To gauge near term trends for the March 2012 quarter, we have again conducted our proprietary KeyBanc Capital Markets Electrical Distributor survey in association with Electrical Wholesaling. This is our seventh quarterly survey of North American electrical distributors in partnership with the magazine, and last month we received more than 60 responses detailing trends in sequential demand, pricing, inventories and outlook going forward. Here are the key trends that emerged from our research.
Sequential demand trends came in stronger than historic seasonal patterns in 1Q12
We estimate end demand rose 1% sequentially in 1Q12 with notable strength cited across industrial OEM, non-residential construction, industrial MRO and voice-data-video verticals (Figure 1). The overall sequential performance is higher than the historical average of down 1% noted by participants and is a slight deceleration from the year-ago period. The higher than historical average is potentially attributable to more favorable weather, which is apparent in the stabilization of construction end markets. We think both residential and non-residential construction markets will begin to contribute to results toward the end of 2012, given improved conditions with architectural firms, as shown in the recent Architectural Billings Index (ABI) published monthly by the American Institute of Architects (AIA), Washington, D.C., and more favorable construction put-in-place data over the past few months. However, other markets such as utility, institutional construction and national accounts showed a meaningful step down on a sequential basis (and lower than 1Q11 sequential growth). This is worrisome and should be closely watched.
Inventory levels remain low and should be supportive of pricing power
Approximately 73% of respondents said they expect to either maintain or slightly build inventory levels for 2Q12 vs. the 1Q12, even as historical seasonality suggests demand improves 9% on a sequential basis (Figure 2). Any build in distributor inventories during the first two quarters of 2011 was most likely worked down by the 4Q11 with healthy industrial activity, and there has been little in the way of additional restocking. We believe inventories are historically low across the supply chain when you consider information available from publicly traded industrial companies and other economic data such as the Institute for Supply Management (ISM) data, and U.S. Census data on wholesalers' inventories. Low inventory levels should be supportive of pricing power going forward if demand were to accelerate from here.
The price/cost spread shows improvement from 4Q11, which should augment volume leverage ahead
Primary input costs for goods that distributors sell rose in 1Q12 vs. 4Q11, reversing the trend witnessed in the 4Q11 where copper fell 16% and aluminum fell 13%. We believe recent appreciation in 1Q12, in conjunction with lean inventory levels addressed previously, should enable distributors and manufacturers to more successfully pass along higher cost inventory and augment volume leverage. Our belief is underscored by survey results showing only 28% of customers are now requesting price reductions, down from 40% in 4Q11. At the same time, 60% noted they were still able to pass along some of the cost inflation. On average, results from our survey indicated products sold into the industrial MRO and utility markets were able to realize the least amount of pricing concessions necessary to sell goods during the quarter (Figure 3).
Hiring slightly improved from 4Q11
The employment situation indicates a stabilization of hiring practices since last quarter with the majority of respondents (67%) noting their customers have largely retained existing levels of employment, added hours to existing employee workload, or hired new employees due to high capacity (Figure 4). These results are relatively consistent with 4Q11 (68% of respondents). Looking at distributors themselves, the employment situation has slightly improved on a sequential basis as approximately 86% retained employees, added employee hours or hired new associates. While this is up from 85% in 4Q11 and 83% in 3Q11, the percentage of new hires showed more improvement on a sequential basis (24% vs. 20% in 4Q11) and is comparable to the improvements in hiring data from public sources. Because of a good business climate early in 2012 that's partially attributable to more favorable weather, we find it encouraging that respondents believed their customers' outlooks for 2012 remained in line with the outlook established during the 4Q11.