Building Product Distributor Valuations – June 2022
The building products industry has experienced improving financial performance and growing valuations over the last several years. High customer demand, rising prices, and elevated merger and acquisition activity fueled this recent growth. However, valuations declined in 2022 as expectations of an economic contraction grew and investor sentiment toward the broad equity markets deteriorated. Building product distributors have (thus far) weathered the downturn in the equity markets. This article will examine some of the factors that appeared to impact the valuations of companies in the building product distribution industry.
This article updates our December 2021 analysis.
See also: Building Product Manufacturer Valuations – June 2022.
Important notes: This article examines potential driving factors for 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, this article will focus on what is typically perceived as primary value drivers to keep the length manageable. 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. One company incorporated in our December 2021 analysis of the industry was excluded: Huttig Building Products, which Woodgrain, Inc. acquired as of May 2022. The effective date of this analysis is June 30, 2022.
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” (2021), while the latest 12 months is labeled “LTM” (latest available information as of June 30, 2022).
MVIC, revenue, and EBITDA for the industry constituents increased over the last four fiscal years, fueled by high demand for building products. In our previous analysis, we identified the following factors as having had a significant impact on growth through 2021:
- Federal Reserve Economic Data (“FRED”) reported hardware building materials and supplies retail prices to have increased over 60% between January 2020 and June 2021
- Increased merger and acquisition activity.
Since the end of 2021, there have been signs of cooling in demand. Truist releases a nice quarterly industry update on the building products industry. Per their Q1 2022 market update, supply chain capacity constraints have caused home building activity to slow. The ready availability of raw materials for building product manufacturers has also restricted these companies’ ability to meet demand. Furthermore, Truist believes that consumer demand for building products may also decline in light of interest rate increases, inflation, affordability, and geopolitical uncertainties. These headwinds will make it difficult for manufacturers and distributors to pass rising costs associated with production to price-weary consumers. Nevertheless, the ongoing housing shortage in the U.S. will likely mitigate a demand contraction for building products in the near future.
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 four fiscal years before declining in 2022. On the other hand, EBITDA multiples declined in the previous three fiscal years and the LTM period. The decline in valuation multiples through June 2022 is consistent with the trends observed in Figure 1. We will explore the 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 2022 for most companies, NFY (orange line) = calendar 2021 for most companies. “Current year” means June 30, 2022, while “prior year” means June 30, 2021.
The orange line in Figures 4 and 5 represents data as of June 30, 2021. At the time, the industry expected strong revenue growth for 2021 and more stable growth in 2022 and 2023, while EBITDA was projected to be much more volatile. Actual results for 2021 fell in line with expectations as of June 2021. However, as the blue line (current data) illustrates, the industry is expected to continue to generate strong growth through 2022 before contracting in 2023.
We also looked to identify meaningful relationships between growth and observed revenue and EBITDA multiples—Figures 6 and 7 present these relationships.
In Figures 6 and 7, we observed that the lowest valuation multiples are associated with the lowest projected growth rates.
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 8 presents each company’s market capitalizations plotted against its respective LTM revenue multiple.
Based on Figure 8, it appears that size has a measurable impact on revenue multiples for companies with market capitalizations of $4 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, we did not observe meaningful relationships valuation multiples and historical profitability. We did, however, identify a tendency for companies with higher projected levels of profitability to trade at higher valuation multiples, as shown in Figure 9.
The relationship between profitability and revenue multiples appears to stick for most companies in the group. We noted that the comparison is between LTM revenue multiples and projected 2023 EBITDA margins. Therefore, the observed relationship between valuation multiples and profitability is likely also related to projected EBITDA growth.
The Leverage Story
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 10 plots LTM revenue multiples against their associated debt to total capital ratios.
While the least leveraged companies appear to be trading at the highest revenue multiples, we noted significant dispersion of multiples among the more highly levered companies in Figure 10. For the least leveraged companies, Richelieu Hardware and Watsco were among the largest companies of the group, generated some of the highest EBITDA margins, and are expected to produce some of the highest growth rates. This suggests that, while leverage may play a role in pricing the public building product distributors, other factors are likely more important to investors.
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 December 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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