Brickworks Expected To Weather WA Downturn

This story features BRICKWORKS LIMITED, and other companies. For more info SHARE ANALYSIS: BKW

Investments and record east coast building activity are expected to help Brickworks weather the downturn in Western Australian construction, but some headwinds are on the way.

-Medium term more uncertain because of higher energy costs and slowing residential building
-Reduced building activity should be offset by income from associates and investments
-Capacity constraints also envisaged affecting building product earnings growth
 

By Eva Brocklehurst

Building products and investments company Brickworks ((BKW)) is counting on investments and record east coast building activity to pull through the trough in Western Australia, where the business has a significant presence.

The company's first half result was well ahead of most expectations and brokers consider the short term outlook remains positive, although the medium term is more uncertain because of higher energy costs and the potential for slowing in residential building activity.

Building products were weighed down by continued weak activity in Western Australia, although bricks recorded impressive growth, Bell Potter observes. The company has a large presence in Western Australia and record levels of construction activity on the east coast work were required to almost, but not completely, offset the decline in west coast developments.

West coast developments declined 30% in the first half, the broker notes. Although suspecting the worst is now behind Western Australia and the company will emerge in better shape following a significant restructuring, Bell Potter suspects it will take some time for excess capacity to be worked through.

The broker believes the building products division still presents value when compared with listed peers, and property and investment will provide a solid earnings base in the event of a construction downturn. Bell Potter, not one of the eight stockbrokers monitored daily on the FNArena database, has a Buy recommendation and $14.95 target.

Interim underlying earnings rose 44% and underlying net profit rose 48% in the half. The building products division produced an improved result but the main feature was land and development (earnings up 48%), as well as associates and investments (earnings up 78%).

Austral Bricks delivered earnings growth of 17% while there was a small increase in earnings for Austral Masonry. Morgans notes this was partially offset by weaker earnings from Bristile Roofing, Austral Precast and Austwest Timbers.

The investments division is expected to deliver steadily increasing earnings and dividends over the long-term. Morgans expects land and development earnings to normalise from FY18, which will also coincide with a slowing in building activity. This should be partially offset by stable expectations from associates and investments.

The company's 17.0c per share dividend continues the record of increasing over the long-term and the balance sheet remains in good shape, Morgans observes.The broker considers the stock to be fully valued at current prices and retains a Hold rating.

Investment Earnings

Building products earnings will be challenged over the next few years as the cycle peaks but Morgans expects this to be mitigated by the company's cross holding (42.72%) in WH Soul Pattinson ((SOL)) and increased land and development activity. Dividends from the investment were up 3.3% on the prior corresponding period.

The rally in thermal coal prices was observed to be the most significant driver of the rise in earnings from the company's investments, and the sale of the Oakdale West site into the property trust added an extra $50m in earnings in the property division.

Results were also ahead of Macquarie's expectations. The broker notes that, beyond 2017, higher energy costs will impact margins and, with a projected $20m increase from energy costs looming in FY19, Brickworks continues to evaluate alternative gas and energy options. Macquarie does not expect it will be easy, especially as the full impact of higher gas prices and higher electricity costs annualise.

Capacity Constraints

The company flagged a full order book for FY17, with a long pipeline of work at higher margins in major east coast markets, yet acknowledged sales volume is failing to keep pace with orders as the housing industry is operating at capacity in the east coast and being limited by supply chain, trade shortages and a lack of titled land.

Macquarie assesses that shortages of bricklaying capacity are not the issue, rather it is the broader absorption of skills into multi-residential activity which appears to be affecting the growth trajectory. As multi-residential activity slows, the company expects this could alleviate some of the constraint in detached housing activity.

In any case, Macquarie suspects macro factors will get the better of broader growth. The broker believes the stock has progressively de-rated to a point where the valuation is well below its historical trading range relative to the ASX 200 industrials. While this appears attractive, Macquarie is wary that earnings pressures are mounting.

While it is conceivable that profits in the land and development portfolio could sustain earnings in the face of a slowing building market, the broker believes the quality of visibility associated with this profit source makes the stock less attractive when considering the overall earnings profile.

Top-line growth in building products appears increasingly dependent on price while bottom-line growth will be affected by energy costs, in Macquarie's summation. Hence, the broker maintains a Neutral rating.

Of importance for the second half, Deutsche Bank points out Western Australian housing has stabilised in the last few months. Because of seasonality, second half earnings usually increase by around 200 basis points and the broker expects solid margin expansion in the second half will be forthcoming. Deutsche Bank expects an increase of 4% in FY17 earnings, noting price increases of 5-8% is were announced for July 2017.

There is one Buy recommendation on FNArena's database (Deutsche Bank) and three Hold. The consensus target is $14.91, suggesting 5.4% upside to the last share price. Targets range from $13.62 (Morgans) to $16.08 (Deutsche Bank).
 

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