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

Sam Darkatsh, on behalf of Raymond James. We'd like to welcome you to the WESCO International presentation for today. With us today from the company, Dave Schulz, Executive Vice President and Chief Financial Officer; as well as Scott Gaffner, Senior Vice President, Investor Relations. Dave, I think you mentioned your presentations is what -- 15, 20 minutes or so or thereabouts. Keep in mind, the company did not schedule a breakout. There is no breakout after this. So if you do have questions, now would be the time to ask or at least not now, but after Dave's done, and we'll try and facilitate as many as we can. So with that, Dave, welcome again.

Great. Thanks very much for having us. Thank you for your time today and your interest in WESCO. As Sam mentioned, I'd like to introduce Scott. Scott, is our Senior Vice President, Investor Relations and we're happy to engage with you all while we're here today. I'd also, again, like to thank Sam and the entire Raymond James team for having us. This is always a pinnacle event for our team to come down here and spend time with you. Let's go to the next slide, just to give you a very quick overview of our company. So this is WESCO. You can see that we did about $21 billion in sales. We are a global provider of business-to-business distribution and supply chain services. We operate in 3 strategic business units, our Utility & Broadband Solutions; Electrical & Electronic Solutions; and Communications & Security Solutions. You'll also note that about 88% of our business is based here in the U.S. and Canada. Some of the key messages I'd like to just leave you with here today. First and foremost as background, we completed a merger with Anixter back in June of 2020. Over the last 2.5 years, we've transformed our company. And clearly, we're seeing the benefits from a value creation perspective of combining 2 Fortune 500 companies, with now, the broadest portfolio in the industry and the largest channel partner for many of our key suppliers. The other thing I'd mention is that, we're uniquely well positioned for the next decade. We think that the secular trends that many of you are familiar with play very well to the benefits that we can provide within our value chain. And clearly, the secular trends are going to drive for us above-market growth over the next several years. Now the other thing is that with the combination of WESCO and Anixter, we have been investing heavily in our digital transformation. This is a 5-year journey that we're on. And we're making excellent progress, but we believe that this will not only unlock the power of our data that we have available with all of our transactions, but will also provide competitive advantages as we go forward. Go to the next slide. Just again, this is a simple depiction of our value creation as we think about our company going forward. We want to operate in the right end markets. We want to drive market outperformance. We want to make sure that we maintain our operational and supply chain excellence. That includes that we are lean practitioners. So we are always striving for continuous improvement. We are very focused on margin expansion. That has been one of the real benefits of bringing together Wesco and Anixter. And we believe that the combination of above-market sales growth, plus our focus on margin improvement will lead to significant cash generation that supports our strategic objectives. Go to the next slide. I just want to provide you some perspective of the, [ from to ]. If you take a look at WESCO from 2019, you can see that we were primarily in industrial and nonres construction business. Through the merger with Anixter, we have increased our exposure to many of the secular trends. I'll provide you some additional details on that going forward. And we've grown significantly through the merger. So again, we took 2 companies about equal size, and we were able to combine them and really increase our exposure to some of these trends that we're very excited about going forward. Go to the next slide. This depicts those trends that I've been discussing. We think about it in terms of some secular growth trends. That includes electrification, it includes some of the automation and IoT opportunities that we see out there with our customers, a lot of focus on green energy and also the grid modernization, 24/7 connectivity and security as well as the trend of supply chains relocating here to the Americas. On top of that, we also believe that there is significant digitalization opportunities with our customers and with our suppliers to drive growth. On top of that, we've got public spend. So within the U.S. and Canada, our primary markets, we've already seen announcements of considerable spend between the U.S. Infrastructure Bill, the RDOF and then also some significant investments up in Canada. And again, that's what leads us to the statement that we are in a uniquely strong position to take advantage of these trends, given our broad portfolio of products and services. On the next slide, we've outlined what we expect over the longer term in terms of growth for our company. To think about the base market growth. Essentially, we would think about that low single-digit GDP opportunity. Add on top of that, the secular trends will add 1 to 2 points of growth for our company, and we're also very much focused on continuing to grow our share adding another 1 to 2 points to the top line, getting to a mid-single-digit plus organic growth rate over the long term. And again, you can see some of the drivers of that below. If you go to the next slide, one of the things that we're very pleased of is bringing WESCO and Anixter together has not only provided a tremendous opportunity to grow our sales, but it also provided the opportunity for both cost and revenue synergies to expand our margins. And you can see that we ended 2022 at an 8.1% EBITDA margin. That's an adjusted EBITDA margin. We provided an outlook for 2023 that we continue to expand that margin. And we've also set the expectation that we expect over the long term, aspirational goal is a 10%-plus EBITDA margin. So when you compare and contrast that to where we came from, we believe that the value of scale, the value of our digitalization, our focus on driving cost and revenue synergies, along with some of the aspects that we would look forward to in the future, including M&A, would assist us in getting to that 10% plus EBITDA margin target. The next slide, I talked a little bit about digital transformation. And we've provided some additional details about this at our Investor Day back in September. What we're not talking about here is doing a wholesale ERP, we would do a big bang. That is not our intent. Our intent is to really focus on enterprise systems in both the front, middle and back office, using and leveraging our big data. So all that transactional data we have with our customers and our suppliers along with some digital services to continue to grow our business. And again, we're innovating across our entire landscape. We think that these investments are important for us to continue to drive competitive advantage within our industry. Go to the next slide. Again, we talked a little bit about this previously with investors. But when we think about our long-term growth framework, it's really around that mid-single-digit plus organic growth. We expect to continue to drive margin expansion. With that, we would expect that our EBITDA would grow at 2x the rate of sales. That will provide us with significant cash flow generation and with that cash flow generation, we invest back into our own business, but then we also look for increasing returns of capital to our shareholders. On this slide, we've talked about our expectations for operating cash flow generation. And from the period 2022 to 2026 we expect to generate about $4 billion of cash. And we've outlined that over the course of our history, we're not a big capital expenditure company. We invest primarily in our facilities. We invest primarily in our information technology systems, but we're not a big user of capital expenditures. If you go to the next slide, I want to just highlight a couple of things. What do we do with the cash? And our expectations going forward is we'll continue to invest, and we'll continue to invest in our top line, not only for organic growth purposes, but also we are going to continue to be focused on M&A activities. When it comes to the return of capital to shareholders, last year, our Board authorized a $1 billion share repurchase. That includes both the common and the preferred shares that we have an authorization to buy back. We also initiated a common stock dividend so that was just announced last Friday, and that would be payable at the end of this month for our common stock shareholders at an annualized rate of $1.50 per share. So we have begun that journey of increasing the capital returns to our shareholders. And of course, this is something that we will always balance between the amount of leverage we have on our balance sheet, how we pay down our debt, but then also make sure that we're investing in our business and returning that capital to our shareholders. Go to the last slide, again, just some reasons to invest in WESCO. We're a Fortune 200, business-to-business, supply chain solutions leader. We've demonstrated the ability to grow the business. We've also generated significant higher margins than we had previous to the Anixter WESCO merger. One of the things that we're most impressed by is our organization's ability to continue to drive those revenue synergies. So we are getting the benefit of offering a broader portfolio of products and services to our customers that continues to play through for us. We have a strategy that will deliver above-market growth. We've talked about share gains, secular trends and more importantly, our expectation that we will continue to grow our EBITDA 2x the rate of sales. And then lastly, we expect to generate significant cash and with that cash, we will have the ability to not only invest further in our business, acquire other companies, but then also deploy significant capital back to our shareholders. So with that, I'm happy to take any questions that you may have.

Questions for WESCO. So your inventory turns right now are about 5 turns or so. Historically, they're around 6 or 7. Talk about your plans to monetize inventories, but more so, what's a normal or normalized inventory turn level for the new WESCO Anixter, how long do you think it's going to take to get there?

Yes, certainly. We have spent -- one of the areas that we clearly made the choice to invest in inventory, primarily that investment in inventory was one of the drivers. So we became less efficient in that inventory because of the supply chain constraints that we're dealing with. So across the board, many of our suppliers are seeing longer lead times in order to deliver the products that we need. I'll tell you that our goal is to get back about half of that efficiency in 2023. So our expectation is that we saw our inventory days increase. We know that we can't get it all back in 2023, given the current environment for supply chain, but we want to make progress on inventory days in '23 and again, it's something that we're focused on every day. One of the things that we're clearly dealing with is not all of our supply chains have completely healed. We're still seeing some modest improvements in some parts of our supply chain, but not across the board. We expect that we'll be dealing with this through 2023. Yes. Right here, yes.

Just talk about free cash flow. I saw the goals you kept there, we could look last 2 years has been -- about over than expected -- distribution business some of that seem to be inventory, some of it seemed to be...

Yes, very clearly disappointing results for us.

Please, repeat the question.

Yes. So the question was, given our cash flow expectations that we outlined of $4 billion through 2026, how does that -- how do I think about that in terms of what we delivered in 2021 and 2022? In 2022, we are actually a cash draw on the business for the year, primarily because of the increase in the inventory. One of the other key drivers to this is when our organic sales were up 18%, and it requires a lot of net working capital in order to run our company. And so very clearly, in periods where we're seeing well above market growth like that, we will invest in net working capital. On the receivables and the payables, those days were consistent with our historical averages. It was the inventory that was much higher because of the supply chain constraints. Over the course of our history, combined pro forma Anixter WESCO, we generally delivered about 100% of net income and free cash flow. In periods where we have extraordinary growth, it's always much lower. In periods where we've seen the business contract like with the COVID year in 2020, we are -- our sales were down 7% in 2020 pro forma. We delivered just under $600 million of free cash flow that year.

So your backlog has swelled obviously, over the past couple of years or so. Based on your visibility in terms of your orders, your RFPs, I guess the other side of that would be your vendor lead times. Are you anticipating backlogs at the end of this year to still be up year-on-year?

I'll tell you what I would like, and then I'll tell you what I think is going to happen is. I would like our backlog to come down. Our backlog is elevated because supplier lead times are elevated, there is a lot of demand for the products and services that we provide. But I would like to see our backlog return to more normal levels. We only think that, that will be enabled when the supply chains heal and we're able to more efficiently manage that order lead time and the delivery of our products and services to our customers. Right now, for 2023, we are assuming that we will see a typical seasonality to our business and a typical seasonality to our backlog. What that means is that we typically see our sales per workday increase sequentially from Q1 into Q2, Q3. We see our sales sequentially decline in the fourth quarter, just given the timing of some of the projects and the end markets in which we operate, typically, our backlog operates the same way. So in a normal year, which I'm hoping 2023 is more normal like that, we should see our backlog come down sequentially to the fourth quarter.

Sequentially. But on a year-on-year basis?

Year-over-year, I would like it to come down. Tough to predict. It will really be dependent upon the demand and the supply chain environment we're operating in.

But your guidance but for both free cash flow and on the P&L, would that assume or would you be assuming a backlog rise on a year-on-year basis by year-end with that?

We're not including a backlog projection in our outlook. What we are including in our outlook, particularly, for free cash flow, where, as I mentioned earlier, we typically assume that we would be able to convert 100% of our net income into free cash flow. We have not assumed that in the current year. We've assumed 60% to 70%, primarily driven by this inventory issue and the supply chain constraints that we're dealing with. Now we anticipate that will improve somewhat on inventory days, but we'll still have an elevated level through 2023.

Got you. Typically, for public forums like this, intra quarter, you'll update in terms of what you're seeing quarter-to-date. Can you help us with what you saw through February? January, I think, was up 17%.

Certainly, yes. January, up 17% versus the prior year. The month of February, preliminary up low double digit on sales. And one thing that we would highlight here is last year, our sales per workday comp got progressively tougher as we went through the first quarter. So again, we were up against a tougher comp as we turn in here into March. But again, our business continues to perform well.

Question here, yes?

Across your segments, industrial construction and datacom [ can we hear ] a little bit part of the supply chain challenges? Are there certain segments in there that are a little bit more challenging or worried at this point...

Repeat the question.

Yes. The question was around within each of our strategic business units. Are the supply chain constraints about the same. Provide some characterization of that. Each of our business units is seeing some pockets of product category with significant constraints. And within the context of our CSS business, Communication & Security Solutions, that was a much bigger part of the issue for that business in 2022. So we saw about a 2-point lower growth rate across the company due to supply chain constraints. That was higher in the CSS business. Given some of the product categories, including things like some of the IP security equipment that we sell, we just didn't have product availability. That did improve as we went through Q3 and into Q4. Within our Utility & Broadband Solutions business, fiber optic cable, still tight on supply, transformers, still tight on supply. And we haven't seen any real improvement from a lead time on those product categories. Within EES, that's Electrical & Electronic Solutions. That's our largest strategic business unit. It's roughly 40% of our sales. They've had some product categories, which we have not seen fully recovered yet. So still dealing with constraints. A lot of our manufacturers have talked about things getting better as we progress through the front half of 2023.

Question here in the front?

Just maybe articulate the margin expansion we've seen over the last 5 plus years. How much of that also increase a bit of prices [indiscernible] behind that but how much of it is also is result of driving the increased share of service compared with [indiscernible]

Repeat the question.

The question is comment on the margin expansion that's occurred over the last 5 years. We showed you a chart, where we showed back 2018, 2019, WESCO pre-merger and then the pro forma results through 2022 and our outlook for 2023. So we went from roughly a mid-5% EBITDA margin. We finished 2022 at an 8.1% EBITDA margin. A lot of components that drove that. I think that one of the thesis behind the merger with Anixter was that we would get the benefit of scale. And so being able to get operating leverage on the higher sales has clearly played through. We also were able to mix up our business. So we were getting the benefit of some higher-margin businesses with higher secular growth trends as we did the merger and we invested heavily into some of the different parts of each business. So that was clearly one of the key benefits. We also delivered a significant amount of cost synergies. So to put the cost synergies into perspective, when we announced the merger back in early 2020, we said that we would get $200 million of cost synergies to the bottom line, cumulative through the end of 2023. We're on pace now to deliver $315 million. So we have been able to get extra synergies, so that's expanded the margins. We have gotten some temporary increases through price increases. So one thing I'll highlight here though is there have been a number of price increases, we called out that in 2022, 18% organic growth, 8 points of that was the benefit of price. The -- about half of our business is project with negotiated cost from our suppliers which are not impacted by price increases as they're announced. The other half of our business goes back to our stock and flow inventory. We turn that 6, 7 times a year. So there is some temporary average with inventory profit on the inventory, but it's not material in the long scheme of our overall EBITDA margin expansion.

So your target debt leverage is fairly wide. It's between 2 and 3.5 turns. We're getting pretty close to the midpoint of that range right now. Is it -- you also have a $1 billion share repurchase authorization. So is it fair to assume that once you go below the median of the range that the share repurchase activity would meaningfully accelerate?

Yes, our intent is to continue to manage against some key priorities on our capital and how we leverage our cash. We'll continue to invest in the business. We stop -- we still want to stay active in the M&A space, but it has to be balanced against the right fit at the right time. And of course, it has to be the right culture to fit with our company. But as we think about our outstanding debt, particularly, given the environment that we're operating in, we want to continue to drive down our net debt levels. We will be opportunistic, of course, if we have available cash on buying back our shares. We do have the $1 billion share repurchase authorization. But again, we will balance that on how we think about generating the best value for our shareholders over the long term.

So at the risk of throwing a bunch of math at you and in the room. So your EBITDA margin was 8.1% last year. You're guiding 8.1% to 8.4% so you're guiding basically 0 to 30 basis points of margin expansion this year. Yet when you look at a number of exogenous items, whether it's an extra synergies on the come, a variable comp reset, maybe offset by SVRs and logistics costs, I think the net of all that is like a 20 basis point tailwind for you. You're also guiding for mid- to high single-digit organic growth, which you would leverage. So the -- I guess, the cynic or the question would be why only 0 to 30 basis points of operating margin improvement. Is that [ controversy ]? Or is there something else that external observers might be missing?

The construct for our outlook on the EBITDA margin includes a couple of things that we did call out during our earnings call. But Sam, as you mentioned, we do have the benefit of incremental synergies. It's roughly about 20 basis points of EBITDA benefit in 2023. We also have the benefit of -- we paid higher than target incentive compensation for our performance in 2022. That will go back to target in 2023. That's about 20 basis points of tailwind. Offsetting that is we are seeing higher logistics costs. That's the combination of not only from our freight carriers and our internal fleet, but then also as we renew leases on warehouse properties, those are all coming in at a higher cost. We also are seeing higher than normal inflation on people costs. So as many of you, I'm sure, are seeing and hearing with other companies, if -- we typically would assume about a 3% people cost inflation on wages, salaries, benefits. Going into 2023 and incorporate it into our outlook, we've assumed that, that will be at a much higher rate. So that is, again, a headwind that we're facing. We do anticipate that we will stay focused on our margin improvement program and benefit the gross margin line. We'll also get the benefit of scale on the 6% to 9% sales growth. That's how we get to the 0 to 30 basis point improvement in our outlook.

Any other questions here from the room? One here, yes?

How much cumulative pricing can you take in since 2020? And what's your confidence you can move on to that pricing...

Repeat the question.

So the question is how much pricing have we experienced since 2020? And do we expect that we'll be able to hang on to that given the current macro environment. Did I state that? Yes. So 2020, we did not see any real benefit of price because our -- everybody was down with COVID. As we got into 2021, we began to see price increases from our suppliers. And we were in the mid-single-digit range every quarter for the benefit of price in 2021. And then we did mid- to high single digits in every quarter in 2022. Right now, that includes just the supplier price increase, notifications that we experienced. So remember, about half of our business is project-based. So it's not subject to those incremental price increases. We are not seeing or hearing our suppliers reduce their prices to us. So we're right now assuming in 2023 that we will see a 3- to 4-point benefit from price carryover from 2022. So we are assuming that we hold the pricing that has been in the marketplace. We are not assuming in our outlook any new pricing announcements. Now many of our suppliers have indicated that they are announcing price increases. Those are not yet incorporated in our outlook for 2023.

Any final questions here in the room? Okay. Dave, Scott, thank you.

Yes. Thanks for having us. Appreciate it.