Valuation of the metal fabricating industry

Corporate Growth Report Weekly, Dec 16, 1996

Metal fabricating companies are generally in the SIC #'s 3400 to 3499. These companies build industrial, commercial and residential products out of metal. Their business results are tied to the movement of the local and world economy. Metal fabricators are a, "capital intensive business". In a capital intensive business a modest rise in sales usually produces a good increase in profits. This is because once the fixed costs are covered, the incremental sales increase only has to cover the incremental cost of manufacturing.

But the reverse is also true. A slight decrease in sales produces a slightly greater decrease in profits.

The metal fabricating industry is also known as, "smokestack America". The companies tend to be old, well-established firms with substantial blue collar employment. Because they are not in high growth "glamour industries", such as the Internet, software and bio tech companies, the metal fabricating companies sell for relatively low purchase price multiples. For example, the average metal fabricating company sells for 82% of annual sales, a price to earnings multiple of 24.0 and a purchase price to net/ worth ratio of 2.45.

When you add in all of the seller's liabilities (current liabilities, long term liabilities and intangible items) the purchase price paid plus the assumption of all liabilities produces a purchase price to sales ratio of 1.20. This is a relatively low purchase price multiple compared to other industries. That figure does not net out the current assets and current liabilities assumed by the buyer.

One of the reasons for the lower purchase price multiple is the conservative growth curve companies in the metal fabricating industry exhibit. Another reason is because of the historically lower profit rate produced by the industry. For example, the average net after tax profit for the companies in the Value Line classification as metal fabricating is 3.6% for 1996 up slightly from 1995's 3.5%. The companies in our study had a slightly higher 6.0% after tax profit In general, U.S. industry produces a much higher rate of profitability. For example, the S & P 500 through November 1996 had an after tax profit of 9.46%.

Metal fabrication is a mature industry with a modest sales growth and modest profits, so the valuation of companies in this industry tends to be lower than many other industries.

The forecast for the years 1997 to 2001 only expects non-residential fixed investment to grow at 4% per year. Spending on construction and durable goods are important markets for metal fabricating companies. The modest growth in non-residential fixed investments will produce modest sales and profit growth for metal fabricating industry.

On the positive side the multiyear Federal highway bill is producing accelerated growth for construction related equipment, supplies and hardware.