While electrical distributors don't appear to be expecting a big bounce back in the electrical market's business conditions, a recent survey conducted in the fourth quarter of 2011 (4Q11) tapped into a current of quiet optimism for the year ahead.
Results from the survey conducted by by KeyBanc Capital Markets, Cleveland, and Electrical Wholesaling indicated demand in 2011's fourth quarter was slightly better than the normal seasonal sequential demand decline associated with the construction cycle, but they didn't point toward a substantial outperformance to the upside. By end market, datacom and institutional construction exhibited the strongest sequential growth, while residential construction was weakest. In addition, it appears inventory levels should return to normal following a seasonal draw-down for the fourth quarter. It also appears the pricing environment remains generally stable, as commodity prices have pulled back during the 4Q11. Pricing concessions were not widely reported. Finally, results indicate that sentiment has not worsened but still remains generally cautious.
KeyBanc and EW recently completed the sixth in a series of quarterly surveys of conditions in the U.S. electrical distribution market. All responses were anonymous and have been aggregated 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. Here are the results of the quarterly survey for Oct. 2011 through Dec. 2011, based on more than 80 responses.
Core markets show signs of improvement
Based on the conditions cited in the survey, we believe the operating environment in the United States remains generally healthy and core industrial markets remain strong. Demand rose four percent sequentially in the 4Q11 and performed better than last year's sequential performance of up two percent (Fig 1). Overall, 71% of respondents saw flat or year-over-year improvement in revenues in 4Q11, down slightly from 80% in 3Q11 and 76% in 4Q10. End demand improved sequentially in 4Q11 with notable strength cited across all end markets except residential construction (Fig. 2). Relative to the sequential growth noted in 3Q11, voice-data-video (VDV) replaced industrial MRO as the fastest-growing end market. Additionally, non-residential construction improved the most on a sequential basis (up 2.7% versus up 1.4% in 3Q11) while industrial OEM realized the largest sequential drop (up 1.5% versus up 3.1% in 4Q11), which is most likely attributed to seasonality.
Since the inauguration of our survey, respondents have consistently noted residential construction remains the weakest market, but we believe this end market will begin to improve toward the end of 2012 given somewhat improved readings from the American Institute of Architects' Architectural Billings Index (ABI) and more favorable construction put-in-place data over the past few months.
Inventory levels suggest most of the seasonal inventory destocking dynamic has occurred
It appears forward-looking sentiment on future inventory builds has improved from the last quarter, as only 23% of respondents expect to reduce inventory for 1Q12, significantly less than the 39% of respondents who said they would reduce inventory for 4Q11. We believe any build in the first three quarters of 2011 was worked down in the fourth quarter with healthy industrial activity, and there has been little in the way of additional restocking. We note the survey did not take into account the dollar value of inventory, which most likely fell during the 4Q11 as commodity costs have declined since 2Q 2011. Similar to last quarter, only seven percent of the respondents said they are reducing the amount of capital spent on inventory for the upcoming quarter (1Q12) at a faster pace than normal (versus 10% in 4Q11 and 11% in 1Q11), suggesting the bulk of the reduction is not based on fears of a significant contraction in demand (Fig. 3).
The price/cost spread is favorable but appears to be moderating
Primary input costs for goods that distributors sell (copper, steel and resin, etc.) have for the most part remained at similar levels from the end of 3Q 2011. We continue to believe distributors will not have to concede a reduction in selling prices equal to the full amount of the decline in the underlying commodities since the beginning of the year, as past price increases should remain intact. We believe this outcome should help 4Q11 results as it offsets any slowdown in volume during the quarter. However, given most distributors will begin to lapse last year's price increases at the end of the 4Q11, it's unlikely they will realize the same benefit in price/cost spread in FY12 versus FY11 if commodity costs remain at these levels. This observation is underscored by survey results that show 40% of customers are now requesting price reductions, up from 36% in 3Q11 (Fig. 4).
At the same time, a smaller percentage (17%) are noting customers were still accepting price increases (down from 23% in 3Q11). On average, results from our survey indicated products sold into the industrial MRO markets were able to realize the most pricing latitude during the quarter. While non-residential construction and residential construction markets were forced to concede the most price, the overall percentage of respondents who suggested price declines were necessary to sell goods into those markets significantly declined from the prior quarter. This may be an indication of the aforementioned improving conditions in the construction markets and underscores our belief that construction markets may begin to improve in the second half of 2012.
The hiring picture is cautiously optimistic for 2012
There seems to have been a stabilization of hiring practices since last quarter, with the majority of respondents noting their customers have largely retained existing levels of employment. Approximately 52% of respondents in 4Q11 suggested their customers are maintaining current employment levels and, at the same time, only 32% of contractors are either laying off current employees or suffering from idle capacity by being forced to reduce hours to existing employee workload. Customers' layoffs/reduced employee hours are slightly up from 28% in 3Q11 and 29% in the year-ago period.
Most electrical distributors did not add or cut headcount during 4Q11 (58% in 4Q11 versus 46% in 3Q11 and 60% in 4Q10). Approximately 27% actually added employee hours or hired additional employees, slightly down on a sequential basis (36%) and flat year-over-year (27%). We believe prospects for hiring by electrical distributors show the channel's cautious confidence level, as distributors are typically one of the last players in the value chain to hire in an up-cycle. That said, it appears most electrical contractors have a “wait-and-see” attitude until business conditions become clearer.