Business Strategy and Outlook:
In 1994, Westinghouse Electrical sold its electrical distribution business, Westinghouse Electric Supply, or Wesco, to a private equity firm. Wesco went public in 1999. Since its separation from Westinghouse, Wesco has used most of its cumulative free cash flow on acquisitions, which have expanded its scale, diversified revenue, and fuelled a meaningful portion of the company’s growth. Wesco now serves a much broader array of customers across industrial, construction, utility, commercial, institutional, and government markets. Wesco operates in very fragmented markets, but its large scale, global footprint, expansive product portfolio and supplier base, and service offerings differentiate it from smaller local and regional competitors. Service offerings, such as vendor-managed inventory, efficiency assessments, product repairs, and training, generate a meaningful portion of Wesco’s sales and are key components of the firm’s value proposition to customers.
Wesco doubled in size after it completed its acquisition of close peer Anixter in June 2020. We expect the merger to be value-accretive to Wesco’s shareholders. Management is targeting $315 million of cost synergies and $600 million of cross-sales synergies by 2023, which we think is achievable. A combination of factors, including normalizing industrial demand and pricing, the Anixter acquisition, and a continued trend of customers consolidating their spending with larger distributors, will provide ample opportunity for Wesco to gain market share and grow faster than its end markets. Improving gross profit margin performance due to price increases and internal initiatives should also support better profit margins.
Financial Strength:
Wesco’s $4.7 billion acquisition of close peer Anixter International in June 2020 caused the firm’s net debt/EBITDA ratio (excluding synergies) to swell to 5.7. Wesco’s elevated free cash flow generation in 2020 allowed the firm to reduce net debt by $389 million, finishing 2020 with a 5.3 net leverage ratio. At the end of 2021, Wesco had $4.7 billion of debt, but we’re modelling about $4.2 billion of free cash flow over the next five years. As such, management’s goal of reducing its leverage ratio to 2-3.5 by the second half of 2022 is very achievable. Wesco has a proven ability to generate free cash flow throughout the cycle. Indeed, it has generated positive free cash flow (defined as operating cash flow less capital expenditures) every year since its 1999 initial public offering, and its free cash flow generation tends to spike during downturns due to reduced working capital requirements. Given the consistent free cash flow generation, Wesco’s financial health is satisfactory.
Bulls Say’s:
- Wesco’s transformative acquisition of Anixter should result in stronger growth and profitability, which should help the stock fetch a higher multiple.
- Wesco’s global footprint and focus on value-added inventory management services help the firm take market share from smaller distributors and support pricing power
- Despite serving cyclical end markets, Wesco’s business model generates strong free cash flow throughout the cycle. The firm will likely continue to use its cash flow to fund organic growth initiatives, acquisitions, and share repurchases.
Company Profile:
Wesco International is a value-added industrial distributor that has three reportable segments, electrical and electronic solutions, communications and security solutions, and utility and broadband solutions. The company offers more than 1.5 million products to its 125,000 active customers through a distribution network of 800 branches, warehouses, and sales offices, including 42 distribution centers. Wesco generates 75% of its sales in the United States, but it has a global reach, with operations in 50 other countries.
(Source: Morningstar)
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