Why Investing in Electrical Equipment Companies Is a Good Idea

The electrical equipment industry is marked by certain aspects that investors should seek out in companies they are considering for investment. Specifically, the best sector participants are highlighted by one or more of the following features: Expansion into emerging geographical markets, accretive acquisitions, capitalizing on positive economic trends, and a broadening of existing technologies into untapped product markets. One example of each, by way of a representative company, should help investors decide where to invest.

Emerging geographies
One of the best examples of an equipment company benefiting from growth in newly entered global markets is also among the largest overall. Emerson Electric (NYSE: EMR  ) derived 44% of its fiscal 2012 (ended in September) pre-tax income from non-U.S. sources. During the current year, it has been achieving growth in regions such as Latin America and the Middle East/Africa, while also bringing in sizable proportions of sales from Europe, Asia, and Canada.

The overall impact of Emerson's geographical diversity is a stabilization of results. Revenue has been trending slightly lower in the U.S., while being about flat overseas, the effect being relatively consistent earnings.

For instance, the impact of Thailand floods on profits in the core Process Management division was offset by strength in other foreign markets, such as Asia. In its Industrial Automation unit, rising sales from Asia and Canada limited the impact of weakness elsewhere. Also, in Network Power, results would have been even worse if not for growth in certain regions. Finally, the Climate Technologies segment-related challenges were alleviated by growth in emerging regions. This discussion is all in relation to the latest June quarter.

Emerson is a worthwhile holding for long-term price upside and yield, which is an impressive 2.70%. 

Economic cyclicality
Most of this industry is tied to the prevailing economic climate, some to a greater extent than others.

W.W. Grainger (NYSE: GWW  ) states that its North American sales are positively correlated with five specific economic statistics. These are

1. Gross Domestic Product

2. Industrial Production

3. Exports

4. Business Investment

5. Business Inventory (U.S. only)

All of these metrics are on track to increase in 2013 (see charts). Accordingly, Grainger is enjoying solid earnings growth this year, with earnings likely to expand about 15% from fiscal 2012--ending in September).

W.W. Grainger is focused mainly on the facilities maintenance end market. It produces items such as material handling equipment, safety and security supplies, and lighting/electrical products, along with a wide range of other supplies/products.

Notably, too, Grainger has apparently gained share in the light and heavy customer manufacturing end markets, as sales to these sectors outperformed employment levels and output. I believe the company can consistently exceed expected growth rates in this manner through e-commerce, sales force expansion, and inventory management initiatives.

Shares have appreciated considerably in 2013, but still look good for the long run. Its financial strength and profitability ratios exceed the broader industry.

Acquisitions
The electrical equipment industry is currently consolidating probably to a greater extent than most, a factor that has supported income gains among many of the largest companies.

My example here is WESCO International (NYSE: WCC  ) and its buyout last December of EECOL Electric, a distributor with locations across Canada and a presence in South America. The acquisition boosted sales by 15% in the June quarter, when sales grew 13% year over year. It helped WESCO to realize a gain of a penny in earnings to $1.25 for the quarter.

WESCO aims to achieve organic growth above that of the industry, accompanied by gains from acquisitions. Its customer contingencies are industrial, construction, utility, and the commercial, institutional, and governmental contingency; the respective contributions of each sector to sales in 2012 was 44%, 32%, 12%, and 12%, respectively.

The shares, at a forward P/E of 12.1, look good as WESCO should continue to realize benefits from the EECOL purchase.

Expanding applications
This industry, while heavy on acquisitions, is light on R&D. Companies do occasionally aim to bring their existing technologies to new product markets with favorable outcomes.

For example, NCR (NYSE: NCR  ) , a manufacturer of automated-teller machines and retail-point-of-sales systems, has in recent years built a presence in the Hospitality (hotels, gaming) industry. Indeed, the hospitality segment was its fastest-growing business during the June quarter.

The company also sees opportunity for kiosk technologies in additional markets, such as travel, restaurants, cinema, DVD rentals, and others. These offerings now comprise an emerging industry segment that ought to be a contributor to profit gains in subsequent periods.

NCR's overall performance has been excellent of late and earnings are on track to climb solidly this year. Should investments related to further end market expansion bear fruit, NCR could be a worthwhile long-term holding.

Finding the best selection
All of the factors discussed concerning electrical equipment stocks can probably be considered in relation to almost any industry participant to some extent. If a company is benefiting from two or three of these conditions, it may well be a good investment.

Those with a conservative bent of mind would likely be best served with an investment in Emerson or Grainger, two of the lower-beta choices among these four stocks. WESCO is best-suited for those looking for a firm aggressively expanding in growing markets (see "This Electrical Product Maker Is Well Positioned"). Finally, NCR holds appeal to those anticipating rising spending by banks and other industries on self-service technologies.

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