Private equity opportunities in lubricant distribution
Assessing the case for “buy and build”
Recent private equity successes have made a case for a “buy and build” investment thesis in the lubricant distribution space. Financial sponsors have effectively deployed capital to aggregate a number of smaller operators on a common, professionalized platform, resulting in:
- The creation of formidable industry players
- Full realization of the benefits of a strong M&A strategy
- Very attractive investment exits
Based on its current metrics and anticipated trajectory, we believe the space is primed to offer significant opportunities for private equity investment.
The sale of lubricants in the United States is a $25 billion market and products are used to serve large, steady end markets, providing a base of stability for investment. Margins for lubricants are attractive relative to other refined petroleum products and revenues are typically recurring in nature. Taken together, these attributes indicate that leverage is more easily attainable for lubricants than for other commodity-linked businesses.
While the number of lubricant distributors in the United States has declined by more than 50% over the past decade, the industry remains highly fragmented. Looking forward, several outcomes seem likely:
- Consolidation will continue as the major oil companies continue their push to rationalize the number of distributors with whom they maintain relationships.
- Customers will continue the already growing trend of seeking suppliers that can serve as value-added partners.
- Scale will become increasingly important.
- Opportunity for private equity to participate in the continued consolidation of the lubricant distribution space will be significant.
In aggregate, the U.S. finished lubricants market is expected to grow less than 1% on a volume basis over the next several years according to industry consultants. That unspectacular growth trajectory notwithstanding, the market is large and demand is steady.
The U.S. Lubricant Industry: An opportunity
3% OF INDUSTRY VOLUME
comprised by largest distributor
10% OF THE MARKET
controlled by top six distributors
- Relatively attractive and stable margins: Lubricant margins compare very favorably across the refined petroleum products universe. Additionally, they are generally quite stable and insulated from commodity price volatility
- High customer retention: Relative to the costs associated with equipment failure, consumable lubricants are low-cost, indispensable products for the applications and users that require them. As a result, lubricant distributors generally enjoy high customer retention and a regular order pattern.
- A highly fragmented industry: The lubricant industry in the United States is a $25 billion marketplace with more than 2,500 distributors generally confined to limited geographic areas. Despite considerable consolidation the industry remains highly fragmented: the largest distributor comprises only 3% of industry volume and the top six distributors control just approximately 10% of the market.
- Declining number of U.S. lubricant distributors: Industry consolidation has been driven primarily by two notable factors: customers increasing demand for value-added lubrication services and the drive from top national suppliers to concentrate distribution amongst a set of fewer, more mature partners.
Four major players – Brenntag AG, PetroChoice, RelaDyne and Pilot Thomas Logistics – sit atop the industry, yet they control less than 10% of the market, which indicates abundant opportunity to replicate the “buy and build” strategies that have already proven successful.
Private equity firms interested in developing an organizational focus on growth through acquisition and supporting it with a strong integration capability can produce the benefits of rapid growth as well as significant cost savings and operational synergies. Generally, minimal incremental overhead is required to support the operations of an acquired distributor. As the platform expands, economies of scale through purchasing, route density, operational leverage and the elimination of working capital provide upside to the acquired cash flow stream. Pro forma acquisition multiples after the full effect of savings and synergies can be quite attractive.