For the last two years or so, through the run-up and run-down in commodity lumber prices, our firm has tracked weekly commodity lumber prices and regularly updated a proprietary “Price Effect” model we created in Excel.
What do lumber prices have to do with the acquisition value of your company? In every M&A deal we have been involved with, we have encountered acquirers who want to discount the EBITDA—earnings before interest, taxes, depreciation and amortization—achieved during high commodity lumber price periods. Acquirers apply—some say “inflict”—this discount because lumber prices have come off extraordinary highs of the Covid/supply-chain-disruption period.
This link, Lumber - Price - Chart - Historical Data - News will take you to the latest commodity prices at TradingEconomics.com. As of this writing in early December, it was just over $530 per 1,000 bd. ft. Contrast that with the spike in mid-2021, where lumber topped $1,600.
During that time, if you, as a lumber dealer, showed discipline in your operating expenses (OPEX), you likely maintained your historical gross profit margins from before the price run-up. So, your OPEX did not go up, but you made more gross profit dollars on every commodity sale.
For example, let’s say you had been selling an 8ft. SPF 2×4 for $4, and your EBITDA margin was 10%. You were making a profit of $0.40 per stick. If the retail price of that 2×4 doubled, and your OPEX costs had not increased, your gross profit dollars doubled, and your EBITDA doubled to $0.80 per stick. Your EBITDA margin also doubled for that sale.
If you enjoyed the same higher gross profit dollars across tens of thousands of sticks, you reaped extraordinarily high EBITDA dollars in the period of higher prices. It was common for our clients to have EBITDAs almost twice what they are today, especially for commodity-heavy operations. (Universally, every LBM dealer we work with has shown YTD 2023 performance lower than 2022, by the way.)
If acquirers were valuing your company in that time of volatility, they justifiably doubted that the $0.80 per stick would be a sustainable EBITDA or that the 20% EBITDA margin was realistic. Since they buy companies on a multiple of EBITDA (and they typically look at the trailing twelve month’s performance or “TTM”), they would have been overpaying if they acquired you by applying a multiple to the unsustainably high EBITDA. They knew that prices would settle back down eventually; we all knew that. And acquirers were discounting the higher EBITDAs to account for this for the commodity lumber portion of your sales.
We saw 15% to 20% EBITDA discount requests, which we were able to negotiable to our clients’ advantage because we had been tracking prices all along with our Price Effect model; we could calculate, to the dollar, what the effect would be at the time the EBITDA was “pegged” and the multiple was applied.
Our Price Effect model has already been accepted by the major private equity groups that we do business with in the LBM sector. Now, back to our initial question in the title of this article: Has lumber price volatility disappeared? Recent prices indicate that high prices and the volatility are out of the system. For now.
The gross profit dollars, EBITDA, and EBITDA margins you are experiencing today—even in a trailing 12-month perspective—would not have to be adjusted (discounted) to account for so-called unsustainability. This can change, of course. Forest fires, the effects of climate change, supply chain disruptions, undependable access to labor, the effects of war … all of these factors can show up again, and prices can spike.
That said, we are having fewer and fewer discussions about the sustainability of EBITDA in the valuation formula for our clients, and acquirers are buying with confidence that the TTM EBITDA is likely to repeat for the next twelve months, which is more or less the contemporary definition of “sustainable.” That’s not to say that deal values and deal structures have remained that same as they were a year or two ago, but that is a subject for a future column.