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Recent economic indicators leave distributors with more questions than answers about the business turnaround

The economic recovery that many Thought was imminent just a few months ago continues to elude most distributors. Despite positive signs in some sectors, and improved internal operations at many companies, sales are still lagging and uncertainly over The future prevails.

A look at some of the industry's publicly traded companies illustrates the point. Sales at No-land co., Newport News, Va., were down slightly through the first half of the year, at $240.5 million compared to last year's $242.4 million. Sales for the second quarter, however, were up 2.6 percent compared to the same period last year. Noland serves the construction and manufacturing industries.

Much of the improvement was due to strong res dential construction and favorable weather conditions, which helped boost Noland's plumbing and air conditioning sales. Electrical and industrial sales were down 16 percent, however, reflecting continued erosion in the firm's integrated supply business.

The company said the improvements, combined with its continued tight control of operating expenses, contributed to a 32.2 percent increase in earnings for the second quarter.

The mixed signals leave company leaders cautious about the pending recovery.

"There is too much economic uncertainty to predict what business conditions will be like over the next several months," said John Gullet, Noland's vice president of corporate communications. ".. We have spent the past several years working on improving operational efficiencies and better managing our inventories, and this has made a difference in a sluggish sales environment."

The situation is similar for other distributors. In July, Anixter International Inc. president and CEO Robert W. Grubbs Jr. said: "While we were encouraged by the sales trends ... there is no clear evidence that these trends will accelerate in a meaningful way in the near term."

Nonetheless, the Skokie, Ill., distributor will acquire Pentacon, Inc. for $121 million in cash.

One factor affecting distributors is that their cash position tends to be counter-cyclic, said R.W. Baird & Co. research analyst David J. Manthey. Therefore, many distributors have paid down their debts significantly.

"Distributors generate cash in the short term as business slows," said Manthey. "In the longer term, reductions in headcount and expenses tend to make them operationally leaner, leaving them in a better position from a cost point and increased leverage."

Most distribution companies have effectively contained costs and remained stable or better through the downturn, added Manthey. He expects to see increased profits and merger activity in an eventual recovery, although mergers will not reach their pre-recession frenzy.

While cost-control strategies are allowing firms to keep a hold on profits, lagging sales and uncertainty over the manufacturing sector's turnaround are cause for concern. A number of indicators, such as new orders, production and inventories, have dropped recently and manufacturing employment continued a 22-month decline in July.

The Precision Metalforming Assn.'s June 2002 Business Conditions Report showed a decline in economic optimism for the fourth month. These figures show that manufacturers don't expect the economy to improve before the end of the year.

There is talk in some circles about a possible double-dip recession, but there is no evidence of that yet, said Airgas, Inc. CEO Peter McCausland. Business may be nearly flat, but it is not cause for panic, he added.

The Institute for Supply Management's[TM] Purchasing Manager's Index dropped 5.7 points to 50.5 in July, but has indicated growth since February. A reading above 50 indicates the manufacturing economy is generally expanding. The PMI dipped to 39.5 in October 2001, its lowest point since February 1991.

"We are a good barometer for the economy because of our diverse customer base," said McCausland. "The activity over the past months was not as good as some of the optimistic reports in the press. These lower numbers in recent reports are more in line with our results."

Airgas has improved its performance during the downturn by pursuing strategic accounts and increasing penetration with existing customers. McCausland said the company's strategy focuses on helping customers manage the supply chain.

"Our goal is to take costs out and share our cost reductions with our customers," said McCausland. "Supply chain management is becoming an increasing concern for even small to medium customers, and that interest will extend beyond any economic cycle."

Lehman Brothers analyst Joel G. Tiss follows industrial market companies like Kennametal, Inc. and says the forecast for profits is murky through the end of the year.

Nonetheless, he said there should be continued slow improvement in manufacturing and that companies like Kennametal have, for the most part, worked to improve their balance sheets and internal efficiency.

"This should create a gradual improvement in profitability," said Tiss. "Still, they won't be decimated if the economy drops."

Minnesota-based Fastenal Co. takes the 10-year view and is optimistic about its future, says CFO Dan Florness. The company's long-term business model is growing and it's increasing market share in up and down economies.

"We've stepped up our pace in opening new stores," said Florness. "Last year we opened 128, but we expect to open 140-170 stores in 2002."

With 77 opened through June, the company is on track to meet that goal. Florness said Fastenal has seen steady growth since November 2001. Though growth slipped from 11 percent to 8.7 percent in July, Fastenal remains upbeat about the future.

For W.W. Grainger, slow sales are the greatest effect of tough economic times. In other ways, the company is in a unique position to weather the admittedly long-awaited turnaround, said Grainger spokesman Michael McGrew.

The company's sales for the first six months of the year decreased five percent compared to the 2001 period, but earnings were up.

Grainger has been able to invest in key business functions that will help the firm gain marketshare, McGrew said.

"I think that in situations like this, when others are scrambling to stay alive, we can be strategic about what we're doing and gain that market share when the market rebounds," said McGrew.

He cited Grainger's $200 million investment in revamping its distribution network. Begun before the recession hit, the project involves rehabilitating nine distribution centers nationwide to improve efficiency and customer service.

Grainger is also investing $100 million in inventory for its branch network. This will give the company a leg up on competitors who've cut back on inventory as a way to reduce costs, McGrew said. While the economic recovery is taking longer than expected, Grainger has seen positive signs, as well -- particularly with government and national accounts business.

"Things are continually happening that are delaying the rebound, but there are some positive signs out there," said McGrew. "Our main focus now is to put ourselves in a position to really capitalize on that when the economy does rebound."

Managing Editor Victoria Fraza contributed to this report.

COPYRIGHT 2002 Reed Business Information in association with The Gale Group and LookSmart.