Australia | May 28 2021
This story features FLETCHER BUILDING LIMITED. For more info SHARE ANALYSIS: FBU
Building activity in both Australia and New Zealand is robust and if Fletcher Building can execute on its initiatives there is potential upside
-Clarity on the building outlook has improved since February
-Cost pressures likely to persist into FY22
-More confidence required in an Australian turnaround
By Eva Brocklehurst
If Fletcher Building ((FBU)) can execute on its plans and end-markets stay strong there is upside available while brokers assess, after the company's investor briefing, the key variable is margins.
Fletcher Building has updated guidance ranges for FY21 and announced an NZ$300m on-market share buyback. Market activity is pointing to ongoing robust volumes in both New Zealand and Australia and the building industry is operating at, or near, capacity in some areas.
Back in February there was some uncertainty regarding the sustainability of the momentum in the building trade and concerns have now ebbed. Citi highlights Fletcher is now a structurally leaner business and well placed in New Zealand. FY21 earnings (EBIT) guidance has increased to NZ$650-665 and development also increased to 850 houses in FY21 with 1000 new homes by FY23.
The company highlighted margin expansion of 100 basis points compared with pre-pandemic levels, through more favourable operating leverage and stronger residential and infrastructure activity in Australia.
Meanwhile, input cost pressures, particularly steel and energy, have been flowing through to prices, although the company has noted supply chain constraints and input cost pressures in the second half will cost -$10-15m. There was no guidance for FY22 and Macquarie presumes cost pressures will persist.
Fletcher has set a group earnings margin target of 10% by FY23. The assumptions behind the margin target include lifting the Australian margin to 5-7% from 4%, construction margins to 3-5% from 2%, and NZ margins through operating leverage and residential & development margins by more than 15%.
UBS finds these aspirations reasonable although questions whether growth in Australian margins can be so readily achieved.
Still, Morgan Stanley points out Fletcher has been one of the few companies that transformed its cost base during 2020 and further margin improvement should mean additional upside for earnings and the share price. While acknowledging the 10% margin target is aspirational the broker believes there is now a clear path to achieving it.
Confidence may have increased yet Credit Suisse remains cautious about Australian margins and Citi agrees the 10% target will be difficult to achieve without a more meaningful turnaround in Australia, requiring more solid evidence this is occurring.
The broker expects EBIT margins of 9.1% by FY23, factoring in Australian margins rising to 4.8% and a turnaround in building products and TradeLink. The broker points out the combined businesses of Fletcher Building have attained margins of around 5% since FY16, when activity levels were peaking.
The balance sheet is roomy and gearing is within the target range. Citi calculates NZ$270m to NZ$1.3bn in excess capacity. Nevertheless, an elevated capital expenditure profile in FY22 means management is likely to be conservative, while there is potential for capital management should earnings surprise to the upside.
The business is beginning to spend money to drive future growth initiatives and will also pay a dividend in August. Morgan Stanley, reiterating an Overweight rating, forecasts a NZ16c dividend, which would be on the conservative side of the pay-out target range of 50-75%.
Jarden, not one of the seven stockbrokers monitored daily on the FNArena database, finds the path towards the FY23 growth target is now clearer and raises medium-term forecasts, lifting the target to NZ$7.34, while downgrading to Neutral from Overweight because of valuation. FNArena's database has three Hold ratings and two Buy.
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