Australia | Nov 28 2018
A slowing Australian housing market has made brokers cautious about Brickworks, although the company has signalled an expansion strategy in the buoyant US market.
-Building product earnings materially weaker in the first half
-Glen-Gery a beachhead for expansion in the US
-Large US market should create long-term growth prospects
By Eva Brocklehurst
Earnings from its property portfolio have put Brickworks ((BKW)) on a firm footing, while the expansion strategy in the US has triggered interest. Brickworks has guided to higher property earnings amid a moderation in building products in the first half.
The company expects property revaluation benefits will be forthcoming, reflecting continued cap rate compression in the industrial market, particularly Sydney. Completion of Oakdale South is also expected to contribute to profits. Property earnings will be skewed to the first half, supported by the sale of the Punchbowl site. The company is forecasting a record result for the full year.
Meanwhile, building products are materially weaker in the first half. Wet weather affected in NSW affected building products in October although this was countered by better weather in November. In contrast, Brickworks observes demand in Victoria is at unprecedented levels.
The company has indicated credit availability has affected demand yet fundamentals remain supportive for new housing construction, with solid employment, low interest rates and high immigration levels.
Energy costs are expected to increase by $11.7m in FY19. The company has experienced increased manufacturing costs as energy prices have an impact. There have also been some one-off production problems which have now been resolved.
Macquarie observes the property portfolio should continue to offset building products, although there is a lower degree of visibility and significant lumpiness around the earnings impact. Still a slowing Australian housing cycle makes the broker cautious on the investment outlook.
Morgans expects the increase in property earnings and the recent Glen-Gery acquisition will more than offset a decline in Australian building products. The broker increases FY19 property operating earnings estimates (EBIT) by 28%.
Given the significant premium to the sector, Citi envisages there is limited valuation upside for the stock, despite the fact that the strong November performance stood out in a sector battered by downgrades and soft macro data.
Brickworks has acquired Glen-Gery for $151m, funded by debt. Glen-Gery is a US-based brick manufacturer, the number four, and the deal provides exposure to a market that is around 3x larger than the Australian market. Citi calculates the acquisition is accretive while, strategically, it should provide diversity and potential growth in a fragmented market.
Morgans points to a strong tradition of brick in the US in both residential and commercial applications. Macquarie was surprised by the acquisition, noting that the company envisages Glen-Gery as a beachhead for expansion in the US.
Yet, while there appears to be opportunities to improve efficiencies, the broker contends that the intensity of brick use is under pressure in the US, and the geographical separation from existing operations mean synergies are limited.
Macquarie is of the opinion that Brickworks could be better placed by building out its core competency through a diversification strategy. Nevertheless, this is not a large transaction and the company will keep the existing Glen-Gery team while assuming leadership, which reduces risks.
Morgans is more keen, citing supportive tax policies, a proactive energy policy and efficient transport infrastructure in the US. The company's focus is on improving efficiencies at Glen-Gery, partly through investment and extension of ranges.
Glen-Gery has sales exposure to non-residential activity of 49% and limited multi-residential exposure of 13%. The acquisition does not alter the investment thesis meaningfully, although Macquarie is intrigued by the strategic aspect, which signals growth options may have been limited for Brickworks.
Morgans believes, given the tough operating environment in Australia, expansion in the US is a good strategy and the larger market should create long-term growth prospects. The broker points out Glen-Gery will only contribute around eight months to FY19 earnings and the first half is expected to be negative because of plant shutdowns and lower sales during winter months.
FNArena's database has three Hold ratings and one Buy (Deutsche Bank, yet to comment on the AGM or acquisition). The consensus target is $16.93, suggesting 5.7% upside to the last share price.
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