Sector focus: Industrials & chemicals

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Industry robot

PE investors are increasingly turning their attention to the industrials & chemicals sector. What is driving this interest, and what might the future have in store? Clearwater International’s partner and head of industrials & chemicals Michael Loudon and managing partner Markus Otto explain.

PE-backed industrials & chemicals deals in 2021 broke all previous records, with transactions totalling €70bn. This is the highest annual deal total on recent record for any sector in Europe and represents a 42% year-on-year increase in value, placing industrials & chemicals far ahead of second-placed TMT (€56bn).

PE-backed industrials & chemicals deals in 2021 broke all previous records, with transactions totalling €70bn

Dealflow was similarly stellar, with PE transactions surging 46% year on year to reach 296. This is a new record for industrials and marks a decisive recovery for the sector, which saw deal volumes plummet to a four-year low amid 2020’s pandemic-related disruption.

Focusing on deal multiples, growth in valuations has been steady rather than spectacular over the past 12 months. The average LTM multiple for industrials in Europe in Q4 2021 – 10.6x – represents an increase of 0.9 turns of EBITDA compared with the same quarter in 2020. While 10.6x is an all-time high for industrials, it was among the lowest long-term multiples achieved in Q4, with only real estate (10.2x) lower.

Modest multiples mean industrials have become a prime target for investors, says UK-based Clearwater International partner Michael Loudon: “There is a growing appetite from PE to invest across the wider industrials sector, perhaps indicating a rebalancing of focus to businesses with proven resilience and exposure to long-term structural growth tailwinds. PE firms seeking to invest in industrials are able to acquire high-quality assets at sensible prices, which is perhaps somewhat in contrast with the TMT sector currently.”

Regional characteristics

multiples everywhere are being driven upwards by three common factors: competition for targets, abundant liquidity and technological convergence

The industrials & chemicals sector is nothing if not diverse, embracing everything from traditional heavy industry to advanced manufacturing. There is also notable regional diversity. Many industrials in the DACH region (Germany in particular) have close ties with the automotive sector. Distinct regional characteristics give rise to significant variations in LTM multiples, with Southern Europe (9.6x) and the Nordics (12.9x) representing the extremes.

While valuations vary from one part of Europe to the next, multiples everywhere are being driven upwards by three common factors: competition for targets, abundant liquidity and technological convergence.

“Competition is one of the main drivers,” says Germany-based Clearwater International managing partner Markus Otto. “In tandem with this, acquisition finance for PE is favourable and there is an attractive banking sector providing access to money. On top of that, a lot of corporates have good cash positions and are actively seeking assets. All of this is driving valuations. At the lower end, we are seeing multiples of between 8x-9.5x. But with industrial tech, it could reach double digits.”

Industry 4.0 and ESG

One of the big factors driving multiples is the convergence of industrials and technology, otherwise known as ‘Industry 4.0’. Industrial businesses that are integrating digital technology – or where scope for integration exists – are increasingly sought after by PE investors. “Everybody is seeking tech,” says Otto. “Industrial tech assets attract the best pricing, the best valuations and the best financing.”

COVID-19 has served as an accelerator of ESG consciousness

Hand in hand with digitalisation is the rise of ESG. “COVID-19 has served as an accelerator of ESG consciousness,” says Loudon. “It has gone from being a consideration to an imperative for businesses that are looking for investment or considering a sale process. It is coming through in the investment themes we are seeing from PE. For example, businesses that are linked to the decarbonisation agenda are garnering a lot of interest.”

Companies that fail to get onboard with digitalisation and ESG could be in for a rocky ride, predicts Otto: “They will have real difficulties getting investors and getting attractive valuations. These are mega trends and they have accelerated dramatically over the last six to nine months.”

Challenges and outlook

businesses are typically having to hold more stock and they are paying more to get freight shipped

The industrials & chemicals sector faces its fair share of challenges. More so than TMT and financial services, the sector relies heavily on physical inputs – from steel and copper to plastics and semiconductors. It is also a major energy user – more than 25% of all European energy consumption is accounted for by the industry, and rising input prices are a key concern.

Supply chain disruption also continues to cause headaches. “Businesses are typically having to hold more stock and they are paying more to get freight shipped. This is influencing sale price strategies and customer service levels and in turn impacting profitability and liquidity,” says Loudon.

On top of this are the macro factors that affect all businesses, from rising inflation and tightening monetary policy to the precarious security situation on Europe’s eastern fringe. Meanwhile, tougher rules on foreign direct investment are an increasing hurdle for dealmakers. “More or less every transaction is subject to government approval,” says Otto.

investors are attracted to businesses that have clear structural growth drivers

Yet despite these headwinds, opportunities abound. “Infrastructure services is one really hot area – investors are attracted to businesses that have clear structural growth drivers,” says Loudon. “There is an immense amount of public investment planned over the next decade on roads, rail and transport systems, as well as in digital connectivity. The scope for private investment to support this is huge, and industrial service providers in these areas are capturing a great deal of attention.”

Sound fundamentals and strong growth prospects point to a bright outlook for dealmaking, concludes Otto: “Momentum is very strong, the climate is positive, and we are on a good track.”

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