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Electrical Equipment Industry and the Economic Cycle
The Electrical Equipment Industry tends to be more cyclical than the majority of groups covered by Value Line in terms of product demand. Sales are tied largely to overall economic conditions, with an emphasis on the industrial, utility, and construction sectors. Earnings may also be driven by consumer-based industries, including electronics and automobiles, as well as capital spending by manufacturing firms and government outlays. On the cost side, too, fluctuations in the price of commodities, such as steel, may significantly affect profitability among this group.
Included in this industry are major suppliers of electrical and electronic products, such as Cooper Industries (CBE), Emerson (EMR), Grainger (GWW), Thomas & Betts (TNB), Hubbell (HUBB), and WESCO (WCC). There are also numerous other participants that fill a particular niche, such as wire and cable maker General Cable (BGC), audio products manufacturer Harman International (HAR), and lighting equipment producer Acuity Brands (AYI).
Macroeconomic growth tends to lift industrial production along with investments in power generation, driving top-line gains, as a sizable proportion of sales are derived from these markets. System upgrades by utilities also serve to enhance results, as does higher manufacturing volumes.
Important, as well, is the construction market, consisting of both residential and nonresidential sectors. Within the nonresidential market are both commercial and institutional customers, the latter consisting of entities that construct schools and government buildings.
Consumer spending, particularly in the automotive area, a key factor in the broader economy, is also instrumental to a few of this industry’s inhabitants. Harman ‘s core business is audio and navigational systems, while Garmin (GRMN) and Trimble (TRMB) produce GPS (global positioning systems). FLIR Systems (FLIR), meantime, is reducing its dependence on government spending largely through products utilized in the automotive and marine markets.
During the course of this year, strengthening industrial MRO (maintenance, repair, overhaul) end markets and rising capacity utilization have been favorable to Electrical Equipment companies’ bottom lines. In fact, U.S. industrial production has been slowly on the rise in 2011. Additionally, spending upticks by utilities for replacement, expansion, and efficiency projects, such as the upgrading and maintaining of the electrical grid, are also supporting improved results.
At the same time, though, softness in residential and commercial construction markets is inhibiting larger profit advances. While spending on housing has begun to pick up, the nonresidential sector is unlikely to rebound prior to early 2012. Additionally, spending by Asian electronics firms and the U.S. military has either been weakened or delayed of late, hurting the likes of liquid-crystal-display glass maker Corning (GLW) and thermal imaging equipment company FLIR Systems.
Climbing prices of commodities, such as steel, aluminum, and nylon, can be a burden to electrical equipment firms. But, the earnings effect is often mitigated by price hikes, allowing margins to expand despite the added costs. Most of the major product suppliers have increased their prices this year as they combat inflation.
In sum, the Electrical Equipment Industry’s prospects are greatly a function of various macroeconomic trends. Although companies also look to target new product applications and acquire overseas businesses, the environment will always be the primary driver of results in most cases. Accordingly, the stocks here, mostly with betas near or just above 1.0, are best viewed as being cyclical.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.