The U.S. Electrical Products industry is highly fragmented, with the largest suppliers together accounting for only a small percentage of total sales. Some of the largest players in this market are Hubbell Inc (HUB.B) and Thomas & Betts (TNB), which distribute their own products. Other manufacturers sell through distributors such as WESCO International (WCC), W.W. Grainger (GWW) and Anixter International (AXE).
The primary factors influencing growth in this market are new construction activity (residential, industrial and commercial), regular repair and maintenance activities, large government construction projects and calamity-driven spending (natural disasters and terrorist attacks). The split between new construction revenue and rehabilitation/renovation revenue is roughly 2:1 in non-recessionary market conditions.
We track the Architecture Billings Index (ABI) for determining the condition of construction markets. The ABI indicates architectural billings, which lag construction spending by around 9-12 months. A score above 50 generally means growth in billings.
The ABI for August 2009 was 41.7, compared to 43.1 in July. The sector-wise breakdown was commercial/industrial (ABI 45.6), multi-family residential (ABI 43.4), mixed practice (ABI 41.4) and institutional, which includes religious and government, (ABI 37.5). The below-50 number for all sectors and regions across the U.S. indicates continued broad-based weakness across all construction markets in the next 9-12 months.
Government spending was one of the last to decline, although spending requirements continue to increase. In a report published last year, The American Society of Civil Engineers estimated the total cost of fixing the country’s infrastructure at $1.3 trillion over the following five years. The snag is the funds crunch, which is being exacerbated by budget deficits and the recession.
The lone encouraging factor in the construction market is the new project enquiry index, which was 55.2 in August.
Industrial market growth indicators are mixed, indicating that although the worst may be over, it will be some time before the economy gets back to normal. Capacity utilization was 69.6 % in August 2009 compared to 77.6% in August 2008. However, this was higher than the 68.5% recorded in July 2009. The unemployment rate in 2008 averaged 5.8%. Unemployment levels continue to rise in 2009, reaching 9.8% in September.
The Purchase Managers Index (PMI) was again positive in September at 52.6, compared to 52.9 in August. This was the second time in the last 18 months that that the PMI crossed 50. A score below 50 generally indicates a contraction in the manufacturing sector and a score below 41.2 over a period of time indicates contraction in the overall economy.
Utilities have also been severely impacted by the recession, with poor construction activity impacting demand on the distribution side and the recession impacting flow of funds for investment on the transmission side. The government stimulus package is a positive, although government focus remains on “clean green energy.” The government continues to push back the overhauling of the national power grid, which would be a big driver for companies operating in this market.
According to the AIA, a major natural disaster resulting from hurricanes, droughts, tropical storms, floods, severe cold weather, tornadoes, wildfires etc. occurs around 10x a year, while minor disasters are numerous, and occur all through the year. The resultant damage runs into billions of dollars. Research shows that disaster declarations by FEMA and SEEMA have been rising over the last fifty years, giving rise to new concepts such as disaster management and disaster preparedness. This is a long-term driver of revenue for the industry.
OPPORTUNITIES
While it is easy to see the weakness in the near-term outlook, we continue to believe that the market is attractive for longer-term investors.
Hubbell, for instance, is one of the largest players in the wiring segment, with a leadership position in the commercial and industrial sectors. As the residential market turns the corner, the company will also benefit from the newly launched, comprehensive residential wiring line. The company is also a major player in other electrical markets such as commercial, industrial, harsh and hazardous-location, high-voltage test and measurement, and lighting.
Although the recession has had a negative impact on results, one can hardly discount the company’s market position and scale of operations, which are sure to act in its favor as the economy strengthens. The company has also generated stable margins over the last five years.
We also like W.W. Grainger, which continues to invest in long-term growth. The company has initiated market expansion and product-line expansion programs, which are aimed at increasing its market share. The company also has a solid balance sheet and generates strong cash flow.
Both HUB.B and GWW beat our earnings expectations in the last quarter.
WEAKNESSES
Although WESCO does have positives (we particularly like its national account model and focus on large regional and national contractors), the company has been severely impacted by the recession. End markets are very weak and we currently expect revenue to decline 21% in 2009, followed by another 8% growth in 2010.
Thomas & Betts is another poor performer. Management stated that the company had not seen the effects of government stimulus spending and end markets remained extremely weak. The low revenue is also pushing down margins, which have declined significantly compared to 2008.
Both WESCO and Thomas & Betts have a huge net debt position, which impact their valuation.Zacks Investment Research
