A company bucking the building downturn

Shares in paving group Marshalls (MSLH) and building merchants Travis Perkins (TPK) are 62 per cent and 48 per cent below their late 2021 highs, respectively. Given the uncertainty in both companies’ end markets, neither show signs of significant near-term recovery.

Volution (FAN), a Crawley-based assembler and supplier of ventilation equipment, hasn’t come out of this period unscathed. Like many in the sector, higher energy, labour and parts costs have hit margins and put upward pressure on selling prices. Unlike others, though, a decline in volumes hasn’t followed, and the company has proved itself to be a resilient operator.

Formed in 2002 by a private-equity-backed buyout of the air movement and cables business of engineering group Smiths (SMIN), Volution changed hands a couple of times before being floated on Aim by TowerBrook Capital Partners in 2014.

Barring a pandemic-disrupted 2020 (when operations kept running but demand took a hit), revenue and profits have grown in every year since its listing. And even the pandemic has had a silver lining, in that it meant organisations started paying a lot more attention to air quality and ventilation systems.

In the UK, for instance, there were changes to regulations in June last year that set higher standards for builders of new properties covering ventilation and the conservation of heat and power. These have triggered a “greater transition to continuous ventilation systems” among housebuilders, the company said last month as it announced a 9 per cent rise in sales for the half year to 31 January.

This means that instead of installing singular extractor fans in, say, a kitchen and a bathroom, housebuilders are opting for continuous air systems throughout a property. Many of these include additional heat recovery elements to ensure homes are more energy efficient.

The potential upside for Volution’s sales is considerable. Although price tags vary depending on the size of a property, an extractor fan unit might go for £75 to £150, compared with between £250 and £450 for a continuous system or £800 to £1,000 for one including heat recovery. The addressable market is also significant: Volution estimates that around a third of properties currently use extractor fans, another third use a basic continuous system and the remainder also have heat recovery built in.

On top of this, social housing landlords are under pressure to ensure they meet acceptable standards in terms of ventilating existing homes.

After a coroner last year found two-year-old Awaab Ishak died in December 2020 from a severe respiratory condition caused by prolonged exposure to mould in a home provided by a Greater Manchester housing association, housing secretary Michael Gove wrote to all councils and housing associations demanding “urgent action” when tenants complain of damp or mould problems. The government also amended a Social Housing Regulation bill, giving new powers to the Housing Ombudsman to act on complaints.

Heightened social housing demand is already feeding through to sales. Despite a slowdown in new housing starts across the UK, Volution’s domestic residential revenues increased by 16 per cent to £41.4mn in its first half and helped to offset declines in the commercial and export divisions, of 9 and 6 per cent respectively.

Whether this trend can continue to hold back the grim outlook for both the residential and commercial markets is a big question. In the last quarter of 2022, new housing starts fell 9.5 per cent on the prior year, according to the Office for National Statistics, and in January, the Construction Products Association forecast an 11 per cent decline in private housing output this year, as housebuilders focus on building out existing schemes.

Higher interest rates, as well as hitting the residential mortgage market, have knocked commercial property values and increased the cost of borrowing for new schemes.

Thankfully for Volution, it is less reliant on its home market than it once was. At the time of its listing, almost two-thirds of sales came from its home market; today, the group operates from 14 countries and last year generated 62 per cent of sales outside the UK.

This diversification has largely been achieved through acquisitions. Since floating, Volution has bought 17 businesses, usually through a mix of cash and debt, as well as slugs of deferred awards contingent on certain targets being met. An ability to turn earnings into the cash flow required to fund deals has also been solid, as measured by an average adjusted cash conversion rate of 94 per cent over the past five years. Although this slumped to 76 per cent in the 12 months to July as inventory spending increased to mitigate supply chain problems, normalising stock levels in the first half of this year pushed this back up to 88 per cent.

Of course, higher interest rates aren’t just a UK story. A reversal in the multi-decade bull run in house prices in Australia and New Zealand (which account for 15 per cent of sales), has put the brakes on new project starts there, too. And although the pattern is similar in the Nordics, the wider continental Europe arm grew sales organically by 8 per cent in the six months to January.

Declining project starts are undoubtedly a concern, given that 30 per cent of group-wide revenue comes from housebuilders. Perhaps this, and the fact that Volution shares trade at 17 times forecast earnings, above the five-year average of 15, could explain why a leading investor has halved its stake.

PrimeStone Capital, listed in Volution’s 2022 annual report as the biggest shareholder with a 9.95 per cent stake, cut its holding in December to 4.79 per cent. PrimeStone declined to comment on the reason for the disposal.

In its defence, Volution management argues that sales are more defensive than they may seem. Some 70 per cent is driven by the refurbishment market, and although the CPA expects private housing repair, maintenance and improvement output to shrink by 9 per cent this year, Volution chief executive Ronnie George tells us that his products are “far less discretionary” than a lot of others in the marketplace. Public housing refurbishment output, for instance, is expected to remain flat.

George, who has been in the top role for more than a decade, also sees opportunities to grow Volution’s share of a fragmented market. That would mark a shift from recent form. Unusually, given the pace of historic deal-making, the sole acquisition of the past 18 months was the purchase of German distributor Bera for £0.8mn last July. Instead, excess cash generated in the first half of this year was used to cut debt by almost £25mn to £79mn, leading Berenberg analysts to forecast a drop in net debt to just 0.4 times cash profit by the year-end.

Deal-making is still firmly on the agenda. George told us the company is “pleased about the development of the M&A pipeline and where we sit with a number of different opportunities”. That should be positive to existing and prospective investors, given the company’s track record on integration and Liberum analysts’ estimate of a 24 per cent average return on investment per deal.

End markets are hardly likely to be a breeze, but the company has maintained adjusted operating margins above its stated goal of at least 20 per cent. There are enough tailwinds to suggest that can continue.