In the LBM space, “a rising tide lifts all boats” ... or better yet, a “reversion to the mean” would be great!
While it is a fruitless exercise to try to figure out what big deals we might expect in the future, it may be worth a minute or two to try to figure out what trends will likely drive those deals.
Since investing is often described as the process of laying out money now in the expectation of receiving more money in the future, we’ll look at several broad trends that indicate that the next several years may be a good time to invest in building material–related companies.
So here they are, in no particular order.
Housing starts: Double-digit growth is expected for the next three to five years, need we say more? Whether total starts get back to 1.5 million in 2015 as the National Association of Home Builders has forecast, or in 2017, it will be an increase of approximately 60% over the expected level of this year. The average for total starts since 1959 is 1.5 million and the average for single-family starts is 1 million. These would be low-end expectations for starts in the next cycle since the period includes many years where the population was significantly less than it is now.
A conservative 50% to 60% increase in housing activity will mean a 25% to 50% increase in revenue for most companies producing, distributing, or retailing building materials. These sales increases will be welcome, as operating leverage should bring increased profits. However, the increased sales will also bring increases in a number of balance-sheet items, especially accounts receivable and inventory, to name the most obvious.
Depending on their capital structure and their banking relationships, these balance sheet pressures may cause some operators to look for well-capitalized partners to help fund future growth.
Corporate cash balances: Businesses continue to make money and are slow to spend/reinvest in this uncertain environment. We all continue to hear about a lot of “money on the sidelines,” and cash is making zero return for those holding it. It will be difficult for all of that money to stay out of the game when there appear to be so many productive and profitable ways to put it to work.
Reduced shadow inventory: There has been much written about the “shadow inventory” and its negative impact on the housing market. Shadow inventory includes properties that are more than 90 days delinquent, in foreclosure, or held as real estate owned by mortgage servicers but not currently on multiple listing services.
Shadow inventory has been coming down since 2010 as measured by units, dollars, and months’ supply and currently represents 3.7 months’ supply compared with the previous year’s supply of six months. The trend is good news for building materials–related firms.
Of the trends discussed above, we’d be inclined to make a Buffett-like bet on housing recovering to significantly higher levels in the next three to five years.
—George Finkenstaedt and William Brakken are partners at M&A Advisors, a mergers and acquisitions advisory firm. Contact them at: firstname.lastname@example.org, 425.985.6005, and email@example.com, 425.829.7526.