Valuing a Manufacturing Company
Understanding Industry Benchmarks Can Help Sellers Boost Value
Key Takeaways:
- Despite the unique risks that have emerged in the post-pandemic marketplace, unique opportunities also have arisen.
- Pent-up demand is emerging in the manufacturing sector, especially on the sell side.
- If you plan to sell, take actions now because you want the most recent year to be a good year, showing you have healthy growth.
With two years of the COVID-19 pandemic followed by high inflation and volatile interest rates, the last four years have been a roller coaster in the merger and acquisition (M&A) market.
But now that inflation is settling down and interest rates, although high, are stabilizing, pent-up demand is emerging in the manufacturing sector, especially on the sell side, and both sides are negotiating good deals that fulfill their goals. Investors are bullish and many sellers are motivated by a wish to retire or continue with their companies in a reduced role during a post-sale earnout period.
In general, manufacturing companies in 2024 are well positioned for buyers who want to grow market share or increase synergies.
As a result, valuations of manufacturing companies are strong, but company owners are finding a different mix of factors impacting their valuations in the post-pandemic world than they were accustomed to before 2020.
Heightened Risk Factors
Several pandemic-related holdover issues are affecting not only valuations but ways of doing business in the manufacturing sector as the M&A market heats up. These factors inject increased risk into a manufacturer’s operations that can negatively impact valuation, including:
- Many wholesalers have been sitting on excess inventory as of the valuation date. This is largely due to manufacturers accumulating more inventory than needed once the supply chain shortages from 2021 and 2022 were resolved. Some supply chain challenges stubbornly persist in some manufacturing sectors. This can result in overdependence on certain suppliers.
- Inflation is a continuing concern, heightening risk in the areas of pricing, income and cash flow for manufacturers. While oil and gas prices have declined, prices for steel, a major input for some manufacturers rose significantly in the fourth quarter of 2023. Prices remain above their average as of the date of this article due to a higher demand for steel.
- Labor costs and shortages continue to plague many manufacturers. Aggravating the situation is high employee turnover, which drives up the costs of training new workers who come on board to replace those who have left, leading some companies to invest in training two or three times a year for the same positions.
- Manufacturers in some sectors are reshoring work they took overseas several years ago to cut labor costs. Supply chain challenges abroad and sharply rising shipping costs have made it more manageable and cost effective to bring those jobs back to the U.S. While this sounds like a good thing, it increases a company’s exposure to the labor market shortages that are impacting nearly all industries right now.
- In certain industries, suppliers are asking for exclusive contracts for wholesalers who normally source products from a diversified group. While the cost savings associated with exclusive contracts are attractive, concentrating business with one supplier presents a heightened risk factor that affects valuation.
Trends Boosting Valuations
Despite the unique risks that have emerged in the post-pandemic marketplace, unique opportunities also have arisen. In particular, supply chain problems during the pandemic showed many manufacturers the value of owning their suppliers. Hence, manufacturers located in the Midwest who supply domestic industries such as automotive and consumer goods often received unsolicited offers during the pandemic, and they continue to bring strong prices.
Investments in technology during the lead up to selling a company can help improve efficiency and productivity, in turn strengthening the valuation.
Significant tax incentives contained in the Inflation Reduction Act of 2022 have enabled many companies to make energy-efficient improvements to buildings and manufacturing processes. Besides reaping the tax benefits, to the extent that these investments result in cost savings and productivity improvements, they also help boost valuations.
Strategies for Sellers
If you think you may exit your company within the next year or two, consider the following strategies that could help you reach your goals:
- If you are planning to gift your company to your heirs, you may want to consider obtaining a valuation very soon. When the tax rules changed in 2022 compelling manufacturers to capitalize and expense research and development (R&D) costs over a five-year period rather than all in the year that the expense was incurred, which could have the effect of depressing valuations. Lower valuations are a benefit when gifting company stock.
- Look at your financial benchmarks against your competition and against other players in your industry. If your benchmarks are lower than your peers, take action to improve the margins. Look at asset turnover, inventory turnover and other metrics you can measure against your peers.
- Take these actions now, because if you’re taking your company to market you want the most recent year to be a good year, showing that you have healthy growth.
- If you’re going to market, look for synergistic buyers. These are buyers who may see added value in your company because it helps them solidify their presence in the same vertical market you are in. When a buyer wants to “bolt on” your company to theirs – adding manufacturing capacity, new customer groups and new supplier relationships – they are generally willing to pay a higher multiple to achieve the deal.
Questions?
If you would like to discuss strategies for strengthening the valuation of your manufacturing company in preparation for exit, contact an Adams Brown advisor.