Bank lending, private capital, industry consolidation — What lies ahead for fuel delivery and HVAC companies?
The new year has brought a continuation of 2023 trends that stemmed from a generally higher interest rate environment, tightened commercial bank lending standards, and the slowing deployment of capital from private equity and loan sources on fewer deals. However, there is consistent demand for the services and predictable earnings generated by fuel distribution and HVAC businesses, attracting a variety of buyers and investors.
Here are six industry acquisition predictions for the first half of 2024.
1. Tighter lending standards will persist for the foreseeable future.
Interest rates have stabilized, and the Fed has signaled it will look to institute nominal rate cuts at some point in 2024. Yet, no immediate reductions are expected. For fuel dealers and HVAC companies, this means the costs to borrow for fuel, parts and equipment purchases will remain relatively high. Companies carrying material debt or looking to finance acquisition growth should expect less flexibility from banks when structuring deals. Valuations and offer terms should reflect this fact, especially if the goal is to accomplish growth solely through bank debt.
2. Private capital structures will bring the flexibility needed to close deals.
Where traditional lenders’ borrowing terms and financial covenants are tightening, private capital providers will continue to step in, offering interest-only mezzanine debt solutions and Payment-In-Kind (PIK) structures that defer payments to free up much-needed cash flow. Furthermore, private capital sources will offer creative majority and minority equity structures. These offerings are designed to supplement senior bank debt. While the cost of private capital exceeds that of traditional bank debt, its flexibility can enable companies to win deals and achieve growth with an eye toward refinancing down the road under more favorable interest rates.
3. Cash offers will continue to predominate for quality assets.
Companies with robust service and HVAC activity remain in high demand, as do fuel distribution companies with high-quality customer lists, robust equipment service support, a meaningful automatic delivery base and — for those offering propane — a high level of tank control. A growing list of industry consolidators have substantial financial backing. Smaller suitors seeking quality acquisitions must compete with aggressive structures if they are to win deals in this landscape.
Those seeking to acquire a small fuel or HVAC company (defined here as those below 1-2 million gallons and $1 million in service and install sales annually) should continue to see opportunities to structure earnout payments and seller notes in lieu of all-cash offers. Be prepared to seek financial backing for anything larger.
4. Holders of larger, private capital-backed operating companies will explore exits.
Valuation multiples for both HVAC and propane distribution companies remain strong against a backdrop of increasing industry challenges. We’re seeing regulatory threats in many states with attendant compliance costs. Private capital dealmakers are still offering ample capital. Taken together, it’s a good time for larger financial holders nationwide to consider cashing out. This presents opportunities for other large fuel and HVAC companies looking to expand. The big will get bigger.
5. Forward-thinking companies of all sizes will attract suitors.
Acquirers tend to prefer integrating companies with management teams and staff that have already exhibited a zeal for change. The accompanying human capital is just as valuable in today’s environment, especially with the quickening pace of consolidation in the delivered fuels industry. While some acquirers look to boost earnings by consolidating operations and reducing staffing, many others value consistency in operations management, customer interaction and technician staffing — and the stable earnings that often follow. As importantly, teams that have exhibited a commitment to technology in this period of rapid adoption provide acquirers with a higher comfort level.
6. Pressure to sell due to sunsetting estate tax incentives continues to mount.
We know the standard factors driving consolidation: baby boomers facing retirement, no clear family succession plan, environmental regulatory pressure and challenges finding specialized technician talent. Federal tax regulations will present owners with yet another source of pressure when it comes to estate planning. The Tax Cuts and Jobs Act of 2017 nearly doubled the level of federal lifetime gift and estate tax exemptions, which, in 2024, stands at $13.61 million for individuals and $27.22 million for couples, according to the IRS. These higher exemption levels will sunset and revert to significantly lower levels at the conclusion of 2025 unless policymakers agree to extend them. This tax uncertainty for owners contemplating an exit will act as a catalyst to fire up the sale process in the first half of 2024.
Do you want to discuss how these emerging and continuing trends will affect your business? Contact Notch Capital to set up a consultation.