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Morningstar | Wesco's 4Q Sales Growth Moderates Amid Tough Comparisons, but 2019 Outlook Is Solid

Wesco's organic revenue growth really began to pick up in earnest during the second half of 2017, and that strong top-line growth persisted into the first half of 2018 before moderating during the third quarter of 2018 due to difficult prior-year comparisons. Moderating sales growth continued into the fourth quarter of 2018 as Wesco's organic sales increased under 2% year over year versus about 4% organic growth last quarter and 10% organic growth during the fourth quarter of 2017. In our view, 10%-plus organic revenue growth is not a sustainable growth pace for Wesco, so we're not surprised by the firm's slowing sales pace. Instead, we think mid-single-digit organic growth is a more reasonable assumption for Wesco's long-term sales growth prospects.

Management noted that 2018 was a more challenging year than expected due to inflationary headwinds. However, Wesco did a good job navigating that environment, as demonstrated by the firm's full-year operating margin, which improved 10 basis points year over year to 4.3% despite a 10-basis point decline in full-year reported gross margin to 19.2%. During the fourth quarter, Wesco's reported gross margin expanded 20 basis points year over year to 19.4%, and the firm's operating margin expanded 40 basis points to 4.5%.

Overall, Wesco's end markets remain fundamentally strong, and the firm's year-end backlog was the second largest in company history. Based on current conditions, management expects 4.5% revenue growth and 12% EPS growth in 2019 (at the midpoint of guidance). We don't expect to materially change our fair value estimate as Wesco's 2019 revenue and EPS guidance ranges are in line with our previous expectations, and our longer-term outlook, which assumes mid-single-digit revenue growth and operating margins improving to a sustainable 5%, is unchanged.

On Jan. 16, Wesco announced it was acquiring Sylvania Lighting Solutions, a leading provider of LED lighting solutions that generates $100 million of annual sales. During the earnings call, Wesco disclosed that SLS' gross margins are higher than Wesco's and that Wesco is only paying $28 million for the business. Based on commentary during the call, it sounds like SLS was a carve-out from Osram, a Germany-based lighting manufacturer, and Osram decided to exit this business. Wesco expects the acquisition to close in March, and the financial contribution from SLS is currently not considered in Wesco's 2019 guidance. Assuming the deal closes at the end of March, it should add approximately 1% to Wesco's 3% to 6% sales growth goal in 2019.