Summary of Valuation Approaches
There are four different types of valuation methods that can be used to value wholesale distribution companies, as follows:
- Asset-based valuation
The basic formula to use for this method is: The fair market value of a company’s assets less the fair market value of its liabilities = the fair market value of a company’s equity. This is approach also sometimes referred to as a cost based approach where the value of the business is equal to the cost of acquiring its assets with the same utility. This approach is seldom used for wholesale distribution companies because the value of wholesale distribution company is more closely related to its earnings and cash flow.
- Income approach to value (capitalization of earnings)
This method is most the accurate for wholesale distribution companies that have a constant growth of earnings and have a long history of operations. This method is equal to the cash flow projection for one year divided by the capitalization rate.
- Income approach to value (discounted cash flow)
The value of equity utilizing this method is equal to the present value of free cash flows available to equity holders over the life of the business. This method works well for both established businesses with low growth rates as well as newly opened distributors with higher rates of growth.
- Market approach to value
This method utilizes market indications of value such as publicly traded comparable company stock as well as acquisitions of privately held wholesale distribution businesses.
Description of Industry
The wholesale distribution industry is an important force serving nearly all sectors of the U.S. economy. The industry serves as the means by which many products are moved from manufacturer or producer to retail stores, exporters or even other wholesale distributors. There are generally two business models for wholesale distribution. These models are often referred to as merchant wholesale and wholesale electronic markets. Merchant wholesalers deal in both durable and nondurable goods and take ownership and possession of these goods in anticipation of selling them to customers. Wholesale electronic markets including agents and brokers act on behalf of the buyers and sellers of good but generally do not take ownership or possession of the goods to be sold. Often transactions under this business model are conducted though Electronic Data Interchange (“EDI”)
Under both models wholesale distribution cuts across many types of products ranging from agricultural produce to high tech devices and components. There are approximately 250,000 wholesale distributors in the U.S. According to the United States Department of Labor the industry is highly fragmented with 90% of its companies having 20 employees or less. According to the National Association of Wholesale Distributors (“NAW”) there are 19 wholesale distribution sectors in the United States.
- Oil and gas products
- Grocery and foodservice
- Electrical and electronics
- Motor vehicles and motor vehicle parts
- Miscellaneous durable goods
- Agricultural products
- Consumer products
- Computer equipment and software
- Commercial equipment and supplies
- Metal service centers
- Apparel and piece goods
- Building materials and construction
- Beer, wine and liquor
- Chemicals and plastics
- Office products and paper
- Hardware plumbing and heating equipment and supplies
- Furniture and home furnishings
Wholesale distributors achieved $4.5 trillion in sales during 2008 which was an 8.4% increase over 2007. However after adjusting for price changes in underlying commodities revenues only grew by less than one half of one percent. Nearly all sectors in the U.S. experienced negative growth during the second half of 2008. The first quarter of 2009 was particularly bad for the industry. Wholesale distribution’s first quarter sales in 2009 decreased by 9.5% when compared to the first quarter of 2008 after adjusting for inflation.
Despite the current economic recession in the United States, wholesale distribution has continued to be the life blood of manufactures with industry growth that has outpaced growth in GDP. However, the industry is not immune from the current economic recession. Most manufacturers continue to rely on wholesale distribution to deliver goods to their customers because they can offer greater service to their customers due to their local presence, quick response, and flexibility.
The wholesale distribution industry leads the way in productivity technologies that automate activities like order processing, billing, inventory control, delivery and route scheduling, as well as automated warehouse management. Adopting these technological advances has allowed the productivity within the industry to outpace the entire non-farm business sector as measured by output per hour.
The following are some trends within the wholesale distribution industry:
- President Obama has supported the Employee Free Choice Act. This act will make it easier for unions to form. If it passes, the cost of working with newly formed unions could place added financial pressure on already struggling distributors. Whether this legislation passes in 2009 or not, it is clear that the current administration is pushing for unionization and labor laws. It would be wise for those wholesale distribution companies not currently unionized to strategize how they might respond to potential labor disputes and examine their current labor policies to determine if unionization is likely.
- Radio frequency identification (RFID) technology is becoming used more frequently by larger wholesale distributors with warehouses. RFID tags coupled with a satellite and receiver system allow wholesalers to keep track of the goods they have in stock and through transit to ensure delivery.
- Many large distributors contract with manufacturers in order to put their own name on the label. This is done so that a level of service becomes associated with brand that is controlled by the wholesale company rather then the manufacturer.
Financial Benchmark Statistics
Distributors generally experience relatively low margins with average operating margins across product types ranging from 2%-5%. During periods of economic recession it is particularly important that distributors pay close attention to key performance indicators on a regular basis. Trailing twelve month financial statements are helpful for proper analysis. The following are some key performance indicators that distributors should closely monitor.
- Drop in trailing twelve month sales
- Drop in trailing twelve month gross margins
- Drop in trailing twelve month cash flow
- Rising cash cycle
- Credit line utilization increases
- Vendors tightening credit terms
Industry Organizations and Publications
- National Association of wholesale distributors
- US Economic statistics published by the department of labor
Availability of Publicly Traded Comparable Companies
There is a large supply of publicly traded wholesale distribution companies across the 19 sectors listed above. Yahoo! Finance reports a significant dispersion of price to earnings multiples across all sectors. For example, public pharmaceutical wholesale distributors are reported to have an average price to earnings multiple of 9.7, while food and food service wholesale distributors currently have an average price to earnings multiple of 12.6. Industry averages for valuation multiples will vary based on the overall financial performance of public companies within the sector. It is important when selecting and using publicly traded comparable wholesale distribution companies to select companies that are reasonably close to the subject company in terms of products offered, markets served, financial performance, and size of operations.
Availability of Purchase Transactions
In addition to publicly traded comparable wholesale distribution businesses, a valuation professional would need to place some reliance on acquisition data for privately held wholesale distribution businesses when performing an appraisal. One database that tracks acquisitions reports data for 129 wholesale businesses sold since 2002.
- Market value of invested capital to Net Sales (MVIC/Sales)valuation multiples ranged from 0.1 to 3.4 times
- MVIC to earnings before interest, taxes and depreciation (MVIC/EBITDA) valuation multiples ranged from 2.0 to 19.0 times.
This range of market multiples is too variant to be useful without further analysis. A proper value for the company that is being assessed should be based on the performance of the subject enterprise, compared to the performance of others in the same industry. Industry economic conditions also vary at different times, which obviously affect wholesale distributors as investment opportunities. Specific factors that are unique for each store or business must be considered. Some of these factors include:
- Is the warehouse real estate owned or leased
- The duration of the lease and landlord/tenant relations
- The history of the operations and financial performance
- The competitive environment