WESCO International, Inc. (WCC) Earnings Call Transcript & Summary

Hi, good morning. I'm Josh Pokrzywinski, Morgan Stanley's electrical equipment and multi-industry analyst. Thanks for joining us for day 2 of our Laguna conference. Joining me this morning is WESCO, including CEO -- Chairman and CEO, John Engel; and CFO, Dave Schulz. John, thanks for joining us this morning. I'm excited to talk about electrification as well as the Anixter transaction. Congratulations on that. Before we get started though, I do need to read a quick disclaimer and just remind everybody on the line that for questions about our research disclosures, please visit our research disclosure website at morganstanley.com/researchdisclosure. And that for all other questions, please reach out to your Morgan Stanley salesperson. Like I said, John, thanks for joining us this morning. John and Dave, thanks for joining us. John, I understand the -- you have a couple of opening remarks here. So I will pass it off to you, and then we'll dive into some questions.

Josh, great to be with you, and thanks to Morgan Stanley for hosting this conference. It's really terrific to participate. Just some -- a few brief comments. It's been one heck of a last 18 to 24 months for us. We've done the most noteworthy thing in our company's history. We put together 2 Fortune 500 companies forming a "Fortune 200 Company" as a result of WESCO and Anixter coming together. It's a transformational combination. We did it against the pandemic backdrop. We announced this deal pre-pandemic and closed it in 5 months against the pandemic backdrop. We're building a new company and digitally transforming our business and our industry. And this is really a story of market leadership, scale and transformation. We're becoming a growth company. And I know we'll talk quite a bit about that. Regarding the integration, it's going exceptionally well. We're exceeding expectations. We delivered $117 million of cost synergies in the first-year post-acquisition close, and we've raised our -- cost synergy targets through the end of 2023 twice. We initially put out a $200 million cost synergy target pre-acquisition close. We raised it to $250 million after the first full quarter together. We closed on June 22 last year. So at the end of Q3, as part of our Q3 earnings, we went from $200 million to $250 million. And we just raised that target again as part of our Q2 earnings call to $300 million. That's cost synergies through the end of 2023. With respect to sales synergies, we had -- initially had outlined 1% of the combined company sales as sales synergies, top line upside. We just raised that to 3%. So we went from $170 million of sales synergies to $500 million and that's 3% of the combined sales on a pro forma basis and it's really driven by outstanding execution on our cross-selling programs. And I know we'll talk more about that. Finally, free cash flow generation has been exceptionally strong. And we improved our leverage 1.2 turns in the first-year post-acquisition close. We've gone from 5.7x total debt-to-EBITDA to 4.5%. We're very pleased overall with the execution progress, and momentum in our transformation is well underway. And Josh, again, great to be with you.

Thanks for those remarks, John. And yes, it sounds like that deal has been a total home run. And we'll -- like you said, we'll get into some of the -- more of those details here in a second. Maybe to start off with what's been a pretty dynamic operating environment, I'll say, over the last, call it, 30 to 60 days, in particular. How have you seen some of the stresses from the supply chain side -- as a supply chain company yourself manifest? Whether it's cost, logistics, product availability? Maybe describe the challenges that you guys have undertaken and what you've been able to do to mitigate that? Or -- and how you see that progressing over the next few quarters is hopefully we move past these things.

Yes. I mean, it's a great question. The overall value chain is challenged. Demand has stepped up, and we're in a recovery cycle, but the supply chains are constrained. They're not fully rebuilt yet. And that's -- it varies by product categories. But that's an overall assessment of current state because demands pulling on a supply chain is not rebuilt. As we recover, that's driving -- pulling through the value chain and driving inflation up. Relative to supply chain constraints, we've not seen any material issues to date manifesting themselves in our numbers. We have had no really missed sales to date that's material. We're measuring ourselves, Josh, against 2019. That's the important thing for us because we're a totally new company, we doubled the size of the company with Anixter and WESCO coming together. And we're -- our sales in Q2 were up 5% over 2019. So we think that's the important mark because 2020, depending on the company, their end market exposure and such, there's a lot of noise in that data. What have we done specifically? We've increased our inventory. So if you take a look at what we've done across at least the first half of this year, we've thoughtfully and materially increased our inventories in a number of areas. We're driving very high fill rates, I'm happy to say. And most importantly, we're really learning how to manage with our increased scale and our new found market leadership. And that's manifesting itself with the ability to get the proper allocation coming off our supplier manufacturing production, our partners that we partner with. We're not a manufacturer. We're a distributor, supply chain companies you mentioned. So it's incredibly important that as we all work to support this demand and supply chains are being rebuilt, that we deliver against our customer commitments. And I'm really happy to say our suppliers have been really stepped up their partnership with us. Our customers are saying, this is really important. Supply chain integrity, supply chain resilience is becoming this -- it's a risk management matter, quite frankly. And I think this is something that the pandemic has put a spotlight on that, the fragility of global supply chains. It's a core part of our value prop, Josh, and we're very focused on it. So, so far, so good. We've actually had a number of customers come to us to ask us to source new products that we've never sourced because they see us as having the ability to use our -- with doubling the company overnight, use our newfound supply chain muscle and our global supplier relationships to go find materials that they're having trouble with. So I would say net-net, it's challenging. No doubt. Your questions suggests that it's -- your last part of your question is what do we see -- how long does it continue? Look, it's going to continue through this year and in the next. I mean the amount of disruption that was causing the global supply chain is significant. I will tell you, customers are increasingly having discussions with us about bringing back selected parts of their supply chain in North America, and they're trying to shorten those supply chains. Again, all in support of resilience and integrity.

Got it. And one thing that I think we've sort of learned over the past day of the conference and maybe even leading up to it is, in this environment, probably a bigger pricing envelope than what we've seen in past recoveries. I know that you guys see that because every market is inherently local. It seems like that passage of price from the supplier to the distributor to the end customer is maybe a bit more well lubricated in this environment than it would have been in the past. Is that sort of how you see this as well?

Yes. I think that it's a great question. So you talk about price/cost and the whole dynamic. I think there is some improved lubrication, but I wouldn't spotlight that as being the most notable thing, at least from our perspective. The supply chain is still very tight. We've got accelerating demand. So now it becomes more of an ability of, can you actually -- do you have the relationships and can you source those materials that customers need as they're rebuilding? I think, again, this is this power of the market leadership in us doubling our company. We've had positive price/cost in the first half. I've been with WESCO since 2004. I've lived through a number of cycles, first as COO and then over the last 11 years as CEO. But I can tell you that I've never seen kind of the results that we're driving now. And a big part of it is special clause driven by us doubling the company overnight. Our gross margins expanded 50 basis points in Q1, expanded 140 basis points in Q2. Our pricing pass-through is faster and more effective than I've seen in my tenure. And again, I joined the company in 2004 and I think I'm part of it is our increased scale and strength that you're doubling up on supply chain relationships. But the bigger part, Josh, I talked about this quite a bit in our earnings call is an enterprise-wide gross margin improvement program. Anixter had launched one, 2.5 years pre-acquisition close. If you go in a publicly traded company, Fortune 500, if you go and look at their gross margins in '17, second half '18 and to '19, they had 8 quarters in a row of gross margin expansion. That's pre the conditions we're facing now and how many other distributors have expanded gross margin in that period? We combined, we took their enterprise-wide gross margin program, did some initial refinements and standard it at enterprise-wide across the combined company, that was done in January of this year and I couldn't be more pleased with our results. So I would say that a good part of our success, the overwhelming part of our success is special cost-driven. I believe fundamentally, we've got a stronger margin profile overall as a result of putting these 2 great companies together going forward.

Excellent. I'd like to pivot over to something we've done a lot of work on and one of the reasons I'm particularly glad you're able to join us on electrification. So as you know, this means a lot of different things. It's not a monolith. It's EV infrastructure, it's renewables, distributed power, solar storage, the list goes on. You guys play some role in all of these things. I guess, maybe 30,000 foot view, where are you guys most focused organizationally on driving some of these opportunities? And where do you think you sit in the value chain in terms of helping those customers kind of execute on these projects, whether it's specification work or procurement, offering breadth, I don't know. I don't want to presuppose the answer, but it seems like there's a lot of excitement in an industry that has historically been very good, but maybe not as exciting. And you guys are well positioned for that.

Yes, I mean, you're -- Josh, you're spot on. I mean if you look at the electrical industry, and by the way, that's where WESCO has deep, deep roots going back to capital distribution on a Westinghouse founded over 100 years ago or almost 100 years ago in 1922. This secular growth trend that we outlined it as 1 of 6 key secular growth trends driving our business, our combined business and outsized growth, we believe, in the next decade and beyond. This one, electrification is arguably one of the most exciting growth trends to ever impact the electrical industry, the whole value chain. It is going to drive substantial growth. And you had a couple of questions combined there, so I'll hit a few of the facets. I think we're exceptionally well positioned as a result of the combination. I'll come back to that. But how do we win? How we're going to win is we're very focused on a complete solution. It's our products plus our services, and that was significantly strengthen the complementary nature of the 2 portfolios coming together as a result of this combination. Previously, WESCO, we used to talk quite a bit about our end-user relationships. And the fact that we served over 50% of Fortune 500 companies directly. When you looked at Anixter, and by the way, that was markedly different than all our other distributor competitors who predominantly serve their customers through the contractor channel. We're integrators, not direct with end users. So it was a distinction that WESCO had, particularly in the overall industrial market, but also utility, with investor on utilities and public power customers. When you looked at Anixter, they also had a utility business they bought from HD Supply Power Solutions. So they serve direct there. And in what they used to call their NSS business, we now call it CSS, their datacom and IP security, they're the global leader. You look at the array of end-user relationships that are direct, it's incredibly impressive. So when we put the 2 companies together, Josh, we couldn't see the customer level data until we actually closed on June 22, 2020. The -- very few customer overlaps. And when you look at the direct end-user relationships on both, 1 plus 1 was much greater than 2 because they weren't really -- we weren't really competing at the same end customers with the categories we're bringing to market. So it's these direct end-user relationships that allow us to directly influence the solution through engineering-driven and application-specific solutions. So in your question, you were spot on, and we work on that in conjunction with our supplier partners that we kind of doubled up with. So I'm really excited about this growth trend. I believe, and I know a number of our supplier partners have talked about how many points above market this can mean for them. We've not quantified it specifically yet, and that's something we will be doing in the future. But I can tell you, all those trends they're talking about, and for most of our supplier partners, if we're not their #1 customer or channel partner, we're either #2 or #3. And I think we all know who these companies are, they're the leading electrical companies. We have deep roots in electrical. What WESCO was missing, Josh, is a major point. We didn't have strong wire and cable capability. Anixter was the leader, period. Their deep roots was a wire and cable company pre fiber. So you go back and look at Anixter's deep, deep roots wire cable, then they pivoted to fiber organically. We now have the complete electrical package. That is instrumental and foundational to supporting electrification. So I'd leave it with this. I think our competitive advantage is to drive outside growth due to electrification -- first of all, we have a terrific array of supplier partnerships. And again, we're their largest customer. But it's our end-user relationships, it's our tech-driven selling, technical selling, the specification, application-specific solutions, coupled with leading project management capabilities. So it's a deep, deep competence across both WESCO and Anixter. So I'm really excited about it. The final point I would make is, we've got 3 business units. They're global. We go to market with 3 segments now. It's clear EES. Well, electrification is a major driver for EES in the next decade. It also is for UBS. Because when you think of electrification, when you start thinking about green energy and grid modernization, it actually figures squarely into that, right? And then you think about CSS, Communications & Security Solutions, it also supports that because as data centers grow out, hyperscale data center growth, it drives tremendous demands on the whole electrical power chain. And so I think as convergence continues and bandwidth growth continues, IoT applications are expanding and the charging you mentioned, all these drive increased growth in electrical content. That's the bottom line, I'll end on that note. Overall electrical content in our solution in the applications is clearly stepping up and will increase as a result of electrification.

I appreciate that. That's very helpful. It seems like the utility side is probably the tip of the spear today. We've seen those markets start to accelerate more recently. I think even pre-acquisition or pre-merger, WESCO had been pushing more on those relationships and kind of owning that whole supply chain process. Have those customers started to purchase differently? Are you seeing that show up in the business today? And I guess, what does that look like from your perspective? Because you're the ones on the front line is actually interacting with the customers, watching the budget stack up?

Short answer is, yes. Yes. It's notable, its material, but it isn't starting in 2021. I mean this is something we saw that started literally over 5 years ago. We got deep roots in utility, to your point. I'll talk legacy WESCO and legacy Anixter, deep roots in utility. It goes back into Westinghouse days. And then Anixter bought the Supply Power Solutions, which really was comprised of the original Hughes Supply that rolled up a series of utility specialized distributors in the U.S. 15 plus years ago. So what we had with WESCO and Anixter is coming together, Josh, is we had clear #1, clear #2 in utility distribution in North America come together, undisputed. So a very strong market leadership position. And #3 was a distant third. So this is really important. We're exceptionally well positioned to take advantage of the secular growth trends impacting the utility power chain, its electrification, green energy, grid modernization. We're much more than a distributor. Today, back when Duke bought Synergy well over a decade ago, we proposed an integrated supply solution back then. We had first-to-market mover advantage with implementing an integrated supply program. We had deep roots and foundation in industrial -- in the industrial sector with industrial companies. In utilities, first-to-market mover advantage, and we've built on that. We have many variations of that. Utilities, to the heart of your question, are outsourcing our supply chains, larger pieces of it for us to manage. And they are much more strategic. They've added a lot of talent from other industries. If you look over the last decade, they're much more strategic about their operations and supply chain and they're outsourcing what's not core. We're an integral part of their business. We're literally interwoven with their operations. And the best way I could describe this, Josh, is very timely is we're part of their first responder efforts for storm recovery. So Hurricane Ida, the devastating storm that just ripped through the U.S. We've deployed many dozens of WESCO and Anixter personnel as well as multiple tens of millions of dollars' worth of inventory down towards those areas and are supporting our utility customers working side-by-side with them, setting up localized warehouses supporting the storm recovery efforts. We're an integral part of those response efforts because -- and you can't tell -- if you were to go on site, you actually can't tell who's the WESCO personnel from one of our customers personnel. You can't tell. I mean we're literally interwoven. So I'll end on that note. The comprehensive business models we've been implementing with utilities, direct with investor and utilities and public power, with co-ops, et cetera, it has a much higher order value proposition. And it's something that we're migrating our other customer relationship to, be it industrials, be it other end-user customers.

Got it. That's helpful. Kind of pivoting over to the recovery. I want to go back to something you mentioned in your opening remarks about some customers looking at supply chain. Near shoring, I think, is now been used so much. Shoring has kind of lost meaning for me, I have to say it 3 times just to restore the definition. But CapEx is clearly something that's happening. How have you guys seen this -- the cadence of MRO, which I know is a big part of your business as well, versus CapEx evolve in this recovery?

So I'll start with saying, we're clearly in a recovery cycle. We're not seeing -- and we're in the early phases of the CapEx portion of the recovery cycle. Let me make that distinction. Relative -- I'll start with MRO and then move to CapEx. Our -- keeping facilities safe, secure, up and running is paramount for our customers, particularly given the disruption has been caused by the pandemic through the global supply chain and their own operations, and we're part of that value prop. So that drives MRO. And so we're seeing the MRO demand pick up, Josh. We're clearly seeing that. I think we're relatively in the early phases, and it varies by end-market vertical. But overall, I would say the economic recovery is underway, industrial recovery is underway, therefore, MRO is underway. CapEx, I think, is also underway, but it's in the very early phases. And I just see this as providing significant upside as we look to 2022 and 2023 and beyond. There are some parts -- there's some value chain oriented customers we serve where the CapEx cycles continuing. And it may have taken a slight step down a moderation due to the pandemic, but the secular growth was there. What fits that category, data centers? Hyperscale, multi-tenant data centers, strong double-digit growth. That's due to convergence and due to shifting to the cloud. And convergence is voice data video. It's everything we, as consumers, are taking advantage of. And then shifting from on-prem to cloud. So that I don't -- that trend may have moderated a bit in the heart of the pandemic, but it's strong. It's secular, it's growing and that drives CapEx. That drive CapEx across the tech sectors. And we serve those customers directly. That was a part of Anixter's strength serving the tech sector customers directly with datacom and IP security solutions. Secondly, automation and IoT applications. I would argue we're in the early part of that, and that's a secular trend for the next decade and beyond. But that CapEx cycle has clearly started. And we're also at the beginning of non-resi. Resi has been relatively strong -- relatively against other end market verticals through the pandemic and particularly recently, and non-resi's just barely begun its recovery, right? Most non-resi indicators still show that overall spending in markets and projects, whether on a dollar or per square footage basis are down this year. And so we think we're at the front end in non-resi cycle and that bodes well for us because our backlog has increased sequentially every month this year through the first half, that is very counter to normal seasonality. Normal seasonality, we would eat into our backlog in Q2 and Q3. But every month sequentially, it's grown to an all-time record level. Six months in a row, we've set success of all-time record levels. Finally, we talked about the other secular trends that are not impacting CapEx yet materially with the front end, electrification. So think of that as a new driver that will drive CapEx, green energy, grid modernization, infrastructure investment and clearly the infrastructure bill, ultimately, when something will end up passing, right? And that will have a meaningful impact on project activity in the CapEx cycle. And then finally, what you also mentioned, the relocation of supply chains portions of those back to North America. So I would argue those 4 areas, which are secular trends. We're in the very early stages of what the CapEx drivers will be. So I'm very bullish. When I look at the next 10 years, notwithstanding some challenges with this constrained supply chain right now. I see it as the front end of a CapEx cycle that could have long legs to it with multiple secular growth trends driving.

And just to clarify something because I think folks are familiar with the industrial space, but maybe not as deep in electrical. You guys have a decent amount of MRO exposure. I think it's an area of strength. But if I look at electrical markets, it's not really defined by rotating parts, right? Like wear is a little different. So when you say MRO, how should people think about that and kind of real-world terms, like what's breaking, what are people fixing? Because I think in a lot of cases, electrical equipment sits in a closet for 50 years.

It's a great question. The MRO market in the U.S. annually, I'm going to round it, is $600 billion a year. It's part of the overall B2B wholesale distribution market that's $3 trillion a year. So it's a very large market. It doesn't include just repair, it's maintenance, repair and operating supplies and solutions. This is an incredibly important point. So small projects where there's an upgrade to the factory floor that helps improve energy utilization or efficiency, many times is classified as an MRO project. It's not considered large. So -- and that's in that $600 billion annually. It's an incredibly important point that you're bringing up. A lot of folks that aren't familiar, think about, oh, wait a minute, it's just break/fix. And there's an outstanding set of solutions to do some upgrades to the electrical power chain that exists through the industrial sector, to improve overall productivity and that many times falls under the category of MRO projects. Customers actually describe it that way. Then there's the normal things that break, fuses burnout or break. There's normally an array of electrical products that we've got to have available to keep the facility up and running. Because that could happen, right? Circuit breakers, fuses, et cetera, can break or need an upgrade, sometimes driven by some other regulation. So it's an outstanding question because I think that really understanding what's required to keep our customers' facilities up and running, that's what MRO does. It's not just nearly defined as break/fix for stuff that has physical movement.

Got it. Got it. I appreciate that. I think it's an important context for folks. Pivoting back to kind of the market at large and the transaction, the successes you've had. As you step back, absent a couple of large players, these are still fairly fragmented markets. I don't have to drive too far around my own town to see electrical distributors that are small and family owned and kind of one-stop shop. How do you see consolidation progressing from here? I mean with some of the mega trends you just described and a pretty long list at that, I would imagine that expertise, scale, breadth, all these things sort of matter more. Does that drive more consolidation from here? Or have we kind of reached a near-term kind of equilibrium?

Short answer is, yes. I've said for years that I believe that consolidation and the value chain would accelerate when the right external drivers, the appropriate set of its kind of impinged on the value chain. I think we're seeing that. We're seeing that in terms of the cost of money is essentially 0, right, with low interest rate environment and in the pandemic and what it's really driving. Just there's a set of conditions and depending on what could happen with tax policy in the U.S. will incentivize because the overwhelming majority of these smaller competitors are local or regional or private-based companies. And so there's just a whole series of dynamics as well as the aging workforce. These have been multi-generation run businesses. And many of these companies don't have the successor to take over. So the value chain remains significantly fragmented in our portion, distribution. Suppliers have been consolidating at a more rapid rate. If you look at the last decade, I'm talking core electrical. I went -- I stood up at our 2019 Investor Day and made a bold statement. Some of you will recall that, that digital was going to completely transform the B2B value chain and that we were in the early days of that. I used the analogy that industries like companies, like products, go through the proverbial S-curve. And that we were at the beginning part of the steep part of the S-curve in terms of digital applications and disruptions in B2B. And if we look B2C retail distribution, it's been completely transformed over the last 2 decades. Wes -- I made the strong statement, middle of 2019, 2 years ago, that the bigs had to come together in distribution. The bigs had not come together. There was a bunch of little acquisition. WESCO has done 50 acquisitions since it's spun out of Westinghouse in 1994. But I made a strong statement that bigs have to come together. WESCO and Anixter is a major first move in that regard. We've doubled up overnight. And now we have a situation where I think the bigs are going to get bigger, faster. And they're going to get bigger, faster for 2 reasons, Josh, to the heart of your question. Number one is the power of scale and the -- benefit will accrete the market leaders. Number two, it's going to continue to consolidate driven by digital. I made the strong statement that the strategic rationale for the bigs coming together is none of us could invest in digital at the right rate going forward. When you put the 2 bigs together, you'll have substantial synergies, and you can use a portion to invest in digital and that's what we're doing. And so I just -- I feel terrific about the move that we've made. And I do think, as we look forward, we'll see the supply chain consolidation -- or value chain consolidation, particularly in distribution continue. Because ultimately, scale matters.

Well, John, I see we're at time. I appreciate all the time. Thanks for joining us. Super exciting time for the company. So thanks for sharing it with us and hope to see you next year on the Beach in California.

Thank you, Josh. Thanks for the time again today.

You're welcome.

Have a great day.

You too.