WESCO International (WCC) recently announced second quarter earnings that exceeded the Zacks consensus estimate by 7 cents, or 7.5%.
Revenue
WESCO reported revenue of $1.52 billion, which was up 6.5% sequentially and 21.1% year over year. The average revenue per employee was up 4.9% sequentially.
Acquisitions and currency positively impacted revenue by 7.4% and 1.0%, respectively, netting a 12.7% organic growth from the year-ago quarter. Sequential comparisons were impacted by a 0.9% positive impact of acquisitions and 0.4% positive impact of currency, resulting in an organic growth rate of 5.2%. Pricing had a positive 3% impact on sales in the last quarter.
End Market Update
All six product lines and all four end markets served by WESCO grew from the year-ago quarter. Sales to industrial, construction, utility and commercial, institutional & government (“CIG”) customers increased 18%, 13%, 6% and 3%, respectively from the year-ago quarter.
The datacom business was impacted by a product transition at WESCO, but the core business saw backlog growth of 30%, which indicates strong growth in future quarters.
WESCO stated that the Industrial market continued to grow in the last quarter, although at a slower rate and that the important markets of oil, gas, metals, mining, core industrial, OEM and government were all up from last year. The execution on the global account and integrated supply model was very good, helping to drive this growth.
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.
The Construction market remains a mixed bag, with the non-residential construction market remaining soft, although WESCO was able to buck the trend in the last two quarters through its global account model. Residential construction, to which WESCO has limited exposure will take a couple of years to turn around, according to management. Government stimulus funded projects are expected to add to strength in the area.
The Utilities business started turning around in the last quarter, helped by transmission and alternative energy projects. WESCO has been increasing offerings on the transmission side that held up better during the downturn, although traditionally these products have been sold directly. The recovery in construction has had a positive impact on utilities’ spending (mainly on the transmission side) and stimulus driven spending will be another tailwind going forward.
Construction markets typically provide the impetus for greater spending by utilities, so any significant growth at utilities is inevitably linked to the construction market. The distribution side of the business, which is WESCO’s primary market, will be slower to recover, although management expects the business to stabilize this year.
The gross margin was 19.6%, up 17 basis points (bps) sequentially and 78 bps year over year. The improvement in the gross margin was helped by WESCO’s margin expansion initiatives, as acquisitions, cost efficiencies, pricing, supplier volume rebates and inventory-related reserves all contributed. Cost inflation remains a headwind.
Operating expenses of $214.2 million were flat sequentially and up 15.2% from the year-ago quarter. As a result, the operating margin of 5.6% was a 105 bp increase from the previous quarter and 150 bps higher than in the year-ago quarter. This marked the fourth straight quarter of year-over-year expansion in the operating margin since December 2006 and was the effect of management initiatives to keep a rein on expenses.
Net Income
WESCO reported net income of $50.2 million, or a 3.3% net margin, compared to $37.3 million, or 2.6%, in the previous quarter and $27.8 million, or 2.2% 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 a dollar, up from 74 cents in the March 2011 quarterand 60 cents in the June quarter of 2010. WESCO stated that around 3 cents of earnings were attributable to recent acquisitions.
Balance Sheet
Inventories were up 0.5% sequentially, with inventory turns increasing slightly from 7.3X to 7.7X. DSOs went down a day to around 55. The cash balance at the end of the quarter was $78.6 million, up from $52.4 million at the end of the previous quarter.
WESCO used $9.3 million in cash from operations and spent $10.3 million on capex, resulting in free cash flow of -$19.6 million during the quarter. The net debt position at quarter-end was $679.8 million, up $24.1 million during the quarter.
Guidance
For the Third quarter of 2011, WESCO expects year-over-year revenue increase of at least 18%, gross margin in the high-19% range and operating margin at or above 5.4%. Interest expense will be slightly down sequentially and tax rate in the 30-32% range.
The strong first half results and expectations for the second half of the year prompted management to raise full-year expectations. Accordingly, sales growth is expected to be 19% (previous expectations 17%), gross margin at or aove 19.9%, operating margin at or above 5.1% and a full-year effective tax rate of 29-31%. Full year cash flow is expected to be at least 80% of net income for the year.
Conclusion
WESCO’s business appears to be undergoing a gradual turnaround and we are encouraged by the strong guidance for next quarter.
WESCO has solid strategies, a good operating model, market positon and customer clout. However, results are impacted by economic activity, given the company’s exposure to core segments, such as industrial, utility, construction and government. The GDP growth rate is therefore a suitable barometer of the company’s performance, both in the past and the future.
Given the continually improving trends, the Zacks Rank on the shares has moved up to #2, implying a Buy recommendation in the short term. Our long term recommendation remains Neutral.
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