Given the negative U.S. industrial production figures from November and December, Wesco International's (NYSE:WCC)earnings report was already certain to reveal that its fourth quarter was a tough one. That said, industrial supply company MSC Industrial Direct (NYSE:MSM) is actually up more than 11% year-to-date at the time of writing. The market rewarded MSC Industrial after the company executed well in a quarter of negative daily sales growth. Could Wesco duplicate that trick?
Wesco International's fourth-quarter earnings: The raw numbers
The results were slightly disappointing, with fourth-quarter sales declining 6.7% compared to guidance for a fall of 5% to 8%. Moreover, its operating margin of 4.8% was below the company's guidance range of 5% to 5.2%.
Of course, guidance is one thing, and a few months of deteriorating industrial conditions is another, and it's unfair to beat up the company for delivering sales at the low end of its guidance range. Indeed, the market was in a forgiving mood, and bid the stock up a few percentage points after the report, not least because management maintained its full-year 2016 guidance:
- Full-year 2016 sales guidance for flat to negative 5% sales
- Full-year 2016 operating margin guidance of 4.8% to 5%
- Effective tax rate of 30% in 2016
- Full-year 2016 EPS range of $3.75 to $4.20
- Free cash flow conversion from net income of more than 90%
The last bullet point is especially pertinent given Wesco's emphasis on good cash management in declining markets, and the company certainly delivered on that front in 2015. Full-year 2015 free cash flow increased 13.3% to $261.4 million as conversion came in at 125% of net income.
Trends in the numbers
It's useful to break out Wesco's sales by end markets in order to see where trends might take it in 2016. Whereas a company like MSC Industrial is heavily exposed to manufacturing and, to a lesser extent, commercial construction, Wesco's end markets appear to have significant exposure to energy, metals and mining, and commodities. A look at its end market exposure:
As you can see from the chart below, Wesco's industrial operations have suffered significantly more declines than, say MSC Industrial has in recent quarters. Wesco's management said that the sales declines were "driven by oil and gas, metals and mining customers."
It's a similar story with its construction markets, where management talked of expectations for a modest uptrend in U.S. nonresidential construction outside of oil and gas, metals and mining.
What management had to say
Clearly, the question on everyone's minds is: When will its end markets start to stabilize? The subject came up on the earnings call following a question by RBC Capital analyst Deane Dray. CEO John Engel replied by citing increasing requests for proposals (RFPs):
Our bid activity levels as measured by request for RFPs, RFPs we are generating in response to customer requests ... As we moved across the year in 2015, each quarter successively grew our RFP activity levels, bidding activity levels and this is for global integrated supply in the aggregate.
Given that management maintained full-year guidance, even though end markets clearly deteriorated further in the fourth quarter, it's safe to assume its RFP growth is a reason for management's relative optimism.
Wesco faces another difficult year, but its free cash flow generation remains strong even as revenue and earnings are in decline. MSC Industrial has demonstrated that companies can be rewarded if they execute well and take market share, and Wesco's task in 2016 will be to adequately position itself for any upside when its end markets stabilize.