IP&E: Awaiting Stronger Distribution & End-Market Orders

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Manufacturers of passive products anticipating strong sales growth in 2014 are pinning their hopes on improvements in key end-markets, including automotive, consumer electronics, telecommunications and even the defense sector but they say tepid distribution orders and low inventory levels indicate channel partners remain wary about the strength of the ongoing market recovery.

Many of the leading suppliers of interconnects, passives and electromechanical (IP&E) components that have announced first quarter results reported decent sales uptick in their core businesses and point to increased optimism in key economic regions – Europe, for example, is not just growing as an exporter but is also experiencing rising consumption, according to John Gilbertson, CEO of passives supplier AVX Corp. (NYSE: AVX).

The challenge facing the industry and which companies like AVX are struggling to understand is how to accurately determine the strength of an economic recovery that anecdotal evidence indicate is happening but that hasn’t shown up in the orders they are receiving from components distributors. Since stronger orders from distributors and higher channel inventories have in the past preceded a surge in market recovery, IP&E makers – while still hopeful – continue to be hesitant today about cranking up manufacturing to meet the anticipated demand, according to industry executives.

“Some of our distributors are increasing their demand although they remain conservative regarding inventory positions,” said Gilbertson during a conference call to discuss AVX’s fiscal 2014 fourth quarter results earlier this week. “They have not yet begun to speculate on increasing activity or load up on extra inventory as in past cycles in the advance of market growth.”

It’s not that distributors are not seeing signs of economic improvements or that they are not experiencing rising demand from key market segments. They are just similarly concerned about the strength of the recovery because pricing pressures remain low and orders from industrial OEMs that could confirm the beginning of a market upswing haven’t been as strong as in previous market expansions, according to Gerry Fay, global president of Electronics Marketing, one of the two major business groups of distributor and IT integrator Avnet Inc. (NYSE: AVT).

“We are still in a low growth environment across the world,” Fay said in an interview with Electronics Purchasing Strategies after Avnet announced strong fiscal 2014 third quarter results last week. “All the indicators seem positive but it’s still a murky market environment.” EPS will publish an extensive report based on the interview with Fay next week. In the package, we will address Avnet EM’s global strategy, growth plans and Fay’s comments on the likelihood of consolidation in China’s currently fragmented distribution market.

Fay observed that lead-times for components are still very short, which indicate companies are not having any problems securing needed production parts. Once lead-times start stretching out beyond the current three to four weeks, pricing would become firmer and both component suppliers and distributors should see significantly better margin improvements, he said.

Downward margin pressures remain the Achilles heel of the IP&E market. The stress is more intense in the commodity IP&E sector dominated by low-cost producers in Asia that compete primarily on pricing, forcing companies like AVX, Molex, Kemet, Kyocera and TE Connectivity to migrate to the higher-end proprietary components market. These companies regularly update current product offerings, piling on differentiating applications to give them an edge with design engineers.

“The movement away from commodity type components remains a key strategy of the company,” said AVX’s Gilbertson. “This was another quarter where margin management was critical. We saw pricing pressures as uncertainty continues but it’s still in the range of past experience.”

One other strategy leading IP&E companies have effectively used is the acquisition of rivals to add on specialized products similar to the recent $490 million of specialist connector maker Seacon Group by TE Connectivity Ltd. (See: TE to Buy Specialist Connector Maker Seacon).

“The addition of SEACON will add over $115 million of revenue and bring our total business [of solutions for the underwater oil & gas markets] to $250 million,” said Tom Lynch, CEO of Harrisburg, Pa-based TE Connectivity. “We’ll also double our served market to over 1 billion. We expect to continue to generate double-digit revenue growth in this market going forward as this acquisition positions us with the leading product offering.”

The good news for suppliers of interconnects, passives and electromechanical components is that the products go into so many end-equipment that they can offset a weakness in one market segment with strength and improvements in others. In the last six months, demand has been strong in markets like automotive and for portable computing products such as tablets, which grew 25 percent globally in the first quarter, according to Gilbertson. In addition to surging demand from newer markets like wearable products and internet of things, improvements have also been noted in many other sectors although sections like PC, industrial and transportation haven’t yet perked up.

“The majority of the markets we serve are exhibiting solid growth trends and this growth is fairly broad-based across most of the regions of the world,” said TE Connectivity’s Lynch. “There are still some uncertain spots but overall I am encouraged by the trend. It’s good to see other markets in addition to automotive picking up some steam.”

In his presentation to analysts, Gilbertson provided some insight into how each market is shaping up for IP&E suppliers even as he noted the industry’s dependence on distributors to validate his assessment. Here’s how Gilbertson described each market segment:

Aerospace (commercial & military): This continues to increase in electronic content and adding to the volume. We believe this segment will be stronger this year than it was in 2013.

Automotive: All the news continues to be good. We're seeing growth in all regions and product lines associated with automotive.

Cloud Storage: It will add strong demand to support hardware increases in the balance of this year.

Defense & Medical: Good but not strong.

Notebooks: The notebook market has been suffering from shipment declines since 2011 [but] with units above 150 million each year it remains a significant device category in the market.

Wearables: The new hot item but it is just beginning to find its place in the consumer market and to-date has not been a big user of components.

Tablets: Tablet demand is taking up a lot of shortfall in the PC market. There is some confusion as to which brand or platform is the best solution. We think this will clear up more during the summer and fall with some shakeout in offerings.