Building Product Distributor Valuations
The building products industry recently experienced a 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.
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. Companies selected for this analysis had to be traded on a major U.S. exchange for at least a year with a stock price equivalent of $1 or more as of June 30, 2021 (the effective date of this analysis).
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 June 30, 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 LFY and LTM periods. 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; and
- Increased merger and acquisition activity.
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.
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 June 30, 2021, while “prior year” means June 30, 2020.
In Figures 4 and 5, the orange line represents data as of June 30, 2020 – some of the worst months of the COVID-19 pandemic. The industry expected modest revenue and EBITDA declines in the NFY (2020) before resuming growth in 2021. Actual results for 2020 significantly outperformed these expectations. As the blue line (current data) illustrates, the industry generated solid revenue growth and a substantial improvement in EBITDA in 2020. The industry expects growth to continue to accelerate in 2021 before tapering off in 2022.
We also looked to identify meaningful relationships between growth and observed revenue and EBITDA multiples. We were unable to identify a solid correlation between growth and multiples. The best relationship we were able to identify was between NFY EBITDA multiples and projected NFY+1 (2022) EBITDA growth rates. 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. Half of the companies (GMS, Beacon Roofing Supply, Richelieu Hardware, and Watsco) were expected to generate between 4% and 6% EBITDA growth in 2022. However, these companies were traded at NFY EBITDA multiples ranging from approximately 8x to 20x. Clearly, other factors are impacting valuation multiples for companies with positive projected growth.
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.
We were unable to identify a meaningful relationship between market capitalization and EBITDA multiples. To provide a consistent comparison to Figure 6, we present market capitalization vs. NFY EBITDA multiples in Figure 7.
On its own, Figure 7 does not seem to suggest that size has a meaningful impact on valuation multiples. However, when viewed in conjunction with Figure 6, this chart might help explain the NFY EBITDA multiples.
- Hardwood Holdings had the highest 2022 EBITDA growth rate but traded at a relatively low 6.9x NFY EBITDA multiple (see Figure 6). The impact of high growth on this company’s valuation multiple might be mitigated to a degree by its small size. Hardwood Holdings had one of the lowest market capitalizations among the group analyzed.
- Among the four companies with 2022 growth rates of 4% to 6%, GMS is the smallest in market capitalization, while Watsco and Beacon Roofing Supply were the largest. Watsco and Beacon Roofing Supply both traded at higher NFY EBITDA multiples as compared to GMS.
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, LTM revenue multiples appeared correlated with margins projected for 2022. Figure 8 presents this possible relationship.
The relationship between profitability and revenue multiples appears to stick for most of the 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, which may be due to Watsco’s large size (see Figure 7).
Tying it All Together
The trends observed in this article suggest that growth, company size, and profitability all influence (to some degree) the valuations of publicly-traded building product distributors. However, investors are likely also considering many other considerations, such as:
- Product focus,
- Customer concentration,
- Merger and acquisition potential,
- Geographic and product diversification, and
- Financial leverage,
- Among other factors…
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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