State of the Industry
There’s just one question after a year of rapid growth, rising prices, and record-setting profitability in the flooring industry: How do we top it?
So it was with this year, coming off the whirlwind that was 2021. Work from home policies, COVID relief, a strong economy with low unemployment, rising home prices and low interest rates all combined to make 2021 a year for the ages. 2022 is three quarters of the way over; how have we stacked up against such a banner benchmark?
The overwhelming feedback we’re hearing from both public and private market participants is mixed. Volumes are down, but prices are up or steady. Higher interest rates, falling home sales, and shaky consumer confidence combined to slow the breakneck pace of growth we saw last year. Retail foot traffic is down and fewer second home sales are slowing the demand for remodel projects. However, with tight supply chains and product availability continuing to be a problem, price increases have been the saving grace (for those fortunate to be able to get product to market). Floor and Décor, for instance, reported a 13% increase in same store sales through the quarter ended June 30, largely driven on price inflation but also warned on softening demand.
Q1-Q3 M&A Dealflow
The murky market has had an impact on both buyers and sellers. In the first half of the year, M&A was flourishing in flooring with some marquee transactions. In April, Platinum Equity’s Paramount Global Surfaces (home to Happy Floors and Ceramic Technics) acquired Stone Source, doubling down on a rebound of commercial flooring surfaces. The next month, Bauwerk Parkett, the Swiss manufacturer, purchased Somerset Hardwood in a bet on the U.S. hardwood flooring market.
The second half of the year to date has seen a M&A slowdown, as buyers remain cautious about future earnings profiles, the sustainability of margins, and the fate of the single-family home market. Sellers remain opportunistic, but balance sheets after years of strong earnings have them in a very comfortable spot to wait out buyers looking to trade down on the negative economic news.
A particular bright spot has been the services and installation space, especially those with long-term, recurring multi-family or commercial businesses. Blue Sage Capital’s Impact Property Solutions completed four bolt-on acquisitions this year. Georgia-based Real Floors completed a merger with Ardor Carpet, which greatly expanded the combined company’s geographic reach. Shop-at-home retailers/installers also continue to thrive, with Empire Today adding California-based Sitton Flooring, and Georgia-based 50 Floor green-fielding new locations.
2023 Market Outlook
For owners and operators looking forward, we offer the following insight.
Inside the walls of Anchor Peabody, we believe single-family residential housing exposure will likely continue to face headwinds in the short term. The full impact of last year’s run up in prices and this year’s interest rate increases continue to work their way through the system. We anticipate continued, slowing growth of new housing starts and further builder concessions to help prop up demand. Given longer than usual build cycles, these changes may take some time to show up in flooring and interior finishes. However, we also believe long-term housing fundamentals remain strong, and most markets still suffer from being under-built. We expect this market to settle out over the next 6-12 months before heading back on the path to growth; the hardest part about it is figuring out the exact timing.
Multi-family residential housing remains a strong bright spot with starts continuing at a robust level not seen since the 1980s as single-family affordability and financing issues have pushed more households into multi-family. We are very bullish on companies with exposure to new multi-family construction in the near-term, but especially to the rip-and-replace tenant turnover business. We expect continued acquisition activity as contractors in the space are acquired, and some consolidators may venture outside of flooring into adjacencies such as countertops and appliances.
In commercial construction, we expect a mixed bag. Luxury retail and hospitality should continue to recover from their COVID-induced troughs as consumers get back to travel and shopping. However, a meaningful recession could hurt mid-tier and discount retailers, restaurateurs and lodgers. A certain amount of commercial office and business travel space may never fully recover in the wake of permanent work from home transitions. This said, we do believe education and healthcare markets will continue their near recession-proof track record.
Flooring M&A in 2023
Looking ahead to 2023 with the benefit of what we’ve learned this year, what does the flooring M&A landscape look like?
More Consolidation. Expect distributors and contractors to continue to consolidate and reap the benefits of scale (purchasing power, rebates, geographic diversification, working capital management, etc.)
Retailers Join the M&A Mix. While manufacturing is far down a consolidation path, and distribution is beginning in earnest – retail is in its M&A infancy. Competition with the big box retailers and market entrants of buyers with a consolidation thesis (e.g., 31st Capital Partners) should jumpstart M&A in the space. Independent dealers, both buyers and sellers, should begin considering their short- and long-term M&A plans for how to participate and position themselves in the coming consolidation.
Separating the Good from the Great. Warren Buffet has a great quote: “Only when the tide goes out do you discover who’s been swimming naked.” While the rising tide of late 2020 and 2021 buoyed all ships, as things come down to earth we’ll see which companies are exceptionally run. Operations with a diverse customer base, those who produce strong margins, manage working capital well, are in favorable geographic regions (West Coast, Rocky Mountain West, Southeast), and have strong, tenured management teams will appeal most to buyers. These companies will also likely be the best positioned to be acquisitive, and/or take market share from those who are not as strongly run.
Flooring M&A participants across the industry should begin to think about how consolidation will impact their markets and how to prepare/ position their businesses for an outsized outcome in a sale process, should they go that route, or as the buyer of choice if they’re acquisitive.
As we head into uncertain times, please consider us a resource. Anchor Peabody has a dedicated flooring M&A advisory practice where we seek to know who is doing what to who and why more than anyone else. We welcome conversations on any front from owners and executives interested in discussing the strategic and financial alternatives for their business and/or the impact of M&A on their business.