Chapter Corner

Industrial Contractor Trends for 2015

Posted in: Features, March 2015

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Over the next several years, the industrial construction sector in the U.S. is poised for a dramatic and welcome pattern of growth. Contractors who work in this sector are seeing several key trends that will significantly impact their operations. The emerging U.S. energy renaissance will certainly drive increased demand for services. Yet the ability of contractors to staff up to meet those demands is challenged by an overall lack of skilled tradespeople. Industry demographics indicate that many firms will be experiencing ownership transitions in the next decade; the attractiveness of this industry sector in the mergers & acquisitions (M&A) market may provide opportunities to facilitate these transitions.

Abundant Low-Cost Natural Gas Is Creating Tailwinds

Throughout the nation, for union and nonunion firms alike, backlogs are strong and margins are higher than they have been in recent memory. Whether focused on the power, food and beverage, petrochemical, or manufacturing segments, opportunities abound. The demand for U.S. manufacturing facility construction all but disappeared in the waning years of the last century, during the historical move to outsource manufacturing. However, rising incomes for Chinese and other emerging market workers, combined with U.S. manufacturing workers’ higher productivity, mean that the labor cost differential, particularly in the southern U.S., is projected to fall to less than 10 percent over the next five years. This makes the cost of energy in both manufacturing and transporting goods a much more important component of the manufacturing process. With the U.S. returning to net exporter of energy status in 2013, insourced manufacturing should continue to be a key demand driver for industrial and manufacturing construction.

By 2015 natural gas will account for only two percent of average U.S. manufacturing costs, and electricity will account for just one percent, according to Boston Consulting Group estimates. By contrast, natural gas will account for between five percent and eight percent of manufacturing costs in Japan and in Europe’s major exporting economies, where it is more expensive, while electricity will account for between two percent and five percent in Japan and Europe respectively. Cheap energy will also help further narrow the cost gap between the U.S. and China, where natural gas and electricity combined will account for six percent of manufacturing costs. 1

This reduction in energy and transportation cost for goods manufactured in the U.S. versus overseas will increase demand pressure on the industrial market segment. At first, some of this higher demand will be absorbed by increasing the number of shifts worked, but undoubtedly a surge in expansion, upgrades, and new construction will follow. Each of these means of handling surging demand has a different impact on the industrial contractor. During the initial focus on increased shifts to better leverage the factory assets, downtime management will be essential, so firms skilled in short-term maintenance shutdowns and turnarounds will see their services in high demand. During later stages, when renovations and new plant construction emerge to handle the manufacturing needs, larger project sizes will give big firms an increased opportunity as well. In short, if the expected onshoring trend holds true, the industrial construction segment is in for a boom of several years’ duration.

Succession Issues Threaten the Continuity of Many Firms

As mentioned, not only will the shortage of available labor affect the ability of firms to staff up, but also the demographics of an aging generation of leaders and managers is causing leadership gaps in firms. This condition affects firms across the industry, but the impact is more strongly felt among industrial contractors for several reasons. According to the U.S. Census Bureau, the Baby Boomer generation (born between 1945 and 1964) comprises 76 million people, while Generation X (born between 1965 and 1976) includes only 51 million people. As the huge population of baby boomers retires over the next 20 years, the number of Generation Xers available to move into roles as senior managers and leaders is short by roughly 24 million people. Quite simply, too many baby boomers want to exit senior management positions, and there are too few Generation Xers to replace them. Nowhere do we see this imbalance more clearly than among industrial contractors. Since many industrial contractors are led by former tradespeople, the multi-decade decline in young people entering the trades has led to significant leadership gaps.

Complicating this situation, many owners and senior managers have delayed retirement because of the economic downturn’s reduction in the value of the firms and are unwilling or unable to execute traditional succession and ownership transfer techniques that can take up to 10 years. The delayed retirement of these boomers has led many of their best potential successors to seek other opportunities where growth trajectories are not blocked. Meanwhile, it is often difficult or impossible to bring in managers from the outside, and the lack of internal management and leadership talent threatens the continuity of many firms.

Finally, too many industry firms remain difficult to sell for a variety of reasons. Some owners still retain unrealistic ideas about their divestiture options or the firm’s valuation. Other companies lack anything worth selling—they are competing solely on price and have no differentiated selling possibilities, or they have no systems or processes that allow for growth.

Merger and Acquisition Activity Remains Strong

In spite of the perceived challenges to sale faced by many industrial contractors, M&A interest remains strong in this sector due to its anticipated growth and profit margins higher than the construction industry as a whole. Unlike the rest of the industry, much of the potential for ownership transfer in this sector comes from the outside; the industrial sector has attracted the attention of both strategic and financial buyers. Factors that make this group attractive include:

  • Generally lower bonding requirements than the commercial segment.
  • Higher concentration of work performed directly for the owner.
  • Often higher opportunities for maintenance work and recurring revenue.
  • Sophisticated safety and risk management programs.
  • Relatively high barriers to entry.
  • Capital available.
  • Geographic flexibility allowing for operational expansion over a broad footprint.

Combined with the large number of owners of industrial engineering and construction firms reaching retirement age, this trend should continue.

New Day Dawning for the Industrial Market Sector

The last several years have been tough throughout the construction industry. Yet, at least for the industrial market sector, happier days are here again. The rebalancing of manufacturing overseas with manufacturing at home is creating opportunities for construction. While the sheer size of the retiring boomer generation creates many challenges for both staffing and ownership transition, many owners may find external M&A opportunities offer them new exit avenues. Companies with a good book of business, solid relationships, and the ability to execute are in a position to gain from the current market opportunities.

Michael D. Clancy is a principal with FMI Corporation. He works with companies across the country to help them leverage their unique organizational resources and capabilities to build competitive advantage. He can be reached at (713) 936-4945 or via e-mail at mclancy@fminet.com.

Randal G. Stutzman is a managing director of FMI Capital Advisors, Inc., FMI Corporation’s Investment Banking subsidiary. As a specialist in corporate mergers, acquisitions, and strategy development, he helps contractors throughout the country develop and implement plans that are uniquely tailored to meet individual needs. He can be reached at (813) 636-1247 or via e-mail at rstutzman@fminet.com.

1. The Boston Consulting Group. Study: Manufacturers Will Benefit From Low Cost U.S. Natural Gas. February 13, 2014. www. manufacturing.net/news/2014/02/study-manufacturers-will-benefit-from-low-cost-us-natural-gas (accessed August 12, 2014).