With the European sovereign debt crisis and international conflicts roiling markets, it can be easy to overlook some of the stock market's less glamorous sectors. Yet the industrial distributors sector has been quietly undergoing a resurgence from the economic doldrums of the past few years. Investors would be wise to take notice and consider some of the players in this industry for possible investment opportunities.
Back from the abyss
The Great Recession certainly took its toll on this industry. For instance, WESCO International (NYSE: WCC) saw its earnings decline nearly 51% last year, while Anixter International (NYSE: AXE) saw its once-strong earnings turn negative. MSC Industrial (NYSE: MSM) managed slightly better, with earnings declining about 36% in 2009. W.W. Grainger Inc. (NYSE: GWW), which saw its earnings fall just under 10% in 2009, was relatively unscathed in comparison to its peers. In sum, it was a dismal time for these companies.
But things are looking up. For the nine months ending in September, Grainger has seen its earnings increase about 14% compared to the same time a year earlier. Anixter has seen its negative 2009 earnings return to positive territory in 2010. MSC Industrial recently reported a 20% increase in net income for its fiscal year 2010. Meanwhile, WESCO continues to struggle, as its income has declined slightly so far this year. However, at least WESCO has seen sales rise 7%; if that trend continues, a bottom-line improvement will hopefully follow. So despite WESCO's troubles, there is clearly evidence that the economic recovery is in full swing for these stocks.
Better inventory management
While earnings have bounced back, no one is taking it for granted. The downturn caught these businesses with inventory levels that were too high for product demand. As a result, they are still adjusting inventory levels to the new business environment.
As a result of recent lessons learned, there has been much caution regarding managing inventory levels. Anixter decreased its inventories 20% as a result of the downturn, but since then it has steadily grown from the recession's low levels. Grainger saw its inventory decline substantially as a result of slower sales in 2009, but has since slowly worked toward building its inventory levels back to 2007 levels. Similarly, WESCO has grown its inventories about 9% this year, but is still below 2006. MSC Industrial is in a similar position as WESCO. Expect this guarded approach to continue as no one is predicting an economic boom in the foreseeable future that would require a dramatic increase to previous inventory levels.
Improving operating margins
Partially as a result of improved inventory management, industrial distributors have also benefited from increased operating margins. While sales have been slow to recover, with the exception of Grainger, the focus on keeping costs low is helping the industry regain some of the profitability it lost in the past few years.
While they have more work cut out for them, there has been a distinct improvement in this metric for all of the above mentioned firms. The table below displays the operating margins of the previously mentioned companies for both 2009 and the trailing 12 months.
|
Company |
2009 Operating Margin |
TTM Operating Margin |
|---|---|---|
| WESCO International | 3.9% | 4.0% |
| Anixter International | 2.1% | 4.8% |
| MSC Industrial | 13.7% | 14.3% |
| W.W. Grainger Inc. | 10.7% | 11.7% |
As you can see, there was improvement in the operating margins for all four companies. Anixter and Grainger were particularly effective over the past few months at increasing their margins, with Grainger above prerecession levels of 10.4% in 2007. As we move forward, it will be interesting to see if these firms can further improve their operating margin if growth in sales continues to be stagnant.
Future expectations
Looking ahead, this industry will likely see improving financial conditions as long as the economic recovery stays on track. Increasing operating margins along with cautious inventory management may be a signal that these stocks can move higher. Certainly, though, this is a sector that is worth a closer look at to see if there are some good options for your portfolio.
More on the industrial distributors industry:
