At FourBridges, we specialize in helping old-world industrial companies navigate the sale of their business. Recently, we sat down with Kathryn Thompson to talk about the future of the construction and building products industries and discuss everything from inflation projections to the effects of global crises.

Kathryn is the founding partner and CEO of Thompson Research Group (TRG), an equity and research advisory firm focused on the construction industry value chain. TRG provides buy-sell public equity recommendations to hedge funds, mutual funds, and pension funds, along with consulting and advising services to a wide range of public and private companies, venture capital, and some of the largest private equity funds in the world.

Read a transcript of our conversation with Kathryn below, or watch the full interview here:

The businesses we work with are subject to economic swings and regional differences. It doesn’t appear that things are the same nationwide. What do you think is driving those differences, and where are we headed?

This is a result of population shift. Just to quantify this, in 1920, three out of 10 Americans lived in the Northeast. Fast forward to today, and it’s only two out of 10, so the numbers bear it out. You can look back at American history and see two things that drive major structural population shifts. There’s an economic or financial driver, followed by social.

First, it was the Great Recession. We saw headquarters and other major businesses starting to move to the Southeast and the Southwest. For example, Nissan North America and Toyota North America moved from the West Coast to Dallas and Tennessee. Then you layer the social side of it, with Covid and the obvious upheaval that had on the market overall, and that poured rocket fuel on population shift.

So, it wasn’t just about more favorable labor laws and tax rates and things like that—it was exposed structural weaknesses. It’s also the ability to work year-round, a better quality of life, and the ability to be outside for a longer period of time. We view it as a multi-decade type shift, and yes, you had some big moves in the wake of Covid, but it’s just going to continue to trickle. It’ll end up having some unintended consequences, which isn’t necessarily bad.

We’re seeing it now through talking to private companies from a research standpoint. There’s a private fencing company manufacturer based in the mid-Atlantic on the edges of the Northeast, and what’s interesting is they have business from Maine down to the Carolinas. When things started to get softer in the late spring and early summer, their business in the Carolinas was pretty steady, but things in the Northeast and the mid-Atlantic had turned negative.

You can’t read a business article these days without the word inflation. What do you see happening with inflation in the back half of 2022 and as we look towards 2023?

It’s funny because at the beginning of ’21, TRG put out an annual piece with things to pay attention to next year, and we anticipated inflation. There were a lot of economists that patted us on the head and said, “Why don’t you just go back to talking to concrete companies?” but it has proven to be a big issue.

Some commodities improved, as steel and aluminum certainly have, but there are other industries that are structurally going to be trickier, like the cement industry. It’s a hugely capital-intensive business, and cement plants across the US have been working so hard to meet demand with huge plants and 24/7 operations. There have been many extended outages and just wacky things happening, like there was a fire at a plant in the Dallas-Fort Worth area. I’ve heard about more fires and chronic breakdowns, which tells me that some parts of the value chain are working so hard right now that they’re experiencing structural weaknesses, and then that ends up trickling down the line.

That’s a long-winded way of saying, inflation is certainly going to get better for many categories, but that doesn’t mean that all categories will be out of the woods, which is a little different than how it’s been previously in the US.

As far as the supply chain, is the worst behind us yet?

We’re a little better, but it depends on where you are. Some industries have done a better job at managing the supply chain, and hence can better manage inventories. Ferguson, the largest plumbing distributor in the US, had to deal with the same issues as everybody else, but they were quick to keep an eye on inventory and are doing fine. With other companies, you see over-inventory, which is a boon. I was at Target this weekend and saw rows upon rows of WillScot Mobile Mini units holding excess inventory. There’s clearly an excess of some types of products, and a shortage of others.

As Ukraine heated up, we asked our company contacts what they planned to do about the unintended consequences for the supply chain. For example, porcelain and tile products are built and manufactured in Italy, and Turkey, relying on Ukraine as a major source of raw materials. The industry ultimately did a pretty good job of navigating around it, and the industry in the US was able to find different alternative sources. In general, people have gotten better at problem-solving and at working around supply chains.

Where do you see the residential and commercial construction and building products industries going in the next year or so?

I’m going to start with the easy one, which is commercial, because there’s a lot of visibility. We were out with Mohawk in New York meeting with institutional investors, and they echoed the same feedback that we’re getting from concrete producers and drywall installers. Even if one project pauses, there are a dozen more in the backlog.

It gets dicier on the residential side. On one hand, a company like Mohawk can say RMI (Renovation, Maintenance, and Improvement) is the first place where we see softening in the market. On the other hand, contractors are saying that because rates have gone up, consumers who planned to buy a new home are tapping into their existing home equity to remodel instead. It’s a very mixed bag when it comes to RMI, but ultimately people are just waiting to see where everything shakes out.

When it comes to new residential, it’s not just that rates are going up, it’s the velocity and understanding of where it’s going to stabilize. Changing rates coupled with inflation caused major home builders to put a pause on buying land early in the summer and late spring. They’ve seen this before, and they think they can get a better price later.

Others are doing just fine as it is. A billion-dollar building products distributor gave us an example of the market down in Florida. They have projects where they need 200 trusses and they absolutely can’t meet that demand. In fact, 160 is their absolute max, so if the demand goes from 200 to 160, they’re still busy.

How is the tight labor market affecting the construction industry?

I think there’s been an underestimation of the existential impact of Covid, and people in our world are a little cautious to say that. I wouldn’t blame this generation and say they’re lazy and don’t want to work. It’s getting down to the why behind it.

Candidly, when it comes down to job security and not the possibility of not being able to get a job, I think that will send people back to work. I have a lot of connections with some of the financial centers in New York and Boston, and we do a weekly call with a bunch of really smart guys in macro. I put out an idea to look at the parking lots for the train stations and commuters that are in Connecticut and New Jersey. Those guys started sending me pictures, and sure enough, about three weeks ago, I got a picture of a full parking lot on a Friday and that to me, that’s telling. People are going back to the office because of concerns about job security.

We’ve been fortunate to be pretty busy the past few years, but we are now seeing buyers be a bit more cautious. Do you have any thoughts on the M&A market?

Private companies often say they’re so glad to not be public. They think they get to rule their own roost and not be impacted by public equity markets. When in reality, that is absolutely not the case. If you’re a company doing business in the US, you’re going to be impacted by public equity markets, because it impacts sentiment ultimately. Publicly traded stocks determine what their future cash flows are and optimism for their future cash flows. It’s a daily snapshot of where the world thinks everything is.

I tend to think that barring some completely unforeseen event, you’ll have some major noise around M&A. I think the marks will get better, and actually, by the start of next year, you’re going to have a pretty robust market. If there are companies that are thinking about doing an IPO process, they’re gearing up to get that going next year. For now, it’s just about the uncertainty, but I think we’re getting closer to a better understanding of where we are. People are learning that some of their fears are perhaps not as big, bad and scary as they seemed.

Are larger strategics slowing down on the add-on acquisitions that they’ve been making in the past couple of years until we see how the rest of the year pans out?

We’re starting to see companies that previously paused now moving forward with pruning activities to prepare for new opportunities. WillScot Mobil Mini spoke pretty publicly about pruning a portion of their portfolio, and they made an announcement about a big transaction of around three million dollars. Another company, Martin Marietta Materials, made a huge acquisition at West Heavy Materials, but we knew certain portions of the assets would be pruned. As for public equity investors and for private equity investors, they’re looking for new ideas. People are starting to be more open to pulling the string on creative ideas. This is all the precursor to bigger things, foreshadowing something that I think will be very interesting.

Watch the complete interview here.