Will the bell toll? Continued downturn putting heat on distributors to boost numbers

Electronic News, Nov 4, 2002 by Heidi Elliott

CHICAGO -- If the distribution industry does not figure out a way to improve its operating margins and return on invested capital (ROIC), Wall Street will invest elsewhere.

Analyst Robert Damron delivered that message to distribution's top executives last week at the National Electronic Distributors Association (NEDA) annual Executive Conference. Damron, senior VP of equity research at Milwaukee-based SWS Securities, warned that distributors have to bolster financials to become attractive to the investment community--or else.

The distribution industry must focus on sustaining consistent growth and strengthen its weighted average cost of capital (WACC) and ROIC figures. "These trends have to be reversed or we're not going to be sitting herein a few years," Damron said.

The audience got a run-through of basic investment principles, starting with what factors determine a company's stock price. Stock price is based on earnings per share (EPS) times the price/earnings (P/E) multiple. High multiples come from macroeconomic factors, including low interest rates and high consumer confidence, coupled with company-specific factors including rapid sales and EPS growth, rising margins, positive cash flow, a high ROIC and strong balance sheet. Few distributors can say they have many (or any) of the attributes for a high PIE.

In fact, distributors have focused on other things. During the last decade, distributors concentrated their efforts on improving market share, acquisitions, globalization and protecting their turf from dot-coms and contract manufacturers. All the while, they have not improved critical financial measures. Even at the height of the upturn when distributors reported record revenues and earnings, ROIC broke no records.

In 1994, for example, operating margins were in the 6 percent to 7 percent range. At the peak of the latest upturn in 2000, margins spiked up to 6 percent--but never raised that bar. Operating margins now hover at about 3 percent.

Return on invested capital has suffered the same fate. "Over the last 10 years not enough emphasis has been make on margins and return on capital (ROC). Operating margins are on a 10-year slide and even the boom didn't reverse that trend," Damron said. "If this trend does not reverse, companies could go out of business. We have wiped out over 10 years of shareholder value creation."

Even in a stock indices performance comparison, distributors can't seem to catch a break. The analyst compared the decade of the 1990s gains versus the collective loss in the first two years of this decade. While the Nasdaq grew 786 percent in the 1990s and has declined 71 percent to date, the Electronics Distribution Index saw 261 percent growth and a 53 percent decline in the comparable periods. Also, the distribution index has declined more than the Russell 2000, the S&P 500 and the Dow Jones. "Electronics distributors did not enjoy as much upside as the others, but they are now experiencing as much or more downside," Damron said.

Damron did commend distributors for making it through the last decade of turbulence. He likened them to cats--in the past 10 years alone they have survived industry consolidation, the rise of contract manufacturing muscle, the rise and fall of dot-coms and the current severe economic downturn. "I congratulate you on making it this far," he told attendees.

Yet despite the gloom and doom, industry executives are hopeful there will be a recovery in the near term. "I can't tell you when the market will turn around," said Burt Rabinowitz, VP of sourcing at Alcatel USA. But, he believes the worst is over. Others agree. TTI Inc. Senior VP of Global Sales and Marketing Craig Conrad noted that sales unit volume has doubled over the last year--but that progress is masked by the decline of average selling prices (ASPs), which continue to fall. "There's no scenario (where) electronics is dead," said Conrad. "It's not the end, it's just the beginning. There's still tremendous opportunity."

[GRAPH OMITTED]

Superstars to Supernovas

Stock indicies percent change

Index           1990-1999  2000-Today

S&P500               308%        -42%
Dow Jones            309%        -30%
Nasdaq               786%        -71%
Russel 2000          197%        -26%
Elec. Distrib,       261%        -53%
Index

SOURCE: SWS SECURITES