Distribution Evolution - October 2007

By FRANK O'NEILL

Don’t count your chickens before they’re hatched. That’s a lesson I thought I learned a long time ago, but in the last issue I reported that Home Depot got lucky because I thought it managed to sell HD Supply before the credit markets collapsed. But I was wrong. Right after that issue went to press, banks and stock markets worldwide got spooked by the defaults in the sub prime mortgage sector. That’s when both the potential buyers and the banks pulled back and forced Home Depot to lower its selling price by 17.5% to $8.5 billion. And Home Depot was forced to keep a 12.5% stake in the company to boot.

The timing couldn’t have been worse for Home Depot—or better for the new owners, the private equity consortium of Carlyle Group, Bain Capital and Clayton Dubilier & Rice.

Frankly, I still think Home Depot did well to get rid of HD Supply—even for a cool $1.8 billion less than it had originally planned to sell it for. The new CEO Frank Blake is going to have enough problems on his hands getting the core business back on the right track without having to deal with a unit that was a bad investment in the first place. As I’ve been saying for years now, Home Depot has never been good at entrepreneurial businesses (witness how it’s manhandled its installed floorcoverings business), and the builder supply business is highly entrepreneurial. Not only that, but the builder business could be in for a prolonged downturn as housing inventory piles up in Metro Markets where the builder business has been the strongest in recent years, places like Florida, California, Nevada and Arizona.

I don’t think the new buyers are going to have an easy time of it turning HD Supply into a profitable business either. As I’ve said before, they not only have to learn to buy well—which should be the easiest part—but also to service their customers well. That’s certainly going to be the hard part. Guys who run private equity firms certainly have a more entrepreneurial bent than most corporate managers, but it isn’t going to be easy getting a diverse bunch of small to medium sized businesses functioning as a well connected unit.

I’ll keep a close watch on this one.

THE CRAZINESS IN HOUSING
As the housing market goes, so goes the residential floorcovering business. And in the past few months, it’s been going completely crazy. At the end of August, existing home sales hit a five year low, the inventory-to sales ratio hit a 16 year high, and housing prices posted their biggest drop since 1987.

Some retailers could be in for a long dry spell, but it truly depends where you live to understand how well you’re going to weather the downturn. Parts of the country, like the Pacific Northwest and Iowa, have done very well, while Florida, Nevada, Arizona, Tennessee, Maryland and California have all been hammered.

The Pacific Northwest has been propped up so far by the success of the tech industry. But Iowa? Fact is, Iowa is one of the hottest housing markets in the country right now, thanks to the resurgence of farming, most notably corn farming. The demand for corn based ethanol has sent investors into Iowa in droves. This year, ethanol production should devour about 20% of America’s corn crop, and that total is just going to keep growing.

Not surprisingly, Florida and Nevada suffered the biggest drop in sales in the second quarter, says the National Association of Home Builders. Those are the two states speculators targeted most heavily during the housing boom. The NAHB says sales in Florida were down 41.3% in the quarter, compared to Q2 2006, followed by Nevada (-37.5%), Arizona (-23.4%), Tennessee (-21.5%), Maryland (-21.1%) and California (-19.8%).

If your business is in Des Moines or Seattle, you can count on a good 2007. But if you live in Orlando or Las Vegas, it could be a long time before your retail business gets really good again.

In fact, five states appear to be the most vulnerable. According to RealtyTrac chief exec James J. Saccacio, 43 states experienced year-over-year increases in foreclosure activity, but just five of them—California, Florida, Michigan, Ohio, and Georgia—accounted for more than half the total foreclosure filings.

The WFCA’s second quarter survey of its members also indicates that things weren’t so bad for much of the country. Some 49% of respondents reported that their sales were higher than the first quarter. Not surprisingly, the builder business performed the worst. Some 30% of the respondents don’t have builder sales, but 35% said their sales were down—most of them between 10% and 20%—and 16% said they were flat.

THE COMMERCIAL MARKET
While the housing slump looks like it could last for awhile, nonresidential construction remains strong. Residential construction slipped 1.4% in July, but nonresidential construction was up 0.6%.

According to The Associated General Contractors of America, nonresidential sectors of the most concern to the floorcovering industry were all up in July. Private office construction was up 0.6%, while lodging was up 0.8%. Private health care (mostly hospitals) was up 1.3%, while education rose a hefty 1.9%.

SURVIVAL TACTICS
As I mentioned last issue, diversification into other products and services is one way to keep the pain of a downturn less concentrated. Interestingly, only 12% of the WFCA survey respondents said they weren’t in the commercial business, which continues to be reasonably strong. The fact that so many have their business spread across both the residential and commercial markets has to take the sting away from the slump in residential sales.

Most interesting, 39% of the retailers surveyed by the WFCA said they’ve increased their advertising expenditures in the third quarter, while 52% said they’ll stay the course.

It’s encouraging that 39% are increasing ad spending. Statistics show quite convincingly that companies which advertise aggressively in economic slumps gain marketshare.

AN EXAMPLE OF DIVERSIFICATION
I thought it was interesting that Home Valu, the big Midwest retailer, has signed onto Creating Your Space, the web partnership of the WFCA and the builder retail group DCS. Home Valu, which ranked 35th on last year’s Focus 100 Retail list with floorcovering sales of $65 million, is one of the most diversified of the privately owned flooring retailers in the U.S.

Besides its substantial floorcovering business, Home Valu also sells and installs a full range of kitchen and bath products and window coverings. That kind of diversification brings the customer into the firm’s nine stores more often, and it can create much greater customer loyalty. If you only see a customer once every ten years, when she decides to get a new floor, you have a much harder time making an impression.

CONSOLIDATION IN HARDWOOD
Just as we were wrapping up this issue, we got the news that Shaw Industries had acquired Anderson Hardwood, the nation’s largest privately owned hardwood manufacturer, for an undisclosed sum. Not only was this acquisition a surprise, but it underscores what we’ve unofficially known for a long time, that Shaw parent company Berkshire Hathaway is no longer interested in the world’s largest hardwood manufacturer, Armstrong World Industries.

Anderson, with estimated 2006 sales of $151 million, was the fourth largest U.S. hardwood manufacturer last year, behind Armstrong, Columbia and Mohawk. The latter two joined forces a few months ago to create a hardwood producer that’s a solid second behind Armstrong, with sales of more than $300 million. Shaw’s acquisition of Anderson will give that company sales in the range of $250 million, moving it into third place among U.S. hardwood manufacturers.

Shaw is actually a newcomer to hardwood manufacturing. Until last year, the firm outsourced all its hardwood. But early last year, it converted a yarn mill in Tennessee into an engineered hardwood plant with an initial capacity of about 20 million square feet. That plant is already in production.

While Armstrong Hardwood is still far bigger than either Mohawk or Shaw, with 2006 sales of $760 million, both Mohawk and Shaw are certain to change that quickly as they integrate the acquired companies into their formidable retail distribution networks. I also think these two acquisitions will ensure rapid growth for hardwood flooring for many years to come. Hardwood has already been on a fast growth track for the past decade; it accounted for 10.6% of total industry sales last year, up from just 6.9% in 1996.

I remember Bob Shaw telling a group of his salespeople and key customers a few years before Armstrong bought Triangle Pacific, the world’s largest hardwood manufacturer, that Triangle Pacific was one company he’d like to own.

Well, Shaw didn’t get the world’s largest hardwood manufacturer, but it did get a prize that could prove to be even more valuable in the long run. Anderson, which is headed by Don Finkell, is a great family owned company that’s been on a fast track of its own in recent years. In fact, Finkell and Anderson can take much of the credit for lifting hardwood beyond a commodity product to a style conscious category with a nearly infinite number of choices. It was Finkell who began experimenting—not too many years ago—with a whole range of new hardwood concepts, from old barnwood to distressed looks and exotics, breaking the category out of its dependence on red oak and maple.

Today, thanks to its focus on style, Anderson probably has the best brand identity among all hardwood producers and with Shaw’s resources behind it, the firm should see some spectacular years ahead.

CONSOLIDATION AMONG DISTRIBUTORS?
J. J. Haines & Company Inc., a distributor of floorcoverings from Pennsylvania to South Carolina, has acquired Wheeler Inc., a Florida based full line floorcovering distributor. The deal not only brings J.J. Haines into the Florida market, but it also puts the company in a race with Hobokin Floors for the number one spot among U.S. floorcovering distributors, with sales of about $400 million.

Does this acquisition signal a move toward further consolidation at the distribution level?

Probably not. Fact is, the U.S. flooring distribution sector has been stronger in the past few years than it’s been since the years immediately following the moves by Shaw and Mohawk to bypass distributors and sell direct.

GREAT IDEAS
If you haven’t looked at our sustainability report in last month’s issue, you should if you have any interest at all in lowering this country’s dependence on hostile oil states and/or in protecting the environment. It’s a great overview of where the floorcovering industry stands in that regard—and I think it stands very tall.

Two of the many tidbits of information in that report which struck me as useful to everybody in the supply chain from manufacturer to retailer: rubber flooring producer Roppe has onsite collection facilities where employees can recycle household items and Bentley Prince Street is putting containers and trailers at Stonybrook University on Long Island to reclaim all used carpet at the big school. Roppe plans to use the money generated from the sale of the stuff its employees bring in to create scholarships for their kids. Bentley Prince Street, meanwhile, is keeping some 35,000 yards of carpet from going to landfills every year—and that’s just from a single location.

What struck me as most interesting about these two collaborations is that both can have a tremendous impact on communities beyond the companies themselves. They certainly add to the prestige of the companies.

Similar types of collaborations would give any retailer or manufacturer a step ahead of the competition, and everybody needs that these days.

GREAT BRAND IMAGES
How often do companies come up with memorable icons like the Nike swipe, or the GE light bulb? It certainly hasn’t happened often in the floorcovering industry. The only one I know of is Tommy Mohawk. But there are a few memorable characters in our industry that are every bit as good as the great logos or icons.

Remember the cute redheaded kid in the first Stainmaster TV ads? He certainly qualifies, although his time in the spotlight was far more limited than the easy talking character who’s best known for mouthing the words “One 800 588 two-three-hundred, Empire Today.”

The Empire Man has been the voice of the rapidly growing shop-at-home floorcovering retailer, Empire Today, ever since the company began its TV advertising in Chicago back in 1977. Lynn Hauldren, the guy who portrayed The Empire Man 30 years ago, is the voice you still here on TV today. Now, though, he’s gone far beyond Chicago, and can be heard in about 50 major Metro Markets around the U.S.

A GREAT LEGACY
At the end of August, the retail floorcovering business lost one of its best minds when Alan Greenberg passed away at the age of 63 after a year long battle with lung cancer. Alan and his partner Howard Brodsky are best known for starting CCA Global and building it into a retail empire with 15 different co-op groups and sales of more than $10 billion.

Alan’s real legacy, though, has to be the way the retail flooring groups under the CCA Global umbrella elevated the status of the nation’s retail floorcovering stores. Two decades ago, many of those stores were not only eyesores, but flooring retailers’ reputations were a notch below used car dealers. Anyone who’s walked into a Carpet One or Flooring America store lately knows those days are just distant memories. Not only are those stores great looking places to shop, but the service is great and the brands have reputations for integrity and quality.

Alan Greenberg will be sorely missed.

If you have any comments about this month’s column, you can email me at foneill898@aol.com.

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