Basic Materials Wholesale: Investor Essentials

A look at what investors need to know about the basic materials wholesale industry.

Aug 19, 2014 at 12:00AM

Middlemen tend to be seen in a poor light. They buy goods in bulk from a producer and sell them at higher prices to retailers, who sell them for even higher prices to consumers. However, these middlemen, or wholesalers, are a vital part of trade as they allow producers to focus on production and enable goods to move more efficiently.

What is the basic materials wholesale industry?

The name really says it all, but let's break it down a bit. Basic materials are quite simply the building blocks of society. These include metals, chemicals, forestry products and in some cases refined petroleum products. The sector as a whole includes everything from the discovery, development and processing of raw materials.

Wholesale, meanwhile, is basically the resale of goods to anyone that isn't the end user. In general terms a wholesaler will purchase a product from a manufacturer and then distribute and sell it to a retailer that will then sell that product to customers.

Add the two together and we have the basic materials wholesale industry. More specifically it includes the companies that distribute and sell basic materials like refined petroleum, chemicals, timber, agricultural supplies and industrial products. An example of a basic material wholesale company would be one that buys gasoline from a refiner and distributes it to gas stations. 

How big is the basic materials wholesale industry?

While the basic materials industry is vitally important to modern society, it is actually just a small portion of the overall stock market. It makes up just 3.5% of the market's total capitalization, which makes it the smallest sector. Given that the basic materials wholesale industry serves the basic materials industry, it's an even smaller subset.

In the U.S. data for the basic materials wholesale industry isn't broken out. However, the U.S. Census Bureau reports monthly wholesale trade data in terms of durable and non-durable. Its latest report totaled $460.8 billion. In breaking out the wholesale numbers for lumber, metals, and chemicals it totals to just $37.2 billion, while petroleum added another $66.5 billion to that number. So, wholesale basic material trade is a small portion of America's wholesale market.  

How does the basic materials wholesale industry work?

The basic materials wholesale industry is basically the middleman between basic material producers and the companies that sell those products to end users. As such basic materials wholesalers make their money on the spread between where they buy a product and where they sell it. Because of this it's a volume based business where sales might be large but profits are tiny.

Wholesalers tend to operate warehouses or storage facilities and require a strong logistics system to move goods from the source to the end users. Because of this basic materials wholesalers need to either lease or own large fleets of trucks, rail cars, barges or other modes of transportation. This leads wholesalers to tend to have higher fixed costs to go along with razor thin margins. That being said, the industry typically has long standing relationships with its clients that provides some sense of sales stability.

What drives the basic materials wholesale industry?

The basic materials wholesale industry is driven by supply and demand. When demand for basic materials are high, volume picks up. Because wholesaling is a volume based business, that increased volume improves both sales and profits.

That said, each segment within the basic materials wholesale industry has its own specific drivers. Refined petroleum product wholesalers are driven by fuel prices. As gasoline prices increase the demand for gasoline tends to slow down. Conversely, as demand for metals like copper or steel increases it can open up more opportunities for wholesalers.

Meanwhile, wholesalers engaged in the distribution and sale of forest products are driven mainly by the construction industry. While agricultural product wholesalers are driven by things like crop prices, droughts and population growth.

Because each wholesale product is driven not just by the economy, but by its own individual drivers, investors need to watch both factors. A growing economy, for example, might not be enough to drive sales of forestry products if the residential construction industry isn't building houses. Likewise, gasoline wholesalers might struggle under the weight of high oil prices in a booming economy. Further, investors need to look at the cost structure of a wholesaler as high fixed costs could have an outsized impact on profitability if demand slows down. 

 

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