Building Product Distributor Valuations – December 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 from December 2021 to December 2022 as expectations of an economic contraction grew, and investor sentiment toward the broad equity markets deteriorated. This article will examine some of the factors that appear to impact the valuations of building product distributors.
See also: Building Products Manufacturer Valuations – December 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 only sometimes 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 only touch on some observations 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. One company used in our prior analyses, Hardwoods Distribution, Inc., changed its name to ADENTRA Inc. The effective date of this analysis is December 29, 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 December 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 analyses, we identified the following factors as having had a significant impact on growth through 2021:
- 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.
Since the end of 2021, there have been signs of cooling demand. Truist releases a quarterly industry update on the building products industry. Per their Q3 2022 market update, residential new construction and “replace and remodel” activity has slowed. However, existing construction backlog and housing shortages are expected to limit the downside of the contraction. Furthermore, Truist believes that the downside of the current cycle will be reduced to a certain extent by aging millennials, who will support ongoing home buyer demand. This continual inflow of home buyers is unlikely to allow homebuilders to create enough supply to offset the current housing shortage in the near term.
In recent valuations we have completed at Helios Consulting, Inc., inflation has significantly impacted expected financial performance for companies in the building products manufacturing and distribution space. Inflation, which drove up prices and revenue for the industry, is now crushing profit margins for some operators. Inventory accumulated over the last year when prices were high sits on their balance sheets, while the prices at which they can now sell that inventory have started to normalize. The decline in demand also means inventory will sit longer in warehouses, putting further strain on profit margins.
Valuation Multiples
Figures 2 and 3 provide a view of 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 two fiscal years and 2022. We will explore some of 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 2021 for most companies, and NFY (orange line) = calendar 2021 for most companies. “Current year” means December 2022, while “prior year” means December 2021.
The orange line in Figures 4 and 5 represents data as of December 2021. At the time, the industry expected strong revenue and EBITDA growth for 2021 and a contraction in 2022 before resuming a growth trajectory in 20237. Actual results for 2021 fell in line with expectations. 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 this relationship.
In Figures 6 and 7, we observed that the magnitude of valuation multiples tended to correlate with projected growth rates. However, we noticed significant dispersion in the data points, indicating 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.
Figure 8 shows that larger companies tended to trade at higher valuation multiples and vice versa. However, the impact of size on the magnitude of multiples was not consistently observed throughout the data set.
The Profitability Story
Revenue multiples are typically heavily influenced by profitability. We usually observe higher revenue multiples in companies with higher levels of profitability. We did not observe meaningful relationships between valuation multiples and historical profitability in this case. 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 sticks for most companies. We noted that the comparison is between NFY 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. 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 in this article suggest that growth, company size, and profitability influence (to some degree) the valuations of publicly-traded building product distributors.
I hope this analysis is helpful to you. Any input, feedback, suggestions, and questions (including disagreements with my high-level analysis) are welcome! Thanks for reading.
