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Credit FAQ: Tough Times Ahead for European Private-Equity-Owned Building Materials Distributors

S&P Global Ratings expects that market conditions in the next 12 months will remain challenging for European private-equity-owned building materials distributors, whose performance is positively correlated with GDP growth. The eurozone economy has barely expanded over the past three quarters, with GDP increasing by a meagre 0.1% quarter on quarter in the second quarter, after -0.1% and +0.1%, respectively, in the previous two quarters. Since the beginning of the year, consumer spending has stagnated and business confidence deteriorated further over the summer, undermining any chance of a strong GDP rebound.

In this FAQ, we address headwinds and their effects on the credit quality of European private-equity-owned building materials distributors.

Frequently Asked Questions

Are European private-equity-owned building materials distributors displaying comfortable rating headroom?

Stable rating outlooks across the portfolio reflect our expectation that the comfortable rating headroom companies built after a strong 2022 in continental Europe should be sufficient to absorb weakening volumes. That said, we believe that distributors' financial flexibility is reduced compared with last year, mainly due to the challenging environment (see chart 1). Yet, rating headrooms also depend on sponsors' financial policies, which may differ from distributor to distributor. Quimper AB (Ahlsell), BME Group Holding B.V. (BME), and Winterfell Financing S.a.r.l. (Stark Group) are among the companies whose reported EBITDA was above our expectations in 2022. For example, Ahlsell's 2022 EBITDA exceeded the company's initial budget by about 10%. We recently upgraded Ahlsell to 'B+' from 'B' to reflect its above-average margins and cash flow generation, and to account for its track record of a relatively more prudent financial policy, which strengthened credit metrics. We revised the outlook on BME to stable from negative because of the company's stronger-than-expected results and our expectation that it will focus on deleveraging over the next quarters, while generating healthy free operating cash flow (FOCF) of at least €100 million. Overall, we believe that BME and Stark Group display less financial flexibility than Ahlsell since their more aggressive financial policies over the past quarters increased their leverage.

Patagonia Holdco 3 Ltd.'s (Huws Gray's) performance, on the other hand, was below our expectations due to a more challenging market in the U.K. Since the second half of 2022, the repair, maintenance, and improvement (RMI) market has suffered from higher mortgage rates and energy costs, which led to consumers postponing non-discretionary improvements. We recently downgraded Huws Gray to 'B-' from 'B' as the company's financial leverage continued weakening significantly above our downside trigger in the first half of 2023.

Chart 1


What is your business outlook for the building materials sector over the next 12 months?

Overall, we think the business outlook for distributors depends on their end-market exposures, product mix, and geographical footprint.

  • We anticipate that non-residential construction investments, including infrastructure investments, will remain more resilient than residential construction investments where we anticipate a drop in both renovations and new constructions this year and next. A rebound in new builds will not materialize before 2025 and will depend on the stabilization of interest rates and the normalization of construction costs. Overall, we believe that rated European private-equity-owned building materials distributors' exposure to new build represents approximately 30% of their sales.
  • Companies offering light products in heating, ventilation, air conditioning (including installation materials for heating ventilation and refrigeration), and electricity (including cables and installation materials, lighting, automation, data, telecommunications, and safety products) should experience a lower drop in volumes than companies that offer heavy building materials. This is, for example, reflected in Ahlsell's volumes, which were more resilient than volumes reported by Stark Group over the past two quarters.
  • The economic environment is more challenging in countries such as Germany and the U.K., while we see a more supportive environment in southern Europe, notably in Spain and France. We therefore anticipate that Stark Group and Huws Gray will report weaker results than other distributors due to their exposure to more difficult markets (see chart 2).

Chart 2


Do you expect EBITDA margins and absolute EBITDA in 2024 will recover to 2022 levels?

We expect EBITDA margins and EBITDA will improve in 2024 versus 2023 but not recover to levels reported in 2022 (see chart 3).

For 2024, we anticipate the following:

  • EBITDA margins will improve slightly versus 2023, supported by structural cost savings and operational excellence initiatives implemented to enhance margins and mitigate the downturn. At the same time, recent mid-size acquisitions--Stark Group entered the U.K. market and Ahlsell acquired Sanistål--may also dilute distributors' profitability in 2023 and 2024 because the acquired businesses have below-average EBITDA margins. We therefore anticipate that profitability should remain below 2022 levels in 2024.
  • EBITDA will improve versus 2023 but remain below 2022 levels. We do not anticipate an improvement in volumes next year on a like-for-like basis as the residential construction market in Europe is still in contraction, and volume stabilization should start only in the second part of 2024. We do not anticipate a recovery in the new build end-market before 2025 either. Despite stable volumes on a like-for-like basis, we expect absolute EBITDA levels will improve in 2024 versus 2023 because of companies' enlarged business scope following acquisitions and the modest improvement in profitability.

Chart 3


Do you expect cash flows will reduce in 2023 and 2024, just like volumes and margins?

Despite weakening volumes, decreasing margins, and rising interest rates, we anticipate that European rated building materials distributors will generate positive FOCF in 2023 and 2024 (see chart 4). Our assumption is based on the asset-light nature of distributors, who tend to have limited capital expenditure (capex). Additionally, they all benefit from countercyclical working capital characteristics and have demonstrated their ability to generate positive working capital inflows during downturns, which somewhat offsets the negative effect from lower volumes.

While capex is usually less relevant for distributors, we anticipate that Stark Group and Ahlsell will report higher capex in 2023 and 2024 versus 2022 because of business expansions--Stark Group enters the U.K. market and Ahlsell increases its logistics center in Hallsberg, Sweden. We anticipate that Huws Gray will report lower capex in 2023 and 2024, compared with 2022, due to the challenging market in the U.K. BME's capex should remain broadly stable at about 1.2% of revenue or €60 million-€70 million annually but understand that the company can postpone some expenditures in case of a more severe downturn. We also note that most private-equity-owned distributors' debt is hedged against rising interests. For example, Huws Gray hedged roughly 50% of its interest rate exposure, while Ahlsell hedged about 90% of its external debt to fixed rates until April 2024, after which a new hedge commences.

Chart 4


Most rated building material distributors have most of their maturities after 2026, implying that there is no imminent refinancing risk in the current higher interest rates. What's more, even if we were to apply current interest rates to existing debt capital structures, we believe that all rated distributors, apart from Huws Gray, would continue generating positive FOCF. That said, Huws Gray's capital structure benefits from a long-term debt maturity that exceeds four years, meaning the pressure to refinance over the next 12 months is limited. Yet, the company's FOCF could turn negative if additional working capital releases do not compensate for a weaker-than-expected performance.

How do you assess building materials distributors' financial sponsors in the current difficult environment?

All rated European building materials distributors that are owned by financial sponsors typically have a highly leveraged financial risk profile pointing to corporate decision-making that prioritizes the interests of the controlling owners. This also reflects generally finite holding periods and a focus on maximizing shareholder returns.

Most sponsors have taken a conservative approach since early 2023 to protect companies' credit metrics, and we have not seen shareholder remuneration or large new acquisitions being announced. We understand that BME, Huws Gray, and Stark Group will instead focus on deleveraging in 2024. We therefore believe an increase in financial leverage because of acquisitions or shareholder remuneration will be less likely in 2024, unless there is a tangible business recovery. Stark Group completed a major, partly debt-funded, acquisition in the U.K., and we expect the company will focus on integrating the new business over the next quarters.

We note that building materials distributors were quite acquisitive in 2021-2022 since the fragmented market increased the importance of scaling up to benefit from synergies and cost savings. Yet, Ahlsell's financial policy has been more conservative, given its track record of deleveraging over the past four years and increasing EBITDA without incurring additional debt (see chart 5). Ahlsell's financial owner CVC Capital Partners may increase the company's leverage in the medium term, but the company has wider headroom than other rated building materials distributors to withstand the current difficult environment and pursue further external growth. This partly explains why we upgraded the company to 'B+' from 'B' recently.

Chart 5


How do you see the business and operating performance trending beyond the current downturn?

We believe European rated building materials distributors will continue benefiting from supportive secular trends related to energy efficiency over the medium to long term. Due to their significant exposure to the RMI market and markets with ageing housing stocks, they can benefit from the European Green Deal program. The program targets the renovation of about 35 million energy-inefficient buildings by 2030, should drive growth in RMI activities related to energy saving, and boost funding for green renovations.

As part of their strategy, we expect distributors will continue focusing on top-line growth, for example through bolt-on acquisitions, increased exposure to RMI by selling products that meet energy efficiency requirements, and improved pricing mechanisms, for instance by accelerating surcharges or rolling pricing frameworks.

We also understand that most distributors will continue focusing on improving their margins through procurement optimization, business expansion, and organizational efficiencies. Finally, we anticipate that light building materials distributors, such as Ahlsell, will continue expanding through digitalization, for example with online sales. Distributors focused on light products like Ahlsell will continue expanding through digitalization, meaning by increasing their online sales. Heavy building materials distributors, on the other hand, will focus more on traditional distribution channels since their products tend to be heavier and bulkier. Additionally, heavy materials require larger storage spaces and more complex logistics than light materials, which can make shipping over long distances uneconomical. Accordingly, online sales only represent less than 5% of heavy building materials distributors' total sales.


Peer comparison

Patagonia Holdco 3 Ltd. (Huws Gray)

Quimper AB (Ahlsell)

Winterfell Financing S.a.r.l. (Stark Group)

BME Group Holding B.V.

Issuer credit rating B-/Stable/-- B+/Stable/-- B/Stable/-- B/Stable/--
Business risk profile Weak Fair Fair Fair
Financial risk profile Highly leveraged Highly leveraged Highly leveraged Highly leveraged
Anchor b- b b b
Diversification/portfolio effect Neutral Neutral Neutral Neutral
Capital structure Neutral Neutral Neutral Neutral
Financial policy FS-6 FS-6 FS-6 FS-6
Liquidity Adequate Adequate Adequate Adequate
Management/governance Fair Fair Fair Fair
Comparable rating analysis Neutral Positive Neutral Neutral
Stand-alone credit profile b- b+ b b
(Mil. €)
Fiscal year ended Dec. 12, 2022 Dec. 31, 2022 July 31, 2022 Dec. 31, 2022
Revenue 1,831.10 3,947.00 5,995.00 5,465.40
EBITDA 164.6 502.2 459 399.7
Capital expenditure 59.6 24.9 95 58.1
Free operating cash flow -13 246.1 95 194.2
Adjusted ratios
EBITDA margin (%) 9 12.7 7.7 7.3
Debt/EBITDA (x) 7.2 4.3 4.5 5.9

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Fares Shweiky, Paris +33140752587;
Secondary Contact:Renato Panichi, Milan + 39 0272111215;

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