In every one of our LBM deals over the past two years, acquirers have used a “price effect” model to determine the sustainable EBITDA of the business, after factoring out the increases in commodity lumber prices driven by COVID-19 and supply chain challenges. The model that acquirers use to establish sustainable EBITDA—defined as the EBITDA figure that is likely to repeat after the price volatility has been bled out of the commodity market—is a price/volume/cost of goods (or COGs) analysis. In our role as seller’s representation, we too have developed a “price effect” model (in the form of an elaborate spreadsheet) that looks at monthly cost of goods sold and inventory levels, while indexing those KPIs against what commodity lumber prices were over that same period of time. (We pull those lumber prices from a data source found at tradingeconomics.com/commodity/ lumber where you can determine past lumber prices to any single day, historically.) The acquirer runs their models, we run ours, and we compare notes, eventually agreeing on the sustainable EBITDA to which a multiple is applied for valuation purposes.
Over the past two years, the general consensus has been that lumber prices would come off their highs over time. Accordingly, the higher the spike in lumber prices, the more pressure we would see from acquirers for a negative adjustment to EBITDA to get to that “sustainable” figure. A quick check of that data at the time of this writing shows that lumber has ranged in price over roughly the last 12 months from $1,426 to $370. (It peaked in May 2021 at around $1,700.)
We are now at time when any price effect adjustment to EBITDA should be out of the system by the end of the 2nd quarter of 2023. In other words, for now there are no new negative price effect adjustments to EBITDA. However, while prices are currently low or stable now, the consensus is that lumber prices will start to rise again during the busy 2023 building season, even as building activity is tempered by higher mortgage and borrowing costs.
If commodity prices start to increase, it could benefit both sellers and acquirers. As a seller, your business will likely be valued on your trailing 12 months performance and/or last year’s performance. That said, if commodity prices continue to increase after you sell your business, that will benefit the acquirer with increased profitability. From a seller’s standpoint, on a trailing 12 month basis, perhaps the higher rolling average of lumber prices (when indexed to COGs and inventory), is something that will continue in 2023 and beyond. Maybe that’s the new normal. And if the higher EBITDA is something you would have enjoyed as the owner, why shouldn’t the acquirer pay to enjoy it as well, by building into their purchase price the multiple on the “extra” EBITDA they are likely to see in their first year of ownership, and potentially far beyond that?
As we have watched LBMers deal with volatile lumber prices over the last two years, we have noticed their gross profit margins have remained largely unchanged. (Just to level set, the gross profit margin—GPM—is the percentage of sales revenue that is gross profit, and gross profit is sales revenue minus COGs.) LBMers have maintained a “steady state” of GPM, and therefore enjoyed more gross profit dollars and higher EBITDA due to the higher lumber prices.
This maintaining of GPMs through these recent flush times is a genuine testimony to the discipline that LBMers have shown in controlling costs. Most LBM dealers benefited (sometimes dramatically) from the increased commodity prices; the commodity price increases, however, were not sustainable, and now commodity prices are at or below pre-pandemic levels. This demonstrated history of holding the line on GPMs will give acquirers the confidence that LBM dealers will be able to maintain their GPMs if commodity prices begin to increase in the future.
