GRACE MATTHEWS INSIGHTS

As the new year continues to unfold, we are embracing the growing sense of optimism for an uptick in M&A activity for manufacturers, distributors, and service providers in the broader chemicals & materials science value chain in 2024. While 2023 was a robust, near-record year for Grace Matthews, we recognize this was an anomaly relative to industry trends, as deal volume in the chemicals & materials science industry experienced its second consecutive year-over-year decline and was down by almost one-third from the peak of 2021.¹ Many factors (rising interest rates, inflationary pressures, and pricing increases, to name a few) contributed to a challenging 2023 M&A environment, but one phenomenon touched nearly every company we worked with or spoke to: inventory destocking and its negative impact on demand. As we sit here today more than halfway through the first quarter, we are taking this opportunity to examine, is inventory destocking behind us, and does that mean the industry is entering a period of “normalized demand”? If so, will the potential end of destocking serve as a catalyst for volume and revenue growth and, subsequently, increasing M&A activity in 2024?

If you rewound to the start of 2023, the very concept of inventory destocking would have seemed counterintuitive. At that time, the chemicals & materials science industry was still navigating lingering effects of sequential, compounding shocks, beginning with COVID-19 shutdowns throughout 2020 into the Texas freeze of early 2021 and transitioning into freight and supply chain issues that lingered throughout 2022. A common point of emphasis was supply chain security, which often meant carrying elevated levels of inventory. From manufacturers’ ability to secure key raw materials to distributors carrying select finished goods to service providers capable of avoiding disruptions for their customers, if you had product in 2021-2022, you were able to generate profits (and, in many cases, command a premium). However, as 2023 unfolded and supply chain issues eased, inventory management became a new strategic emphasis. Improved working capital management, particularly relating to inventory levels, was a common organizational priority; for example, we saw compensation plans and bonus structures place more emphasis on reducing working capital and improving free cash flow, which incentivized everyone from purchasing agents to operations managers to drive down inventory levels. In normal times, working capital management is often an M&A arbitrage opportunity, as PE-backed and public companies may look at working capital levels differently than entrepreneurs, who may not be as concerned with the cash impact of higher working capital.

Throughout 2023, as the ripple effect of destocking began to work its way through the value chain, volatile demand patterns impacted the broader industry. Few companies escaped delayed or canceled orders, uncertain guidance from top customers, and prolonged and often unexpected demand weakness relative to recent years. For most, visibility into near-term performance, which in recent years had effectively already gone from navigating a sunny road to driving in a thunderstorm, was now hindered even further (think driving through a snowstorm in the mountains). Companies looked for clues from customers into demand patterns, and these customers could often only point to their own end users as the reason for delayed orders or a downward trend in volumes as the impact worked its way through the value chain.