Anchor Peabody Offers Q1 Flooring Market Update, 2023 Outlook
March 16, 2023 from TalkFloor
After a robust 2021 and the first half of 2022, mergers and acquisitions (M&A) activity in the flooring sector began to fall off in the fourth quarter, even as negotiations that started earlier in the year finally closed.
From a performance perspective, 2022 headline revenues masked mixed environment. While revenues were up across the board, this was largely a price story, as volumes inched up only 1% in 2022.
Heading into 2023, the flooring industry has started preparing itself for an anticipated revenue drop during the year’s first half. Still, some bright spots could help bridge the gap to the end of the year before an anticipated strong rebound in 2024.
Notable M&A Deals and 2022 Performance
In October 2022, Crown Products Inc., a flooring and installation products distributor based in Bloomington, Minnesota, announced the acquisition of All Tile Carpet Cushions & Supplies. This deal marked a consolidation of the Midwest wholesale distribution space and was one of the most significant top 25 redistribution deals the flooring industry has seen in a while.
October included another significant deal, as Belknap-Haines completed its acquisition of Houston-based STC (formerly Swiff-Train), a top 20 distributor in 2021, to further expand the territory of the industry’s top-ranked distributor beyond its East Coast base of operations. The acquisition adds the Texas and Gulf Coast markets to an already massive territory that stretches from Maine to Miami and many states throughout the Rust Belt.
The end of 2022 also saw Victoria PLC, a UK-based distributor, announce the acquisition of Florida-based International Wholesale Tile LLC, a specialty distributor of ceramic, porcelain, and luxury vinyl tiles (LVT). This marks the second time Victoria made a significant move into the U.S. market in 2022 after having previously acquired Cali, a California-based flooring supplier, earlier in the year.
Wrapping a busy fourth quarter, Mirage, a Quebec-based hardwood flooring manufacturer, announced the acquisition of Parquets Alexandra to further strengthen its reputation as one of North America’s top hardwood flooring manufacturers.
While several notable deals closed in the fourth quarter of 2022, economic uncertainty drives divergence between buyers and sellers in the flooring M&A space heading into 2023. With many sellers having enjoyed record earnings over the previous two years, seller expectations remain high after two years of pandemic-driven revenue. However, buyers remain reluctant to view past success as an indication of future performance.
With an anticipated drop in flooring revenue and uncertainty surrounding new construction in 2023, buyers are cautious when valuing businesses in a post-pandemic market, while sellers remain confident after two years of meteoric success. These differing views could contribute to a downturn in M&A activity that continues throughout the first half of 2023.
M&A Outlook for 2023
Overall, we anticipate the combination of a market slowdown, higher inventory costs, a reduction in new home builds, and divergent views on valuation to create a more muted M&A environment in 2023 until at least the second half of the year, when buyers and sellers gain more clarity about the market and potential future disruptions moving forward. While uncertainty remains the prevailing attitude, reasons for optimism exist that could enable the flooring sector to outperform certain expectations.
Multifamily construction starts held up well, even in the back half of 2022, as rising interest rates and low inventory create affordability concerns in many households considering buying a home. Full year 2022 multifamily starts were 14% higher than the prior year, compared 11% lower single family. This sector should remain a strong source of demand throughout early 2023 as units started last year complete construction, with flooring and interior finishes being some of later trades in the building cycle.
After two years of frozen activity, the commercial construction sector began to thaw in 2022 and looks to have finally regained the traction needed to spur new project growth heading into 2023 and likely continuing to 2024.
Movement in the multifamily and commercial construction sectors should help offset the slowdown in single-family housing.
In the halls of Anchor Peabody, we look at the repair and remodel space as holding the key to better-than-expected revenues for the flooring sector in 2023 and beyond.
Consumers built up a tremendous amount of savings during the pandemic. While concerns over the economy and a looming recession may hamper the number of full-scale remodeling projects property owners undertake in 2023, we believe the repair and remodel space is still very well-positioned in the medium to long-term for several reasons.
- Americans move 50% less than they did 20 years ago, meaning people spend twice as much time in their homes than in the past. Rather than trading in their existing home for one with a bigger kitchen or refurbished basement, homeowners are far more likely to make a home improvement investment that increases property values while also creating a better living environment.
- The robust demand for homes and the competition generated in 2020 and 2021 left many homebuyers willing to purchase whatever property they could afford. Unfortunately, this created a mismatch where the buyer’s needs were only sometimes met by the home they purchased. A higher-than-average level of homeowner dissatisfaction should drive a long-term repair and remodel boom we anticipate lasting through 2025 and beyond.
- Owners who decide against investing in home improvement projects will look to trade in their homes as the residential real estate market settles. Home sales often drive much of the repair and remodel activity as existing homeowners either prepare to place their property on the market or as new owners make changes.
Flooring providers who can pivot from builders and expand exposure to the repair and remodel space should find new revenue avenues to explore.
In the retailing space, many questions continue to surround independent flooring retailers and the potential for the Amazonification of the flooring sector as a whole. In our view, flooring remains a unique product that consumers still want to see and touch before choosing to have it in their homes. This tactile need creates a natural buffer against the flooring industry moving entirely online, as we’ve seen with other industries.
Smaller brick-and-mortar retailers will still need to compete with large chains like Home Depot and Lumber Liquidators, but there’s space for these retailers to carve out. Establishing a clear and convincing value proposition, whether in terms of product offering, service, quality, or installation, is critical to differentiate what separates smaller, more regional retailers from their corporate competition.
We’ve seen some recent activity in this space that indicates institutional money believes in the ability of smaller retailers to compete. Recently, 31st Street Capital purchased five independent flooring retailers, which should provide smaller retailers comfort in knowing that institutional capital believes in their ability to stay relevant as consumers continue to change how they shop.
M&A Seller Outlook for 2023
The outlook for sellers moving into 2023 largely depends on the markets they serve. For example, businesses primarily serving single-family home builders will have just come off a rough Q4 in 2022 and face the prospect of experiencing a tough 2023. Conversely, businesses that service the multi-family and commercial construction sectors will continue to have the wind at their backs, buoyed by existing contracts and orders placed during the second half of 2022.
Patience remains essential for sellers operating primarily within the single-family home sector. The global financial crisis of the late aughts and the subsequent collapse of the housing market brought new housing construction to a crawl for a decade. Then, just as the demand for new housing projects started ramping up, the global pandemic eliminated the glut of available homes on the market while simultaneously creating supply chain issues that delayed the completion of new construction projects.
The housing, and by extension flooring, sectors are waiting to find stability in the market. Once the residential real estate market finishes cooling from the pandemic-driven frenzy and the Fed strikes the right balance on interest rates to curb inflation, consumers will understand better what they can afford. The industry will then be better able to assess the housing market and make more accurate predictions that will provide clarity.
Until we gain that clarity, businesses primarily servicing home builders must remain disciplined by managing costs and trying to position themselves adequately for the inevitable bounce back that will occur at the end of 2023 and into 2024.
Pricing discipline will remain key during what we project will be a difficult Q1-Q3 for many larger distributors with excess inventory clogging their warehouses. If the market moves towards mass liquidation, we could see a race to the bottom and the collapse of margins that will be difficult to recapture.
On the other hand, if wholesalers can maintain price discipline and recapture some margin on the high-dollar products they have in stock, sellers will be far better positioned at the end of 2023 than if a price war breaks out that damages the entire industry’s long-term interests.
Sellers operating in the repair and remodel sector should continue to enjoy solid revenue forecasts, even though the numbers will fall significantly below the COVID remodeling boom that swelled balance sheets for the previous two years.
Smaller flooring projects of less than $8,000 generally escape the gravity of rising interest rates, so the Fed’s effort at fighting inflation will have less of an impact on this sector as long as consumer confidence remains strong. Questions surrounding a looming recession should be answered by the middle of 2023 to give consumers answers on whether they can feel comfortable making a home improvement investment.
M&A Buyer Outlook for 2023
For the first half of 2023, we anticipate many potential buyers will remain focused on executing existing contracts, delivering for their customers, and managing down their inventory while attempting to maintain margin. Of course, this environment won’t preclude getting a deal done if the right opportunity presents itself for buyers. Still, the current uncertainty surrounding the flooring and housing sectors makes it difficult for buyers and sellers to find common ground needed to strike a deal.
We believe buyers know a rebound is coming and that many want to find themselves well-positioned to capitalize on changes in the M&A space. However, most still require more time to see some price stability and a little less uncertainty about what the market will look like for the rest of the year and moving into 2024 before feeling comfortable enough to make a significant move. Super premium multiples are simply off the table until buyers have more clarity, which will hamper the M&A market for at least the first half of 2023.
Potential for M&A Financing in 2023
Currently, bank and non-bank lenders remain highly focused on downside protection which means tighter debt covenants in general. We’re seeing more rigid pricing in the way of rising credit spreads, with even the most aggressively priced bank deals falling into the eight to 10% range all in (SOFR plus spread). Those numbers were in the five to eight range prior to recent rate increases. Between higher interest rates and lower leverage levels, financial sponsors may struggle to be as aggressive as they have been in the immediate future.
Strategic buyers should find themselves well-positioned once the M&A market begins to open up toward the end of 2023/early 2024. Strategic buyers who can finance off their own balance sheets and manage their existing banking relationships will enjoy a better position relative to the financial sponsor community that can’t generate the same type of leverage as they have historically.
Smart private equity that wants to put its money to work will over-equitize and recap later once the markets open up later this year. When the inevitable comeback does occur, we believe the these dynamics will favor strategic buyers over financial sponsors for at least the rest of 2023.
Takeaways and Strategic Outlook for 2023
Looking at the current M&A market conditions, it’s easy to come away with the idea that the flooring sector is closed for business for the first half of 2023. However, at Anchor Peabody, despite the uncertain flooring and housing markets, we believe some excellent M&A opportunities exist in the MA sector.
We foresee very little slowdown for businesses operating in the multifamily and commercial sectors, especially on the contracting and installation side of the flooring industry. Sellers should remain aware and closely monitor what’s happening in these sectors. Strategic buyers remain actively searching for potential below-market deals that could develop due to sellers being fooled by the broader market.
We’re cautioning sellers to remain patient, even if they anticipate a challenging 2023. The Anchor Peabody team is confident in the flooring industry staging a comeback approaching 2024 and that the resurgence will be decisive for the industry as a whole. A fierce fight will break out over the highest quality assets on the market, and sellers don’t want to miss their opportunity when the time comes.
Windows for maximizing the value of their business tend to open and close quickly, so we advise reaching out to our team at Anchor Peabody so we can help walk you through what the selling process may look like one or two years down the road. When those windows open, we’re poised to see some aggressive M&A activity, but it’s not going to be during the first half of 2023.