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Our Outlook for Industrial Distributors

Industrial distributors have a reason to smile.

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After a nightmare of a year, we believe industrial distributors will post decent sales growth on the back of renewed industrial activity and an elevated inventory refill. While operating margins will likely improve slightly, we think free cash flow is likely to suffer from higher working capital investment.

In the industrial distribution space, core demand is a function of U.S. manufacturing output. This metric grew at a 5% annual pace from 2003 to 2008. However, this growth engine slowed abruptly as the credit crisis unfolded. In an earlier article, "Which Industrial Distributors Will Survive This Nightmarish Economy," we opined that the demand slump is likely to moderate during the second half of 2009. This scenario played out as expected, as industrial production dropped 2% in November and improved 3% in December, year over year, when compared with the double-digit declines during the first six months of 2009. In 2010, this upward trend should continue for two reasons. First, core demand will improve in tandem with the economy. We think industrial production will increase in 2010 on the back of higher consumer spending, and as firms increase their capital expenditure outlays.

Anil Daka does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.