Solid Short-Term Outlook For Brickworks

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

Brickworks continues to derive benefit from strong construction activity on Australia's east coast but, beyond the next 6-12 months, the outlook is more uncertain.

-Rising energy costs envisaged eroding margins in FY18
-Property earnings and profits expected to ease from highs
-Strong building product order book, not expecting demand to slow for 12 months
 

By Eva Brocklehurst

Brickworks ((BKW)) is confident in the short-term outlook for building products, particularly on Australia's east coast. Nevertheless, brokers consider the outlook becomes more uncertain as FY18 progresses, because of higher energy costs and slowing building activity.

Macquarie assesses the headwinds to growth are very real. Rising energy costs are removing the shine from building product margins while property & development profits are expected to decline. The broker observes the stock has de-rated, down -12% since May, and is trading below historical norms, while there are no clear catalysts to drive a re-rating, given the context of these headwinds and a mature building cycle.

Still, Macquarie likes the fact the company moved pre-emptively to secure price increases to offset a $20m annualised energy cost impost, predominantly involving the brick business. An average price increase of 6.6% has been realised across brick operations as of July 1.

Morgans flags the good exposure to the residential construction market which has served Brickworks well in recent years. While the slowing of activity and higher energy costs should be mitigated by the company's cross holding in WH Soul Pattinson ((SOL)), and land & development activity, the stock appears fully valued at current levels.

Rising energy costs may be offset by strong price increases across the portfolio but Bell Potter suggests this will only be sufficient to cover increasing gas electricity costs, leaving little margin for cost inflation across other inputs, or for declining activity levels.

As such, the broker expects relatively flat earnings for building products in FY18. In contrast, the broker is very positive about the property pipeline, as higher development activity is underway at both Oakdale Central and Rochedale.

The company is also seeking bolt-on acquisitions and Macquarie assumes its intentions are to augment the building products portfolio with niche products.

Building

Underlying operating earnings (EBIT) declined -13.7% for building products in FY17 as the contribution from Western Australia was down by – $12m and only partly offset by higher earnings of $7.3m from the eastern coast.

Deutsche Bank is concerned about this decline, although acknowledges the negative contribution of Western Australia in FY17, where the business is undergoing a restructuring, and a -$5m impact from Cyclone Debbie, both of which are unlikely to be repeated. In response to the difficult conditions in WA the company has undertaken significant restructuring activity and closed six plants, placing the business in a better position to operate capacity in line with demand.

Management expects the east coast to stay strong, given what is in the order book for the next six months, while its builder customers do not expect demand to slow for the next 12 months. As housing demand on the east coast is still robust and the company has managed to deliver 2017 price increases to more than offset cost increases, Deutsche Bank believes 110 basis points of margin expansion is still likely in FY18, to 9.6%.

The broker accepts increasing energy costs are a heightened concern for the second half onwards so does not expect margin expansion beyond FY18. The company increased its dividend, continuing a track record of longer-term increases.

Property & Development

Land & development revenue for FY17 increased significantly, to $78.3m from $2.4m in FY16. The result was primarily driven by higher contributions from land sales. Citi expects lower earnings in property will occur in FY18 because there are no plans for major land sales.

Property trust distributions increased 20%, supported by completed developments. Macquarie observes the sale of Oakdale West has created a high base in FY17 which is not likely to be repeated.

Bell Potter expects a further 120,000 square metres of development to be completed in FY18, leading to a forecast $20.8m in rental income and a forecast net asset valuation for the company share of the trust of around $540m. Acknowledging earnings will be lower in FY18 because of a one-off substantial land sale in FY17, excluding that item, the broker expects comparable earnings should be well ahead.

Bell Potter, not one of the eight stockbrokers monitored daily on the FNArena database, reduces its price target to $13.85 from $14.38. Stripping out the post-tax Washington Soul Pattinson ((SOL)) contribution and property valuations, the implied valuation sits within the broker's blended target range and, hence, a Hold rating is retained.

FNArena's database has one Buy rating (Deutsche Bank) and three Hold. The consensus target is $14.53, suggesting 5.7% upside to the last share price the dividend yield on FY18 and FY19 forecasts is 4.0%.
 

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