Financial survey reveals metal fabrication growth spurt for 2023

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Inertia is a powerful thing. After a pandemic, supply chain chaos, severe labor shortages, and everything else, will 2023 and the rest of the 2020s really be just a return to the status quo? Or will the industry overcome inertia and usher in a new era of precision metal fabrication?

To answer that question requires a careful look at the status quo and how it's changed over the past few years. And here's where a key report from the Fabricators & Manufacturers Association (FMA) can help. Late last year, FMA released its "Financial Ratios & Operational Benchmarking Survey," an annual report that explores the financial realities of custom metal fabrication. The sample size is small (fewer than 50 shops), but each operation dives deep into its financials. It's a window into an industry dominated by private companies. The most recent survey reveals an industry holding steady through tumultuous times. Challenges remain, but all in all, it's not a bad time to be in the metal fabrication business.

Note that metrics quoted hereafter refer to the fiscal year, not the year of the survey. Numbers from the 2021 fiscal year were reported in the 2022 survey; the 2020 fiscal year was reported in the 2021 survey; and so on. Also know that averages for certain metrics come from a wide variety of responses. This mainly comes from the range and number of customers shops have. Medical customers demanding precision sheet metal work differs greatly from heavy equipment OEMs that contract out heavy cutting and bending. And if a shop has only a handful of customers, one large account pulling its work can wreak havoc on a shop's financials for a particular year.

Revenue concentration has been this industry's Achilles’ heel. Of course, fabricators want large contracts so they can fill capacity and build a predictable business. But they need enough of them, ideally from a cross section of industries, to ensure long-term stability.

According to the FMA survey, many shops have seen an increase in revenue concentration over the past few years. On average, shops received half their revenue from eight customers in 2019 and 2020. In 2021, that number dropped to six.

That metric isn't surprising considering sales growth averages in recent years, and the fact that most of this growth is coming from existing customers (more on this in a bit). In 2018, sales growth screamed ahead at 13.7% before decelerating to 8.2% in 2019. Then 2020 happened, and sales dropped 13.9%—not bad, all things considered. Finally, sales growth rocketed skyward by 34.9% in 2021. Most impressive, nearly 60% of respondents said their 2021 sales growth surpassed 25%.

Anecdotally, I’ve heard many shop sales managers say that current customers are driving much of the sales growth, and the numbers from the survey back up this assumption. According to the latest report, new customers represented just 3% of overall revenue.

Steve Zerio, a partner at Triumph Partners LLC and member of the FMA Management Advisory Council, gave insight in his commentary that opened the study: "It makes sense when struggling to hire operators and deliver on time that adding new customers was not a possibility for many fab shops."

Meanwhile, average quote turnaround time has been rising, from 4.5 days in 2019 to 5.7 days in the most recent survey. Quoting departments are as strained as customers are, and customers might take longer to answer questions or provide clarification. Average win-to-bid ratios dropped too, from 37% to 24% in the most recent survey. Again, win-to-bid ratios vary greatly, as do quote turnaround times, depending on the shop's customer mix and type of work being bid upon.

It's not as if fabricators are hungry for more work. Their current customer mix is keeping them plenty busy, even though on-time delivery might be suffering—no surprise, considering the well-known supply chain challenges. According to the survey, average on-time delivery held at 85% in 2019, 87% in 2020, then dropped to just 77% in the most recent report.

Such an environment rewards those who master the art of cash flow. As Zerio explained in his commentary, "The strong cash management practices seen in survey results in prior years likely played a key role in helping survey participants ride out a chaotic 2021 ... Days sales in accounts receivable improved to 46 days outstanding, down four days from 2020."

Material costs rose, yet shops didn't pass all those costs on to customers. Average direct material costs represented 39% of sales, up from 34% the prior year. Moreover, average inventory turns are down—again, no surprise considering the supply chain uncertainty and the ballooning of raw-stock, just-in-case inventory. The average number of turns annually is 10.7, down from 18.5 in 2019. All that ties of up significant cash, which makes it even more important to keep work-in-process inventory on the move.

And judging by sales-per-employee and labor ratios reported in the latest survey, employees are proving their worth. In the face of rising wages, direct and indirect labor costs actually fell as a percentage of overall sales. Average labor costs (direct and indirect labor combined) fell from 25.7% to 22.7% of total sales. Also, average direct labor cost—again, as a percentage of overall sales—is as low as it's been in recent memory, at only 14.4%. Individuals might be paid more, but collectively they’re producing more too. (There's one caveat here: Considering the inflation and wage increases experienced more recently, the jury's still out as to whether this labor cost trend continues.)

Meanwhile, sales per employee skyrocketed from $208,027 to $242,100. And considering shops aren't passing all material-cost hikes on to customers, not all of the sales-per-employee boost can be attributed to material inflation.

The industry is as competitive as ever, of course. Isolated cases aside, metal fabrication isn't an industry full of windfall profits. The average earnings before interest, taxes, depreciation, and amortization (EBITDA) margin was 9.8% in the most recent survey, in line with previous years. Shops are staying competitive as everyone on the payroll provides more value and gets the most out of software automation in the office and machine automation in the shop, all of which complements never-ending continuous improvement.

Metal fabrication isn't a place for those looking to make an easy buck. Zerio put it this way in his commentary: "Overall, survey participants prospered nicely in 2021, but had to work hard to do so. The worker recruiting and supply chain issues have continued into 2022 and will likely remain as top challenges for years to come. However, FMA member companies are strong and well-run, and survey participants continue to show good operating and financial performance."

Considering the sales growth numbers, as well as just how much value people in this business produce, metal fabrication isn't a bad place to be.