Parthenon EY Perspectives Investing in Distribution
Parthenon EY Perspectives Investing in Distribution
Parthenon EY Perspectives Investing in Distribution
Investing in distribution
$
2 several interesting acquisition targets and consolidation
opportunities.
Page 2
Agenda
Distribution industry dynamics
Drivers of profitability in distribution businesses
Parthenon-EY overview and relevant experience
Page 3
Distribution industry dynamics
Wholesale distribution is a massive market ($5t+) in the US,
with opportunities across many sectors
Total =
$3.0t $2.6t $5.6t
100%
Miscellaneous Miscellaneous
Paper and paper groducts Furniture and home furnishings
Beer, wine, and distilled alcoholic beverages Lumber and other construction materials
Chemicals and allied products Hardware, and plumbing and heating equipmentand supplies
80
Apparel, piece goods, and notions
Metals and minerals, ex. petroleum
Farm product raw materials
Motor vehicle and motor vehicle parts and supplies
60
Drugs and druggists' sundries
40
Groceries and related products
Professional and commercial equipment and supplies
20
Petroleum and petroleum products
Electrical goods
0
Nondurable goods Durable goods
Page 4
Source: Bureau of Labor Statistics
Distribution industry dynamics
Distributors have outperformed the equity markets, corresponding
with a vibrant M&A environment
Num ber of
Com pany name by segment
acquisitions
10X Electrical
ADDvantage Technologies Group Inc. 8
Medical Anixter International Inc. 14
9 (n=3) Arrow Electronics, Inc. 63
Avnet, Inc. 75
8 VOXX International Corporation 25
WESCO International Inc. 24
7 Food
Sysco Corporation 49
6 United Natural Foods, Inc. 13
Industrial/MRO
Industrial/ Applied Industrial Technologies, Inc. 24
5 MRO (n=6) Fastenal Company 4
MSC Industrial Direct Co. Inc. 10
4 IT (n=4)
Law son Products Inc. 2
Food Watsco Inc. 9
(n=2)
3 W.W. Grainger, Inc. 26
IT
2 Electrical Insight Enterprises Inc. 6
(n=6) McKesson Corporation 48
S&P 500 ScanSource, Inc. 13
1 Tech Data Corp. 18
Medical
0 Henry Schein, Inc. 55
June June June June June June June June June June June June June June June June Patterson Companies, Inc. 35
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Ow ens & Minor Inc. 11
Note: Segment lines composed of a sample of public companies that hav e been public since 1/1/2000, equally weighted Page 5
Source: Capital IQ
Distribution industry dynamics
Profitability varies across verticals, with durables commanding higher gross
margins than consumables
Durables Nondurables
40% 40%
Gross margin Gross margin
Operating margin Operating margin
32% 32%
30 30
27%
28% 27%
26%
25%
22% Average GM%
21%
21%
22%
20% (weighted)
20 18% 20
17%
14% Average GM%
(weighted)
14%
10%
10 10 9%
4%
0 0
HVAC
Furniture
and software
Electrical goods
Machinery
Motor vehicles
Misc. durable
commercial
equipment
Professional/
Petroleum
Computer
Metals/minerals
Lumber
Nondurable
Apparel
Misc.
Wine/beer
Paper
Groceries
Drugs
Farm products
Chemicals
Page 6
Source: U.S. Census
Distribution industry dynamics
Profitability is generally driven by a combination of industry and
company-specific factors
Drivers of profitability
Inventory turns
Distributors are paid to hold inventory; slower-turning
inventory typically indicates higher margins
Product complexity and technical sales requirements
Technical expertise and consultation increase distributor
value to customers and create stickier customer
relationships
Fragmentation of supplier and customer base
High fragmentation typically indicates additional value-add
from distributors
Regulatory environment
Strict regulatory environments can control margins or
require the use of certain products and impact growth
Pricing dynamics
Pricing environment can play a major role in distributor
profits
Page 7
Distribution industry dynamics
Inventory turns are inversely correlated with profitability, as distributors are paid
for holding inventory longer
60%
Fastenal Commentary
MSC The higher the inventory turns, the lower the margin.
Fire protection and safety
Distributors are paid for holding the inventory because it
Gross margin percentage
Fluid power
Retail distributors in apparel or groceries want to turn
Metalworking
their inventory as fast as possible and sacrifice margins
Roofing to do so. Something like complex, heavy machinery parts
have longer sales cycles and shelf lives, so higher
Plumbing, HVAC
20 and utilities margins are earned.
Wesco
Distribution industry analyst
Electrical
0
0 2 4 6 8 10
Page 8
Source: Company CIMs; Barclay s Distribution Industry Chartbook, CapIQ; Parthenon-EY Interv iews
Distribution industry dynamics
Distribution of more complex products with additional technical
support is associated with higher margins
Machinery and
Fuel
equipment
Page 9
Source: Parthenon-EY analy sis, industry websites
Distribution industry dynamics
Distributors in traditional hourglass supply chains with fragmented supplier and
customer bases create value by facilitating distribution, and typically earn higher margins
Producers Producers
e.g., Pfizer, Roche, Pumps Instrumentation Valves
GlaxoSmithKline, Novartis e.g., March, e.g., Dynasonics, e.g., Rotork,
Goulds Eurotherm Jomar
Distributors
e.g., Ryan Herco Flow
Solutions, FCX Performance
Page 10
Distribution industry dynamics
Regulation can allow distributors in certain industries to command higher
margins and provide technical expertise
Value-chain position of the distributor is protected Building codes require that certain HVAC safety and
by law as the 21st Amendment ensures that wine, energy-efficiency standards are met
beer and spirits must move in legally sanctioned
transactions from producer to wholesaler to retailer Increased regulation and financial grants/incentives
or restaurant to make buildings more energy efficient have
allowed HVAC distributors to offer higher-quality,
Several states have laws that regulate distributors higher-margin solutions
markup on alcohol; markups can range between
20% and 50%
Page 11
Source: U.S. Census
Distribution industry dynamics
Distributors can benefit from (or succumb to) the underlying pricing environment
of distributed products
Distributors can stand to benefit (and earn great Conversely, distributors carrying inventory come
profit dollars) from increasing prices of their end under significant or even catastrophic pressure
products when prices fall
Example: The roofing shingle industry consolidation Example: Distributors were severely impacted by
led to sustained price increases and distributor profit precipitous declines in steel
growth
$1,250 Steel price index
$300 Asphalt shingle price index
1,000
200 750
500
100
250
0 0
2008
2009
2010
2011
2012
2013
2014
2015
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Higher prices are a win-win for manufacturers and One of the issues with imported steel is that you have
distributors across the value chain as long as to be able to plan much farther in advance, and once
distributors can pass along price increases. you commit your money it is tied up.
Roofing industry CFO Plumbing supply purchasing manager
Note: Steel Price Index comprised of av erage monthly settlement prices f or domestic hot rolled coil steel, rebar steel and wire rod steel, equally weighted Page 12
Source: BLS, Capital IQ,
Distribution industry dynamics
Industry drivers of profitability
Fragmentation of
Technical Regulatory Pricing
Inventory turns customer/
expertise environment dynamics
supplier base
Page 13
Agenda
Distribution industry dynamics
Drivers of profitability in distribution businesses
Parthenon-EY overview and relevant experience
Page 14
Company profitability drivers
Profitability is generally driven by a combination of industry and
company-specific factors
Drivers of profitability
Page 15
0
20
40
60%
Vehicle parts EBITDA margin Gross margin 55%
MRO 40%
Alcohol 40%
Educational
40%
products
Automotive
30%
engine systems
Aftermarket
30%
consumables
Metalworking 30%
IT 26%
gross and EBITDA margins
Sample distribution company
Insulation 25%
Plumbing,
25%
HVAC and utility
Tires 20%
Ophthalmic
20%
products
Distribution businesses can have very different margin profiles
Apparel 20%
Electrical 15%
IT 15%
Food 15%
Page 16
Company profitability drivers
RMS mattersdistribution companies with high relative market shares are
associated with better performance
15%
14%
Auto aftermarket
Other auto parts
Average consumables
(Parthenon-EY
10 sample) Distributes consumable Distributor of automotive
maintenance parts and aftermarket driveline
accessories to oil change solutions to driveline repair
shops outlets, general repair shops,
fleets and auto retailers
15-20% market share
0 7-10% market share
Vehicle Safety Auto Other auto
parts equipment aftermarket parts
consumables
Page 17
Company profitability drivers
Technical expertise and value-added servicessuch as maintenance, product repair, or in-
house design and engineeringenable some distributors to drive higher margins
High
Technical Provides value-added Apparel
Low
expertise system design and
engineering services
Distributor of undecorated branded apparel and athletic
accessories
Maintenance/ High Sells 38,000 SKUs from 55 brands to over 24,000 advertising
Low
repair Owns service and companies, promotional products distributors, and screen printers
services repair centers and embroiderers
Little value-add in addition to management of many SKUs,
vendors and customers
EBITDA ~9% ~4%
9% EBITDA
Page 18
Company profitability drivers
Emphasis on private label products, which typically generate 20% higher gross
margins, can be a tool to expand margins
Gross margins,
private label and branded products Distributor case studies
Educational supplies
80%
Private label
Other branded products Distributes early childhood educational products to schools,
districts, early learning centers and more
63% Private-branded products have increased from ~29% of sales in
61%
60 2008 to 34% in 2010; EBITDA margin grew 200 basis points in
that time
49%
44%
40 37%
Small vehicle parts
0
Oil change Small Educational
consumables vehicle parts supplies
Page 19
Source: Company CIMs
Company profitability drivers
A focused and aggressive sales strategy, such as expanding the account management
program, can significantly improve top and bottom line performance
Information technology
$80m
Account
management Distributor of digital data systems, such as product tracking
Tech sales systems (i.e., barcodes, scanners) through a multi-pronged sales
Online approach
Initiated
Online: 20% of sales through e-commerce platform
60 aggressive
account Account management: 40% of sales driven by outbound calling
management/ efforts by 40 account managers to existing customers to sell
sales program additional products
Tech sales: 40% of sales are handled by 25 technically trained
40 phone operators fielding incoming calls from potential customers
seeking consultative advice
Historical investments in customer relationship management
(CRM) and enterprise resource planning (ERP) systems facilitate
metrics-driven culture
20
0
2007 2008 2009 2010 2011
Page 20
Source: Company CIMs
Company profitability drivers
Primary company drivers of profitability
Relative market
Value-added services Private label Sales strategy
share
Page 21
Company profitability drivers
Successful acquirers have been able to leverage the market structure to
generate superior returns through multiple levers
Potential
Levers Commentary Value driver
impact
Roll-up/ Smaller players have struggled over the last few Roll-up accelerates share gain in a market
consolidation years and have limited ability to grow where relationships are sticky
Larger players are driving consolidation in this Consolidation helps in volume rebates and
market; ~80% of independent MRO distributors getting dedicated regions from key
(facility sub-segment) have been approached in manufacturers
Strategic
Value-added Increasingly becoming an important part of the Wrap-around services such as fabrication
services/ distributors portfolio and engineering services are high margin
partnerships and drive sticky relationships with end-
users and manufacturers
Pricing Broad price changes will cause unsustainable Pricing, if used selectively, can add a few
share, however, selective pricing has the ability to points of margin (customer segmentation,
drive revenue growth bundling, etc.)
Route optimization Regional consolidation allows optimization of Optimized sales and distribution routes
distributions routes, warehousing and sales
Operational
Consolidated warehousing
resources
Optimized sales resources
Cash management Most independent distributors are not sophisticated Optimizing inventory management/turns
managers of inventory and cash cycles
Improving the bill-to-cash cycle
Page 22
Agenda
Distribution industry dynamics
Drivers of profitability in distribution businesses
Parthenon-EY overview and relevant experience
Page 23
Introduction to Parthenon-EYs Industrials practice
Parthenon-EY has deep experience in helping investors evaluate potential
distribution investments
What is the underlying market growth? Proprietary and customized Over 100 industry evaluation and due
How stable is the market and how does econometric demand and market diligence projects covering many
it perform across business cycles? forecasting segments within the distribution and
industrial MRO market (e.g., HVAC,
What is the role of the distributor? Primary research, including market flow control, janitorial-sanitation, fluid
Is the distributor going to be participant and sales force surveys, and power, electrical, automotive)
disintermediated? industry expert interviews
Adjacent market and international
How sticky are the relationships Market sizing and competitive analysis market prioritization analysis
(vendor and end customers)? What are
Revenue forecasting and full potential
the platforms for growth? Investment thesis generation and
analysis potential target company identification
What are the potential business levers
that an acquirer can use to increase Sector scans for investment trends
value?
Identification of acquisition targets for
potential industry roll-up
Page 24
Introduction to Parthenon-EYs Industrials practice
We have broad experience across verticals
20
Petroleum and petroleum products
Electrical goods
0
Nondurable goods Durable goods
Page 25
Source: Bureau of Labor Statistics
Introduction to Parthenon-EYs Industrials practice
Parthenon-EY background and author contact information
About Parthenon-EY
Parthenon joined Ernst & Young LLP on August 29, 2014. Parthenon-EY is a strategy consultancy, committed to bringing
unconventional yet pragmatic thinking, together with our clients smarts, to deliver actionable strategies for real impact in
todays complex business landscape. Innovation has become a necessary ingredient for sustained success. Critical to
unlocking opportunities is Parthenon-EYs ideal balance of strengths specialized experience with broad executional
capabilities to help you optimize your portfolio of businesses, uncover industry insights to make investment decisions, find
effective paths for strategic growth opportunities and make acquisitions more rewarding. Our proven methodologies, along
with a progressive spirit, can deliver intelligent services for our clients, amplify the impact of our strategies and make us the
global advisor of choice for business leaders.
Contact
Scott Orleck
Managing Director
scott.orleck@parthenon.ey.com
+1 617 478 6382
Facebook | facebook.com/ParthenonEY
Twitter | @parthenon_ey
Parthenon-EY | Page 26
Introduction to Parthenon-EYs Industrials practice
Industrials practice key contacts
Page 27
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