The Price of Steel and Business Value
[Please note that the steel prices listed as examples in this article were valid as of March 2022.]
FIRST SEEN IN BPN MAGAZINE | We all know what has happened to steel prices in the last year. The high cost has impacted propane marketers and some of the more popular propane tank sizes are up over 80% from two years prior. In addition, wait times for truck loads are over a year in some locations.
Every couple of years we survey tank prices for completing our client’s business valuations. Below is a comparison of 2020 to 2022.
Bobtails are also in short supply. In speaking with Tracy Timmerman, President of Jarco, the bobtail manufacturer, he confirmed that cold rolled steel prices have gone from around 30 cents a pound in early 2019 to over 80 cents in 2022. Coupled with supply chain issues, truck prices are up an estimated 30%-40%, if you can find a vehicle for sale. Mr. Timmerman also points out that “Planning is key in this environment; axles, electronics and specialty steel or stainless all have lead times in excess of 6 months. Without aggressive forecasting, the shelves would be bare.” Regarding costs, he points out “some suppliers have raised their prices to us 3 times in the last year by multiple percent each time instead of a more traditional 2-3% once per year that we had become accustomed to in a more stable environment.” The Wall Street Journal reported that in some cases, three-year-old used vehicles were selling for their original price. Throw in cost of propane, inflation, and difficulty in finding drivers and our industry is facing some challenging times.
Well, that was the bad news and the “not as bad” news is that your competitors are in the same place as you are. The first step in addressing these challenges from a financial perspective is to quantify them and understand the impact on the bottom line. Smart marketers will review their income statement and make appropriate adjustments and they will likely track down any unutilized tanks and keep their trucks longer than they may have in the past.
Our company focuses primarily on the valuation of a business during a sale transaction. We help buyers determine competitive offers for the purchase of businesses but mostly we help sellers determine the amount they can expect when we assist them in selling their business assets. The traditional method to value a business is to determine an adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) and multiply it by a factor based on the quality of the business using industry-accepted value drivers, such as percentage of company-owned tanks (tank control), age of vehicle fleet, and real estate to mention just a few. The multiplier is also affected by factors in the financial markets which we will explore here.
EBITDA measures cash in (gross profit) and cash out (operating expenses). That is why it is sometimes referred to as cash flow. Twenty years ago in 2002, the tax code was changed to allow for what is known as accelerated or bonus depreciation. The code has since been modified to include more assets, and in many cases, it includes vehicles and propane tanks. The challenge for valuators is that the capital expense needed to run a business has increased substantially. As an example, if a company three years ago had a $1 million EBITDA, purchased 200 tanks a year for $1,000 average cost, and purchased a new bobtail for $140,000, they would have $660,000 or 66% left to distribute to their owners before taxes. This is the concept of distributable cash flow (DCF). Public companies set up as Master Limited Partnerships (MLPs) focus on DCF as do other companies who focus on pretax distribution to shareholders.
So now take the same company making $1 million EBITDA with an average tank cost of $1,800 and a bobtail cost of $200,000 and the same company with the same earnings now distributes $440,000 or 44% to their owners or a 33% cut in pay before taxes.
So common sense would make you think that the high price of steel would negatively affect business value as distributions to shareholders has gone down so the return on investment has gone down. Well, that has not happened and we are seeing just the opposite. In our opinion there are several financial factors keeping business values strong. Low interest rates are an obvious one, and in addition, the higher values of propane tanks, real estate, and vehicles allow for acquirers to leverage those assets and borrow at favorable rates. In very simplistic terms, if a buyer can borrow money at 4%, they can buy a company with 12% earnings and come out ahead. In addition, the continued bonus depreciation has tax advantages that have the ability to produce more cash on an after-tax basis. You can even amend your return from last year and carry the depreciation back and receive cash refunds back. As we keep hearing from investors, there is a lot of cash out there looking for a home, and we see this driving up values and activity levels. Another major factor pushing up values is the continued interest in essential businesses by investors as a safe haven for funds.
Many marketers we speak with think their company value has gone up because the value of propane tanks they own has increased. They are correct that company values are up, and they are correct that the value of their tanks has gone up, but it may not be just because of the price of steel.
Cetane Associates LLC
First published in BPN Magazine, April 2022 edition