July 24, 2007
Zacks Research Digest
Research Associate: Sudhanshu Damani, M. Fin.
Editor: Payal Jalan, M. Fin.
Sr. Editor: Ian Madsen, CFA imadsen@zacks.com; 1-800-767-3771 x9417
www.zackspro.com
111 N. Canal Street, Suite 1101 . Chicago, IL 60606
WESCO International Inc.
(WCC-NYSE)
$58.70
Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for report: 2Q07 Earnings Update
Previous Edition: June 13, 2007
Recent Event
On July 19, 2007, WCC reported its financial results for the quarter ending in June 30, 2007. Total
revenue reported increased by 13.6% annually to $1,518.1 million. EPS increased by 11.9% annually
to $1.17 per share.
Overview
Wesco International Inc. (WCC or the Company), based in Pittsburgh is one of North America’s largest
wholesale distributor of electrical construction products and industrial maintenance. WCC distributes
electrical supplies and equipment and provides integrated supply procurement services. The Company
offers multiple products that include electrical supplies such as wiring devices, fuses, terminals,
connectors, tape, and splicing and marking equipment; and industrial supplies, including tools and
testers, personal protection, consumables, and janitorial and other maintenance, repair and operating
(MRO) supplies. For more information about the Company, please visit www.wescodist.com.
Key investment considerations as identified by analysts are as follows:
Key Positive Arguments
Strong Fundamentals: WCC is the second largest
supplier and distributor of electronic construction
products in the U.S.
Selling Strategy: Products are sold through a sales
and marketing force of about 2500 located in 350 fullservice branches.
Acquisitions: The acquisition pipeline of WCC is
robust and there appears to be plenty of opportunity out
there.
Growing Utility Market: Currently, WCC derives 17%
of its revenue from the utility market that continues to
be robust.
LEAN Efficiency Initiatives: LEAN initiatives helped in
raising operating profit from the core business.
Additionally there is a new focus in driving lean
initiatives in both sales and marketing.
CSC Performance: Revenues grew by 14% driven by
CSC acquisition, which appears to be performing well.
Key Negative Arguments
Highly Leveraged Company: Management has
already used $335 million, out of 400 million committed,
to repurchase its share. Even debt has increased year
over year.
Project Delays: Commercial construction project
delays, weaker housing markets, and sluggish
industrial activity are cause of concern.
Sluggish Growth: Organic growth is negligible and is
expected to remain low for the coming quarters
Potential Risk: WCC faces risk from other distributors
as well as mass merchants, retail chains, and buying
groups.
Note: WCC’s fiscal year references coincide with the calendar year.
© Copyright 2007, Zacks Investment Research. All Rights Reserved.
Revenue
Provided below is the summary of revenue as per Zacks Research Digest:
Total Revenue ($M)
2Q06A
1Q07A
2Q07A
Zacks Consensus
3Q07E
4Q07E
2007E
2008E
$1,595.0
$1,563.0
$6,176.0
$6,559.0
2009E
Digest Average
$1,336.0
$1,450.7
$1,518.1
$1,554.7↓
$1,519.6↓
$6,042.9↓
$6,370.8↓
$6,593.3↑
Digest Low
$1,336.0
$1,450.6
$1,518.0
$1,541.5
$1,486.1
$5,996.0
$6,296.2
$6,555.0
Digest High
$1,336.0
$1,451.0
$1,518.1
$1,563.6
$1,571.8
$6,104.2
$6,488.8
$6,625.7
14.6%
13.6%
15.8%
10.4%
13.6%
5.4%
3.5%
5.4%
4.6%
2.4%
-2.3%
Y/Y Growth
Q/Q Growth
5.6%
Zacks Digest average 2Q07 revenue stood at $1518.1 million versus $1336.0 million in 2Q06 and
$1450.7 million in 1Q07 showing an increase of 13.6% annually and 4.6% sequentially. The annual
increase was primarily due to revenue of approximately $181.0 million from Communications Supply
Corporation (CSC), which the Company acquired in 4Q06, representing roughly 13.5% of total growth
in revenue.
However, revenue in the quarter was well below analysts’ expectation and the consensus outlook of
$1574.0 million due primarily to organic growth being essentially flat, up just 0.1% versus guidance of
about 6% and analysts’ expectations of 2%–3%. The Company said that the shortfall in core sales
growth resulted primarily from an unanticipated decline in utility expenditures for distribution material,
and lower commercial construction activity.
Outlook
The Company has reduced full year core growth expectations from 6%–8% to low to mid single digits, it
still believes that 2H will be more positive than 1H. It expects organic sales growth of approximately
2%–4% in 3Q07 with CSC adding between $180 and $190 million for overall sales of about $1.55
billion.
The Company maintained long-term operating margin target of 8.0% and even announced that it is
investing in multiple programs to increase organic topline revenues to achieve this.
Most analysts have reduced their revenue estimates due to slower-than-expected growth rates, pricing
pressure, and higher operating expenses.
One analyst (Morgan Keegan) states that inflationary pricing of products contributed approximately 1%
to internal revenue growth for the quarter. In addition the firm believes that though the Company has
operated in a mode wherein it is not gaining market share to the degree investors have become
accustomed to over the past five years, yet it continues to post growth rates in-line with the underlying
economic trends. It expects that the Company will regain its historical market share advantage in 2008.
Another analyst (R W. Baird) believes that given the current sales trends, coupled with increased
pricing pressure, WCC is losing some market share to competitors and significant sales and earnings
gain will be difficult to achieve.
For more details on individual analyst opinions please see the Consensus tab of the WCC spreadsheet.
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Margins
Provided below is the summary of margins as per Zacks Research Digest:
Margins
2Q06
1Q07A
2Q07A
3Q07E
4Q07E
2007E
2008E
2009E
Gross
Operating
Pre-Tax
Net
20.3%
7.1%
6.2%
4.1%
20.6%
6.1%
5.1%
3.5%
20.3%
6.6%
5.5%
3.8%
20.5%↓
6.8%↓
5.7%↓
3.9%↓
20.9%
6.9%↓
5.8%↓
3.9%↓
20.5%↓
6.6%↓
5.5%↓
3.8%↓
20.7%↓
7.0%↓
6.0%↓
4.1%↓
20.9%↓
7.4%↓
6.5%↓
4.4%↓
Gross margin for 2Q07 stood at 20.3%, flat annually, versus 20.6% in 1Q07 thereby showing a
sequential decline of 30 basis points attributable to significant pricing pressure in some product
categories and markets. Management commented that it is not inclined to relax pricing discipline and
trade-off profitability for volume.
One analyst (Morgan Keegan) believes that price volatility, a later-than-expected round of supplier price
increase, competitive market demand conditions, and the Company’s competitors holding lower cost
inventory than WCC likely created a 10 bps inventory loss on the gross margin line for the quarter.
SG&A expenses for 2Q07 stood at $199.3 million versus $170.2 million in 2Q06 and $202.6 million in
1Q07, thereby showing a y/y growth of 17.1% and a q/q decline of 1.7%. Depreciation and
amortization for 2Q07 stood at $9.2 million versus $6.3 million in 2Q06 and $8.9 million in 1Q07 thereby
showing a y/y growth of 45.8% and a q/q growth of 2.9%.
Operating margin for 2Q07 was 6.6% thereby falling by 50 bps on y/y basis.
Outlook
According to the management, gross margins for 3Q07 should expand modestly with SG&A expected
to improve by 10 bps and depreciation and amortization expense should come in at $9.5 million leading
to operating margin guidance between of 6.7%–6.9%. Management maintained 32% tax rate guidance
with share count between 48 million–49 million for 3Q07 and 49 million–50 million for 2007. The
Company maintained its 2008 target of 8% operating margin. However, one analyst (R.W. Baird)
believes that higher-than-expected revenue growth would be needed to reach this target.
One analyst (J.P. Morgan) believes that gross margin will see a headwind as the business moves
toward more direct ship for late-cycle project business but should still expand owing to productivity
improvements and some acquisition mix benefits.
For more details on individual analyst opinions please see the Consensus tab of the WCC spreadsheet.
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Earnings per Share
Provided below is the summary of EPS as per Zacks Research Digest:
EPS
Zacks Consensus
Digest Average
Digest Low
Digest High
Y/Y Growth
Qtrly. Seq. Growth
2Q06
1Q07A
2Q07A
3Q07E
4Q07E
2007E
2008E
2009E
$1.05
$0.98
$1.06
$0.99
$0.92
$1.08
15.3%
-10.3%
$1.17
$1.17
$1.17
11.9%
18.0%
$1.35
$1.25 ↓
$1.20
$1.30
12.0%
7.1%
$1.29
$1.24↓
$1.09
$1.38
12.0%
-1.2%
$4.89
$4.64↓
$4.45
$4.80
12.1%
$5.62
$5.41↓
$5.17
$5.65
16.7%
$6.14↓
$5.92
$6.40
13.5%
21.6%
Zacks Digest average 2Q07 pro forma EPS was $1.17 versus $1.05 in 2Q06 and $0.99 in 1Q07, a y/y
growth of 11.9% and a q/q growth of 18.0%. GAAP EPS in 2Q07 stood at $1.17 versus $1.01 in 2Q06,
a y/y growth rate of 15.8%.
Outlook
Highlights from the EPS table are as follows:



2007 forecasts (total 10) range from $4.45 (Morgan Keegan) to $4.80 (Wachovia), the average is $4.64.
2008 forecasts (total 10) range from $5.17 (William Blair) to $5.65 (UnionBankSwitz.; Wachovia), the average
is $5.41.
2009 forecasts (total 3) range from $5.92 (Raymond James) to $6.40 (J.P. Morgan); the average is $6.14.
All analyst providing EPS estimates have lowered it for both 2007 and 2008 mainly to reflect the weak
2Q07 and to account for lower organic growth and higher operating expenses.
One analyst (UnionBankSwitz.) believes that the Company’s sales and marketing initiatives, combined
with a pick-up in customer spending, a discipline on pricing, a lagged benefit from copper prices, and
help from share buybacks could drive earnings growth over the next 12 months.
For more details on individual analyst opinions please see the EPS tab of the WCC spreadsheet.
Target Price/Valuation
Of 11 analysts covering the stock, 8 gave positive ratings and 3 gave neutral ratings. There was no
negative rating on the stock. The Zacks Digest average target price was $74.11 (↓ from the previous
Digest report; 26.3% upside from the current price). The price targets range from $66.00 (FTN Midwest
Res.) (12.4% upside from the current price) to $81.00 (J.P. Morgan) (38.0% upside from the current
price). The firm (J.P. Morgan) with the highest target price of $81.00 rated the stock Overweight. The
firm (FTN Midwest Res.) with the lowest target price of $66.00 rated the stock Neutral.
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Provided below is the summary of rating and valuation as per Zacks Research Digest:
Rating Distribution
Positive
72.7%
Neutral
27.3%
Negative
0.0%
Digest High
$81.00
Digest Low
$66.00
$74.11 ↓
Avg. Target Price
Analysts with Target Price/Total No.
9/11
According to analysts, risks to the target price include sensitivity of revenue to foreign exchange
fluctuations, various risks associated with the Company’s acquisition strategy, commercial construction
project delays, intense competition in the electrical distribution industry, and risks associated with the
Company’s high financial leverage/debt burden.
Metrics detailing current management effectiveness are as follows:
Metric (TTM)
WCC
Industry
S&P 500
Return on Assets (ROA)
9.88%
7.00%
8.36%
Return on Investments (ROI)
17.47%
9.49%
12.36%
Return on Equity (ROE)
37.75%
18.28%
20.84%
ROA, ROI, and ROE are higher than the overall market averages (as measured by the S&P 500) of
8.36%, 12.36%, and 20.84%, respectively.
For more details on individual analyst opinions please see the Valuation tab of the WCC spreadsheet.
Capital Structure/Solvency/Cash Flow/Governance/Others
Balance Sheet
Cash and cash equivalent in 2Q07 stood at $65.0 million versus $55.3 million in 1Q07, trade accounts
receivable for 2Q07 was $892.2 million versus $865.7 million in 1Q07, inventories for the quarter stood
at $634.8 million versus $606.1 million in 1Q07. On the liability side accounts payable for 2Q07 was
$664.6 million versus $646.7 million in 1Q07, long-term debt for 2Q07 stood at $838.4 million versus
$777.2 million in 1Q07, total stockholder’s equity for the quarter stood at $556.5 million versus $623.2
million in 1Q07.
Share Repurchase
WCC maintained its commitment to the $400 million share repurchase program announced in February
of 2007, repurchasing a total of 5.2 million shares thus far, out of which 2.2 million shares were
purchased in 2Q07, leaving approximately $65 million in authorization.
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Acquisition of Cascade Contols Corporation
At the end of June, WCC closed on the acquisition of Cascade Controls Corporation. Cascade has
annual sales of $11 million and is a well-established automation and controls distributor in the
Northwest region of the U.S. Cascade provides WCC with additional capabilities to serve its growing
customer base of original equipment manufacturers.
Potentially Severe Problem
There are none other than those discussed in other sections of this report.
Long-Term Growth
Long-term growth rates vary from 10.0% (FTN Midwest Res.) to 15.0% (Wachovia, William Blair) with
an average of 13.0%.
One analyst (UnionBankSwitz.) estimates that WCC’s business is currently 95%+ domestic. It believes
some of the growth opportunities that could result from exposure to engineering and construction
companies are more international.
Another analyst (Stephens), though cautious in the near term, believes that the Company’s long-term
term business trends remain solid across all of its key markets. In addition, the firm continues to expect
the industrial economy to rebound in 2H07 and into 2008, utilities are expected to continue to build out
the electrical infrastructure across the U.S., and the outlook for large construction projects remains
generally strong – all of which should give WCC a boost.
Management expects the industrial market to remain stable supported by capital spending and
sustained manufacturing. According to analysts, management has been aggressive in using
acquisitions to boost growth, and will likely continue to do so in the future. Analysts expect topline
growth to receive equal contributions from both organic initiatives and acquisitions. The bottomline
growth will likely be driven by further improvements in operating leverage as benefits from the
Company’s Lean initiative, a cost reduction program implemented in 2005, roll out for another 2–3
years.
Upcoming Events
On October 18, 2007, WCC expects to release its 3Q07 earnings.
Individual Analyst Opinions
POSITIVE RATINGS (72.7%)
Goldman – Buy ($75.00) – 07/19/07: The firm maintains a Buy rating with a price target of $75.00.
INVESTMENT SUMMARY: The firm expects improvement in organic growth rate, with better utility endmarkets. It also believes that the investors should capitalize on the attractive relative valuation of the
Company.
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J.P. Morgan – Overweight ($81.00) – 07/23/07: The firm reiterates a price target of $81.00 and an
Overweight rating. INVESTMENT SUMMARY: The firm believes that WCC has fairly low business risk
given a very diverse customer, industry, and regional base, as well as variant growth drivers in
integrated supply, national accounts, and the local branch-based operations.
Lehman – Overweight ($77.00) – 07/20/07: The firm maintains an Overweight rating but reduced its
price target from $77.00 to $75.00. INVESTMENT SUMMARY: The firm believes that the Company’s
refocus on investing in sales and service capabilities in combination with positive end market conditions
could generate improved organic sales growth and leverage.
Morgan Keegan – Outperform – 07/20/07: The firm maintains an Outperform rating. INVESTMENT
SUMMARY: The firm believes that despite a weak 2Q07 and the core revenues remaining almost flat,
annually, the most important factor is that the Company is not losing market share.
Raymond James – Outperform ($75.00) – 07/19/07: The firm, though positive on the stock, has
downgraded its rating from Strong Buy to Outperform and decreased the target price from $80.00 to
$75.00. INVESTMENT SUMMARY: The firm believes that the downside on the stock is limited, and
that a reacceleration in organic sales growth is possible, and not imminent, by the end of the year,
following 2Q07’s weak results and particularly weak organic growth guidance for 3Q07.
Stephens – Overweight ($75.00) – 07/20/07: The firm maintains an Overweight rating and a price
target of $75.00. INVESTMENT SUMMARY: The firm believes that the stock is undervalued. In
addition, it also expects 2H07 to be better than the first half of the year, which should result in multiple
expansion over time.
UnionBankSwitz. – Buy ($75.00) – 07/20/07: The firm maintains a Buy rating on the stock but
decreased the target price from $77.00 to $75.00.
Wachovia – Outperform ($73.00) – 07/19/07: The firm maintains an Outperform rating but decreased
the price target from $75.00 to $73.00. INVESTMENT SUMMARY: The firm believes that the
Company’s long-term earnings remain favorable and that current valuation levels represent a buying
opportunity.
NEUTRAL RATINGS (27.3%)
FTN Midwest Res. – Neutral ($66.00) – 07/20/07: The firm maintains a neutral rating but decreased
the price target from $67.00 to $66.00 based on reduced expectation for EVA improvement through
2008.
R W. Baird – Neutral ($72.00) – 07/20/07: The firm maintains a Neutral rating, with a price target of
$72.00. INVESTMENT SUMMARY: The firm believes that low organic growth rates, weakness in the
utility and non-residential end-markets and weak pricing are indicative of near-term market share loss,
which may make sales and profit growth more difficult.
William Blair – Market Perform – 07/20/07: The firm maintains a Market Perform rating.
INVESTMENT SUMMARY: The firm is of the opinion that the Company represents strong growth
prospects, high operating leverage, room for margin expansion, and improving ROIC. Although these
positives are in place, the firm is yet not confident that in the near future these factors will be able to
overcome slowing sales growth, significant pricing pressure, and declining incremental operating
margin.
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NEGATIVE RATINGS (0%)
None
DROPPED COVERAGE
Prudential – 06/11/07 – The firm dropped its coverage of WESCO International due to departure of the
covering analyst.
Research Associate: Sudhanshu Damani
Copy Editor: Salma Islam
Content Ed.: Payal Jalan
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