Capital from financial institutions, strategic buyers, private equity firms and individuals continues to flow into the wholesale distribution industry. This influx has led to strong valuations for publicly traded distributors and solid transaction multiples for operators who sold businesses. In our opinion, two main fundamental drivers lead this charge – the attractiveness of the distribution industry and the current availability of capital.
Attractiveness of Distribution
The wholesale distribution industry represents a large, diversified and growing market. This attracts a meaningful number of entrants to the industry as well as additional opportunities for consolidation. Some of the larger players within the industry – Wolseley, HD Supply, WESCO and MSC Industrial, to name a few – have seized the consolidation opportunity and pursued strategic plans that include acquisition growth as a key component. Despite the current residential slowdown, this strategy enables them to achieve above average growth rates, attract investors and gain higher valuations.
Distribution Composite includes Airgas, Applied Industrial, Barnes, Beacon Roofing, Builders First Source, Building Materials Holding Corp, Fastenal, Industrial Distribution Group, Interline Brands, Lawson Products, MSC Industrial, SCP Pool, Watsco, Wesco International and W.W. Grainger.
After all these years, distribution is finally shedding its “stepchild” connotation and earning a reputation as a vital link in the supply chain. For example, in today’s climate of outsourcing and cost containment, manufacturers are increasingly relying upon distribution to supplement their internal sales forces and reps. Distribution is a service-based industry and vendors recognize the leverage that distribution partners provide with the end customer. And, while both outsourcing and the importing of products from overseas markets have increased, distribution itself cannot be outsourced overseas. This allows distributors to boost bottom line performance by importing materials produced in economies where labor costs are lower while remaining customer-facing in their markets.
Finally, the macroeconomic factors that are highly correlated with the distribution industry continue to send positive signals. The Purchasing Managers Index continues to trend above 50 (citing manufacturing expansion), the Industrial Production Index is still tracking upward and interest rates remain near historic lows. While the residential construction slowdown has hurt valuations of publicly traded building materials distributors, the strength of the commercial market and strong commodity pricing has bolstered the results and corresponding valuations of the distribution sector as a whole.
Massive amounts of capital continue to be raised in the private equity market and private equity firms’ interest and willingness to invest in the distribution space remains strong. According to CapitalIQ, over the last 12 months private equity firms have completed approximately 1,500 transactions with a total reported transaction value of $748 billion. This is a roughly 90% increase over the comparable period 12 months prior. Private equity investments in distribution have matched this increased pace with such notable transactions as Bain/CDR/Carlyle’s acquisition of HD Supply and Goldman’s acquisition of McJunkin.
The strength of corporate balance sheets also continues at unprecedented levels. This has lead executives to either return capital to shareholders through dividends, and share repurchases, or grow their companies through acquisitions. Within the distribution industry, it appears acquisitions have been the flavor of choice. This appetite on the part of corporate buyers, coupled with the active and well-funded private equity universe, has lead to a significant increase in the number of transactions completed within the distribution industry.
In conclusion, the distribution industry presents an attractive investment thesis. We anticipate this will lead to continued activity, both in the form of investment and M&A, in the space.