The recent electronics industry boom was great—even exceptional—while it lasted but the party appears to be finally ending. As is typical for their segment of the market, component distributors are bringing up the rear and have not fully experienced the economic downdraft that has in recent quarters clipped sales at memory vendors and other suppliers to vulnerable areas like consumer electronics.
The leading public component distributors closed their most recent reporting periods with higher year-over-year sales, stronger margins, and better order backlogs than many of their suppliers. At Phoenix-based Avnet Inc., for example, revenue jumped 14 per cent in the December quarter, rising to $6.7 billion, from $5.9 billion, in the year-ago period.
Avnet’s margins turned upward, highlighting the strong performance it has recorded over the last couple of years. Operating income increased 41 per cent from the year-ago quarter while operating margin strengthened almost one percentage point on strong contribution from the components business. Executives said they were thrilled at Avnet’s performance, adding it was the company’s “eighth consecutive quarter of double-digit year-over-year sales growth” despite macro-economic headwinds that were beginning to impact the industry.
“Our team has executed very well in helping our customers manage market complexities, as they face dynamic supply chain conditions and uncertainties,” said Phil Gallagher, CEO of Avnet, speaking at a conference call early February to discuss the company’s quarterly results. “From a demand perspective, in the quarter, we saw continued strength in key vertical segments, most notably transportation and industrial.”
Arch-rival Arrow Electronics Inc. ended 2022 with strong year-over-year performance although its results indicated the market was beginning to slow down. The company said 2022 revenue increased almost 8 per cent, to a record $37.1 billion, from $34.5 billion, in 2021. Net income strengthened to $1.4 billion, from $1.1 billion. The 2022 results reinforced Arrow’s position as the global No. 1 electronic components distributor.
“We have delivered the strongest financial results of any year in the history of the company,” said Sean Kerins, president and CEO of Arrow, while discussing the results with analysts. “The fourth quarter was in line with our expectations and one of our best quarters ever, despite some challenging conditions. Our sales grew by eight per cent year-over-year on a constant currency basis, fueled by both growths in our global components and our global enterprise computing solutions businesses.”
Other publicly owned distributors, including UK-based RS Group and Taiwan’s WPG Holdings, posted similarly strong performance for 2022 or parts of it. In January, the RS Group announced a “trading update” and said revenue for the first nine months of its fiscal 2023 grew 14 per cent despite what it termed “tougher economic backdrops and strong comparatives.” In December, the company had announced the departure of CEO Lindsley Ruth for “personal reasons” and named CFO David Egan, acting chief executive.
“Our differentiated proposition continues to resonate as we grow market share with our core industrial customer base, prioritizing our efforts on where we can add greatest value,” Egan said, in a statement. “We have continued to outperform thanks to the strength of our high-performing people who are focused fully on delivering our strategy. Tight control of our pricing, costs and inventory indicates that our full year adjusted profit will be towards the top end of consensus estimates.”
Anecdotal results from the industry’s privately owned component distributors also point to strong performance across the board, including at smaller and mid-size companies. Digi-Key, Future Electronics, Mouser, Sager, TTI and other distributors have seen sales skyrocket to record levels and are believed to be in their strongest financial conditions in years.
The strong performance of the last several years cannot obscure an important fact: the component distribution business is not immune to the electronics manufacturing industry’s boom and bust cycles. The recent financial results reflect historical performance, which industry executives have been happy to celebrate. At the same time, though, they are getting concerned about the immediate future as weaknesses in the general economy filter into their sector.
The outlook is currently mixed. Demand remains robust in certain markets, including the automotive segment where manufacturers are still struggling with shortages of some components. Although the tight supply conditions have eased in recent months, the market has yet to return to its pre-pandemic level, executives said.
“While we are pleased with the strong finish of the calendar year 2022 and the better-than-expected results for the quarter, we are closely monitoring market visions and the impact of component lead times on our backlog and inventory levels as products become more available,” said Gallagher at Avnet. “We’re also keeping an eye on the impact of rising interest rates inflation and the signs of slowing growth in the global economy.”
Forecasters, too, are uncertain about the direction of the global economy. After initially projecting the possibility of the economy shrinking in 2023, economists are now predicting slower but still positive performance for the year. China’s reopening will help offset the weakness expected in other parts of the world, according to the International Monetary Fund.
“The global economy is poised to slow this year, before rebounding next year,” said Pierre-Olivier Gourinchas, director of research at the IMF, in a report. “Growth will remain weak by historical standards, as the fight against inflation and Russia’s war in Ukraine weigh on activity. Despite these headwinds, the outlook is less gloomy than in our October forecast, and could represent a turning point, with growth bottoming out and inflation declining.”
The IMF had in October projected a slight decline in global economic growth due to the continuing spread of the Covid-19 virus in China and amidst fears the Chinese government could further clamp down on business activities. That concern has subsided and the opening of both China and Japan to tourism and manufacturing endeavors has sparked increased confidence, the organization said.
“Global growth is projected to fall from an estimated 3.4 per cent in 2022 to 2.9 per cent in 2023, then rise to 3.1 per cent in 2024,” the IMF said, in its forecast update in January. “The forecast for 2023 is 0.2 percentage point higher than predicted in the October 2022 World Economic Outlook (WEO) but below the historical (2000–19) average of 3.8 per cent.”
What does this mean for the electronics industry and component distributors in particular? First, there are huge challenges ahead, including difficulties determining the actual direction of the market. Industry executives said they see “mixed” conditions, noting strength in industrial and transportation segments and weaknesses in consumer electronics, PCs, smartphones, communications equipment and other sectors that are sensitive to economic swings.
“The market conditions continue to evolve as we enter 2023,” said Kerins at Arrow. “Supply and demand conditions have been moderating somewhat. However, we are comfortable with our near-term outlook based on the quality of both our inventory and our backlog. While conditions may continue to moderate as we enter 2023, we remain focused on helping our customers secure the products they most need.”
Economic confidence is another factor that industry executives are keeping an eye on. Brighter signs of an upswing will help remove the gloom that was beginning to creep over the industry. Planned cuts in human resources, capital expenditure and other expenses may be scaled back, lifting demand, they said. A slowdown in interest rates hikes by central bankers worldwide could also help shore up market confidence, according to economists.
“The global growth outlook remains depressed, but we do not see the global economy at imminent risk of sliding into recession in early 2023,” said Bruce Kasman, Head of Economic and Policy Research at J.P. Morgan. “The financial conditions drag is being cushioned by a fading of supply chain and commodity price shocks.”
Distributors are already taking action to cushion the impact of a likely slowdown on their operations even as they bulk up on inventory for any unexpected upswing in demand. Over the years, the leading distributors increased their demand-creation activities and benefitted strongly from these investments during the recent period of shortages. In addition to supply chain management activities, demand creation contributed to the revenue increase that companies like Arrow and Avnet experienced in 2022, according to executives.
“Overall, across all regions we continue to benefit from our unique engineering and demand creation capabilities with our field application engineers and digital design tools once again achieving record revenue and gross profit dollars for demand creation,” said Avnet’s Gallagher.
Suppliers and OEMs are leaning more on distributors for assistance with demand-creation efforts with the goal of improving time-to-market and strengthening their competitive position. In response, distributors across the market have added to their engineering teams or acquired design-focused enterprises. Avnet, for example, said it tapped the design strength of its Farnell unit during the period of component shortages.
Smaller and mid-tier distributors have not abandoned demand-creation activities to their larger competitors. They have expanded their technical support resources, adding these to bill-of-materials management and other supply chain services.
In January, for example, Mouser Electronics announced the creation of dedicated resources for medical equipment OEMs to help them “find the necessary tools, information and materials quickly and efficiently while highlighting trending topics within the medical field, like next-generation medical devices for brain-computer interfaces and the evolution of medical wearables.”
Tools like this will be critical in the next evolution of the market as distributors manage through the cloudiness of the new year, executives said.
“We spend a lot of time looking at how the complexion of our business has changed over the past three years, and as the supply-demand market continues to normalize,” said Arrow’s Kerins. “We feel confident about our ability to retain some of the structural benefits that we built into our model. I can’t say exactly when the market will fully normalize, but it will, and we’ll reach something that we might call a steady state.”