Building Product Manufacturer Valuations – June 2023
The building products manufacturing sector saw strong improvement in its growth and valuations from 2018 through 2021. This growth was fueled by high customer demand, rising prices passed on to customers, and elevated merger and acquisition activity. However, valuations declined from December 2021 to December 2022 as economic contraction fears grew, and investor sentiment toward the broad equity markets deteriorated.
Valuations reversed course again through June 2023, reaching levels last seen in 2021. This article will examine some of the factors that appeared to impact the valuations of these companies.
This article updates our December 2022 analysis.
Important notes: This article examines potential driving factors for building product manufacturer 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. The effective date of this analysis is June 30, 2023
Figure 1 summarizes three items for the building products manufacturers:
- 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”).
We notate the latest fiscal year as “LFY” (2022), and the latest 12 months as “LTM” (latest available information as of June 30, 2023).
Corresponding to years of increasing customer demand and favorable pricing trends, revenue and EBITDA for the industry constituents increased through 2022. Valuations declined in 2022 despite continued improvements in financial performance that year. We previously discussed in our December 2022 update, economic uncertainty and cooling demand created concerns about inventory accumulations and the impact of pricing on profitability in the future.
In June 2023, valuations recovered to their December 2021 levels. Financial performance stagnated, however. There are a number of factors that may be supporting the resurgence in valuations. According to Truist in their Building Products Market Update as of Q2 2023:
- Single family builders believe the residential markets have hit bottom after experiencing the worst housing correction since the Great Recession.
- Non-residential construction is expected to slow in 2024, but certain property types are unlikely to see a slowdown due to significant project pipelines.
These factors could support demand for building products in the near term.
Valuation Multiples
Figures 2 and 3 provide a view into the historical trend in valuation multiples (revenue and EBITDA).
Revenue and EBITDA multiples declined sharply from the end of 2021 to December 2022, corresponding with increased uncertainty associated with the industry. These multiples increased again in June 2023. Let’s dive into what appears to be influencing valuation multiples among the industry constituents.
The Growth Story
Growth often has a strong influence on how companies are valued. Figures 4 and 5 below summarize the consensus forecasts for each group. Next, we present a summary of the consensus forecasts for each group in Figures 4 and 5 below (note that “NFY” means next fiscal year; NFY = calendar 2023 for most companies).
In Figures 4 and 5, the orange line represents data as of June 2022. The industry expected revenue and EBITDA to grow in the NFY (2022) and beyond. Actual results for 2022 generally met analyst expectations. The blue line (current expectations) shows that some contraction in revenue and EBITDA is expected for 2023. Modest growth is expected for 2024 before a stronger growth trend emergest in 2025.
We also looked to identify a relationship between growth and observed revenue and EBITDA multiples.
Figures 6 and 7 present these relationships.
We did not observe a meaningful relationships between revenue growth and valuation multiples based on the data presented in Figure 6. However, EBITDA multiples appeared aligned with projected EBITDA 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.
We present each company’s market capitalization plotted against its LTM revenue multiple in Figure 8.
As shown in Figure 8, there appeared to be some correlation between size and revenue multiples among companies with market capitalizations of less than $8 billion. However, there was significant dispersion in the data among the companies with the lowest LTM revenue multiples.
The Profitability Story
Revenue multiples are typically heavily influenced by profitability. We usually observe higher revenue multiples in companies with higher levels of profitability. Figure 9 presents this correlation.
Based on the trend shown in Figure 9, the relationship between profitability and revenue multiples appears to stick for most of the companies in the group.
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.
In Figure 10, there is some tendency for companies with higher debt to total capital ratios to trade at lower revenue multiples than their less leveraged counterparts. However, we noted significant dispersion within the observed data (particularly among companies with the lowest debt to total capital ratios), indicating that investors are likely considering other factors as they price companies in this sector. For example, Insteel Industries had one of the lowest leverage ratios and also traded at one of the lowest revenue multiples. This company ranked among the least profitable and smallest companies of the group and had some of the lowest projected growth rates, which likely had a greater impact on how it was valued.
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, 2022.
The trends observed in this article suggest that growth, company size, profitability, and use of leverage all influence (to some degree) the valuations of publicly-traded building product manufacturers.
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.
