HUB.B

WESCO International (WCC) announced fourth-quarter earnings that missed the Zacks Consensus Estimate by $0.03, or 2.8%. The guidance for 2013 also disappointed.

The Zacks Consensus Estimate for 2013 moved up 59 cents during the last 60 days, but guidance missed by 14 cents. As a result, the shares slid 1.35% in extended trading.

Revenue

WESCO reported revenue of $1.64 billion, which was down 0.7% sequentially and up 3.5% year over year.

Acquisitions and currency positively helped revenue by 4.3% and 0.5%, respectively, excluding which there was a 1.3% decline in organic revenue from the year-ago quarter. Management stated that the 2.4% sequential decline in organic sales was in line with seasonality.

End Market Update

WESCO experienced weakness across all end markets, as demand slowed down. Utilities were an exception, driven by Hurricane Sandy-related expenses. Management reported two major customer wins, one each in the industrial and utilities markets.

WESCO stated that although sales into the Industrial market slowed down with respect to the first half of the year, growth was helped by the company’s global account and integrated supply model, which helped score new multi-year distribution wins.

Similar to Hubbell (HUB.B), which reported last week, WESCO is seeing a mixed Construction market, with international remaining stronger than domestic (backlog down 3% in the U.S. and up 10% internationally) in the last quarter. The U.S. non-residential construction market remains soft, but there are signs of improvement that should benefit WESCO in the back half of the year. Here too, WESCO has been able to buck the trend through its global account model. The residential construction story has however turned positive, although WESCO’s limited exposure to the segment means that there will be no material impact on WESCO’s results.

The Utilities business continues to see good growth, which management attributed partly to WESCO’s integrated supply model and partly to its initiatives in the wind energy segment. The last quarter also benefited from an additional $12 million in revenue as a result of power restoration efforts related to Hurricane Sandy. WESCO has steadily improved its offerings on the transmission side, which has seen it through the recession. However, the current strength is also attributable to an improving distribution business, which is the natural result of stronger construction markets. Construction markets typically provide the impetus for greater spending by utilities, so any significant growth at utilities is inevitably linked to the construction market.

Sales into the CIG market (schools, hospitals, property management firms, retailers, financial institutions, cable companies and governmental agencies) were down from last year due to more difficult comps (WESCO shipped a large datacom government project in the year-ago quarter).

Margins

The gross margin was 20.5%, up 6 basis points (bps) sequentially and down 12 bps year over year. WESCO has maintained very steady gross margins over the past year or so, which is the result of its global account model and tight cost control.

Operating expenses of $246.0 million were up 4.4% sequentially and 4.0% from the year-ago quarter. As a result, the operating margin of 5.6% shrunk 67 bps from the previous quarter and 20 bps from the year-ago quarter. Significant headcount additions contributed to the higher expenses (up 18.7% sequentially and 21.9% year over year) and management expects recruitments to continue.

Net Income

WESCO reported pro forma net income of $54.6 million, or a 3.3% net margin, compared to $63.4 million, or 3.8%, in the previous quarter and $54.8 million, or 3.4% in the year-ago quarter. Our calculation excludes acquisition-related charges and a loss on debt extinguishment on a tax-adjusted basis in the quarter.

Excluding the special items, the GAAP net income was $48.6 million ($0.95 a share), compared to $63.4 million (1.25 a share) in the previous quarter and $54.8 million ($1.12 a share) in the Dec quarter of 2011.

Balance Sheet

Inventories were up 19.8% sequentially, with inventory turns down from 8.0X to 6.6X. DSOs were up from 56 to over 57. The cash balance at the end of the quarter was $86.1 million, down $21.5 million during the quarter.

WESCO generated $98.5 million in cash from operations and spent $3.6 million on capex, resulting in free cash flow of $94.9 million during the quarter. The net debt position at quarter-end was $1.62 billion, up $1.03 billion during the quarter.

Guidance

For the first quarter of 2013, WESCO expects year-over-year revenue increase of at least 12-14% (flat excluding the contribution from EECOL), gross margin at or above 20.6% range and operating margin at least 5.5%. The tax rate is expected to be in the 27-29% range.

For the full year, WESCO expects sales to be up 16-18% on a consolidated basis (flat in the first half and up mid-single-digits in the second half excluding EECOL). The gross margin is expected to be at least 20.7%, with the operating margin at or above 6.2% and the tax rate at 27-29%. All this is expected to result in an EPS of $5.75 for the year (well below the Zacks Consensus Estimate of $5.89).

Conclusion

WESCO’s business is currently being driven by international strength. The guidance appears rather weak and is indicative of softer-than-expected industrial markets. Utilities appear to be doing quite well however, and the company continues to deliver on its global account and integrated supply model.

While near-term results will be impacted by economic activity, given the company’s exposure to core segments, such as industrial, utility, construction and government, we continue to believe in WESCO’s solid strategies, good operating model, market position and customer clout.

WESCO shares carry a Zacks Rank #1 (Strong Buy). Other technology distributors, such as Avnet (AVT) and Richardson Electrictronics (RELL), with Zacks Ranks of #1 and #2, respectively are also worth considering.

 
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