We live in a connected world. Tap a few keys on a keyboard and we can connect to virtually anyone, anywhere and at any time. Unless of course the power goes out or our battery dies. That's when we realize our connected world wouldn't be possible if it wasn't for electricity. And that electricity wouldn't make it past the power plant if it wasn't for the electrical equipment that takes it from the power source to the power consumer. Needless to say, without electrical equipment our world wouldn't be the same.
What is the electrical equipment industry?
At its core the electrical equipment industry supplies the key components needed to keep electricity flowing through our electrical distribution system. Common electrical equipment includes electric switchboards, distribution boards, circuit breakers, electricity meters, and transformers.
How big is the electrical equipment industry?
The global electric equipment industry generates sales of more than $200 billion per year according to Marketline. The biggest segment of the electrical equipment market is the sales of power cables, which generates sales of more than $60 billion a year, or 30% of the electrical equipment industry's sales. Another important segment is heavy electrical equipment, which is growing faster because it includes items like wind turbines.
Electrical equipment is a mature industry with sales growing in the low single digits each year. Overall, the industry is dominated by large conglomerates like General Electric (NYSE:GE), Siemens, and Eaton (NYSE:ETN), which tend to snap up smaller electrical equipment manufacturers because it's an industry where scale really matters when it comes to margins.
How does the electrical equipment industry work?
The reason why scale matters is because manufacturing is a capital intensive industry with high fixed costs related to building the factories needed to manufacture electrical equipment. Further, because the industry uses materials like steel, aluminum and copper, which can have volatile prices, scale and diversification can help to mute the impact of commodity prices.
What drives the electrical equipment industry?
The electrical equipment industry is driven by the global economy and as such it is a very cyclical industry. That being said there are a handful of additional trends that are driving the electrical equipment industry's growth.
While U.S. electrical equipment sales have fallen since the Great Recession, it was already a fairly mature market for electrical equipment. Emerging markets, on the other hand, offer growth opportunities to electrical equipment manufacturers as more people move into the middle class. Countries like China have bold urbanization plans that will bring several hundred million people from rural areas and into cities. The nearly $7 trillion plan will require a substantial amount of electrical equipment in order to provide electricity to all those people.
Another important trend in electrical equipment is the increased power generation coming from cleaner power sources. Wind turbines, for example, are a more than $40 billion business. But the massive wind towers and associated electrical equipment on site are just part of the story. Because wind turbines are typically built miles from urban centers, utilities need to invest to build large transmission lines to get the power from the wind farm to the consumer. It's a similar story with large solar power plants, which can be constructed out in the middle of a desert area miles and miles from population centers. The combination of electrical equipment and power lines due to the growth of renewable power will be an important driver of the electrical equipment industry.
A final emerging trend in the electrical equipment industry is smart meter technology, which is now a more than $7 billion segment. A smart meter communicates usage directly with a utility, which helps the utility monitor usage and bill the customer without having to send someone to read the meter each month. As more utilities invest to install smart meters it will improve profitability of both the utility and the smart meter manufacturer.
The combination of strong growth from emerging markets along with renewable power and energy efficiency technology will drive the electric equipment industry in the years ahead. Because of this investors should focus on these trends as these offer faster growth than the industry as a whole.
Matt DiLallo has no position in any stocks mentioned. The Motley Fool owns shares of General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.