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Boral And CSR Go Separate Ways On Bricks

Australia | Nov 01 2016

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Boral and CSR will disband their joint venture in bricks on Australia's east coast. Brokers declare the decision a win for both parties.

-Deal multiple considered supportive of CSR's building products expansion
-Well timed transaction for Boral, allowing easier transition to infrastructure activity
-Affords CSR greater control over property and plant


By Eva Brocklehurst

Boral ((BLD)) and CSR ((CSR)) will disband their joint venture in bricks on Australia's east coast, with CSR acquiring Boral's 40% stake for $133.9m including $7.5m in loan repayment. The JV was initiated in April 2014 and from Boral's standpoint the bricks business is now considered non-core.

Deutsche Bank believes the deal is 3% accretive for CSR and 2% dilutive for Boral in FY17. Boral continues to own the Midland brick business in Western Australia, which the broker expects to break even at best. After the JV divestment, Boral’s FY17 net debt is reduced to 0.9 times net debt/EBITDA (earnings before interest, tax, depreciation and amortisation).

The move to full ownership of the east coast bricks business is in line with CSR's strategy to grow its building products business and the broker finds the FY17 enterprise value/EBITDA multiple attractive, particularly given its view Australian housing activity will remain robust for the next 18-24 months.

The main downside risks Deutsche Bank envisages for Boral are declines in the Australian & US housing sectors and increased import competition in cement. For CSR the downside risks include softer aluminium prices, a slower recovery in Viridian Glass and a decline in the Australian housing sector.

Credit Suisse downgrades CSR's rating to Neutral from Outperform. The acquisition reduces the relative importance of the highly volatile aluminium business, while the broker also notes financial discipline was maintained and the acquisition multiple commensurate with near-peak cycle earnings.

The broker believes housing is approaching its cycle peak and, in conjunction with the emerging competitive threat in plasterboard, remains cautious on the medium-term outlook for CSR. Importantly, revised aluminium assumptions suggest that Tomago aluminium smelter, part owned by CSR, will be near break-even in 2019. The broker does not consider this development is appropriately reflected in the prevailing share price, despite the potential for a favourable outcome in terms of Tomago's electricity contract renewal.

For Boral, while the company has been criticised for a lack of capital discipline over the past decade, Credit Suisse believes this is a well-timed transaction, citing management's awareness of the cycle and the losses incurred in the bricks business in FY12-13 when housing last troughed.

Cash proceeds should improve an already under-geared balance sheet. The broker surmises that surplus balance sheet capacity could be used for acquisitions in the US, investment in a cement import terminal in Victoria or investment to enhance its quarry position, as well as capital management via a buy-back.

Post this transaction, Boral retains its WA brick business, which the broker suspects will eventually divested. Credit Suisse flags the precipitous decline in WA housing activity, which implies there will be some variable views around asset valuation, and estimates the value of this business at $25-75m.

Boral should continue to benefit from strong residential construction activity and the emerging road and infrastructure cycle, complemented by an improving US business and strong momentum in gypsum. While all this adds to the stock's appeal Credit Suisse looks for a cheaper entry point and retains a Neutral rating.

Macquarie considers the valuation outcome of the sale reasonable for Boral, with its medium-term outlook supported by an elongated residential cycle which is making the transition to infrastructure-driven activity easier to manage. At the upcoming AGM the broker suspects there could be some negative impact from an aggregate of 12 days of more than 10mm rainfall across key markets in Sydney and Melbourne, but expects positive commentary on residential activity and the outlook for infrastructure.

CSR, meanwhile, may be buying a cyclical asset near the high point in its earning potential, but Macquarie believes the transaction reflects a reasonable valuation. A key support for the acquisition is the exposure to a more resilient detached residential building market. It also affords CSR greater control over the property and plant, the broker asserts, as CSR's position in bricks is attractive in the context of the property angle it offers while the structural challenges in the industry are likely to remain.

Boral has a $6.76 consensus target on FNArena's database which signals 8.9% in upside to the last share price. Targets range from $6.07 to $7.10. There are two Buy ratings, three Hold and one Sell (Morgan Stanley). For CSR there are two Buy, one Hold and three Sell. The consensus target is $3.58, suggesting 1.4% downside to the last share price. The dividend yield on CSR's FY17 and FY18 forecasts is 6.8% and 6.0% respectively.

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