WESCO: M&A And Digital Transformation May Move The Price Up

WESCO International, Inc. (NYSE:WCC) is very diversified, and the recent merger is exceeding expectations. Management recently noted that successful digital transformation of the business segments could enhance FCF margins, and increase the company’s fair valuation. Even considering supply chain risks or goodwill impairment risks, I believe that WCC appears significantly undervalued. I believe that the name is a must follow.

WESCO’s Diversification Is Impressive, And The Business Combination With Anixter International Is Exceeding Expectations

With an estimated 18,000 employees base and an active customer relationship currently estimated at 140,000 globally, WESCO International presents itself as a company well positioned in terms of logistics services, solutions in supply chains, and distribution operations for businesses.

Some of the industries to which many WESCO’s clients belong are the telecommunications industry, power generation and distribution, lighting, and security among others. WESCO has 1.5 million products designed mostly to meet the needs of its customers in a customized way, for any of the areas mentioned above as well as automation, registration, or catalog processes in transport fleets or industrial plants.

During the year 2020, WESCO acquired Anixter International allowing it to expand the business scale both nationally and internationally. Right now, WESCO has offices, distribution plants, and storage facilities in more than 50 countries, allowing it to provide close support to the needs of its customers besides hiring trained personnel who know and are involved in the commercial codes of each region. In this regard, I believe that the transaction with Anixter International needs to be mentioned. In a recent presentation, WESCO reported that the business combination is exceeding expectations.

WESCO’s Balance Sheet Includes A Good Amount Of Liquid Assets And Some Debt

As of September 30, 2022, WESCO reported cash worth $234.083 million, accounts receivable of $3.622 billion, and other accounts receivable worth $388.748 million. Inventories were equal to $3.49 billion with prepaid expenses worth $162 million. Finally, total current assets stand at $7.897 million. The total amount of current assets is quite significant as compared to the total amount of current liabilities.

Property stands at $372 million together with an operating lease assets of $575 million. Intangible assets were equal to $1.85 billion, with goodwill worth $3.12 billion and total assets of $14.08 billion. The asset/liability ratio stands at more than 1x, so in the view of most investors, WESCO’s financial position is stable.

The liabilities include the payable accounts of $2,578,741 million, the accrued payroll and benefit cost of around $239.309 million, and other current liabilities of $680.227 million, resulting in a total current liabilities of $3,567,572 million. The long term debts were around $5,192,816 million with an operating lease liabilities of $455,356 million, deferred income taxes of $443,245 million, and other noncurrent liabilities of $229.629 million, resulting in a total liabilities of $9,888,618 million.

Revenue Drivers Include Digital Transformation And WESCO’s Leading Position In A Consolidating Industry

WESCO’s strategy includes the integration of new business models and leading a process of digitization of its different business segments. This last term is possibly the most tangible of the objectives set by the company, since through the digitization of its services it will be able to take advantage of the global trends in this regard, and attract new customers as well as companies with potential growth for future years.

In line with my previous words, I believe that readers may want to have a look at a recent slide from management. The company believes that WESCO’s acquisition efforts will help maintain its leading position in an industry that is already consolidating. With regards to digital transformation, WESCO will likely experience FCF margin expansion, which will most likely enhance the company’s fair valuation.

Expectations From Analysts Include Sales Growth And Growing New Income

For 2024, estimates include 2024 net sales of $22.794 million, 2024 EBITDA of $1.806 million, 2024 EBIT of $1.572 billion, and an operating margin of 6.90%. The pre tax profit will be $1.334 million. Finally, we have a net income of $908 million. I believe that the figures expected are beneficial, so readers may want to have a look at them.

My Valuation Of Business Segments Leads To An IRR of 5%-6% And A Fair Price Of $305-$306 Per Share

WESCO currently divides its operations into three segments: Electronic and Electrical Solutions or EES, Communications and Security or CSS, and Utilities and Logistics or UBS.

The electronic solutions segment concentrates the largest number of employees and the highest number of annual revenues. Its main customers are the construction industry and engineering design and production markets. In the logistics and broadband segment, WESCO offers distribution and management solutions of this type to municipalities, public bodies, and in some cases end consumers.

For the communications and security segment, which, like the electronic solutions segment, operates in more than 50 countries, the company offers products for networks, technological installation, and data management. Its clients vary in a large number of educational and government institutions as well as companies from different industries.

In the nine months ended September 30, 2022, the EES business segment reported $6.654 billion, CSS stood at $4.63 billion, and UBS reported $4.56 billion. I believe that the operating segments operate distinctive business models, so I assumed different sales growth rates and different EBITDA margins for each of them.

In the three months ended September 30, 2022, EES’s EBITDA margin stood at 10.1%, CSS reported an EBITDA margin of 9.8%, and CSS’ EBITDA margin was equal to 11.6%. It is worth noting that the EBITDA margin of each business segment was better than that in the same period in 2021. My figures are not far from these financial figures.

The Power Electronics market is expected to grow at 6.64% CAGR from 2020 to 2026. Besides, the security solutions market is expected to grow at 9.4%. I also used these numbers for my discounted cash flow model. I don’t believe that the company’s future financials will be far from those of WESCO’s target markets.

Power Electronics Market valuation is poised to reach USD 59.40 Billion by 2026, registering an 6.64% CAGR throughout the forecast period (2020-2026) – Source

According to a comprehensive research report by Market Research Future “Security Solutions Market 2030” market size could reach USD 510 billion, growing at a compound annual growth rate of 9.4% by 2030 – Source

The numbers for EES’ business segment include net sales growth of 7%, EBITDA margin of 8.9%, and 2033 FCF of $745 million with a FCF margin of 4%.

My numbers for CSS’ revenue include 2033 net sales of $23.061 billion, an EBITDA margin of 9%, and a FCF margin of 5.1%. 2033 FCF would stand at 5.1%. Finally, UBS’ revenue would include 2033 net sales of $12 billion, with an EBITDA margin of 9.1% and a FCF margin of 4.3%. 2033 FCF would stand at $534 million.

If we sum future free cash flow and use a WACC of 10.8% the net present value of future FCF would be close to $9 billion. With an EV/EBITDA multiple of 8.1x, the net present value of the exit value would be $11 billion.

Finally, we would be talking about an enterprise value of $20.58 billion, an equity valuation of $15.56 billion, and a fair price of $306 per share with an internal rate of return of 6%.

Supply Chain Risks, Failure Of M&A, Or Failed Expansion Into New Markets Could Lower The FCF Expectations

It is difficult to pinpoint risks for a corporation of such magnitudes. First, in my view, WESCO has not yet settled the financial cost of its acquisition of Anixter, nor has it fully integrated the operations of this other company into its strategy. This is a risk while considering future operations. In my opinion, if management has to impair the goodwill accumulated, the book value per share will likely decline, which may lead to a decrease in the FCF expectations. As a result, the company’s implied valuation would decline.

On June 22, 2020, we completed our merger with Anixter. It is possible that the integration process could result in the loss of key employees, higher than expected costs, diversion of management attention, the disruption of either company’s ongoing legacy businesses or inconsistencies in standards, controls, procedures and policies that adversely affect the combined company’s ability to maintain relationships with customers, suppliers and employees or to achieve the anticipated benefits and cost savings of the Merger. Source: 10-k

In addition to the risks to be taken into account due to the instabilities and variations in the macroeconomics themselves, we must add WESCO’s dependence on its suppliers and the magnitude of transport in this regard. A fluctuation or variability in supply chain costs could hinder operations, opening the way for other competing companies to attract customers who seek to maintain their activity without going through an increase in the payment for this type of service.

It is worth noting that entering new markets or offering new products could also represent a risk. WESCO may enter into new markets, where competition is elevated, or may fail to understand the taste of new clients. Under this particular case scenario, I believe that the FCF margin would not be as large as expected. Management offered some commentary in this regard.

Our expansion into new and existing markets, including manufacturing related or regulated businesses, may present competitive distribution and regulatory challenges that differ from current ones. We may be less familiar with the target customers and may face different or additional risks, as well as increased or unexpected costs, compared to existing operations. Growth into new markets may also bring us into direct competition with companies with whom we have little or no past experience as competitors. Source: 10-k

Conclusion

WESCO reports a diversified business model with exposure to many geographies and many products. The recent acquisitions also appear to be exceeding expectations, so I may expect more inorganic growth in the coming years. In my opinion, successful digital transformation may bring larger EBITDA and FCF margins, which could push the company’s valuation north. Under a very basic financial model, the sum of the business segments implied an IRR close to 6%. Hence, I believe that WESCO appears significantly undervalued by the market. Even taking into consideration supply chain risks or goodwill impairment, WESCO appears to be a great name to follow carefully.