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

Good afternoon, everyone. Thanks for joining us. My name is Dave Manthey. I am the Senior Industrial Distribution Analyst for Baird and it is great to have WESCO International here with us today. To talk with us about the company, we have John Engel, Chairman, President and CEO. Scott Gaffner is here. the Senior Vice President of IR. I'm going to turn it over to John for a brief overview. He's going to go through just a couple of slides to level set everyone, and then we're going to turn it over to Q&A. If you have questions, as always, you can reach us up here by [email protected], and I'll field those off the iPad. Raise your hand, we'll call on you. And I will moderate that once the introductory remarks are behind us. So with that, John Engel.

Dave, thank you. Always a pleasure to be here at your conference. I know it's a record-setting conference again. So congratulations to you and the Baird team. Great to be with all of you today. Just a few brief comments. I'm going to touch on a page or 2 from our recent Investor Day. The first is our investor thesis, why invest in WESCO. First, we are a market leader. We're a market leader in our end markets. We have 3 large businesses, leaders in their own right; an electrical business, a utility and broadband business, and a data communication and security business focused on data centers. And we think we're best positioned, best positioned to deliver outsized growth going forward given the very attractive secular growth trends we're facing into in our served markets. Second, significant cash flow generation as a B2B distributor. We've had that historically, and that's our commitment going forward, we invest organically in the business first to drive outside growth and margin expansion. And we'll talk briefly on the next page in terms of capital allocation. But we've been acquisitive over the years, and we intend to continue to be acquisitive. And then third, we're going through a massive, and I use the word massive enterprise-wide business transformation. We're more than halfway complete. It's a 6-year-plus journey. We're digitalizing every part of the business. I'll leave you with this. We're a Fortune 200 company. When we're done, brand-new tech stack, every system we're operating on, every system will be new to the company. We're more than halfway complete through this journey. We launched this in earnest 6 months post the closing of acquiring Anixter back in the middle of 2020. And this is going to be absolutely transformational for our business. We think it will position us as we unlock the power of our big data and one world-class data lake to accelerate our top line growth, dramatically expand our margins and also in speed -- increase our speed to value for future acquisitions. Quickly on cash flow. If you look at the right-hand side of this page, you can see our average annual cash flow for 10 years pre-Anixter acquisition. We closed with them in 2020. We've averaged over all parts of the economic cycle, roughly 100% of net income is converted to free cash flow. Our guide for this year is $800 million to $1 billion. To give you a few data points, second half of last year, we generated $400 million of free cash flow. First half of this year, $500 million of free cash flow. We just generated $280 million in our third quarter of this year. So well on track to deliver the guide for this year. We've committed to a cumulative target of $3 billion over '25 through '27. The drivers are shown on the left of this page. Finally, in terms of capital allocation, we're going to direct 75% of our free cash flow, that $3 billion plus to M&A. We've been acquisitive over the years. We're going to continue to be acquisitive. We've played a major role in industry consolidation. We expect that to continue as well as focusing our acquisitions on services and adding services to our company portfolio, and I know we'll talk more about that. That leaves 25% of the allocation to a consistent buyback program, and we did initiate a dividend 2 years ago. We increased it 10% after the first year, and we expect to increase that over time as well. To the extent that the M&A opportunities aren't manifesting themselves because you can't always time those perfectly, we would direct the cash flow to buybacks and debt paydown. To give you a sense, through 3 quarters of this year, we paid down $475 million of debt, and we bought back $375 million of stock through 3 quarters. So with that, Dave, I'll open it up.

All right. [email protected], if you have any questions, Trimble, we don't want to do that. My first question for you, John, is we're asking about the interest rate situation. I'll reframe it a little bit to apply to your business. The economic environment, we're in this period, I'm calling stall speed. I mean when they put up GDP and looking at 2.8%, I'm asking myself, where is that? It's not on my coverage list. I guarantee you that. And with a -- what is it, 40% of your business directly in sort of that EES that more of an industrial angle. Could you talk about the -- as we sit here today, your outlook for 2025 and just thinking about relative to the overall economy, I mean, does -- can we see some growth next year, new administration, potentially lower rates, maybe we get a little bit of growth next year. Can you talk about how you feel about it?

Yes. We've not given our formal guidance for 2025 yet. We typically do that with our Q4 earnings release. With that said, we've outlined a bit of the framework on how we're thinking about it. Look, in this year, we clearly have seen what you said, Dave, which kind of stall speed. I mean, I guess the good news is we didn't really experience any deep recession. Soft landing appears to be underway. And -- but with that said, we did not deliver the growth we expected this year. As we got through the third quarter, we have 3 business units. It's very good to see one returning to growth, our CSS business on the back of very strong AI-driven data center growth. The Utility business, obviously, has had some headwinds through the year and broadband is part of that, coupled with utility and electrical as well had a series of kind of minor tailwinds, but a lot of headwinds as well. As we look forward to 2025, we expect all 3 businesses to grow. Again, we're not going to give the outlook today. But I think what we'll see in 2025 as the first year of a multiyear process, I'd leave you with this. The secular growth trends we see in our value chain, our served end markets are going to begin to really rule the day. That was my view pre-election. I'll come back to that. But clearly, when you -- these secular trends that many companies talk about, whether it's electrification, IoT applications, automation, AI-driven data centers, Gen AI-driven data centers, nearshoring, reshoring, all of that requires one thing - increased power generation. And electricity demand in the U.S. has been -- is flat in 2024 back to 2007 levels. So you're talking about 17 years, we're at the same level. We're now facing a rising power demand curve. And that's required for anyone, let alone collectively all these secular growth trends. So I think those trends start to rule the day. Now when you factor in the election outcome, I think one thing can be said, this nearshoring, reshoring secular growth trend was underway pre-election, I'll digress for a moment. We sell to 90% of the Fortune 100 companies directly. They're all looking at reshoring, nearshoring to varying degrees. It's because of what happened in the pandemic. They put an electron microscope on the global extended supply chains. And in many cases, these companies have supply chains that got single threaded. And no one ever thought about that black swan event happening. It's raised the priority of supply chain not only to a C-suite and board level, but to a country level. And so near-shoring, reshoring was absolutely underway, even though you don't hear a lot of companies talking about, they don't admit it. They don't want to talk about it. But this is absolutely a secular trend that started pre-election. With the administration that won, I think you're going to see an amplification of that. And so clearly, there'll be a focus on USMC markets with U.S. at the top of that, which should result in even more support for, I'll call it, captive U.S. investment, which should bode well for those companies that have a large infrastructure base in the U.S. So I think, again, I'll end on that note. The secular trends will rule the day. If they are secular, they're multiyear in nature, and it's not 1 or 2 years. I think we start to see that. I think we're already seeing it in data centers, but I think you see that spread to other applications as we move into 2025.

Yes. We have heard some of the companies at this conference start to talk a little bit more about the onshoring that they are seeing some -- we talk about chip fabs and battery plants and things like that, that we're starting to see some.

The new semiconductor wafer fab plants that hadn't been done in 3 decades in the U.S. and you have more than one now, right? Again, it needs power. But I think -- again, it's just -- I think it's just -- there's a lot of examples. Look, it's interesting. I've been in B2B distribution for 2 decades, all with WESCO. Prior to that, in different end markets at engineering manufacturing companies. My whole career, 40-plus years, the businesses I worked in, again, 7 or 8 different end markets, everything was being outsourced south of the border to Southeast Asia. And just think about that over the last several decades. So this didn't happen overnight. I think there's a fundamental shift. The knife edge switch has been thrown. And again, that's independent of the election outcome. And I think, look, here we go. There's an opportunity for a reindustrialization of America. It will have a totally different mix, higher electronic content, but we're at the front end of that potentially, clearly.

All right. Some analysts at Baird gauged it at $15 billion over 10 years. I don't -- maybe that's right, maybe not. It's a good guess anyway. One other thing I wanted to ask you, John, was that we're hearing a lot about is, of course, tariffs. It's related to what we're talking about. But in the near term to medium term, if there are any tariffs enacted and maybe reflect back on what happened last time around, I think, for the company.

I think -- I mean, obviously, this is a hot topic now because it's expected that there will be increased tariffs or at least it will be used as a lever. As a first derivative effect, it's a rounding error. We don't have a meaningful in terms of size private label business. As a distributor, if you got a meaningful private label business, you're going to have to deal with this directly. So where do we see it? We'll see it with our supplier partners. Again, we're a business-to-business distributor between customers and suppliers. And for many -- for most of our supplier partners, we're their biggest customer and channel to market. So clearly, they're going to -- depending on their mix of their products and where they manufacture, they're going to have to deal with that. Now I'd say the good news in this is, at least in core electrical and even for, I'll call it, fiber optics and datacom like a Corning, many of our supplier partners have been investing in the U.S. and stepped up those investments meaningfully as we came through the pandemic. And so there's some investments that are already made with increased capacity in the U.S., and there's other in-flight investments underway. So I think that gives them the opportunity, Dave, depending on the supplier, what the tariff hits for them to continue to leverage and pivot even more to kind of a U.S. or a USMCA manufacturing base. But clearly, look, again, this is -- we'll have to see -- the mix is going to matter, like what's addressed to what degree, the devil is in the details.

And I guess if you're saying it's a secondary or tertiary effect, that means that the manufacturer would incorporate whatever that tariff is into the price of their product, which relates to inflation, which has obviously historically been a positive for distributors.

So to your point, I mean, if we have a reignition of inflation, we're not wishing that on anyone, but to the extent inflation occurs and it's broad-based, that's good for distribution. And I think what might be interesting this time is -- and to the extent that happens, -- how does that play against the demand environment? And if you believe these secular trends are really starting to build steam, it will be interesting to see that dynamic. It's going to vary by value chain. But net-net, Dave, to your point, right now, our view because you can't do anything else. I mean we saw about 1% to 2% of price this year. If you -- we get a good insight into our suppliers anticipated or planned price increases, we get a 3- to 6-plus month look out. Number of SKUs and magnitude of price increase relatively stable with our forward-looking view. We're 1% to 2% kind of realization this year. That's our kind of base case. But to the extent it starts stepping up, Dave, to your point, we know how to manage in that environment. As our suppliers, if we want to pass that through, we'd work with them and hopefully, we'll see what the market bears. Some markets will bear it more than others, again, based on demand profile.

All right. That all sounds very good. Thanks for sharing that information. Maybe we could talk about -- you mentioned capital deployment and M&A that you discussed at the Investor Day. One of the things I talked with Dave, your CFO there at the conference was, it sounds like you're looking at more like the Ascent deal or like a Rahi, where you've got maybe more of a service element or you're trying to skew the business toward higher-margin opportunities. But I think with that would typically come higher acquisition multiples. So my question is, how are you going to strike the balance there? And can you continue to move returns on invested capital higher with higher margins if you're paying more for the deals. Can you talk about how you would bridge that gap?

So -- and Scott just framed up the page from our Investor Day. Thank you for that, Scott. So as we think about our M&A priorities going forward, first, I'll say we historically have been very acquisitive. I think some of you know WESCO, some of you don't, but WESCO spun out of Westinghouse in 1994. So we're talking 30 years ago. It was $1.5 billion in sales and losing money. And so we've done over 50 acquisitions since '94, over 30 under my watch. I would say that the acquisitions, at least over the last 5 to 10 years have been focused on strengthening our category positions and building out more scale. Anixter was actually game changing because we took 2 equal-sized Fortune 500 companies and put them together and did that in the beginning of the pandemic and successfully integrated those. So that was a big scale move. So I don't -- that's still on the table, Dave. We still -- any -- look, any deal that's getting done, we get a call and many times we get last call and sometimes we get only call. But anything that's happening, we will look at. Some we're choosing to put into play. So I wouldn't rule that out. But to the extent we lean in that direction, it does take us out of the market for a while to do these other priority of acquisitions, which is services. And I think probably the best example of what we've done organically in the business, and it was organically, was our utility business when I joined 20 years ago was sub-5% EBITDA. Now it's our highest profitable business, because we're much higher on the service value proposition, direct end-user customer. We're more than products, it's services, supply chain solution management and includes some fee-for-service-based business model. So we added services organically at a relatively slow rate over the last 1.5 decades plus. Now we want to use our balance sheet to inject services quicker. The most recent example is post Anixter, the first deal that we did was Rahi Systems 2 years ago, November 2022. It wasn't that large a company, but that put us in a great place for a more complete data center solution. It added services, and they had a rack and roll program, which is not just products, they would build out the server rack, test it, qualify it, certify it and support global deployment of direct end-user customers. So we climbed the value chain a bit, coupled it with Anixter -- legacy Anixter's data center position, and it's the basis upon which we're growing our data center business that went from teens growth in Q2 to we're in north of 40% growth. Our data center business grew in Q3. It's a $2 billion of our $22 billion plus run rate, so -- and accelerating. So we want to tuck in these acquisitions that are services and use that as we cross-sell with our end-user customer base and kind of expand the scope. We announced a deal the day of earnings after earnings, called Ascent, another data center services company. This has no products. It's not a product distributor. It's pure-play services. It includes an on-site staffing model, helping manage the operations of the data center. And so we're exceptionally well positioned now to kind of participate across the life cycle of the data center. One thing that's not getting written about quite enough, quite frankly, is when you think about this mega data center growth, this secular growth, everyone is talking about building these new data centers, right, 800 megawatts, gigawatt mega data centers. With Gen AI, you're going to see a significant amount of investment around upgrading current data centers. And you're talking about an order of magnitude in terms of power density. And so if you're in there working the whole life cycle of the data center, even better positioned to participate in those upgrade or retrofit projects. So it's services, we're willing to pay a little higher multiple if it's got higher margins and if the growth rate, if the equation works such that we get the payback quickly. That was the case with Rahi. And we expect that to be the case with Ascent. It's been running a 30% CAGR for the last 3 years. So again, we're willing to pay up a little bit, again, with the eye on the price being delivering the outsized growth tied with the secular growth trends. But to your point, Dave, this balancing act is going to be delicate. We want to still use our balance sheet right. It's the biggest balance sheet, strongest balance sheet we ever had. We are seeing the power of scale in our business. I mean, WESCO and Anixter coming together is -- I know it's textbook, is case in point of what scale can do. And so there may be some of those opportunities. You can't time those right. You got to be positioned. Our pipeline now, I say, is very robust in terms of a number of different types of deals and many of them have high services content.

Okay. Any questions from the audience? -- here. Okay. Let's think about -- just before we leave the Ascent acquisition, I wanted to ask you if you could -- I don't pretend to know exactly how data centers are run and this sort of thing. Could you just talk about Rahi and Ascent and how that fits into the data center operations? And importantly, I think there's been some questions that I've gotten from other industry players that have asked, is there any kind of channel conflict potential with these sorts of deals relative to your other potential customers that you'd be selling to in the data center arena. Again, I don't know, but maybe you can explain it to us.

So I'd say the data center position started with the legacy Anixter business, and they served data centers either directly as an end-user customer. And this would be whether it's a hyperscaler, one of the big global hyperscale players or MTDC, a multi-tenant data center. That's a company that builds a data center and then sells out the capacity to others to use that compute capacity or enterprise-class data center, which is a customer that has their own captive data center on site dedicated to them. So those are the end-user relationships that Anixter had when we acquired them, merger them, integrated them. And they also went to market through specialty integrators. So there's a number of specialty integrators that also serve those end users. So it's a very interesting when you map out the whole channel flow. There's direct end users and then there's these specialty integrators that will also do projects for data center customers. Not unlike what can be done with an industrial customer with electrical and sometimes, where you have a specialty contractor or you do a project direct for them. So Anixter's blue-chip relationship with the end users was something that we really coveted because WESCO's datacom business didn't really have those end users for data centers. So that's the structure of the industry. And Anixter, by and large, was a product-based distributor for the white space of data centers. The white space is that is under HVAC control. Again, it's not -- we're not Ingram Micro or Tech Data that got merged with SYNNEX. We're not -- we don't provide the switches or the equipment that goes in the racks. But everything else that's in the data center, the racking, the fiber optic connectivity, the thermal solution, IP cameras that are in the room, how it ties into the infrastructure, we're heavily involved at the design level. So Anixter has a captive engineering team that works in conjunction with its end customers to help design and spec in these -- the connectivity solutions, let's say. So that's how it works. Now what did Rahi do? Rahi gave some additional services to the Anixter portfolio, but also this rack and roll capability where they would build these racks full up, test them, certify them that they work to a spec and then would help globally deploy them to that hyperscaler or MTDC or enterprise class customer. So it climbed the value chain a little bit. What does Ascent do? Ascent has no product sales. They're in there with the data centers operating, they have an interesting software package that helps monitor the KPIs of the data center, can give early warning indicators if there's issues, they help support maintenance and other upgrades. They also have part of that software will manage some of the capital projects and ensure they're getting ROI as upgrades are made to the data center. So they're embedded in the operations of the data center. So now we have more of a full life cycle view. And again, as I mentioned, I think it's going to be very interesting as we go forward because obviously, new data center builds, these big mega data centers are great opportunities, but the retrofit renovation and upgrade of data centers represents another great, I'll call it, demand stream. Pre-AI, the half-life of a data center was 4.x years. What does that mean? They would take everything in the rack, change it out because, again, Moore's Law has not reached its limit. So okay, there would be good payback to basically increase the capacity and speed and compute power of that data center. With Gen AI, it dramatically reduces that half-life, right? So -- and there's massive investment and upgrades required to go, which includes much more exotic cooling solutions, liquid cooling for Gen AI right because of the power demand. So it's just a holistic look at that value chain, Dave. We're so much more than a product-based distribution company. The services and then looking at the whole life cycle. This is why at our Investor Day recently, we didn't have each of the 3 businesses present. We picked 2 major topics, our digital transformation, which we gave a lot more detail than we had previously on that publicly and data centers. And I'd encourage you to listen to that replay.

Well, in the last 3 minutes here, as long as we run the data center thing, which I think is super important and a really interesting part of the business. Could you talk about the opportunity? You talked about the white space. Talk about the gray space given that, that's kind of legacy WESCO it is where you reside?

It's where we reside, but it's interesting because if you look at how that industry grew up, and these are these giant hyperscalers were onetime small tech companies, and they've been managing their own hyper growth, no pun intended. The electrical switchgear for the gray space of data centers historically has been provided direct from manufacturers to the end user. So the Eatons of the world, Schneider Electrics of the world, our big supplier partner, Siemens of the world, they've been providing that direct. As a structural matter, that's how the industry worked. We are now picking up some of those projects. We have a much more complete solution under 1 tent that combined WESCO and Anixter and our direct end-user relationships because now they're trying to execute globally to a set of design standards and deploy globally, they all have massive spend budgets. These are -- the big companies we're talking about are magnificent 7 plus. You see what their annual investments are. They're trying to execute globally with these data center build-outs. There's no one else who has the global execution capability. That's a value-added distribution function. Anixter built it organically over 2 decades. They were in 53 countries around the world when we bought them. No one else has it today. So they are now looking at what they used to do inside their 4 walls. This is much more complex, and they're looking for, quite frankly, one outsourced partner to help manage that for them, and we're filling that bill. Yes, they want one throat to choke, but I think it's an opportunity for us to pick up gray space. And then the final point, which will be the ultimate determinant, quite frankly, is power. That's our -- so the gray space is our EES business, the white space is our CSS business, the power is our UBS business. And at the end of the day, you need to have the power solution or you can even begin to think about where to site the data center, and that's instrumental to the siting. Here's a stat, and there's a lot of estimates you'll see. Total data center power demand in the U.S. this year is about 25 gigawatts. The estimates of that will be 80 to 100 gigawatts in 2030. So you're talking north of 10 gigawatts per year added if it was linear. 1 gigawatt is the equivalent of one new nuclear power plant. Think about that. So this is why I've said for quite some time that the utility industry, which was a cyclical GDP industry, is fundamentally shifting to secular growth. You're not going to be able to talk about data centers without talking about power, but we're uniquely positioned for that, too. And I do think back to utility, I think we're entering -- again, electricity demand has not grown since 2007, but now we're facing this rising power demand curve. So very exciting opportunity.

Great. Well, thanks for the download on data centers. That was great. And so what I'm hearing you say is you expect growth next year. Hopefully, with that, we can get some margin expansion, 10 basis points, $0.30 per share. It's got a lot of operational leverage. And in a better economic environment, I think this can be a really interesting story. So thank you, John and Scott. Appreciate it.

Thank you.

The guys will be available at the [ salon C ] breakout session immediately following this presentation. Thank you.