WESCO International (WCC) announced third quarter earnings that exceeded the Zacks Consensus Estimate by 9 cents, or 13.8%.

 

Revenue

 

WESCO reported revenue of $1.32 billion that beat the Zacks Consensus expectation by 3.9%, increasing 5.2% sequentially and 14.9% year over year.

 

The average revenue per employee was $869 million, up 5.2% sequentially and 20.6% year over year.

 

Pricing, currency and acquisitions positively impacted revenue by 2.5%, 0.9% and 0.7%, respectively in comparison with the year-ago quarter. Sequential comparisons included a 0.7% positive impact of acquisitions and a 0.2% negative impact of currency. Pricing did not impact the seqeuntial comparison.

 

End Market Update

 

Three of the four end-markets served by WESCO grew from the year-ago quarter. Sales to industrial and government customers increased 27% and 30% respectively from the year-ago quarter. Construction and datacom markets were not far behind, growing 15% and 21%, respectively from the year-ago quarter. However, utilities remained sluggish, declining 9% on a year-over-year basis.

 

Industrial market strength was driven by share gains, according to WESCO, since strength was broad-based across MRO, OEM and capital projects. Management stated that global bid activity levels were growing competitive at smaller accounts, but remained encouraging at larger players.

 

Management expressed satisfaction regarding the working of the global account model. The model also includes some construction and utility customers, so some of the bid activity relates to those markets as well. The strength in industrial is expected to moderate but continue through 2011, according to WESCO.

 

Construction—primarily commercial, institutional and government—was a mixed bag, although here too, management believes that WESCO is taking share. As expected, sales to the government sector continued to strengthen in the last quarter, the positive result of focused management actions. Government stimulus funded projects are expected to add to strength in the area, since the company booked around $40 million in orders for qualified projects in 2009.

 

The stimulus-related opportunity pipeline increased to $460 million by the end of the quarter. Overall, WESCO expects the commercial and institutional construction market to remain weak until 2012, although other areas are expected to pick up gradually through the rest of the year and in 2011.

 

Utilities spending remains restricted by weak demand, as commercial markets did not pick up sufficiently, which resulted in lower occupancy rates. As a result, both investor-owned and public power utilities’ spending on capital and maintenance activities was conservative in comparison to the year-ago quarter. Sequential comparisons continued to improve in the last quarter, with WESCO expecting a gradual recovery in 2011.

 

Margins

 

The gross margin was 19.0%, up 16 basis points (bps) sequentially and 40 bps year over year. While volume, pricing and mix contributed to improvement from the year-ago quarter, sequential comparisons related to higher volumes alone.

 

Operating expenses of $190.6 million were down 2.5% sequentially and 13.2% from the year-ago quarter. The persistent decline in operating expense dollars is the result of cost-reduction programs initiated by management, which resulted in the elimination of 1200 positions. The operating margin of 4.6% increased 55 bps sequentially and 61 bps from the September quarter of 2009. This was the first quarter of year-over-year expansion in operating margin since December 2006.

           

Net Income

 

The company reported net income of $33.7 million, or a 2.5% net margin, compared to $27.8 million, or 2.2%, in the previous quarter and $27.7 million, or 2.4% in the year-ago quarter. There were no special items in the last quarter. Therefore, the GAAP EPS was same as the pro forma EPS of 74 cents, up from 60 cents in the June 2010 quarter and down from 79 cents in the September quarter of 2009.

 

Balance Sheet

 

Inventories were up 3.9 sequentially, with inventory turns edging up from 7.7X to 7.8X. DSOs increased from 53 to 55. The cash balance at the end of the quarter was $103.1 million. The company generated $6.7 million in cash from operations and spent $4.1 million on capex, resulting in free cash flow of $2.6 million during the quarter.

 

The net debt position at quarter-end was $380.5 million, down $7.5 million during the quarter. Short term debt inched up to around $96.7 million, as the company reclassified its 2025 debentures as short term in the Dec 2009 quarter, expecting them to be redeemed in the fourth quarter of 2010.

 

Guidance

 

Management expects revenue in the second quarter of 2010 to be down 3-5% sequentially, with gross margin at around 19.5% and operating margin at around 4.2%. The operating margin is expected to be around 4.0%. The full-year effective tax rate is expected to be 28-30%.

 

Conclusion

 

WESCO’s business appears to be undergoing a gradual turnaround and we do not really see any surprises. Management execution has been good and execution through the downturn has been good so far. The company has solid strategies, a good operating model, market positon and customer clout. However, results will no doubt be impacted by economic activity, given the company’s exposure to core segments, such as industrial, utility, construction and government.

 

The GDP growth rate is a suitable barometer of results. We therefore, have a short term Hold recommendation on the shares, as indicated by the Zacks #3 Rank. Our longer-term recommendation is also Neutral, since we expect only gradual improvement over a period of time.

 
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