The industrials sector includes a broad range of sub-industries, which have experienced varying degrees of recovery following pandemic-induced struggles. With the recovery in full swing on the backs of pent-up demand and record backlogs, companies are facing pressure from supply-chain disruptions. For example, U.S. construction spending is well above pre-pandemic levels, but has begun to taper off as a result of longer lead times for components, labor shortages and raw material inflation.
Despite current supply-chain headwinds, industrials have managed to post impressive earnings growth through 2021, albeit with an easy comparison to 2020 revenues. Companies have done their best to pass on higher costs to consumers by raising prices for products as demand remains strong. Meanwhile, credit metrics across investment-grade and high yield industrial names have largely improved year-over-year, due in part to conservative financial policies.
During the pandemic, shareholder returns took a backseat to boosting liquidity. As a result of cost controls and improved liquidity, some companies have shifted focus toward mergers and acquisitions (M&A) with plenty of cash available to put to work. Specifically, private equity firms have spent more on acquisitions in 2021 than any previous year, with the majority of spending directed toward technology and health care.
Not unlike the rest of the market, the industrials sector has seen a spike in M&A activity, with a record number of deals as aggregate deal volume has rebounded from a seven-year low in 2020. Through the first half of 2021, deal volumes were up more than 250% compared to the first half of 2020. Companies putting cash to work are doing so at elevated multiples, as earnings prospects for industrials show relative strength. Record spending at high multiples.
Forward enterprise value to earnings before interest, taxes, depreciation and amortization (EV/EBITDA) multiples for the North American industrials universe stood at an all-time high during the summer before falling on the news of supply-chain complications. Deal activity and volumes have also fallen off in the second half of this year. Aggregate deal volume in the fourth quarter currently stands just above $3 billion, while volume in the first quarter of this year alone was over $68 billion.
It has been reassuring to see companies turn their attention away from dividends and share repurchases, and prioritize free cash flow generation. Strong demand, record backlogs and $550 billion in planned infrastructure spending from the Infrastructure Investment and Jobs Act should support future growth in the sector.
2022 is expected to be a strong year for industrials if supply-chain headaches subside and companies are able to realize record backlogs as revenue. If multiples continue to normalize in the near-term, I would expect deal activity and volumes to rebound through 2022, although at a slower pace than earlier this year. Additionally, I would be concerned with companies pursuing M&A opportunities to the detriment of credit quality and/or margins in the medium term.
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