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

Good morning, everybody. I'm Steve Volkmann with Jefferies, and happy to welcome you to the WESCO session here. And sitting with me here obviously is Dave Schulz, the CFO. We have Scott Gaffner, who looks after IR, who's abandoned us for the audience this morning. So we will do this as sort of a fireside chat format. I think we'll start though. There was an 8-K filed this morning and a bit of an update provided. So perhaps we could just start there. I'll do a little bit of the Q&A here, but would love to have participation from any of you that are interested as well. So we'll do that in a few minutes. So think about your questions. But Dave, welcome. Thank you for coming and what's the update?

Well, thanks for having us today. We -- Steve mentioned, we did put out our marketing deck this morning filed an 8-K. Wanted to point out 2 things that are in there that are of interest first. We have our preliminary reported sales quarter-to-date through August, up 4%. The other thing that we highlighted in our marketing materials is that we did buyback shares in the month of August. We bought back $50 million of our shares, again, as part of our overall capital allocation. We have a common stock dividend. We pay a preferred dividend, and we also have a share buyback authorization for which we executed $50 million under that program in the month of August.

Great. So I don't know if we can maybe peel that onion back one more layer. And is there anything to call out relative to the segments in terms of what you're seeing with respect to business trends or perhaps end markets that might be sort of particularly good or bad?

I would tell you that our third quarter to date, it's similar to what we saw in the second quarter. So overall, our second quarter organic sales were up 3%. That included our Electrical & Electronic Solutions business, EES, was down 5% on an organic basis. Within EES in the second quarter, we saw 2 of our operating groups see a sales decline. First was non-res construction. We talked about that coming from customer destocking. The second was our original equipment manufacturer business. That was also down in the quarter. We are seeing softness in certain end markets that we service relative to the prior year. Those trends have generally continued into the third quarter. Our CSS business, Communications Security Solutions, was up 7% organically in the second quarter. Again, in our final business, Utility and Broadband Solutions, was up 10% in the second quarter. Generally, those trends have continued, getting us to the 4% quarter-to-date here in Q3.

And you mentioned on the last call that there are some destocking in certain end markets. Is that sort of also continuing?

We expect that to continue within our EES business through the end of the third quarter. We have also been seeing some destocking in our broadband business. Our broadband business was down double digits in the second quarter. We don't expect to see recovery in our broadband business until 2024.

So maybe let's talk about what's actually doing better then. I think you mentioned the book-to-bill. I think he's put in your slides is above 1 for the quarter so far. Just where are you seeing strength?

Correct. So we did see our book-to-bill was still greater than [ 1 though ] as we finish the month of August. And again, similar to what we saw in the second quarter, those businesses that are exposed to the secular trends have continued to perform well. Where we are seeing some of that strength is in our utility business. Again, we do believe that, that is a secular trend that will continue to be a great opportunity for WESCO going forward. Within our Utility & Broadband Solutions business, I mentioned Broadband was down in the second quarter. We don't expect that will recover until 2024. We also have an Integrated Supply business. Again, that business was up double digit in the second quarter. We continue to see strength within our Industrial portfolio across all of our SPUs. Our Communications & Security Solutions business, that includes the Rahi acquisition that we did back in November of 2022. Rahi has an exposure to data center. So it really picked up the amount of sales that we're able to generate within that data center space. Again, we believe that, that is a strong secular trend going forward, and we're well positioned as a company. Within our Electrical & Electronic Solutions business, Industrial is still doing fine. So Industrial was still up year-over-year. The pressure that we are seeing is on destocking within construction and, of course, as I mentioned, our OEM business was down. There's a couple of specific areas within OEM related to our manufactured structures business. Think about that as specialty vehicle, manufactured homes, with the higher interest rates, we've seen some pressure in that end market.

Great. And then you guys do, I think, benefit from a number of these megatrends that we all like to talk about these days, whether it's reshoring or IRA or CHIPS Act even, I suppose. Are there some of those areas where you're actually starting to see money flow through into these end markets? Or is that still ahead?

That's still ahead. So when you think about the secular trends and a lot of the government investments being made against some of those end markets, which we have a large exposure. We are seeing bid activity at this point, but we don't anticipate seeing revenue until 2024 as it relates to some of those government infrastructure spend bills. As I mentioned, some of the -- particularly broadband area, those funds have been led to the states, and we're bidding on projects there. But across some of the other key secular trends that are being funded by the government, both here in the U.S. and in Canada, we don't expect to see revenue for that until 2024. So it will be a slower pace than perhaps we originally thought. There are no shovel-ready projects, but we are actively engaged with many of our customers with the governments, making sure that we can stay on top of the opportunity going forward for us.

And you mentioned data centers, which is obviously, I think, topical these days. How much -- with Rahi, how much of your business exposures data centers now?

Yes. Right now, we're trending towards about $2 billion of sales within the data center space, all within our Communications & Security Solutions strategic business unit. And that includes the legacy WESCO exposure that we had to data centers. And then, of course, we did the acquisition with Rahi. Rahi not only provided us with incremental sales, but also it provided us with incremental services than what we were able to provide prior to the acquisition. Rahi is doing fantastic. I know several of you have been tracking those numbers. When we first announced it, we were looking at about $400 million of sales on a trailing 12-month basis, that was about a year ago, we first talked about Rahi. And then we talked about within 2022, pro forma 12-month trailing was $480 million. And we expect that business to grow at 20% plus. Again, a huge opportunity for our company, very pleased with how Rahi is performing. And we've also integrated that into our legacy data center business. So we have a WESCO data center solutions business. It's being run by the former CEO of Rahi, who joined to our team. And we see fantastic opportunity within that space.

And are the margins in that end market different than sort of overall core?

Not material. So when we did the acquisition of Rahi, we said that Rahi's margins were about equivalent with what we had across total WESCO. Again, we're seeing some fantastic revenue synergies from the combination of WESCO and Rahi. We expect that to continue. We see this as a tremendous growth play, and we're very pleased with the progress that we've made.

Great. Maybe I'll switch gears a little bit to supply chains, things have been pretty unhelpful, I guess, for the last couple of years, but maybe you can just describe what you're seeing now.

Across most of the product categories that we service the market with, we've seen supply chains return back to normal, so pre-pandemic levels. There are still certain product categories where the lead times are still extended. That's primarily within the switchgear space with our large manufacturing partners. We're also seeing extended lead times for transformers still impacting the utility space, the electrification trends. We're also seeing breakers are still -- have longer lead times. So overall, a lot of the impact that we saw against the majority of our business has returned to normal. And we're enthusiastic that we'll continue to see the lead times return to normal in those product categories, which are still extended right now.

So the market or at least some people in the market, I think, are tempted to view backlog starting to come down as a demand indicator. I'm not sure they may be more of a supply indicator. But how do you view the next few quarters with respect to what you think backlogs will look like and trends there?

We expect that, as supply chains continue to heal, our backlog will come down. And think about what occurred over the last 2.5 years, because there was uncertainty of supply, many of our end-use customers put their orders in earlier, so it was in our backlog. As supply chains heal, lead times come down, those customers will be placing orders more of the historical time frame. And we're already seeing that come to light within our CSS business, Communications and Security Solutions. That was really the first strategic business unit for WESCO that saw lead times improved tremendously. It really started to happen in the end of Q3 of 2022. So through the balance of 2022, things normalized. Our backlog within CSS has been coming down sequentially. We're actually down 12% sequentially Q1 to Q2. We don't see that as a function of demand. Our demand has still been very solid. What we see that is more normalized ordering patterns from our customers, and that is impacting the backlog, but we do anticipate the backlog will come down. Well, again, it's supply related, not demand related.

So I guess related to that, you have had some higher inventories through this COVID period. My guess is there's some opportunity to bring those back down.

Absolutely. That is one of the objectives that we've highlighted. So just to put some numbers behind this, because of the supply chain lead times and just the disruption that we were seeing with our suppliers, like everyone, if we could get inventory during the pandemic recovery, we took the inventory. And we saw our backlog increase. We -- our inventory increased. In many cases, projects were delayed because we didn't have the full package to ship. So we saw about a 10-day increase to our inventory days. And from our perspective, we did what we had to do to make sure that we could service our customers. As supply chains are healing, we expect that we'll be able to reduce our inventory days. You've already seen some of that occur. Our inventory dollars were a source of cash in the second quarter as we've been able to moderate our inventory days. And again, we do see this as a source of cash in the second half of the year. So from an outlook perspective, we have outlooked $500 million to $700 million of free cash flow generation here in 2023. Our June year-to-date was slightly positive. So it's all back half-loaded, that back half load on cash flow is really being driven by improvements in the net working capital, including inventory reductions. So from our perspective, as supply chains heal, it will allow us to more efficiently manage our inventory, and we'll see that as a potential to drive free cash flow here in the second half.

And do you ultimately get that full 10 days back?

That' our goal. It won't happen this year. So it is going to take some time to work our way through the inventory that we have on hand. And again, as supply chains normalize, we would anticipate getting our inventory days down. Our goal is to get back the full 10 days and -- but it will take us some time to get there.

Great. Maybe the last topic, and then we'll open it up for some questions. It's just around your margin goals. Obviously, you have the 10% margin goal, a couple of hundred basis to get there. What are sort of the key levers that you pull to get there?

Yes, absolutely. So just to frame the margin story, we outlined back in September of 2022 during our Investor Day that our goal is to get to a 10% EBITDA margin. And when you think about the history premerger, WESCO was running in about 5% EBITDA margin. With the merger with Anixter, we've been running just around 8%. So we've already seen a sizable improvement in our EBITDA margins through the benefit of scale and the synergies that we were able to capture. Going forward, our expectation is that we will continue to drive scale with the company. And the combination of our focus on gross margin improvement, plus being very aggressive with managing our SG&A, that is the path that we would get to a 10% EBITDA margin. We've not outlined when we expect to get there. But very clearly, that is the goal that we've set for our company. It's what we're working forward to. As we do our digital transformation and we continue to invest in digital, we do see that as a way to drive efficiency and continue to get margin expansion.

Great. Any questions in the room here? I don't know if we have a mic or I can just repeat. We do have a mic. So if you just raise your hand, we have a mic. If not, I can keep going. No takers? All right. Let's talk a little bit about capital deployment. You mentioned that you bought some stock in the quarter. How important is share repurchase to you at this point relative to debt pay down? And then I think that M&A is still a key part of the plan going forward. So how does that all play out?

Certainly. And again, we've outlined our expectation that through 2026, we would be generating about $4 billion of free cash flow. So that's for the period 2022 to 2026. We outlined that back in September with our Investor Day. As we think about how we'll use that cash, we'll continue to invest in our business. So that includes the digital transformation that we've undertaken as part of the integration of WESCO and Anixter. We also think about returning capital to shareholders. So we initiated the common stock dividend here in 2023. We also have the $1 billion share repurchase authorization I mentioned earlier, that we do expect to utilize going forward as well. So from our perspective, that creates still a sizable amount of funds that we can then deploy. And as we think about our M&A strategy, we do see it from 3 specific target areas across the M&A universe. First is consolidation within our industry. So our industry is still highly fragmented. So there are about 4 players that make up about 30% of the market share here in the U.S., but there are thousands of operators within the space here in North America that we compete against. So we would be looking for consolidating M&A. So think about that similar to what we did with Anixter. We find that as an opportunity for us to not only get scale, but also to drive significant revenue and cost synergies. The second focus area for our M&A strategy is more of the adjacencies. So where we would look for adjacent product and service providers, similar to what we did with Rahi, where we had a presence within data center. But the Rahi acquisition really increased the amount of services that we could provide to our customers and really drive additional revenue synergies across our company. And then the third is to really continue to optimize our portfolio for growth in margins. So if there are areas that we could continue to invest in, to expand our presence within a certain end market, we would look to do that. Think about that as more of a tuck-in type acquisition expanding our scale within a certain vertical or within a certain geography. So that's how we think about our overall allocation of capital going forward. Again, we're pleased that we were able to buy back shares, $50 million in the month of August. We've got the authorization. We're a common stock dividend payer now. But again, given the cash flow characteristics of our company, we're always looking for ways to continue to grow our company. M&A would be one of those opportunities.

And you did start off -- oh, we do you have a question here. Let's do that.

In those product areas where there's still supply chain issues, as you mentioned, transformer, switchgear, breakers, could you talk about what you're hearing from suppliers about when they may be resolved? Are there capacity expansions taking place at some of the providers of those who are a year from now, are we still going to be kind of wringing our hands that those things were tied in holding our projects?

Yes. So in terms of the -- what we're hearing from suppliers, many of them have announced capacity increments, particularly against those areas where there are shortages. And again, I think that this plays through to the opportunity in front of our industry as it relates to the secular trends. So our supplier partners are seeing that opportunity. They've been talking to investors about that opportunity, and they're investing behind it. So we do anticipate that there will be capacity increments and more supply coming on board. That will obviously help the lead times as we do see this tremendous opportunity for demand going forward from the secular trends.

[indiscernible].

I couldn't speak to that. It varies by supplier. I know one of our large suppliers announced several capacity increments that are already underway. Again, this is also related to some of the reshoring activities that are going on. But again, I think it would vary by supplier and where they are in their capacity build-out. So I couldn't speak specifics on how that will impact the number of weeks or by when.

Just curious, to go back maybe quickly to your quarter-to-date comments, curious for your perspective on non-res markets. You may have touched on it a little bit with the quarter-to-date update. But curious to delve a little bit deeper given there was another company out this morning talked about softness in new project activity. It's obviously something that people are pretty sensitive to this morning, generally. So curious if there's any update there you can talk about?

It varies by the end market within in non-res construction. And what we're seeing is some slowdown, particularly in some verticals within non-res construction. I'm sure all of you are familiar -- I mean there's just not going to be a lot of Class A office build-outs in some of the major cities. But we are still seeing a lot of activity within the reshoring activity. So all the production capacity moving to North America is creating opportunities. We're also seeing quite a bit of opportunity for some of our customers that are looking for automation within their facilities. So there are still opportunities out there. So from our perspective, we still see non-res construction as a long-term opportunity for us, particularly given some of the secular trends that we called out earlier. But there are some pockets of softness that we've been experiencing. Right now, most of our issue has been with the destocking.

Right. Right. And it sounds like the commentary is fairly consistent, right, across say office buildings, it's something we've known about for some time. Just curious whether there's anything incremental that's happening.

Nothing outside of what you're already hearing.

You mentioned the $4 billion free cash flow 2022 to 2026. How much in that $4 billion do you include working capital improvement inventory decrease? And if you do, how much of the $4 billion comes from working capital versus just cash flow from operations?

Sure. So the $4 billion is our operating cash flow expectation for 2022 through 2026. Over the course of that period, we do expect that we will see a return to normalcy within our inventory days. Our payable days and our receivable days have been relatively consistent with pre-COVID. So we do see some opportunity from an inventory days perspective. But through that period, we're expecting to grow our top line mid-single-digit plus. So with that $4 billion of cash flow does include a net working capital draw over that period to support that growth, but we will be more efficient on the inventory days.

[indiscernible] challenging. Like who do you guys view as your true competitors from a valuation and a business standpoint?

That's always been the tough area that we have to deal with is there aren't a lot of companies like us that are in the public domain. And there are some very well-known competitors within our space that do provide -- they're either publicly traded, so they provide the full disclosures; or they have public debt, so they do file quarterly and annual reports, so we can see some of the makeup of their financials and their disclosures. We think about it from the perspective of -- we're a business-to-business supply chain solutions company. There are others within our space that don't service the same end markets that we do, but we look at their valuations and they tend to be higher. So what we're looking at is how do we continue to demonstrate and deliver the results relative to the expectations that we laid out. Going back to what we said in our Investor Day, we expect over the long term mid-digit plus sales growth on an organic basis. We also expect to have 2x EBITDA growth relative to sales. So if sales are growing mid-single-digit plus, we would expect double-digit EBITDA growth. We think as we continue to demonstrate the performance, we continue to generate the synergies from the merger with Anixter, that is an opportunity for us to continue to benchmark against other investor peers that tend to have higher multiples and higher ratings.

We have 1 minute left. Maybe we'll just call that even then. So thank you guys for the questions. And appreciate it.

Thanks very much for having us. Really appreciate being here.