Roofing and Siding Market Update: Relative Stability in a World of Chaos
The landscape of building products has seen a lot of turmoil over the last several years. We had the post-COVID boom in remodel spending and homebuilding, lifting revenues and pulling forward demand for many players. This was followed by massive supply chain disruptions, a result of logistics issues, unprecedented demand and lingering COVID impacts, driving up costs and prices. Then we saw a once-in-a-generation pace of interest rate hikes to combat inflation, putting the breaks on new residential construction and impacting financing costs for commercial developers and operators.
The 2023 macroeconomic issues, coupled with difficult comps from prior year expansions, led to a marked drop off in M&A activity across the building sector. One of the few bright spots to remain resilient through this uncertain and volatile period has been the roofing & siding contractor sector. According to data from S&P CapIQ, trailing twelve-month M&A activity in the roofing & siding sector rose throughout the year as deal volume increased, trailing off slightly last month, but the longer-term trend remains positive.
Two Reasons Roofing Has Bucked the Trend: Non-Deferable Demand and High Investor Interest
In our view, the roofing (and to a lesser extent siding) sector has remained relatively resilient for two separate but related reasons.
First, roofing, along with sectors like HVAC/plumbing/electrical, remains one of the least deferable spending categories for consumers and property owners. Re-roofing and maintenance account for approximately 75% of non-residential roofing spend, and approximately 70% for residential. With the bulk of the industry not levered to the build cycle, roofing represents one of the less cyclical subsectors in the space.
Moreover, when repair and reroof needs arise, they are often immediate. Homeowners with storm damage, leaks or other issues need to address them at discovery. Commercial operators with foot traffic or valuable products in their building must ensure that roof issues are resolved quickly or risk significant losses. While the decline in existing home sales, driven by the so-called “mortgage rate lock” of existing homeowners with low mortgages being unwilling to sell their home and trade into a higher rate, has put a damper on inspection-driven repairs, this represents a relatively small part of the market. Roofing issues are the highest single inspection-related finding but are still only identified in less than 20% of home inspections.
The second driver here in roofing remaining a resilient spot for M&A activity is the elevated level of investor interest. Private equity is investing heavily in the sector, with dozens of platforms already established and growing actively through M&A. Anchor Peabody continues to receive multiple inbounds each week from institutional investors either looking to add to existing platforms or hunting deals to establish one of their own. Private equity tends to follow somewhat of a herd mentality, and with many marquee investors aggressively getting into the space (see for example Morgan Stanley Capital Partners’ [MSCP] acquisition of All Star in May 2023), more money is going to continue to flow into the sector. MSCP’s managing director Adam Shaw told PE Hub “We believe that the consolidation is in the very early innings.”
Private equity’s interest in roofing is driven by three main factors. First, the business model and dynamics are highly attractive to PE. The non-deferable nature of roofing maintenance discussed above provides a strong bulwark against cyclical downturns, and regular, predictable cash flows are critical to private equity’s debt-driven financing model. Additionally, the businesses tend to be asset light with minimal reinvestment and capex requirements. The labor model, especially in residential, is often highly flexible, with a heavy reliance on independent contractor labor that can be flexed up or down with demand.
Second, PE investors see an attractive opportunity to scale and diversify. The roofing industry remains highly fragmented, with the top five industry players representing less than 5% of total market share. Combining independent roofing contractors in a roll-up strategy allows investors to diversify geographically, being less dependent on the volatility of a single market. Further, it provides opportunities to achieve economies of scale in functions that can be centralized and optimized – think marketing, administrative, accounting and purchasing.
Finally, the best private equity firms can bring a level of operational expertise and sophistication that drive growth and profitability. Residential roofing in particular is, at the end of the day, largely a lead-generation and conversion business. Private equity operators with experience in consumer-focused businesses have tools and expertise to dissect marketing efforts, concentrate investments on the highest converting opportunities, track and optimize cost of customer acquisition and generally drive more revenue more profitably.
The upshot here is that there is a large pool of deep-pocketed investors highly interested in continued investment across the entire roofing sector. There are institutional-backed platforms concentrating on buying assets in commercial roofing, residential storm roofing, and residential retail, and the number is only growing by the day.
Capital Markets – Financing Challenged but Available, With Brighter Days Ahead
Access to financing is critical for deal making activity, and in that regard 2023 faced meaningful headwinds. As base rates like the Fed Funds and Secured Overnight Funding Rate (SOFR) climbed with the Federal Reserve combatting inflation so did borrowing costs. Additionally, lenders increased the credit spreads to these base rates resulting in all-in borrowing costs for companies in the middle market (defined as those with less than $40MM of EBITDA) of approximately 11.5% – 13.5%, a hefty burden, especially compared to the zero-rate interest environment we had seen for years prior to 2023.
The good news is weak deal flow has put pressure on lenders to put more money to work and they are slowly getting more aggressive. Middle market lenders have come down 0.25% – 0.50% in their credit spreads. As base rates are expected to come down this year, with further tightening of credit spreads, 2024 should be a much better year for access to acquisition financing. Additionally, many larger platforms have been able to finance smaller bolt-on deals from existing cash and lines of credit, allowing them to remain active despite harder than average debt market conditions.
Finally, Owens Corning announced its $3.9 billion acquisition of Masonite in February of this year in an all-cash deal, securing $3 billion in committed financing prior to the announcement. This signals that the debt markets are open to even very large strategic deals, that lenders are not shying away from the construction industry, and likely that Owens Corning believes they can refinance this debt at a rate meaningfully below current costs in the near to medium term. All of this is good news for M&A activity going forward in the sector.
Advice For Potential Sellers: Know Your Company Identity and Value Proposition
Owners of roofing contractor businesses should take stock and consider 2024 carefully as a time to consider selling. The sheer volume of buyer interest and dollars chasing the space has never been higher, and there are multiple buyers for most types of business regardless of end market. Bidding processes will be highly competitive driving value for sellers.
The most attractive businesses will be those in the residential and commercial reroofing markets. In the residential market, companies in high growth areas like the Southeast (which has both higher population growth and shorter average roof life than the national average) will draw increased interest, but the market is open for operators across the country.
In the commercial roofing market, we expect to see a downturn in new construction as both commercial/industrial and new multifamily construction is poised for a downturn relative to prior years. However, those companies with a significant portion of their revenue derived from maintenance and reroofing should avoid most of this and will be in demand for acquirers.
The most important thing for potential sellers, I believe, is to understand what your company identity is and what are the strengths of your value proposition to which end markets. Are you a pure play residential retail roofer? Do you diversify between storm and non-storm repairs? Do you serve both commercial and residential markets and what is your core competency and source of growth going forward? Most of the PE backed platforms and funds looking to acquire new businesses have specific theses on what markets they want to target and what kind of business mix makes sense for them. Being able to articulate your customer and market strategy, why it works, and how it could fit in with another business is critical in maximizing value and achieving optimal outcomes.
We expect consolidation in the contractor industry to continue at a robust pace this year, and independent operators will need to think about how they respond to that. With the current strength of the market likely to improve as macro conditions stabilize and interest rates retreat, potential sellers may want to get while the getting is good.
Advice to Buyers: Be Competitive, But Disciplined
In a crowded market with a lot of sophisticated buyers chasing deals and a large, fragmented group of businesses, buyers can sometimes succumb to a herd mentality and fear of missing out. While we don’t think the roofing & siding contractor market is overvalued given the tremendous opportunity for scale and synergies, we do encourage buyers to be thoughtful about their strategy. The insurance pay vs. non-insurance/retail residential markets vs. commercial markets are very different in many important respects including marketing, labor, product type, payment terms, etc. Determining the pros and cons of each market and business model and how, if at all, they can work together for you, is vital in achieving success. Effective buyers will absolutely need to be competitive on value and terms given the buyer/seller dynamics but will also need to be disciplined in their thesis and how to make it all work together.
If you have any interest in discussing any of the above in further detail, have ever thought about selling, or simply want to talk about the market in general – please reach out to Aaron Toomey at [email protected] for a confidential discussion anytime.
Anchor Peabody serves the middle market building products market, and no one is more plugged in than we are.
Good luck this year.