Adelaide Brighton Opts For Caution

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Adelaide Brighton is more cautious than its peers regarding a recovery in Australia's residential construction market, suspecting 2020 will remain subdued.

-Final dividend reinstated
-Highly leveraged to housing activity but rebound not anticipated until 2021
-Does the risk/reward profile compensate for structural challenges?
 

By Eva Brocklehurst

Cement and aggregate producer Adelaide Brighton ((ABC)) anticipates a subdued Australian construction market throughout 2020, noting a soft start to the year because of the impact of bushfires and extreme weather.

The company was circumspect about the timing of a recovery in residential construction compared with its peers such as Boral ((BLD)) and GWA Group ((GWA)), Morgans observes.

Adelaide Brighton assesses consumer sentiment is poor and has been further affected by the bushfires and coronavirus. Low wage growth and the challenges in accessing funding are also factors that will prevent investment in housing. However, the longer term outlook for population growth on Australia's east coast is expected to drive an eventual recovery.

There was a pleasant surprise with the 2019 results, as the company reinstated a final dividend. The dividend represents a pay-out ratio of 68% of reported earnings per share, in line with the policy. Macquarie calculates this would amount to a -$32m cash outflow.

Increased cement, lime and aggregate volumes were offset by weak earnings from joint ventures and the concrete margin as well as lower near-term property earnings. Management has provided maiden guidance for 2020, with net profit ex-property expected to be down -10% on 2019. This incorporates a net $10m benefit from cost initiatives.

Joint ventures were weaker than Morgans expected, while earnings were down -16% and are expected to decline further in 2020. The ability to acquire the remaining 50% of Mawsons has been noted in the accounts as an unrecognised contingent liability. Mawsons is the largest pre-mixed concrete and quarry operator in northern Victoria and also operates in southern NSW.

South Australia

The main pressure point is South Australia, where competitive intensity is affecting volumes and prices. Ord Minnett cites risks around cement import competition, particularly in South Australia, which weighed heavily on earnings in 2019. The broker envisages the risk that further import capacity is added in coming years.

However, Citi upgrades to Neutral, noting the balance sheet has been restored and the re-basing of the South Australian market, after the entry of a new cement importer and distributor, has resulted in more stability.

Nevertheless, the broker highlights that, unless infrastructure projects are forthcoming in that state there will be pressure on volumes. Elsewhere, pricing challenges are continuing in Queensland given the new capacity.

Housing Recovery

While assessing little cause for optimism in 2020, Credit Suisse views the company's outlook as realistic, as no improvement in South Australia or south-east Queensland competition is anticipated, nor is a recovery in housing or the infrastructure contribution expected until 2021.

This aligns with the broker's view, which forecasts a more benign housing recovery in 2020 compared with many other analysts. There is also increased import competition in Victoria and NSW in cement.

The broker suspects the company will face a squeeze on cash flow arising from the required refurbishment of plant, downstream expansion and the recommencement of dividends. Adelaide Brighton is continuing to accelerate surplus property sales but the sites that have been identified have not changed since the beginning of 2019.

UBS is more positive, assessing the stock is highly leveraged to housing activity and the market is at a positive inflection point. The broker acknowledges, against a positive call, higher expenditure in the near term, concerns over SA imports and the company's comments on the relatively slow return in housing activity.

Still, UBS likes the increased focus on cost control and the compelling valuation. The share price appears to be pricing in significantly more weakness, which the broker believes is overdone. Morgans points out 2020 capital expenditure guidance of $130m has caused investors to question whether the company had under invested in the asset base over the past five years.

Funds will be used to purchase the land at Badgery's Creek to develop the future concrete plant in western Sydney, refurbish its Accolade vessel in FY21 and the company is also evaluating the potential upgrade of Kwinana cement grinding facilities.

Meanwhile, Adelaide Brighton is monitoring the impact of coronavirus but has not called out any specific issues at this stage. The company sources its clinker from Japan and imports other raw materials from Indonesia and Southeast Asia, with no material exposure to China.

Morgans suspects 2020 will be a trough in the earning cycle and upgrades to Add. The broker considers the risk/reward profile compensates for the structural challenges, although the market is likely to take time to gain confidence in the earnings recovery.

Ord Minnett agrees there is valuation support, and further weakness could represent a buying opportunity, but holds back from a more positive rating given the soft demand and pricing outlook for the near term.

Macquarie upgrades to Neutral and believes the risks are now better balanced for the business. Of interest, the broker notes the company has been targeting the substitution of 30% of its energy feed at Birkenhead with refuse-derived fuel and has now set an aspirational target of 50%.

Adelaide Brighton's assets reflect quality, although Morgan Stanley wants greater confirmation that earnings have troughed before adopting a more positive stance and expects investor demand will return once this occurs. The broker upgrades to Equal-weight, given the stock is now in a more reasonable trading range.

FNArena's database has two Buy ratings, four Hold and one Sell (Credit Suisse). The consensus target is $3.09, suggesting 1.8% upside to the last share price.

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