Over the past two years, Nick Lipinski and his team at Vertical Research Partners (VRP), an equity research firm with a tight focus on publicly held companies in the electrical, industrial, automation and transmission and distribution and distributor markets, has partnered with Electrical Marketing to provide a quarterly survey of economic conditions in the electrical market. With all that’s going on with inflation, lead times, geopolitical concerns and the potential for a recession, their Q3 2022 analysis of the survey results are particularly timely. Below is an excerpt of their report.
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Strong sales and pricing that's still robust but moderating. Q3 distributor sales were up +13.5% with prices up +5.8% and volume growth of +7.7%. The result was broadly similar to the +13.7% growth in Q2, with the volume and pricing results roughly flipped this quarter. The two-year growth stack of +28.2% in Q3 was also similar to the +29.5% in Q2.
While pricing moderated from the record seen in Q2, the +5.8% increase was still among the highest reported increases in our survey’s history back to 2006. Electrical equipment sales led for the third straight quarter, showing slight sequential acceleration to +17.2% including price up +6.3%. Power also showed sequential improvement at +11.9% on volume growth of +6.5% and +5.4% in price, and was the only category to see an improved two-year growth stack. Automation sales grew +8.5% on +3.1% volume growth and 5.4% in price.
Brave new world. To say the operating environment continues to be highly challenging and dynamic risks understatement. The days of book and ship are clearly over. The reality of extended and unreliable supply lines are forcing creativity and adaptability in finding solutions to fill customer orders. There is no end in sight as manufacturers have been slow to react in disentangling a just-in-time inventory system assembled over many years. Price increases continue, reflecting the strong demand pull, continued limitations on availability, and the absence of noticeable demand destruction to date. While we may not continue to see price pushed at the pace it has been over the past year, two-to-three increases per year are possible (versus the one increase that sometimes historically occured).
The demand environment remains broadly strong but faces a number of cross currents. Interest rates are clearly beginning to impact some construction projects, with some possibly speculative commercial investments most at risk of cancellations. At the same time, government stimulus is boosting infrastructure and energy retrofit activity. Switchgear availability was mentioned several times as a key limiting factor to sales/delivery, but issues continue to pop up across the product portfolio including in lower end items. Backlogs continue to grow even as some project cancellations are popping up, and should ensure a steady pace of activity into 2023.
High uncertainty driving a cautious distributor outlook. Distributors historically demonstrated solid predictive ability in gauging their next quarter’s sales, but for roughly the past year appear to have been waiting for a slowdown that has yet to arrive. From 2015-2020, the average beat/miss versus the projected growth expectation was essentially 0%, with some lags up and down through the cycle netting out. In the post-COVID recovery since 2021, distributor sales have consistently come in above their expectations heading into the quarter, by approximately +5.5% on average. Distributors overall are expecting +4% growth in calendar Q4 2022. While some slowdown is inevitable, with price up +5.8% in Q3, there is likely enough carryover benefit to support the +4% Q4 growth outlook. The recently understated projections likely reflect some conservatism on the part of distributors in the face of widespread uncertainty relating to the supply chain. The variation within distributor outlooks has been elevated since the COVID pandemic broke out, and this quarter showed the largest variability outside of the peak pandemic panic in Q220.
Survey reach. We surveyed 29 distributor branch managers in total throughout North America capturing an estimated $700 million in revenues. Although the sample revenue represented by our coverage universe is a relatively small proportion of our group’s total revenue, the true power of the survey is the directional growth and anecdotal commentary about end market conditions, which are salient indicators for our entire group. Companies such as Eaton, Hubbell, Rockwell, nVent, Schneider (Square D) and ABB are well represented in the survey because they sell primarily through distribution. Of the 29 distributors, 12 sold electrical equipment, 10 focused on T&D utility customers and seven sold automation equipment.