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Boral’s US Windows Issue Bothers Brokers

Australia | Dec 09 2019

Boral has identified financial irregularities in its North American windows business and brokers expect the investigation to weigh on the stock for some time.

-Was there a substantial deterioration in US windows in FY19?
-Investigation likely to overhang the stock until findings released
-Macro economic conditions are soft in Australia


By Eva Brocklehurst

Boral ((BLD)) is in a spot of bother. The company has identified financial irregularities in its North American windows business and has retained lawyers and forensic accountants to investigate further while still assessing the impact.

The windows business, part of the Headwaters acquisition in 2017, is financially separate from the rest of Boral and generated US$158m in revenue in FY19, or around 15% of US building product revenue.

Hence, as Macquarie points out, the initial estimate of a -US$20-30m impact to operating earnings (EBITDA) from mis-reporting is significant. The discrepancies relate to inventory, raw materials and labour costs. Moreover, as US building products earned a 16% operating earnings margin in FY19, UBS suggests this original estimate of the impact could reduce profitability in the windows business to zero.

Headwaters only acquired the windows business in late 2016, for US$240m, just ahead of the Boral takeover. This was one of three divisions that did not have any overlap with Boral's existing US business, the others being blocks and energy technology.

The former has since been sold and energy technology makes a minor contribution to revenue. Hence, Boral is confident the irregularities are contained to windows. UBS understands Boral did not integrate windows because the division was deemed non-core.

Why 14 months?

The mis-reporting of the financials relates to 14 months from September 2018 to October 2019. Brokers query why the division was able to mis-report for some time before this was uncovered, and Citi suspect it will raise credibility concerns for management.

UBS recently downgraded to Neutral, citing concerns about the earnings skew to the second half, that was partly the result of reduced traction in the US building products division. The broker believes, ultimately, this latest development will weigh on an already poor market perception of the Headwaters acquisition and prevent the stock from re-rating higher.

Citi agrees, believing the investigation will act as an overhang until the findings are released. Morgan Stanley, meanwhile, had highlighted the decline in US earnings over the last two years, ex synergies, and expects this will prompt a further review by investors of the US operations.

The broker points to the complexity of the company's organisation and the potential value creation that could occur from streamlining. In the short term, Morgan Stanley agrees negative sentiment will weigh on the share price.

Credit Suisse, while noting the windows division falls outside of central finance functions, flags the fact Boral conceded amid further questioning that fly ash is also partly decentralised. Hence, was there a dramatic deterioration in windows in FY19? Or was past profitability overstated?


Ord Minnett remains increasingly concerned about the outlook for the North American division and assesses the return on funds employed now appears to have been shy of 5% in FY19, raising the risk of impairments at some point.

While Boral Australia is a better quality business, the broker notes the cycle is working against it. Ord Minnett downgrades to Lighten from Hold on the back of re-basing North American earnings, and lowers earnings forecasts for Boral Australia in the light of soft macro economic conditions.

Citi anticipates consensus estimates for operating earnings will be downgraded and has reduced its FY20 forecasts for earnings per share by -7.7%. At this stage FY21 forecasts are unchanged.

FNArena's database has four Hold ratings and one Sell (Ord Minnett) for Boral. The consensus target is $4.59, signalling -0.4% downside to the last share price. This compares with $4.84 ahead of the announcement. The dividend yield on FY20 and FY21 forecasts is 4.6% and 5.0% respectively.

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