Ongoing Supply-Chain Issues to Constrain US Building Product Sales

Supply chain challenges in the U.S. building products and materials sector are taking longer than expected to normalize, limiting companies' ability to fully benefit from strong end-market demand and grow sales, says Fitch Ratings. The disruption is causing production delays, which have been exacerbated by ongoing port congestion, pressuring sales volumes and leading to higher raw materials and transportation costs.

We expect demand for building materials will continue to be supported by strength in new home construction and residential remodeling combined with improvements in government infrastructure and commercial construction spending. However, some building product companies, such as PPG Industries (A-/Negative) and Sherwin-Williams (BBB/Stable), recently lowered 3Q21 sales guidance. A shortage of raw materials, logistics/transportation issues, force majeure declarations and lower allocations from suppliers drove the downward revision in sales expectations.

Production capacity and supply chains were constrained earlier in the pandemic, due to employee absenteeism, manufacturing and distribution facility closures and social distancing protocols, and inconsistent component sourcing. These challenges were exacerbated by port congestion and adverse weather events. Still, forecast 2021 revenue growth for Fitch-rated issuers is still within our expectations, due largely to higher pricing, which is mitigating EBITDA and cash flow effects of constrained volumes.

The Port of Long Beach, the second busiest gateway in North America by container volume, is experiencing significant congestion due to increased cargo. Some shippers are chartering small vessels, which are more expensive, to go to other ports in order to circumvent bottlenecks in some of the larger ports. However, some Gulf and East coast ports were temporarily shut down by recent hurricanes, causing additional shipping delays.

Fitch revised downward its 2021 U.S. GDP forecast to 6.2% from 6.8% and U.S. inflation forecasts upward to 4.4% from 4.1% this week, as supply constraints are limiting the pace of recovery and resulting in higher prices. The cost of processed inputs for U.S. firms is rising at its fastest rate in 40 years, with some of the higher costs passed on to consumers.

Building products and materials companies are employing actions, including price increases, surcharges, and capacity expansion to navigate the production and inflationary pressures caused by supply chain disruption. Materials and components for construction costs increased at a double-digit year-on-year rate since March and rose 19% in August, based on U.S. Bureau of Labor Statistics data. Transportation costs, particularly for shipping, are also increasing. Inbound freight container costs nearly tripled during 2Q21 for Masco (BBB/Stable), for example.

Gross margins for some Fitch-rated issuers, particularly coatings companies, are tracking modestly below our expectations, despite price increases, but leverage will be in line with our expectations due to higher year-on-year revenues and solid cash flow. Should supply chain issues persist and gross margins continue to underperform, there could be rating pressure for issuers such as PPG Industries, as the company's leverage is currently above negative sensitivities.

RPM International (BBB-/Stable) announced the purchase of a chemical manufacturing facility to increase capacity. The company expects buying versus building to help quickly expand production and meet demand of high-growth products, streamline processes and create efficiencies. Mohawk Industries (BBB+/Stable) plans to deploy $650 million of capital toward capacity expansion over the next 12 to 18 months.

The protracted and, in some cases, worsening industry supply chain disruptions in the U.S. building products and materials sector is having a secondary effect on end-market customers. Homebuilders, such as PulteGroup (BBB/Stable), are working more closely with suppliers but a shortage of building products, combined with labor shortages, is affecting the pace of community openings and housing starts. The company expects its average community count for 3Q21 to be down about 15% from last year due to these supply-chain challenges.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.