Weekly Update: Victoria PLC, Balta, & Flooring Manufacturing
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Victoria PLC, Balta, & Flooring Manufacturing
Founded in 1895 and listed in 1963, Victoria (VCP) is a manufacturer and distributor of carpets and ceramic tiles throughout Europe and the UK. The company was founded as a carpet manufacturer supplying mid to high-end residential properties and even the British Royal Family.
VCP’s performance as a public company was lackluster; in 1989, operating profit was ~£3m and still only ~£2m over two decades later.
In 2012, the direction of the company changed when the great-grandson of Victoria’s founder and Geoff Wilding, former banker and CEO of two prior roll-ups, plotted to overthrow the CEO and half the board.
There are many details and different stories of how Wilding took control of VCP. In short, Wilding’s consortium overthrew management and he was incentivised with a complex CFD that, upon returning roughly the market cap in dividends within 2 years, awarded him with ~50% of VCP’s shares outstanding.
Ten years later, Wilding is still Executive Chairman of VCP and owns 20% of the equity. His performance has been so impressive that VCP’s investor relations website updates automatically to calculate Wilding’s performance since taking over:
VCP’s performance plus the fact Berkshire owns Shaw Industries, one of the largest flooring manufacturers in the US, piqued our interest in the industry. We recently published our first interview on VCP with a Former Balta Director that has 50 years experience in the flooring industry and plan to cover Victoria going forward.
Wilding often quotes Buffett as if two like-minded capital allocators noticed the attractive attributes of the flooring business. The industry is resilient with 85% of revenue from renovations and only 15% from new construction. Although renovation spend is driven by house prices and consumer confidence, the relative size of the renovation market to new builds dampens cyclicality for manufacturers.
Wilding may also operate in an even more attractive market than Buffett because of the fragmentation of retailers throughout Europe. In the US, Shaw and Mohawk compete heavily on price to supply a more concentrated customer base that includes big-box retailers like Home Depot and Lowe’s. These larger customers also offer their own private labels to end customers.
In Europe, VCP supplies thousands of small, independent retailers. Wilding believes that this will lead to structurally higher gross margins than US manufacturers in the long-run.
The underlying unit economics of a flooring company is likely what attracted both Buffett and Wilding. Manufacturers benefit from high returns on tangible capital due to stable negative working capital, relatively low maintenance capex, and low technological risk.
For example, in September 2015, Victoria paid £65m for Interfloor, the leading UK interlay manufacturer. Sleepy flooring manufacturers like Interlay earn high returns on tangible assets and equity but have stagnant organic growth. Since 2016, VCP has received ~75% of the £65m paid for Interlay which is reinvested into acquisitions to drive growth.
Over the last decade, Victoria has made 20 acquisitions and has optimised its capital structure with a mix of debt and preferred equity. In October 2020, Koch Investments acquired 10% of VCP’s ordinary shares outstanding and made a £75m preferred equity investment (preferreds yield 9.35% and Koch also received warrants for up to 12m shares) to finance acquisitions.
A typical VCP acquisition looks like:
VCP runs at 2-3x net leverage, 1 turn higher than its larger competitors, but with long duration and cov-lite features of the debt. Since VCP pulled its bond issuance in 2018, the credit market has warmed to the company and its current senior notes yield ~3.5%.
VCP is a fairly unique model relative to other serial acquirers we’ve studied such as Constellation Software, Addtech, Halma, or Lifco. In Scott’s Management graphic below (the write-ups on acquirers are well worth a read), VCP would fit into the “roll-up” bucket.
Put simply, VCP rolls up flooring manufacturers, centralizes procurement, and integrates manufacturing to improve utilization and leverage fixed costs. Over 60% of VCP’s sales is raw material and manufacturing costs which decline with scale. The raw material cost savings at scale provides VCP with a cost advantage relative to smaller competitors.
However, the scale advantages don’t seem as strong as other 'roll-up's like Waste Management, for example. Firstly, VCP operates within soft and hard flooring which don’t share the same raw materials or manufacturing assets. Even within soft flooring, there are tufted carpets and woven carpets with different raw materials and manufacturing processes. VCP may sell all flooring types to its retail customer base but the scale benefits procuring raw materials and optimizing manufacturing is limited to each flooring category.
Whereas WCM or GFL can inject their trucks into acquired collection routes, VCP's acquisitions seem to require operational improvements to drive synergies. For example, VCP acquired Abingdon for £13.4m and spent over £10m in capex to drive £10m in incremental EBITDA excluding other group-wide savings.
As acquisitions scale, the operational integration adds a level of risk and complexity into the strategy. Especially at 3x net leverage.
VCP’s recent acquisition of Balta’s UK carpet business for 5.5x EBITDA is an example of such changes required. Around 30% of Balta UK’s EBITDA is from tufted carpets and 70% from woven carpet rugs. The tufted carpets are manufactured in Belgium and the woven carpets are from Turkey, which typically has the cheapest yarn and manufacturing unit costs.
Although woven and tufted carpets have different processes, it seems possible VCP can leverage the low-cost Turkish assets to add some tufted capacity over time.
That also gives them the possibility to make tufted carpets, which is what is mostly used in the UK. I would imagine in five to 10 years, there would be a swap of production because it's so cheap down there…which is what BALTA did, swapping more production to Turkey, which was a big success. BALTA is number one globally and in Europe, but Victoria now have the possibility of becoming very big in both. - Former Balta Director
Balta UK also made its own yarn which stablises the supply and cost of raw materials for VCP's tufted carpets in the future:
You have to make the carpet and have it ready within a week, but there was no yarn. Prices skyrocketed because Turkish yarn suppliers no longer wanted to deliver after prices went to $2,100 and they sold to you at $1,800. This is what you call a good service in the bag, which is what Victoria has bought with BALTA. In theory, they dictate prices as they make most of their yarns, whereas all the others depend on Turkish suppliers. European prices are currently more expensive than the Turks, which are artificially low compared to the oil increases. - Former Balta Director
Post-completion, Victoria owns 16% market share of UK tufted carpets. If it can move Balta’s production from Belgium to Turkey, it will have the lowest unit cost and the most efficient logistics network with Alliance’s logistics assets and VCP’s UK warehousing.
By buying BALTA Belgium they have a big distribution center in the UK, which BALTA did not, so all the big customers will be loaded directly. Customers like Carpetright, Tapi and Headlam can all be served direct, full truckloads of number of rolls. Victoria would have a distribution center where they would get the cheap stuff from BALTA into one center in Kidderminster to distribute throughout the UK. They could also think about producing other carpets in Turkey. - Former Balta Director
This combination of low manufacturing unit costs and high on-time delivery rates could provide a moat for VCP in UK tufted carpets.
Reliable, on-time deliveries is a competitive for VCP in UK tufted carpets. Victoria made the wise decision to buy Alliance Distribution, a flooring distribution business, to increase the efficiency and decrease the cost of flooring deliveries to customers. When retailers make an order, they need to commit to a delivery date so the consumer can clear the room and book the carpet installation. The fact VCP has 94%+ on-time delivery is an advantage over European players that ship via 3P wholesalers or distributors to the UK.
There is no doubt Victoria can improve the economics of the businesses it acquires by saving on procurement costs, integrating manufacturing assets where possible, and leveraging in-house logistics. However, the big question we have is around the durable competitive advantage in the UK flooring business:
a carpet manufacturer can make exactly the same carpet as their neighbor, if they want to. They can be competitive depending on their own set up and the way they make carpets, how fine is it, how many stitches, the cost of raw materials and electricity and whether they have any subsidies…If BALTA is too expensive, they could buy from Associated Weavers, who is the biggest in the UK, and similarly with Condor or Betap. - Former Balta Director
Carpets are a commodity; manufacturers can easily replicate competing offerings and heavily compete on price. VCP may have an advantage by being closer to market with more reliable logistics but with such a lack of product differentiation, it only takes one irrational competitor to destroy the profit pool.
It’s also hard to see the scale benefits in VCP financials; the company has recently changed its reporting structure and the acquisitions and supposedly non-recurring add-backs blur the profitability. Over the last 4 years, Victoria's UK and EU Soft Flooring EBIT margin hasn’t moved and the improvement in Group EBITDA margin seems to be from a shift into higher margin ceramics, less so from operational leverage.
Even without much margin improvement, the investment case is interesting. VCP has under 5% market share of the 23bn EUR European flooring market and management expects to add £100m in EBITDA in FY 22 through acquisitions, the equivalent of its FY 21 EBITDA excluding adjustments. Making such large acquisitions in quick succession could prove a significant challenge even for VCP's experienced CEO. There is also no ROIC measure in the bonus structure which is unlike other acquirers and worth exploring deeper.
It’s common knowledge that Wilding doesn’t plan to run VCP for decades and some believe the exit strategy is a sale to Mohawk. A scaled Victoria could be an interesting EU platform for a US player. However, at what price?
Mohawk and Tarkett trade at 5-6x NTM EBITDA and VCP at 9-10x. Given Mohawk’s EBITDA multiple also rarely reaches above 10x, what price would Mohawk pay to break into Europe at scale and add to Morazzi? If it’s anywhere near 10x, Victoria likely needs to get closer to a clean 22% EBITDA margin that management targets.
It’s hard to study companies like Victoria and not be reminded of the quality of businesses like Constellation Software and Addtech. These ‘accumulator’ models buy businesses for similar prices as VCP but with greater pricing power with little capex requirements or significant operational improvements.
Although Buffett is in the flooring business himself, and one could argue the US market structure isn’t as favorable as the EU, the quote below suggests he believes Mohawk and Shaw are rational players. For Victoria’s sake, let’s hope European manufacturers are the same.
“In a commodity business, it’s very hard to be smarter than your dumbest competitor’ - Warren Buffett
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