During the recent economic slowdown, the publicly traded industrial distributors managed their balance sheets very well, generating cash and working down debt levels.

A key maxim of all distribution businesses is that they use cash when they are growing, but generate cash in a slowing environment. Obviously, this is because when sales are rising, distribution companies must invest in inventories and receivables to fuel growth. When sales slow, inventory levels can be reduced and receivables are collected, generating cash.

Because most companies are running their businesses conservatively, the cash is typically used to pay down debt and position them for the eventual recovery. Not only are these ideas good in theory — they describe exactly what has happened over the past 12 to 18 months on the balance sheets of the publicly traded industrial distributors.

Take, for example, the cash flow from operations and the reduction in long-term debt to total capital for eight publicly traded industrial distributors (Airgas, Applied Industrial Technologies, Fastenal, W.W. Grainger, Hughes Supply, MSC Industrial Direct, WESCO International and Watsco. Watsco is an HVAC distributor not included in the ID/Baird Index). During 2001, these eight companies generated a total of $1.2 billion in cash flow from operations. Grainger generated a whopping $516 million, but every company we examined, regardless of size, generated at least $50 million in operating cash flow last year.

The average reduction in long-term debt to total capital among these companies was more than four percentage points (although this figure was skewed lower by companies that already have little to no debt, like Fastenal and Grainger). MSC industrial saw the greatest percentage reduction in leverage — with long-term debt to total capital falling more than 12 percentage points from levels at the beginning of 2001.

Again, the publicly traded industrial distribution companies have managed their balance sheets very well during the current downturn, positioning themselves for the pending recovery. With their "powder dry" and the environment starting to improve, the large, national industrial distributors should be well positioned when the business climate rebounds.