Building Product Distributor Valuations – December 2021 Update
Over the last several years, the building products industry recently experienced notable improvement in financial performance and valuations. High customer demand, rising prices, and elevated merger and acquisition activity fueled this recent growth. This article will examine some of the factors that appeared to impact valuations of building product distributors.
This article updates our June 30, 2021 analysis.
Important notes: This article examines potential driving factors for publicly-traded building product distributor valuations from a financial statement perspective. An actual business valuation requires an in-depth analysis of the business operations and associated risk factors that are not always evident from the data on financial statements. Also, to keep the length manageable, this article will focus on what are typically perceived to be primary value drivers. It will not touch on every observation in the data. Check out What is Value? and Risk and Return in the Market Approach for a quick read on the basics of risk and return and how they apply to this article.
The industry constituents for this analysis are listed below. We focused on publicly-traded companies in the United States and Canada that distribute building products. This analysis includes companies distributing heating, ventilation, and air conditioning (“HVAC”) products, given their similar market drivers.
Figure 1 summarizes three items for the building products distributors:
- Market value of invested capital (“MVIC”) calculated as the sum of market capitalization and interest-bearing debt;
- Median revenues; and
- Median earnings before interest, taxes, depreciation, and amortization (“EBITDA”).
The latest fiscal year is notated “LFY” (2020), while the latest 12 months is labeled “LTM” (latest available information as of December 31, 2021).
MVIC, revenue, and EBITDA for the industry constituents increased over the last three fiscal years and the LTM period. Most notable, however, was the acceleration of this growth in the LTM period. This growth was nearly universal among the public building products distributors.
Growth among the companies analyzed comprised a combination of:
- High demand for building products, particularly lumber, driven by the residential real estate markets;
- Product price increases – for example, Federal Reserve Economic Data (“FRED”) reported hardware building materials and supplies retail prices to have increased over 60% between January 2020 and June 2021 but had retreated from summer highs by December 2021; and
- Increased merger and acquisition activity.
Some indications point to this strong demand for building products continuing into 2022. The recent infrastructure bill, improving construction starts, and consolidation among market participants are all likely to drive investor interest in this sector.
Valuation Multiples
Figures 2 and 3 provide a view into the historical trend in valuation multiples (revenue and EBITDA).
Revenue multiples increased over the last three fiscal years and the LTM period as improvements in MVICs outpaced revenue growth. On the other hand, EBITDA multiples declined in the LFY and LTM periods due to EBITDA growth exceeding increases in valuations. These changes in the valuation multiples make sense in light of the growth trends observed in Figure 1. We will explore the various factors that appear to be impacting valuation multiples in the industry.
The Growth Story
Growth often has a strong influence on how companies are valued. Figures 4 and 5 below present a summary of the consensus forecasts for each group. Note that “NFY” means next fiscal year; NFY (blue line) = calendar 2021 for most companies, NFY (orange line) = calendar 2020 for most companies. “Current year” means December 31, 2021, while “prior year” means December 31, 2020.
In Figures 4 and 5, the orange line represents data as of December 31, 2020. At the time, the industry expected stable revenue growth and a sharp improvement in EBITDA the NFY (2020). Actual results for 2020 significantly outperformed these expectations. As the blue line (current data) illustrates, the industry generated strong revenue and EBITDA growth in 2020. The industry expects growth to have continued to accelerate in 2021 before a pull-back in 2022.
We also looked to identify meaningful relationships between growth and observed revenue and EBITDA multiples. In general companies with stronger projected revenue growth rates appeared to trade at higher valuation multiples. Figure 6 presents this relationship.
In Figure 6, we observe that the lowest valuation multiples are associated with the lowest (or negative) projected growth rates. Analysts predict that more than half of the companies (Doman Building Materials, GMS, Beacon Roofing Supply, Richelieu Hardware, and Watsco) will generate revenue growth between 0% and 10% in 2022. The valuation multiples observed for these companies ranged widely. Other factors may be impacting valuation multiples for these companies. For example, Watsco is the largest company in the group, and its size may be supporting a high valuation multiple for this company, despite its modest projected growth rate.
See also: Need to prepare financial statement projections? See A Practical Guide to Financial Statement Forecasts for Business Valuations.
The Size Story
Larger companies are generally perceived to have lower levels of risk relative to smaller companies. This dynamic can be due to several factors, including improved product or geographic diversification, deeper management teams, access to various distribution channels, and better availability of capital.
Figure 7 presents each company’s market capitalizations plotted against its respective LTM revenue multiple.
Based on Figure 7, it appears that size has a measurable impact on revenue multiples for companies with market capitalizations of $2 billion or less.
The Profitability Story
Revenue multiples are typically heavily influenced by profitability. We usually observe higher revenue multiples in companies with higher levels of profitability. In this case, NFY revenue multiples appeared correlated with margins projected for 2022. Figure 8 presents this possible relationship between profitability and revenue multiples.
The relationship between profitability and revenue multiples appears to stick for most companies in the group. However, we again noted inconsistencies. In particular, Watsco is expected to generate an average level of profitability but traded at the highest LTM revenue multiple. This inconsistency may be due to Watsco’s large size.
The Leverage Story (***New***)
New to this update, we consider the impact of financial leverage (or the companies’ use of debt) and their impact on the valuation multiples. In the last year, we have noticed an increasing trend of risk mitigation among investors, both in the private and public markets. Therefore, we have included financial leverage among the considerations we analyze to explain the observed valuation multiples.
Debt usage tends to increase financial risk to equity holders. Debt holders have a senior position within a company’s capital structure, and debt servicing occurs before any cash flow benefits (i.e., dividends) are issued to equity holders. Figure 9 plots LTM revenue multiples against their associated debt to total capital ratios.
Based on the dispersion of the data in Figure 9, it did not appear that leverage had a measurable impact on valuation multiples within this industry. However, Richelieu Hardware and Watsco, which had the lowest level of leverage among the companies analyzed, traded at the highest valuation multiples.
Tying it All Together
The trends observed in this article suggest that investors are considering multiple factors and that no single consideration is measurably impacting valuations. A summary of the observations in this article is presented below and compared to our analysis as of June 30, 2021.
The trends observed in this article suggest that growth, company size, and profitability influence (to some degree) the valuations of publicly-traded building product distributors.
I hope you found this analysis helpful. Any input, feedback, suggestions, and questions (including disagreements with my high-level analysis) are welcome! Thanks for reading.
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