Residential building products manufacturers and distributors are emerging from housing’s Ice Age of 2006-2011. Starts climbed to a seasonally adjusted annual rate of 899,000 in October, up 62% from the low of 554,000 in 2009. In my opinion, we are at perhaps the most opportunistic point in our lifetime to invest in the U.S. residential building products industry. Operators who seize this day have an opportunity to grow their business’ equity value incredibly during the next five years, through prudent organic and acquisition-related expansion. Here’s why: • While well above 2009’s lows, the 785,000 average annual total starts rate for the first 11 months of 2012 is still only about half the long-term historic annual average of 1.47 million and is still lower than any prior cycle.
• Demographic fundamentals fist-poundingly declare the need for an average of at least 1.5 million single- and multi-family housing starts per year over the next two decades. Existing home inventories and foreclosure overhang will only affect the pace of recovery, but not its inevitability. And as those starts return, the building products sector once again should be regarded as a growth industry.
• For the first time in years, housing market fundamentals and trends are overwhelmingly positive. New and existing home sales, inventories, foreclosures, home prices, affordability, remodeling expenditures, and builder sentiment all are improving. Yes, global and domestic economic and political threats still loom—and always will. With two years of starts growth under our belt now, and today’s starts level still historically far below the norm, the current risk/reward profile is exceptional.
• Now that the starts (and revenue) plummets have passed, many building products companies are EBITDA (earnings before interest, taxes, depreciation, and amortization) positive. This profitability makes acquisitions less risky than at times when companies were bleeding.
• As Warren Buffett says, “It’s only when the tide goes out that you know who’s been swimming without their swim trunks.” The most prudent, conservative, strongest, and shrewdest businesses are those now standing. So, acquisitions targets are the highest quality and least risky they’ve been in many years. Furthermore, the competitive field has thinned, keeping more share of the now-expanding pie for the survivors.
The above adds up to a remarkable opportunity for business owners contemplating expansion or recapitalization. Now is the time for owners who have passive, non-value add partners to explore buying them out. Executives who have long dreamed of buying and building their own business should consider doing so. Companies that have contemplated using other people’s money (i.e., financial partners) to grow their business’ equity value should start exploring.
One note of caution: In the four run-ups prior to the last, the average duration from bottom to top was 2.8 years. The run-up of 1991-2005 lasted 14 years. We’re just three years from 2009’s bottom now. Thus, prudence in expansion is critical. Those who get giddy and overpay for businesses, layer on unecessary fixed costs/overhead, or put a significant amount of debt/leverage on their business to pursue their growth strategy will be the next downturn’s most likely casualties. But if you act conservatively, you’ll be glad you moved now.