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National sales forecasts by DISC Corp. and Electrical Wholesaling’s Market Planning Guide look similar for 2006. For this year, both EW and DISC forecast growth of more than 10 percent.
According to DISC numbers, industry sales will grow 12.8 percent in 2006, with double-digit gains in the distributor-served contractor and industrial market segments. I believe 2006 will go down in history as the best year in this decade. It doesn’t get any better in 2008 or 2009. Led by strength in the distributor-served contractor market, look for a continuation of the industry growth cycle in 2007 that’s not quite as robust as this year. The distributor-served industrial market will cool to an 8-percent growth rate in 2007 after topping a 13-percent rate this year.
This phase of the distributor business cycle took off in 2004 when the distributor-served industrial market ratcheted up more than 8 percent. In the fourth quarter of 2004, industrial sales grew by an exceptionally strong 13 percent. By the fourth quarter of 2005, industrial sales surged again, hitting a 15-percent pace. Now the distributor-served contractor market is leading all market segments and is up nearly 16 percent in 2006. This growth is driven by nonresidential construction spending, which was up 8 percent in the second quarter of 2006. Since mid-year, nonresidential spending is averaging better than 15-percent growth in deflated dollars.
Sizing the Residential Market
Meanwhile, the growth rate for spending on residential construction peaked in the third quarter of 2005 and has been weakening through 2006. DISC forecasts that residential construction spending for the second half of this year will decline more than 10 percent from the same period a year ago.
You may ask yourself: If the residential market is weakening, how can total distributor sales grow nearly 13 percent and contractor sales grow nearly 16 percent this year? In terms of total construction dollars spent, the residential piece (in deflated dollars) is $581 billion; the nonresidential segment is $277 billion. That’s a ratio of more than 2 to 1. In terms of growth, the residential construction market will decrease about 4 percent this year, while the nonresidential construction market will increase more than 10 percent this year, in real terms.
Electrical distributors are enjoying the strongest distributor-served contractor market in more than five years. That performance is taking place despite negative growth in residential construction spending. That can only happen if the distributor market is more tied to nonresidential construction than to residential construction. Of course, the electrical market grows the most when residential and nonresidential construction spending grows at a good clip in tandem, but that doesn’t happen often enough.
We are witnessing a fairly substantial growth differential between residential construction and nonresidential construction spending. For example, for the fourth quarter of this year, DISC forecasts residential construction will be down 13 percent and nonresidential construction spending will increase 15 percent. That’s a 28-point spread and it’s quite significant.
Yet we are looking for an 18-percent gain in the distributor-served contractor market in this year’s fourth quarter over the fourth quarter of 2006. An 18-percent increase in the face of a 28-point spread indicates the residential market, while very important to many distributors and manufacturers, is not the critical driver in overall industry performance.
According to the responses from electrical distributors that Electrical Wholesaling receives to its Market Planning Guide (MPG) survey, the residential market accounts for more than 20 percent of total distributor sales. Twenty percent of total industry sales, according to DISC’s numbers, amounts to about $14.5 billion. This makes the residential component just about half of the distributor-served contractor market, which is a $29 billion market.
If the overall distributor-served contractor market is split equally between residential and nonresidential construction spending, it seems we would have experienced a better industry performance since 2003, because residential construction spending has increased more than 8.5 percent annually (until this year).
To extend the logic, let’s take a case in point and use 2002 as a base because that was the industry low point during the current cycle. The distributor-served contractor market decreased 13.3 percent in 2002. In deflated dollars it declined 10.7 percent. Residential construction spending increased 3.9 percent, while nonresidential construction spending decreased 16.4 percent in deflated dollars in 2002. The combination of residential and nonresidential construction spending in deflated dollars decreased 4.5 percent.
If residential construction spending constituted half of the distributor-served contractor market, we would have seen a much better performance, something closer to a 4.5 percent decrease rather than the 10.7 percent decrease actually observed.
So what’s the point? Simply that at best there is uncertainty as to the size of the distributor-served residential market. This is an important gap in our understanding of the electrical wholesaling industry, and it would help if a better solid residential market number was available. The only way that can be done is if a greater representation of electrical distributors — large, medium and small — reported their sales mix to Electrical Wholesaling in the annual survey it uses to develop its sales forecast for the Market Planning Guide each November.
Outlook for 2007
The DISC forecast for 2007 looks for continued strength in the electrical industry, led by the contractor market and followed by the distributor-served industrial market. From 2003 through 2005, growth in the industrial market led industry sales.
The DISC forecast takes into account the behavior of three key economic indicators for the electrical industry. The two most powerful drivers of industry sales, investment in machinery and nonresidential construction outlays, are largely responsible for the solid overall industry growth beginning in 2006.
Finally, it’s clear that with real growth up a solid 7 percent this year and 4.5 percent next year, order backlogs are high and rising. The electrical industry is challenged to manage its scarce resources efficiently and improve productivity in order to maintain profit margins.