Valuation Affairs Dec 2018
Helping SME business owners have a wealthier affair with the value of their business
A regular review of the market and economic trends that will have an impact on the price of SME businesses
Exit Value Advisers create wealthier affairs between business owners and the value of their SME using in-depth business valuations and innovative exit strategies. We deliver clear and defendable valuations that support transactions, exit strategies, restructuring, investment, dispute resolution and succession planning.
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Contents - This Issue
Reviewing our valuations over the past 12 months has seen we have seen a continuing trend of a majority of SME businesses generating less than a commercial return, and a somewhat patchy year for revenue and EBITDA growth.
Industries we have noted have continued difficult trading conditions include retail, some smaller professional service-based businesses. We have observed a growing demand for food manufacturing businesses, especially those that are positioned for export growth.
The larger mid-market and listed entities have shown some increases in multiples, including:
In line with the increased activity in the mid-market retail sector, the EV:EBITDA valuation multiples increased slightly to 10.7x compared to 10.5x in Q1 2018 (BDO Retail M&A Q1 2019). This included transactions from FMCG, Health and Lifestyle, Agriculture, Apparel and Automotive sectors.
Healthcare continues to provide attractive multiples with an increase in median valuation multiples to 14.0x, supporting a positive industry outlook for 2019 (BDO Healthcare M&A Q1 2019).
Listed entities in the Consumer Goods and Retail sectors have shown a small increase in the latest average EV:EBITDA multiple to 10.0x (InterFinancial December 2018 Update) .
We are also seeing a more pronounced trend where EBITDA multiples are higher for larger businesses. In most cases the larger businesses have more established processes and systems, increased use of technology and well developed performance reporting that is used by management.
Based on a comparison of our proprietary database, EBITDA multiples follow a predictable trend for EBITDA in excess of $5m. In particular these businesses tend to attract Enterprise Value multiples greater than 4.0x
Although our proprietary data remains limited, we are now seeing a widening divide between businesses with revenue of less than $2m attracting low EV:EBITDA multiples of less than 3.0x, and the larger businesses with revenue in excess of $15m attracting multiple greater than 4.0x.
Growth pays and size matters when it comes to valuation.
ASX EBITDA Multiples
The ASX has decreased in value by 2.7% (based on capital growth and dividend returns) over the last twelve months since December 2017, with an average PE ratio in November 2018 of 14.3x and an implied cost of equity of 10.3%, up from 9.7% six months ago.
Despite the recent restrictions in credit supply by the major banks and an expectation of “out of cycle” interest rate rises, small business unsecured loan interest rates remain steady at 8.3 – 14.1%.
EBITDA Mutiples for selected $1bn+ infrastructure, manufacturing and retail stocks remained largely unchanged from May 2018. EV:EBITDA Multiples ranged from 10.2x average for retail to 19.5x average for infrastructure stocks.
The $100m - $200m market cap size range showed an average 13% decrease in EBITDA multiples, driven by large decreases in IT companies Reckon and GBST and service company 3PL. The Median EV:EBITDA Multiple was 11.7x.
The sub $100m market cap stock selection showed a 29% increase in EBITDA Multiples, due largely to increases in VEEM(VEE), Laserbond (LBL) and Farmpride Foods(FRM). Excluding these stocks the average increase in EBITDA Multiple is 7%. The Median EV:EBITDA Multiple was 11.9x
According to the CommSec wrap of the FY18 reporting season at the end of August 2018, ASX200 companies have continued to increase profits:
62% of full year reporting companies increased net profit after tax.
Revenues of ASX200 companies that reported rose by 7.4% from a year ago
Net profits after tax increased by 8.4 per cent
Aggregate dividends were up almost 14 per cent on a year ago.
Our view of this trend is that although profits have increased, the increased global risk (increasing interest rates, China trade wars / US tariffs and other volatility factors) will decrease EBITDA multiples in the short-medium term.
Cost of Capital Trends
Enterprise Value EBITDA Multiples for selected large stocks ($1b EV) and mid-market private transactions remained steady from May through to November.
The largest changes in EBITDA Multiples occurred in the sub $100m and $100m - $200m EV stocks.
An increase in SME EV EBITDA Multiples also showed, although based on limited data.
Overall SMEs are attracting an implied cost of equity of 30% - 38% and the mid-market of 15%.
We are expecting the cost of equity to increase in the near term as global risks start to impact profit margins and growth.
Despite some good news across the board for the economy, there remains a lot concern over short to medium term economic growth and pundits seem split between a cautious continuation of growth to imminent recession. The positives are that we have maintained GDP growth near 3%, with expectations that the annualised result will exceed 3% in the next two quarters (Christmas always provides some growth). Unemployment has remained at low levels and inflation has shown some small increases, along with snail’s pace growth in wages.
One of the key indicators that support ongoing economic growth is the private investment trends – for the previous three quarters it averaged 4% growth, and the September 2018 quarter was still positive at more than 1%. Past recessions have almost always proceeded from contraction in private capital expenditure. With positive investment sentiment by business leaders and an ongoing low interest rate environment, our view is that private capital expenditure is unlikely to contract, and hence we would need a major upset in export and import volumes to result in a GDP contraction.
As AMP Capital’s Shane Oliver put it recently, “…the risks remain skewed to further weakness into the early part of next year as uncertainty remains high regarding global growth, there are still too many political uncertainties around and investor sentiment looks like its still not fully washed out. However, we remain of the view that is more likely part of a “gummy bear” market that leaves shares down 20% or so from their highs a few months back, after which they start to rally again (like we saw most recently in 2015-16), rather than as part of a long and deep “grizzly bear” market like we saw in the GFC. The main reason for this is that we don’t see the US, global or Australian economies sliding into recession any time soon.”
The key factor that will impact our economy are valuations in the housing market and how it will affect demand in related sectors such as trades, construction and building industry services. There is no doubt that house prices have fallen and this has led to reduced discretionary expenditure as families focus on paying the mortgage.
This is unlikely to see a major economic contraction, but rather a reduction in the housing / construction related industries.
On the plus side we have:
Falling exchange rate supporting increased export growth.
Low interest rates supporting private and public capital expenditure.
Expected budget surplus in the next twelve months and an expected spending spree by state and federal governments.
On the minus side we have:
Increasing utility prices.
Expected “out of cycle” interest rate rises
Reduced demand from housing sector.
Global risks such as China/US trade wars, Brexit and global equity market volatility.
Now is the time for businesses to focus on their core offerings, pursue strategic growth opportunities and strengthen their balance sheets.
Adding Strategic Value
The key statistics from recent industry reviews we have completed show the dramatic differences in EBIT margin and revenue growth.
We did note that in the highly competitive industries of gyms, personal training and cleaning services, reasonable EBIT margins are still achieved on average.
This highlights the opportunity that strategic growth has on a business, with indicative EV calculations shown on the right.
The key points from this analysis are that:
Growth is important in growing value from $160k to $3.4m in industries that typically have low EBITDA margins (such as the industries shown).
Strategic acquisition helps drive revenue growth and also
The key foundations to deliver this growth in valuations have been detailed in our Checklists of Highly Valuable Businesses that are free to download.
This publication contains general information and is not intended to be comprehensive nor to provide financial, investment, legal, tax or other professional advice or services. This publication is not a substitute for such professional advice or services, and it should not be acted on or relied upon or used as a basis for any investment or other decision or action that may affect you or your business. Before taking any such decision, you should consult a suitably qualified professional adviser. Whilst reasonable effort has been made to ensure the accuracy of the information contained in this publication, this cannot be guaranteed and neither Exit Value Advisers nor any of its associates or other related entity shall have any liability to any person or entity which relies on the information contained in this publication, including incidental or consequential damages arising from errors or omissions. Any such reliance is solely at the user’s risk.