Distribution stocks off the mark
By Jeffrey Germanotta -- Industrial Distribution, 10/1/1999
So far, 1999 has proven to be a difficult year for industrial distribution stocks, with the aggregate market capitalization of the 22 stocks included in the ID/Baird Index sinking four percent since the beginning of the year, versus a 10 percent increase in the S&P500.Year to date, 12 firms in the index have experienced double-digit drops, with Sunsource, MSC Industrial and DXP Enterprises hardest hit.
A soft industrial economy has been followed by slower industry sales and profit growth, driving lower valuations. A comparison of 1999 forecasted consensus EPS estimates to actual 1998 performance suggests the investment community expects the stocks in our group to realize a 3.3 percent average decrease in 1999 EPS versus a 16.7 percent average increase in 1998 (17 stocks with published 1999 estimates). We believe this perceived deceleration in earnings growth rates, in part, explains the year-to-date decline in stock prices for many firms.
More specifically, the recent challenges faced by industrial distributors have included diminished demand, adverse currency translation adjustments, deflation in commodity prices, rising labor costs, and higher interest rates. Lower valuations for several industry consolidators have further triggered a more moderate pace of acquisition activity. Year 2000 preparations, the development of the Internet as a new marketing channel, and the desire to improve productivity have driven many firms to undertake unprecedented levels of investment in technology. Finally, several firms have restructured their organizations to lower future operating costs and improve customer service.
Several of these issues are likely to continue into 2000. In fact, average analyst estimates for the stocks in our group are projected to be 0.4 percent lower on average in 2000 compared to projected 1999 levels (based on 13 stocks with published 2000 estimates).
Despite this cautious outlook, we believe several factors, including the recent decline in the value of the dollar against several major currencies, an improving outlook for commodity prices, expectations of declining incremental spending in IT projects, and cost-containment programs could contribute to better-than-anticipated industry profits in 2000.
Jeffrey Germanotta is senior vice president of equity research at R.W. Baird & Co. He can be reached at 414-765-3572, or emailed at jgermanotta@rwbaird.com
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