tried-and-true selling concepts, get people moving rather than dwelling on negatives, mix in the present technological marketing and go sell.”
Facing the foe
Asked specifically what changes they're making in preparation for what could be a year or more of contraction in the market, electrical industry executives showed that they won't be taken by surprise. For most in the industry, everything is on the table. “We are going to look at everything, I mean everything. We have to find out a way to cut out some of the fat, without hurting service levels,” said Bill Goodwin, president of Griffith Electric Supply Co., Trenton, N.J.
The prospect of a protracted downturn has raised the premium on resourceful marketing and solid business practices, and has distributor executives sharpening their pencils and donning the eyeshades to hunt down every available dollar.
“We are adding more outside salespeople and pushing hard on selling value-added products,” said Steve Espinosa, The Lighting Company, Irvine, Calif. “We are reviewing all expenses and making adjustments. For example, any vendors who have added fuel surcharges are under the microscope. ”
Barry McEachern, president of Star Electric Supply, Wichita, Kan., is looking at the basics: “Tighter credit controls, leaner inventory and all the other things we normally do. Be more mindful of our business.”
Oliver of Electro Link Sales is looking to new marketing ideas to raise the visibility of the manufacturers his agency represents. “We are changing the way we market ourselves in 2009. We are giving away a classic 1980 Chevrolet Corvette worth over $30,000. We have four manufacturers that we are promoting in this giveaway. … With so much news about how bad things may be and the trouble with the U.S. automakers, we decided to do something with some real teeth. The response has been unreal from both our distributor partners and contractor partners.” The program started in December and the Vette will be given away at the end of December 2009.
Some will place renewed emphasis on the importance of mutually supportive relations within the electrical channel. Along with several other initiatives aimed at eliminating money-losing activities and reducing risks from trade credit, Summit Electric Supply is focusing on supplier relations. “We are carefully evaluating our supplier relationships,” said Jury. “We need to sort out not only who will make the right calls in the coming economy but who our true ‘friends’ are. We need to have suppliers who will respond to deflationary developments appropriately and who will keep us in the market.”
Electrical manufacturers are tailoring production for an expected slowdown and cleaning up their balance sheets, said NEMA's Don Leavens. “Almost everyone is in the process of deleveraging in order to rebuild investor confidence in the underlying soundness of enterprises,” Leavens said. “Our member companies realize that 2009 will be dramatically slower than the record levels many achieved in 2008 and are planning for lower demand by cutting back production.”
Even respondents who operate in markets where the impact of the downturn has not been as deeply felt as in the industry as a whole — specialists in energy-efficient lighting, for example, and distributors and reps operating in the Midwest where construction projects are still ongoing — see plenty of reasons for concern.
Espinosa of The Lighting Company expects his market to grow next year, though not without some struggles. “As we service the maintenance and energy-efficient lighting market, I think our market will be larger next year than this year,” he said. “The problem will be more competitors entering the market and potentially diluting our sales opportunities for growth. Number two, I expect price erosion next year to be higher than any previous year. Possibly 10 percent, which means we would have to grow our sales 10 percent just to match our '08 sales.”
In the Kansas City market, some large jobs including sports stadium renovations, a new power plant and large commercial and industrial projects may soften the blow for the first half of 2009, but Doug Carlson, C&O Sales, Overland Park, Kan., is still wary of price deflation and the risk that the financing freeze will bring further construction to a halt. (For a closer look at this market, see “Coming to Kansas City,” page 32.)
“Deflating prices along with lack of credit might dampen our ability to continue at any pace because it might be cheaper to build at a later time and easier to get credit at a later time so construction stops,” Carlson said.
The doldrums of the overall economy may be the largest challenge, but they are hardly the only one facing companies in the electrical supply chain over the coming year. Asked what those other key challenges are, responses varied, but personnel and credit issues led the list.
“It is our hope to take advantage of the fact that good people will be laid-off and become available to work for a company. We are purposely looking for valuable people to join our company,” said Reynolds of Flynn-Reynolds.
The biggest challenge on Espinosa's radar, other than the economy, is keeping his people current on training, “Ensuring that all our associates are well trained on value-added products and the benefits to the end-user,” he said. “NAILD (the National Association of Independent Lighting Distributors) has an updated version of their LS-1 (lighting specialist 1) introductory lighting training programs online that we are requiring all associates to take and pass the final exam.”
On a national level, some of the industry's associations are looking to the new year's introduction of a new presidential administration and an altered balance of power in Congress. “Defeating pro-union Card Check legislation is a top priority for our members,” said Leavens of NEMA. “SmartGrid and energy-efficiency investment, which remain major initiatives, will be harder to sell as most companies and consumers struggle to survive the recession.”
At the street level in the electrical industry, never-ending challenges such as, “Keeping up with manufacturers' new product introductions and promotions initiatives to boost sales,” will put reps to the test in a tight market, said Dennis Tulimieri Sr., principal of Tulimieri Associates Inc., a rep firm in Glastonbury, Conn.
Reps, says Bliquez, will be facing, “The same challenges we have seen for a decade: consolidation of manufacturing, distribution and contractors; exporting jobs and importing products (too often inferior products); and recruiting good talent to the industry.”
The endless battle against price erosion will also take on new urgency. For Jury of Summit Electric, this challenge results from, “Irrational competition. Our industry has been running amok for so long with regard to how we set prices in the market and how much of our business is run like a Middle-Eastern rug bazaar with limited discipline in the area of pricing, ignorance of cost drivers and lack of clarity about what it takes to contribute to the bottom line. There are rampant inefficiencies in the market, from the way we interact with our customers to the whole SPA process which has become so complicated, inconsistent and abused that our business practices look surreal to an intelligent outside observer. I don't see how we can continue to pay for inefficiencies in a deflationary and recessionary environment. At some point, something has to give.”
Opportunities Do Exist
With a new year beginning, we also asked recipients of the survey to set aside their concerns about the economy for a moment and tell us what new products or programs they were excited about for the coming year. The answers generally came in various shades of green.
“The new administration has already strongly embraced energy-efficient electrical products such as lighting, motors, building controls, and power equipment,” said Leavens of NEMA. “After a relatively slow market penetration rate, markets for these products are likely to expand measurably over the next few years.”
“Alternative energy. Traditional products can be differentiated by promoting a manufacturer's zero-discharge manufacturing technique…or by promoting local manufacturing and its affect on a building's LEED application…or by promoting energy efficiency of a product,” said Haines of Haines Sales. “Certainly, new products and markets will become available — and integrated wisely into a business — can become the most exciting prospect for next year!”
“‘Green’ activities could be good for business,” agreed Carlson of C&O Electric Sales. “Increasing utility rates will make sure that the paybacks are improved. Alternative energy projects should receive more funding and Kansas and Missouri are enviable locations for those facilities.”
Bliquez of Ewing-Foley sees great opportunities for the electrical industry and for U.S. manufacturing down the road in the battery market, a niche seldom considered by traditional electrical distribution. “Battery manufacturing will be a very good technology to bring back to the U.S.,” Bliquez said. “Batteries would expand the service side of our industry: For example, the need for recharging stations for battery-operated cars. What a great market that will be for distribution and contracting! We have seen what battery-operated tools have done over the last 20 years and I think battery use will continue to expand in power tools and equipment.”
For a broader perspective, perhaps it helps to turn to those who've been dealing with the downturn much longer than the rest of the industry. In Syracuse, N.Y., the current turmoil is yet another blow in a market that has struggled for more than 10 years to find its footing after the collapse of some of the region's largest employers. Eric Haines of Haines Sales is counting on his agency's continued perseverance to carry them through.
“Upstate New York hasn't been a robust economy in well over a decade,” Haines writes. “Haines Sales has responded by becoming leaner and more focused. We have kept current with the latest productivity tools, and we continually look for ways to improve our service while keeping operating costs in check. We will continue to invest in developing pull-through demand for our marketing partners.”
In the broader sense, economic hardships do tend to revitalize companies and industries that make it through, allowing them to emerge tougher, more resourceful and stronger in the end.
“There is an unavoidable change in thinking which makes everyone in any company work harder, learn a little more, cooperate and pay attention to business,” said Bliquez of Ewing-Foley and NEMRA. “A little trouble now and then can be a good thing.”
Experts in the electrical industry's mergers and acquisitions game see consolidation continuing through the economic downturn.
Whether the general financial turmoil of this recession will bring a new wave of consolidation in the electrical distribution channel remains to be seen. People active in advising acquirers and acquirees in the market see signs that point both ways.
“Based on what we know or are involved with, we do not foresee any blockbuster transactions in 2009 like Rexel's acquisitions of Gexpro and Hagemeyer, and Sonepar's acquisition of the Hagemeyer U.S. operations,” said Burk Burkhardt, senior managing director, HT Capital Advisors, New York. “However, in our opinion, despite the current tight credit markets and generally difficult economic environment, the level of acquisition activity in terms of number of transactions involving Top 200 companies could be greater in 2009 than in 2008 when there were four transactions. Unlike back six to seven years ago when they just about totally halted their acquisition activity, the major consolidators seem to be taking a longer term view, and indications are that they continue to seek acquisitions. We also know the financially strong super-regionals continue to scout for acquisitions.”
On the other hand, Jonathan Skelly of PCE Investment Bankers, Winter Park, Fla., sees acquisition activity slowing down. “The acquisition climate within the electrical market will likely be slower in 2009 than in 2008,” Skelly said. “The first half of the year will be especially slow but then we expect to see better activity in the second half as ‘value’ buyers enter the market and look to acquire good companies and very fair valuations. We expect industrial- and commercial-driven wholesalers will be more active while those servicing residential markets will continue to do very few acquisitions.”
The new realities of the battered economy will tip the balance toward a buyer's market, with some exceptions, said our respondents. “It depends on the nature of the selling company, and how important the acquisition would be for a potential acquirer,” Burkhardt said. Some strong distributors with limited exposure to the residential market are still considered “must haves” by consolidators and will still be able to command a premium price, but others will find the market less hospitable, he said.
Skelly sees a similar picture. “Those with either cash on their balance sheet or an available line of credit are in a very attractive position in that they are able to offer sellers a fair deal without contingencies,” Skelly said. “The number of potential buyers in this position is limited, so a smaller supply of potential buyers matched against a larger number of potential sellers leads to a buyers' market. This is different from years past where there were multiple potential buyers with access to cheap capital that were competing fiercely for acquisitions, driving higher valuations and providing sellers with many options. Further, certain electrical distributors may find themselves in a weak financial position in 2009 and seeking a sale of the company may be their only option versus shutting down. In this forced position the power sides with the buyer who is able to offer the struggling seller a lifeline and is thus in a very good negotiating position.”
George Spilka, president of George Spilka and Associates, Allison Park, Pa., sees the buyer's market prevailing early in 2009, but possibly easing after that. “In general, the market during the first half of 2009 will be a buyers' market. This will continue until the economy begins to improve, which I believe should occur by the end of the second quarter of 2009,” Spilka said. “However, I strongly recommend to prospective sellers to remember that the sale of their company is the sale of a long-term asset. Consequently, unless there are unique personal circumstances that mandate a prompt sale, they should not sell their company at a discount price due to the current crisis of confidence in the financial markets. This will pass. And it will pass sooner as opposed to later. Don't be intimidated by the future, I don't expect it to be that bad. I am advising all clients to remain steadfast in their pricing. There are no discounts being given to ‘bottom fisher’ buyers.”
Asked whether they expect an influx of new acquirers into the market, the experts we surveyed all expect private-equity funds to play a diminished role in the short term due to the difficulties of accessing capital. Large regionals such as Border States, Mayer and Schaedler/YESCO may continue benefiting from opportunistic acquisitions, Skelly said.
There are some outside influences that could hasten the sale of some companies over the next year. Among them, access to capital is the most significant. Burkhardt also points to the potential for an increase in the federal capital gains tax. “Our legal and other sources think it is highly unlikely that the new administration will increase the rate in 2009, but will sometime in 2010, when the rate was going to increase to 20 percent if no other action were taken,” Burkhardt said. “So there may be a ‘window’ of 12 months to take advantage of the current low maximum 15 percent capital gains rate, and we believe many owners will do so.”