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WESCO International Turns the Corner

Despite having a tough year WESCO International, Inc. (NYSE: WCC) stock is only down single digits on the year so far. After a difficult first half, the supply chain solutions provider finally reported the kind of revenue growth commensurate with a strengthening industrial economy.

That said, the margin performance and earnings guidance may have disappointed some investors. Let's take a look at a mixed set of earnings for the company.

The utility transmission end market was good for WESCO International in the quarter. Image source: Getty Images.

WESCO International third-quarter earnings: The raw numbers

Starting with the headline numbers from the quarter:

  • Sales growth of 7.8% compared to guidance of 2% to 5%
  • Operating margin of 4.5% compared to guidance of 4.2%-4.6%. The company's operating margin in last years' third quarter came in at 5%
  • Effective tax rate of 25.5% compared to guidance of 27%
  • Diluted EPS of $1.12 increased 6.7% compared to adjusted diluted EPS of $1.05 in last year's third quarter

In a nutshell, sales increased much more than expected, but operating margin didn't expand as much as might have been hoped. Furthermore, the tax rate came in lower than expected, so if operating margin had expanded, then WESCO's post-tax earnings growth could have received a significant boost.

Guidance

The theme of WESCO's sales recovering more impressively than margin is played out in the guidance too.

As you can see in the table below, sales guidance has significantly improved compared to the previous two outlooks, and so has guidance for the tax rate. However, the midpoint of the new EPS guidance range is only $0.05 higher than that given in April. The reason is that full-year operating margin guidance is notably lower than April's guidance. Moreover, despite a bumper quarter of sales in the third quarter, management's full-year margin guidance is the same as that given at the time of the second-quarter earnings in July.

Full-Year Guidance

Current

July

April

Sales

3% to 4%

1% to 3%

Flat to 4%

Operating margin

4.1% to 4.3%

4.1% to 4.3%

4.4% to 4.6%

Effective tax rate

26%

27%

30%

Diluted EPS

$3.75 to $3.95

$3.60 to $3.90

$3.60 to $4.00

Data source: WESCO International, Inc. presentations. EPS = earnings per share.

Turning to the specific fourth quarter, WESCO's management expects the sales momentum to continue with sales forecast to increase 5% to 8% with operating margin expected to be in the range of 3.9% to 4.3%.

Data source: WESCO International, Inc. presentations.

What happened in the quarter

It's a good idea to look at WESCO's sales by end market in order to see where the sales recovery is coming from. As you can see below, it's a pretty broad-based recovery.

Data source: WESCO International, Inc. presentations.

Of particular note, WESCO's construction end markets have finally turned up with 6% organic sales growth in the quarter. In fact, it's been surprising that it's taken this long because a look at another construction related market, heating ventilation and air conditioning, suggests good construction-spending conditions. Going back to a review of WESCO's second-quarter earnings, CEO John Engel had spoken of industrial customers deferring decisions on capital spending projects -- usually a sign of a lack of confidence in the sustainability of a recovery. However, this quarter's results suggest a corner has been turned.

The industrial segment's double-digit sales growth was promulgated by "increasing business momentum with industrial customers" while the utility end market had a standout quarter. WESCO exited a large contract in the utility sector last year and its impact is still seen in the results.

Excluding the exited contract, organic sales were up a whopping 18% compared to last year. While the impact of hurricanes helped increase sales by four points -- customers were forced to replace damaged equipment -- the strength in utility suggests the transmission and distribution spending environment is improving.

Looking ahead

Clearly, the fly in the ointment here is margin performance, but the strength of the recovery in customer demand suggests that WESCO is approaching the point where it might be able to have some pricing power. If the company can start to expand margin, then the feed-through into earnings could lead to strong growth in profits.

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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool recommends Wesco International. The Motley Fool has a disclosure policy.