Infrastructure Expenditure Underpins Boral

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The outlook for Boral is increasingly reliant on the upside in infrastructure amid a soft residential market.

-Infrastructure, non-residential activity unlikely to offset a decline in residential in FY20
-Benefits from quarrying and asphalt capabilities in Victoria expected
-Low probability of further asset sales in current conditions

By Eva Brocklehurst

Brokers heaved a sigh of relief as Boral ((BLD)) provided no changes to FY19 guidance at its investor day. Given March quarter residential activity in both Australia and the US was soft, a result roughly in line with guidance is considered likely to be greeted positively by investors.

The company is targeting additional cost savings to offset softer market conditions. The absence of a downgrade was the most significant news from the investor briefing, in Morgan Stanley's view, noting Boral is currently guiding for FY19 earnings, excluding property, to be similar to FY18.

Still, Deutsche Bank warns that Boral has indicated that outcomes are contingent on a strong June. For the first time, management also conceded that rises in infrastructure and non-residential activity is unlikely to offset a decline in residential business in FY20. Weakness is likely to be particularly acute in NSW, the company's largest revenue region and the one with the highest margin. Typically, infrastructure work has lower margins than residential.

The main bright spot, Credit Suisse notes, is the outlook for asphalt, although this is lower margin than cement/concrete. Yet a poor recent track record and impending cyclical downturn means the broker downgrades to Underperform from Neutral. Credit Suisse expects margins to decline in segments with lower volume, noting a declining outlook for concrete demand in Australia.

Management considers it too early to gauge the traction from price increases in April and Ord Minnett observes the outlook in some market segments, such as south-east Queensland and NSW apartments, is becoming more challenging. Macquarie agrees there are mounting risks in NSW and Queensland and, while a recovery in detached housing demand could be an offset, risks exist if Boral is unsuccessful in securing the WestConnex 3B stage (NSW).

The next phase of the infrastructure story is in Victoria, where the company expects to benefit from quarrying and asphalt capabilities. Margins are likely to be lower in Victoria, Macquarie points out, given the weaker integration across the value chain.

Ord Minnett expects free cash flow will improve materially in FY20 as growth persists in the US and capital expenditure moderates in Australia. While lowering earnings forecasts overall, to reflect a softer outlook for volumes and prices, the broker considers the stock remains attractively priced relative to peers.

The broker acknowledges former expectations for flat volumes through to FY21 appear too optimistic and declines of around -3.5% are now expected in both FY20 and FY21. While the company may be on track to achieve FY19 guidance, favourable weather conditions remain a prerequisite in what is a seasonally important period in the US and Australia, Macquarie asserts.

The company is "rightsizing" the business, UBS believes, as exposure to infrastructure work rose to 46% of revenue, from 36%. Longer term, Morgan Stanley, too, likes the Australian infrastructure exposure and upside from the US, particularly the fly ash business.

Plasterboard JV

The value in the Asian plasterboard JV is becoming clearer, with synergies from plant utilisation and freight noted. Boral's preferred option, to return Australasian business to 100% ownership and expand the JV in Asia with Knauf, has progressed and there is greater clarity on the likely structure, with the company maintaining its preference for funding via debt and asset sales as opposed to a capital raising.

Ord Minnett estimates Boral could pay around $800m without asset sales for the plasterboard business, leaving leverage at the top end of management's target range.

Asset Sales

Macquarie has considered the possible implications of asset sales, assessing there is a preference for selling the remaining elements of the Australian building products operations over anything meaningful from the US portfolio. Boral's Australian building products portfolio generates annualised revenue of around $340m but is experiencing declining profits and higher costs. The US windows business generated annualised revenue of just under US$150m in the first half.

While assessing sale options, the broker asserts that the prospect is a pretty low-probability event. Selling the building products portfolio as a package would be extraordinarily difficult. Market conditions in Western Australia, where these businesses have significant exposure, are far from comfortable. Meanwhile, a review of the property portfolio has led Macquarie to the conclusion that the pipeline is long-dated. The broker increases estimates for average earnings from property to $30m from $20m.

FNArena's database shows five Buy ratings, one Hold and one Sell. The consensus target is $5.77, signalling 8.3% upside to the last share price. The dividend yield on FY19 and FY20 forecasts is 4.9% and 5.1% respectively.

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