HUB.B

WESCO International (WCC) announced first-quarter earnings that missed the Zacks Consensus Estimate by $0.05, or 4.3%.

Revenue

WESCO reported revenue of $1.81 billion, which was up 10.0% sequentially and 12.6% year over year.

The year-over-year increase was the positive impact of acquisitions, which adding 16 percentage points of growth and was partially offset by a lower number of working days and a reduction in organic sales. The sequential increase was the strongest in years, helped by the EECOL acquisition. The core business performed in line with normal seasonality.

End Market Update

WESCO is seeing signs of strength across end markets, with a swelling opportunity pipeline, higher bidding activity and growing backlog. The Utilities market remains the strongest.

WESCO stated that Industrial distributors remained conservative and even reduced inventories in some cases. However, the OEM and MRO sides of the business were consistent with the year-ago quarter. Year-over-year comps were hard because of several ongoing industrial capital projects last year that did not continue into the last quarter. Management was optimistic about the opportunity pipeline, which continued to expand. The One WESCO model helped sign up a major telecom provider.

Similar to Hubbell (HUB.B), which also reported at around the same time, WESCO is seeing a mixed Construction market. However, WESCO is seeing improvement in Canada and most other international markets. The U.S. market, though showing improving trends, again had difficult comps because of more conducive weather in the year-ago quarter that pulled some construction business into the quarter. The residential construction story remains positive, although WESCO’s limited exposure to the segment means that there will be no material impact on its results.

The Utilities business continues to see good growth, which management attributed to WESCO’s integrated supply model. The model is particularly helpful for utilities looking for efficiency and effectiveness in their supply chains. 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. Construction markets typically provide the impetus for greater spending by utilities, so stronger construction markets will further add to this strength.

Sales into the CIG market (schools, hospitals, property management firms, retailers, financial institutions, cable companies and governmental agencies) declined for the second straight quarter.The government side of the business is weaker because of budget constraints and deferral of project awards.

Margins

The gross margin was 21.1%, up 57 basis points (bps) sequentially and down 117 bps year over year. WESCO has maintained very steady gross margins over the past year or so, which is the result of its integrated model and tight cost control.

Operating expenses of $280.3 million were up 33.5% sequentially and 18.7% from the year-ago quarter. As a result, the operating margin of 5.6% shrank 217 bps from the previous quarter and expanded 37 bps from the year-ago quarter. WESCO took a litigation charge of $36.1 million in the fourth quarter and a gain of a similar amount in the last quarter (in recognition of insurance coverage). The above comparisons exclude the adjustments in the relevant quarters.   

Net Income

WESCO reported pro forma net income of $58.6 million, or a 3.2% net margin, compared to $90.7 million, or 5.5%, in the previous quarter and $52.9 million, or 3.3% in the year-ago quarter. Our calculation excludes the litigation-related adjustments discussed above.

Excluding the special item, the GAAP net income was $80.6 million ($1.54 a share), compared to $48.6 million ($0.95 a share) in the previous quarter and $53.0 million ($1.03 a share) in the Mar quarter of 2012.

Balance Sheet

Inventories were flat sequentially, with inventory turns going from 6.6X to 7.2X. DSOs were down from 57 to over 55. The cash balance at the end of the quarter was $116.8 million, up $30.7 million during the quarter.

WESCO generated $80.4 million in cash from operations and spent $6.0 million on capex, resulting in free cash flow of $74.4 million during the quarter. The net debt position at quarter-end was $1.56 billion, down $90.9 million during the quarter.

Guidance

For the second quarter of 2013, WESCO expects year-over-year revenue increase of at least 13-16% (down 1% to up 2% excluding the contribution from EECOL). The guidance indicates around 6% sequential increase at the mid-point, better than the Zacks Consensus and more or less in line with the normal level of a mid-single-digit sequential increase. The gross margin is expected to be at or above 20.9% and the operating margin at least 6.0%. The tax rate is expected to be in the 26-28% range.

WESCO didn’t update its guidance for the year, so we assume it remains the same. Accordingly, sales are expected 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 strengthening end markets and its integrated supply model, which is increasing efficiencies for its customers. The guidance is encouraging and could be cautious, particularly so if end markets improve as we move through the year. For the longer term, we continue to believe in WESCO’s solid strategies, good operating model, market position and customer clout.

However, near-term results will continue to be impacted by economic activity, given the company’s exposure to core segments, such as industrial, utility, construction and government that should contain share price appreciation.

WESCO shares carry a Zacks Rank #4 (Sell). Other technology distributors, such as Avnet (AVT) and Richardson Electrictronics (RELL), with Zacks Ranks of #2 and #3 are better stocks to consider at the moment.

 
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