End market trends for the electrical distribution industry remained strong through the first quarter of 2011, according to a recent survey by KeyBanc Capital Markets, Cleveland, in partnership with Electrical Wholesaling magazine.

According to survey results, customer demand improved in 1Q11 with notable strength in industrial MRO, institutional construction (government, educational, health care) and industrial OEMs. Respondents said they were buying more inventory, which is always a good indicator of higher distributor confidence.

While confidence and inventory levels are rising, higher commodity costs continue to pose a risk to margins and profitability for both manufacturers and distributors, as 65 percent of respondents noted at least some negative price/cost spread. We also surveyed distributors on the potential impact from any disruptions to the Japanese supply chain from the after-effects of the tsunami disaster. Judging from the survey results, the impact appears to be relatively minor at this point and should most likely not be a major factor going forward.

Methodology

This survey by KeyBanc and EW is the third 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 comprise what should be a clear and up-to-date picture of trends in demand, pricing, inventory levels and future outlook in the electrical distribution market. The results of the quarterly survey for January through March 2011 are based on more than 150 responses.

1Q11 sequential demand trends pick up over 4Q10

Similar to 4Q10 results, it appears 1Q11 demand trends are higher than the typical seasonal trend for sales in the 1Q. Approximately 52 percent of respondents noted 1Q11 demand levels grew quarter-over-quarter, compared to 41 percent of respondents that stated positive growth was characteristic for the 1Q. Quarter-over-quarter demand trends continued to improve on a sequential basis since 3Q10 with 52 percent of respondents indicating growth vs. 45 percent in 4Q10 and 42 percent in 3Q10 (Figure 1).

Sequential demand trends for 1Q11 show upside to historical norms

According the survey, demand improved sequentially in 1Q11, with the notable strength cited in industrial MRO, institutional construction and industrial OEM (Figure 2). Residential construction continued to lag on a sequential basis (down seven percent quarter-over-quarter vs. down four percent quarter-over-quarter in 4Q10).

Price/cost dynamic remains a risk

Commodity costs such as copper, steel and resin continued to rise during the quarter and pose a risk to profitability for manufacturers and distributors if they were unable to pass these higher prices down the channel. About 65 percent of the respondents indicated some level of negative price/cost spread, suggesting suppliers have been able to combat commodity inflation more effectively than distributors (Figure 3).

That said, it appears the brunt of commodity inflation has fallen on end users, as survey respondents have been able to pass along a greater portion of the commodity costs than in 4Q10. Copper increased 11 percent sequentially and 33 percent year-over-year from the average of $4.43 in 1Q11. While a steady inflationary environment for commodities is generally positive in the long run, rapid acceleration can make it difficult for manufacturers and distributors to recapture selling costs as price escalator clauses typically lag commodity increases by one to two quarters.

Inventory levels appear higher in anticipation of future demand

Based on expectations for inventory builds, it appears forward-looking sentiment is incrementally positive as a greater portion of respondents are anticipating expanding inventories relative to 2Q10. Approximately 37% of respondents noted they are investing capital towards inventory for the upcoming quarter (2Q11), which is a substantial increase from 20% in 4Q10 and 23% in 3Q10 (Figure 4).

Higher inventory levels at the distributor level are being influenced by the construction cycle as well as general optimism that current demand momentum should continue into mid-2011. According to comments from public distributors, inventory levels at the distributor level were balanced exiting the December 2010 quarter. Therefore, a modest inventory build at the distributor level in 2Q11 should not be viewed as problematic and is more representative of healthy demand trends going forward.

2011 outlook appears cautiously optimistic

Since 3Q10, it appears the employment situation points to a higher degree of confidence in the sustainability of the recovery, as approximately 26 percent of respondents in 1Q11 suggested their customers are either hiring additional employees or improving productivity by adding additional hours to existing employee workload. This is up from 16 percent in 4Q10 and 18 percent in 3Q10.

Most respondents did not add or cut headcount during 1Q11 (45 percent in 1Q11 vs. 60 percent in 4Q10). However, 37 percent actually added employee hours or hired additional employees (28 percent in 4Q10) vs. those who reduced employee hours or laid off employees (18 percent in 1Q11 vs. 13 percent in 4Q10). Increased hiring at the distributor level is a great indicator of business confidence, as distributors are often among the last players in the supply chain to hire in an up-cycle.

If you have any questions on the survey, contact Anthony Kure at akure@keybanccm.com or Karl Ackerman at kackerman@keybanccm.com.