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 2019
- Tariffs of 25% and 10% remain in place for imported steel and aluminum from China and others, but have been lifted from Argentina, Australia, Canada, and Mexico
- Although new, privately-owned housing starts are down 3.6% year-to-date, a jump in permits to a seven-month high as of July 2019 may be seen as positive for the housing market
- Annual gains in homeowner spending on improvements are expected to be moderate across more than half of the nation’s largest metro areas in 2019
By The Numbers
Homebuilding starts mixed: U.S. homebuilding was down for a third straight month in July 2019, falling 4.0 percent to a seasonally adjusted annual rate of 1.191 million. However, this represents a 0.6 percentage point increase year-over-year from the July 2018 rate, and a jump in permits to a seven-month high may be seen as positive for the housing market.
Low mortgage rates have yet to translate into a sustained pickup in existing-home sales, which declined 1.7 percent in June 2019 to a seasonally adjusted rate of 5.27 million. Year over year, sales are down 2.2 percent; however, total inventory in June 2019 was up 1.0 percent over June 2018. While supply remains relatively tight, more listings should support existing-home sales in the coming months, with easing prices helping homes sell more quickly. The National Association of Realtors reported that 56 percent of homes sold during June 2019 were on the market for less than one month.
Millennials drive demand: More than half of all mortgages originated by Fannie Mae and Freddie Mac went to first-time buyers in 2018. Data from the National Association of Realtors shows that Millennials made up 37% of all home buyers in 2018, and since 2017 they have accounted for the largest share of U.S. mortgage originations. “This trend shows no signs of reversing in 2019,” according to Odeta Kushi, Deputy Chief Economist for title insurance and settlement company First American.
Remodeling growth slows: According to a June 2019 study by the Harvard Joint Center for Housing Studies, annual gains in homeowner spending on improvements are expected to be moderate across more than half of the nation’s largest metropolitan areas in 2019. The study indicates that the pace of spending by homeowners will slow in 29 of the 49 areas tracked relative to their estimated 2018 gains, with annual growth in improvement expenditures projected to fall to the lowest rate in three years in 22 of the areas tracked.
“Metros with cooling home prices and sales activity are not able to sustain the same pace of investment in home improvements as in recent years,” commented Chris Herbert, Managing Director of the Joint Center for Housing Studies. “Our projections show especially pronounced slowing in markets such as San Antonio, Kansas City, Pittsburgh, Buffalo, and Dallas.”
A senior researcher in the Center’s Remodeling Futures Program noted, “despite the broader deceleration, remodeling gains should remain strong and even accelerate through year-end in some areas of the country including Orlando and Las Vegas where remodeling permitting, house prices, and homebuilding have picked up.” Additionally, the study concluded that, for 2019, the strongest regional remodeling uptick is expected to be in the West, driven by projected growth of 8 percent or more in Sacramento, Denver, Seattle, Tucson, San Jose, and Las Vegas.
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 anything that is colored such as siding, composite decking, or moldings with custom profiles. While there is a market, it’s 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. If they are backed by an order, they usually have a high recovery value because it is assumed the customer will take them for a project that’s 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. Work that is in-process, such as custom hanging doors or roof trusses, is not typically converted. Rather, it’s assumed 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.