No way can a lumber yard earn a 15% AFTER-TAX profit on gross revenues.
I question whether they could earn a 15% pre-tax margin, but I was willing to be charitable (or gulible) and accept that part of the claim.
I agree with you.
I forwarded a copy of the financials from last nights Q&A to an expert in buying and selling small (less than 25 million dollar) businesses.
Here is his analysis for our mutual edification:
It is not possible that a building supply company, with an approximate 30% gross profit margin, can experience a 40-50 percent decline in revenues and realize a 15 percent net income on half of last year’s sales. No business can cut costs that quickly. Plus, the fixed costs built into the business cannot be cut easily or quickly. This business you describe is not in Detroit/Windsor. It is in Fantasyland.
It is possible that the business netted 8-9 percent of $24 million in revenues last year. But most of that net profit came from the second 12 million dollars in sales. The first 12 million in sales has to cover fixed costs, as well as the variable costs. Once the fixed costs are covered, incremental sales are much more profitable. So to lose $12,000,000 in sales off the top probably makes the entire 2005 profit disappear. No way is the company netting 15% of the remaining $12 million in revenues after doing $24 million last year.
Most likely, the company was worth about $10 million last year. I am guessing $2 million (probably high) in profits (i.e. cash flow) on $24 million in sales, with a valuation multiple of 5.0. This year, with no profit on $12 million in sales, the company is worth only about $6 million, plus non operating assets such as real estate and excess cash. That valuation would be derived largely from an asset value of approximately $5 million, plus a going concern value of an additional $1 million, which is generous.
Building supply companies are typically heavy in asset value as a percentage of sales. While the valuation multiple might be 4-6 like companies in other industries, the valuation is usually only about two times asset value. While this makes these companies more expensive to grow than other companies, the high asset value is a barrier to entry, which is a good thing. This company is probably now overloaded with inventory, after a 50 percent drop in sales. Margins are probably way down, as this company and its competitors in that market crash-sell their excessive inventory. This price cutting makes profit margins disappear, making the 15% net profit quoted an impossibility.
The owners of this company have a couple of years of difficulty ahead before sales and profitability can be restored. They should have taken the company to market two years ago.
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