That said, there are several developments which may serve to dampen activity, such as:

• Supply chain disruption—Continued shortages of key inputs, delivery delays, and higher transportation and logistics costs.
• Geopolitical risk—Further sanctions against Russia and the evolution of the war in Ukraine will impact a variety of commodity prices and end markets for globally traded goods.
• Commodity and raw material pricing—Volatility and increases in raw material costs could damage profits and create uncertainty for manufacturers (see chart below). 
• Labour shortages—Continued labour shortages that lead to diminished production capacity and increased strain on staff.

All of these have potential to significantly impact revenue and profitability, notwithstanding strong consumer demand. In brief, there are a great number of manufacturers that simply won’t have as many products to sell in the near term or their products will cost more to produce, hindering financial performance. For the purposes of M&A, uncertainty is a risk and is likely to yield adjusted valuations, altered deal structures, and longer deal processes.

Last year was a record year for global M&A activity, and much of that momentum carried into the first quarter of 2022. In the remainder of this year, we expect deal activity to remain robust (albeit perhaps not as strong as last year), driven by the same fundamental factors that have supported manufacturing deals for several years now.

We see many forces that would support strong M&A opportunities in manufacturing, such as:

• Robust capital markets—Notwithstanding recent and expected increases in the Bank of Canada’s overnight rate, the cost of capital remains relatively low. Further, banks and alternative lenders are actively seeking opportunities to place capital, with many of them keen to support M&A transactions. In short, there is a lot of capital in the market to support deals (see chart below).
• Strong consumer demand—While Canadian lifestyles will continue to shift following the COVID-19 pandemic, demand from end market consumers appears to remain resilient.
• Demographics—The demographics of Canada’s business owners means that many of them will look to sell in the near term and this will likely play out for several years ahead.
• Robust and expanding buyer population—Dry powder sitting on the balance sheet of corporations as well as a growing population of private equity investors, family offices, search funds, and alternative capital providers offer attractive exit options for owners.

“We have several manufacturing businesses in our portfolio, and reshoring is actually front and centre for us as we look at the longer-term strategy for these businesses. When it comes to offshore manufacturing, it was only about cost for a long time. If something cost us $1 to manufacture overseas, it cost say $1.50 to manufacture domestically and that drove decision making. Now, we also need to consider the weighting of other, qualitative factors, such as reliability and certainty of supply. Also, lead times have increased. It’s easy to think of the labour shortage as a domestic issue, but it’s affecting suppliers around the world. To add to it, costs are increasing overseas as well. So where the cost advantage is diminishing, and the supply is less dependable, reshoring becomes a very practical solution to drive stability.”

“As we look at new acquisitions, one place we’re seeing supply chain disruptions play out is in working capital. We see elevated levels of working capital on company balance sheets—even for businesses that are in great shape as they respond to supply uncertainty. Over the past few decades, the expansion and integration of global supply chains has allowed manufacturers to run with leaner levels of working capital, but we can see this reverting to what may be new normal levels in this environment. When it comes to practically getting deals closed, we’re looking at shorter historical periods to set a working capital target, and we’re dealing with working capital much earlier in the process to avoid letting it become a late-stage surprise. We’re also interested to see how manufacturers are increasing prices on their products. It’s a reality most businesses are facing. And for us to get comfortable with forecasted margins, we really do need to see how businesses will pass price increases through to their customer base."

Supply chain challenges are acute and still unfolding. Manufacturers face near-continuous global disruptions that add new costs and test their ability to adapt. Purchasing manager reports continue to reveal systemwide complications from high demand, rising costs of raw materials and freight, and slow deliveries. In addition, North American manufacturers and distributors that remain dependent on foreign suppliers from Asia and other parts of the world continue to face challenges on multiple fronts from ongoing chip shortages to transportation uncertainties (e.g., the Suez canal blockage or rail and port strikes) and rising transportation costs.

After years of the notion of reshoring inspiring much discussion but relatively little real change in direction, the current global situation has many manufacturers seriously considering restructuring their supply chains. There are several reasons to consider doing so, such as: reducing business risk by simplifying the path from producer to end customer, reducing lead times, and reduced inventory requirements, among others.

One of the first places this comes up in M&A is in due diligence, where buyers and their financing partners need to assess the risk in a manufacturer’s supply chain and make any adjustments to valuation or structure accordingly. The theme emerged during the early days of the COVID-19 pandemic, and persists as a key risk to understand as supply chain issues have worsened. It’s also inspiring some manufacturers to look for integration opportunities, and acquisitions that help secure channel access either up or down the supply chain.

Environmental, social, and governance (ESG) issues are continuing to become a bigger topic amongst manufacturers across Canada. Private equity funds and other acquirers increasingly view ESG as a key metric when evaluating transactions, but reporting on ESG status and progress remains a challenge for many businesses. Most industries don’t maintain the same ESG standards, allowing companies to tailor their approach to what matters to them. Further, many businesses have difficulties quantifying the results of their efforts. However, as measurement and reporting issues are worked out, ESG priorities will become an increasingly important part of a business’s value proposition with multiple stakeholders, such as:

• Customers—Businesses are increasingly subject to contractual ESG requirements though government, municipal, commercial, and institutional contracts. In addition, more and more end consumers are looking to understand the environmental footprints of the brands they purchase.
• Insurance providers—ESG requirements are becoming a larger part of the risk profile reviewed by insurance companies when determining premiums.
• Financing partners—Companies engaged in actively improving their ESG metrics may have access to additional financing opportunities compared to those that don’t.
• Talent—Workforce and employee satisfaction have become increasingly important as skilled labour is in short supply, and employees think more about the social impact of their employer.

A strong and up-to-date ESG framework will reduce the risk profile for a manufacturer, thereby improving or supporting valuation metrics considered by buyers. As the industry continues to be reshaped by sustainable business practices, conveying these organizational goals to stakeholders will become more important.