Building Materials & Supplies Trends
COVID-19 Industry Brief
EFFECTS OF THE CORONAVIRUS ON THE Building Materials INDUSTRY Updated May 19, 2020
- Pre COVID-19 Market Sentiment: Prior to the coronavirus pandemic hitting, revenue for the building products industry was forecasted to decline slightly in 2020 based primarily on an expectation of a softening housing market and North American economy. The industry had been growing over the five-year period ended December 2019 at an annual growth of 1.8 percent supported by a housing market that had been expanding steadily since the recovery from the Great Recession began in 2009. The first quarter 2020 results prior to the pandemic were stronger than expected and the housing market and demand for building materials was robust in February 2020.
- COVID Impacts: In all regions, building product distributors were deemed essential businesses allowing these businesses to remain open if they chose. Home center volumes of lumber products were reported to be a bright spot in the lumber business in March and early April, with companies noting that people were making use of their time away from work to complete home projects. Some distributors said they continued to ship steadily to job sites where builders were trying to finish projects. However, some projects were interrupted by changing regulations, as city, state, and federal officials reacted to the virus threat.
- Housing Market Impacts: COVID-19 has reduced residential and commercial construction activity. In most jurisdictions, existing construction was allowed to proceed, but the initiation of new projects has been limited in some regions, and the impact of complying with social distancing rules as well as the availability of inspectors and supplies has limited activity. The residential building permit rate for April 2020 fell to 20.8 percent below the March 2020 rate, 25.3 percent below the February 2020 rate, and 19.2 percent below the April 2019 rate. Privately owned housing starts fell by 30.2 percent in April 2020 following an 18.6 percent decline in March 2020 and were 29.7 percent below the April 2019 rate. On April 23, 2020, JP Morgan Chase predicted a 51.3 percent drop in housing starts by summer from pre-pandemic levels, with a quick recovery to follow.
- Interest Rates: The interest rate adjustments made by the Federal Reserve Board in early March 2020 have had a positive impact on the housing market. The average 30-year fixed-rate mortgage dropped from 3.72 percent as reported by the Federal Home Loan Mortgage Corporation, known as Freddie Mac, for the week of January 2, 2020, to 3.28 percent for the week ended May 14, 2020. This should have a positive impact on housing longer term, but availability of credit both in the primary mortgage market and the secondary home equity market has been curtailed due to the pandemic. Total residential real estate loan volume has fallen since early April by about 1.0 percent likely reflecting the impact of weakened consumer confidence since the beginning of the year, job losses, and lower loan demand due to falling rates of housing starts and new building permit applications.
- Lumber Sales Reports: Despite the restrictions, sales of lumber in April were strong throughout the United States. Random Lengths, a trade journal that tracks lumber and other building products market conditions, reported in its May 8, 2020, newsletter that “dealers in all regions across the U.S. raised their sales expectations for lumber and panels,” which still trailed year-ago levels by about 12.7 percent…Jumps in sales expectations for May were most notable in the Midwest, South Atlantic, and Northeast regions.” Treated lumber demand, particularly from home centers, was “unrelenting” according to the Random Lengths report.
- Roofing Segment: Roofing results have been weak on a year-over-year basis, due primarily to benign weather patterns in 2019. The first quarter of 2019 had heavy roofing sales due to an active hurricane season in 2018. One large manufacturer in the space reported that the first quarter 2020 sales were down approximately 15 percent from 2019, which were up 20 percent over 2018; sales were reported as especially weak in the second half of March. Beacon Roofing Supply, a large distributor in the space reported weakness in roofing sales as well, but reported only a 1.3 percent decline for the first quarter compared to the prior-year period. Both companies expected weakness in April and May due to COVID-19 impacts.
- Tile Segment: A large tile retailer reported a strong first quarter, with sales up 8.5 percent year over year, but was seeing a drop off in sales and foot traffic by 50 percent in April 2020.
- First Quarter 2020 results: First quarter results from Huttig Building Products were positive for the first quarter of 2020, due to a strong housing market and economy. Nevertheless, the company expects conditions to be weak in the second quarter, and on May 4, 2020, announced it had proactively taken the following steps in anticipation of the pandemic impact: “…communicating with vendors and customers, seeking modification of payment and other terms of rental and procurement agreements and monitoring our accounts receivable. We have also reduced inventory levels to meet an anticipated decrease in demand and have implemented cost containment measures, including lay-offs, wage reductions, suspension of matching contributions to our qualified defined contribution plan, and eliminated non-essential spend. We have also delayed or cancelled certain planned capital expenditures.” Boise Cascade also published its first quarter results on May 7, 2020, reporting a sales increase for the first quarter of 12.3 percent, driven by a sales volume increase of 17 percent, offset by lower prices. Despite the positive results, the company curtailed or reduced operating schedules at essentially all of its manufacturing facilities and reduced activity levels at all distribution facilities due to COVID-19 related impacts.
- Valuation Outlook: From an outlook perspective, the building products industry is driven by commercial and residential construction activity. How the housing market reacts to the COVID-19 pandemic is uncertain; the building products distribution market will likely be directly impacted by whatever the outcome is in this sector. The interest rate adjustment made in early March 2020 is likely having and will have a positive impact on the housing market. From an inventory appraisal perspective, other than temporary impacts and commodity pricing issues due to the typical turnover profile of businesses in this sector, Gordon Brothers would not expect to see large declines in valuations. Special orders may be impacted if construction and/or housing projects are delayed.
Date August 2020
- While new housing permits and starts hit five-year lows in April, positive rates for June and July bode well for the industry in the short term.
- Existing home inventory for June increased 1.3% over May, coming in at 1.57 million homes for sale; however, compared to June of 2019, inventory levels dropped 18.2%, marking 13 straight months of declines.
- Expenditures for improvements and repairs to owner-occupied homes are expected to slow by the middle of 2021 as the COVID-19 pandemic continues to impact the broader U.S. economy.
- Other than temporary impacts and commodity pricing issues due to the typical turnover profile of businesses in this sector, Gordon Brothers does not expect to see large declines in inventory valuations
By The Numbers
Homebuilding Uptick: Monthly U.S. homebuilding rates increased for the third straight month in July with 1.495 million new starts, representing an increase of 17.5 percent over June. July starts increased 22.6 percent over June after falling 26.4 percent to a five-year low in April. Although starts for July remained approximately 7.5 percent below the January peak of 1.6 million, the positive trend bodes well for the industry, at least in the near term. Another positive trend was in the number of building permits for residential construction issued, which produced 3.5 percent and 18.8 percent month-over-month increases for June and July, respectively.
After three months of declines (February through April), new single-family home sales also increased in June to a seasonally adjusted annual rate of 776,000, representing a 13.8 percent increase over the revised May rate of 682,000, and a 6.9 percent growth versus the June 2019 estimate of 726,000. Geographically, new, privately-owned home sales for June (on an adjusted basis) increased year over year in all regions except the South. Existing home sales rose to 4.72 million in June after three months of declines and following a near-decade low in May of 3.91 million; however, as compared to 2019, monthly sales for June were down 11.3 percent.
Existing home inventory for June increased 1.3 percent over May at 1.57 million homes for sale; however, compared to June of 2019, inventory levels dropped by 18.2 percent, marking 13 straight months of declines. Based on information from the National Association of Realtors, it would take four months to move the June level of inventory at the current sales pace. Despite this declining year-over-year trend in inventory levels, mortgage applications hit an 11-year high, with refinancing applications rising 120 percent over 2019 driven by a sustained decrease in interest rates. Millennials have accounted for 38 percent of all home buyers in 2020 and the largest share of U.S. mortgage originations since 2017.
Pandemic Impact on Remodeling Plans: Healthy upticks in sales for major home improvement retailers, which were considered essential businesses throughout the pandemic-related store closures, have been a bright spot in the building supplies sector, despite some supply chain and fulfillment issues driven by the pandemic. In its most recent quarterly release, Home Depot management noted “During the last three weeks of the first quarter of fiscal 2020, we saw a significant acceleration in sales with strong performance across most of our departments. This acceleration in sales growth continued through the second quarter of fiscal 2020, as customers maintained their focus on home improvement projects and repairs. The increase in customer demand for certain products together with the impact of COVID-19 on our supply chain has pressured our ability to maintain inventory in-stock levels, particularly for certain high demand products.”
Census Bureau data as reported by Business Wire in late July, supports this sentiment. “According the latest U.S. Census Bureau report, home centers, hardware stores, garden centers and building materials suppliers realized a year-over-year sales increase of 22.6 percent, leading all retail categories except for online purchases. This continues a trend with retailers serving the home improvement market that suggests homeowners are doing projects during the pandemic. Recent research from Consumer Specialists and the Home Projects Council examines why 57 percent of homeowners put an emphasis on home improvement during the first three months of COVID-19.”
However, according to the quarterly Leading Indicator of Remodeling Activity (LIRA) report released in mid-July by the Remodeling Futures Program at the Joint Center for Housing Studies of Harvard University, expenditures for improvements and repairs to owner-occupied homes are expected to slow by the middle of 2021 as the COVID-19 pandemic continues to impact the broader U.S. economy. The LIRA analysis projects a slight annual decline in renovation and repair spending of 0.4 percent by the second quarter of 2021.
The most recent earnings statement from leading manufacturer of wood products and wholesale distributor of building materials Boise Cascade supports the expectation for an eventual downturn in remodeling activity. Boise Cascade management commented, “Although we believe that current U.S. demographics support a higher level of housing starts, the impacts of COVID-19 on residential construction are uncertain. In particular, the economic consequences of COVID-19 may adversely affect the pace of household formation rates and residential repair-and-remodeling activity due to high unemployment rates, lower wages, reduced consumer confidence, prospective home buyers' lack of ability to view homes in person, homebuyers' access to and cost of financing, and housing affordability, as well as other factors.” Upticks in homebuilding activity in June and July bode well for the industry; however, as the coronavirus continues to affect the overall economy, supply chain disruptions and inventory outages have arisen as manufacturers continue to grapple with public health guidelines and fluctuations in demand. As such, major industry operators such as Weyerhaeuser Company have reduced their operating capacity at manufacturing facilities in order to operate efficiently and respond to changes in customer sentiment and order flow.
Ranking Recoveries: While other inventory categories are not as straightforward to value, there are some general rules of thumb to keep in mind. Shingles, insulation, wallboard and other commodity-like products are commonly standardized and widely marketable, meaning that gross recoveries are typically strong. However, drywall typically has lower recovery because it has slim margins, has high transportation costs and is prone to breakage. Other items such as fasteners, moldings, windows and doors are marketable, but have specific applications, resulting in higher discounts. The least marketable and lowest-recovering categories include any items that are colored such as siding, composite decking or moldings with custom profiles. While there are markets for these items, they are much more limited and buyers demand steep discounts.
Some building products are made to order including roofing and flooring trusses, custom millwork, kitchen countertops and bath vanities. Special orders can be high- or low-recovering depending on the circumstances; however, they usually have a high recovery value because it is assumed that customers will take them for projects that are already underway. However, special orders that are abandoned, refused or returned are typically very low-recovering. Lenders should look to appraisers to understand the nature of special orders. It is recommended that any inventory with a deposit against it be made ineligible. Products that are in process, such as custom hanging doors or roof trusses, are not typically converted. Rather, it is assumed that these items would be sold to competitors at a steep discount.
Expenses Can Add Up: In general, gross recoveries are typically high for building products distributors, but often the biggest surprise for lenders is the liquidation expenses that, in some cases, can be as high as 20 percent. Most sell to either retailers or pro builders, which rely on delivery of products to stores or job sites. In such liquidation scenarios, costs to maintain a delivery fleet are typically included in the liquidation expenses and can be as high as 7 percent. For companies that rely heavily on salespeople to maintain customer relationships and market products, an additional commission expense may be built into the liquidation scenario. Depending on whether buildings are owned or leased, real estate may also contribute to the expense burden.
Seasonal Swings: Not surprisingly, the building products industry is a very seasonal business. April through October is typically the high-selling period, during which time as much as 70 to 80 percent of sales may occur. However, variations in the weather can shift this timeframe from year to year, which is why a high-low analysis is typically recommended. Values can swing by as much as 5 to 15 percentage points between seasons. Appraisers can help lenders understand the additional risks associated with low-season liquidations to mitigate exposures.
Valuation Outlook: From an outlook perspective, the building products industry is driven by commercial and residential construction activity. How the housing market reacts to the COVID-19 pandemic is uncertain; the building products distribution market will likely be directly impacted by whatever the outcome is in this sector. The Federal Reserve interest rate adjustment in early March is likely having, and will have, a positive impact on the housing market. From an inventory appraisal perspective, other than temporary impacts and commodity pricing issues due to the typical turnover profile of businesses in this sector, Gordon Brothers does not expect to see large declines in valuations. Special orders may be impacted if construction and/or housing projects are delayed.
Note: This publication is provided for informational marketing purposes only. The material contained herein should not be regarded as advice, nor relied upon to make financial, operational or other decisions; nor should it be used as a substitute for an asset appraisal. Actual recovery values may vary from transaction to transaction and the recovery values referenced herein are for representative transactions without regard to specific key factors. This material may be redistributed only in its entirety, including notice of copyright. All rights reserved. ©2020 Gordon Brothers, LLC.
Reference sources: federal reserve economic data, ibisworld, national association of realtors, joint center for housing studies of harvard university, home depot, boise cascade, U.s. Census Bureau