CSR/Boral JV Welcomed, If Approved

This story features BORAL LIMITED, and other companies. For more info SHARE ANALYSIS: BLD

-JV to improve brick returns
-ACCC may oppose
-Savings seem conservative
-Potential cash from land sales
 

By Eva Brocklehurst

Brokers believe the proposed joint venture between Boral's ((BLD)) and CSR's ((CSR)) Australian east coast brick operations will be of benefit to the brick industry, offering site rationalisation, overheads reduction and an improved industry structure. Nevertheless, they're not being hasty and changing forecasts because at the heart of the proposal is a need for approval from the Australian Competition and Consumer Commission (ACCC) and the regulator could find some stumbling blocks.

Deutsche Bank expects such approval to take around six months and doesn't think it will be straight forward. The broker thinks most of the concerns will centre on Queensland, where the combined market share of the two is around 70%. In the other states the combined market share is more like 50%. Deutsche Bank thinks a JV adds value because the sector is struggling with over-capacity and disappointing returns. This is where Macquarie thinks the ACCC will come to the party. Both manufactures have found conditions challenging in the last several years and this JV is a clear step to improve the industry structure. This should mean that approval is more likely than would be the case if returns were strong. The broker also observes that similar steps have improved returns in masonry, for example the Adelaide Brighton ((ABC)) and Brickworks ((BKW)) tolling arrangements in north Queensland and Victoria.

CSR will own 60% and Boral 40% of the JV. Certain property assets are excluded and there is no cash impact. Boral will retain its ownership of Scoresby (VIC) and surplus land at Bringelly (NSW), with CSR retaining its Schofields (NSW) land and surplus land at Horsley Park (NSW) and Oxley (QLD). Citi thinks the JV will deliver a vehicle for both companies to unlock future value. What excites the broker is the property profits that can be unlocked, releasing capital tied up in legacy land sites. Citi expects the value created by re-zoning and developing surplus land at Horsely Park and Oxley, and then ultimately Schofields, far exceeds the value of the CSR share of the annualised cost savings for the rationalised brick business.

The key to the ACCC's decision is with the definition of the brick market, in Credit Suisse's view. If bricks are defined as a product that competes in the broader exterior cladding market then the transaction should receive approval as the broker observes the ACCC set a similar precedent when Brickworks acquired Boral's NSW masonry business early last year. JP Morgan agrees, observing that, on that basis, the JV would only have 31% of the "cladding" market. The broker also notes Brickworks dominates market share on the east coast, having 49% total installed capacity. Subsequent to the JV occurring, the position of the it and Brickworks would be even across all eastern states, with the JV having the dominant share in NSW and Queensland and Brickworks the larger in Victoria and South Australia.

BA-Merrill Lynch estimates that the JV would have 50-60% of the east coast brick market. Central to the ACCC's case will be this market share. The broker observes a structural loss of share for the brick market over the last 25 years because of unfavourable installed cost comparisons and architectural preferences. Macquarie also draws attention to the trend towards multi-residential construction, which has led to a substantial decline in the numbers of bricks per housing start, with the share of wall finish for detached housing dropping to 60-65%, from 88% 30 years ago. Double brick housing has virtually disappeared from practice and the labour intensity of bricks is higher than with other building product types.

Were the ACCC to reject the JV, UBS thinks the pair might be prepared to take the decision to court, with the costs negligible in terms of the potential benefits of winning. That is, the business operations could still continue on a stand-alone basis in the meantime. That said, UBS thinks Boral would have been better served leaving the industry altogether on the east coast and was disappointed not to see any exit strategy from the JV for either party down the track.

Several brokers think the cost savings cited are conservative. CSR and Boral outlined $7-10m of initial overhead savings but Deutsche Bank thinks synergies of at least $15-20m are likely, given potential revenue and plant rationalisation. The broker observes 33% of Boral and CSR's capacity is currently mothballed and this capacity is most at risk of closing after the JV is consummated. Merrills concurs, noting the JV is already operating at 86-90% utilisation so there is not much opportunity to close current operations, especially as Australian housing approvals are up 30% in the last six months. The opportunity, therefore, is to permanently close the mothballed sites in NSW and this would provide cash flows, although not necessarily improve earnings in the bricks business. 

Based on Deutsche Bank's calculations the JV would lead to a FY15 earnings uplift of 1% for Boral and 4% for CSR. Should the JV receive ACCC approval, the broker estimates Boral's valuation would increase 2.6% and CSR's 4.9%. Citi thinks evidence of the the recovery in building products earnings is vital to allay concerns about CSR's valuation, with the stock trading above the target of $3.00. In terms of Boral, Citi expects continued earnings and margin improvement with the return of pricing power in construction materials. CIMB also thinks the benefits are both real and understated at this stage, given the risks regarding ACCC approval. Still, the JV is not sufficient to change the broker's view that the pair are currently overvalued. Hence a Reduce rating is retained. Ultimately bricks are a "fashion" statement, in UBS' opinion as they serve no structural benefit and compare with alternative cladding systems. The JV does not obviate the need for both companies to find new products to gain market share, in the broker's' opinion.

CSR has three Buy, two Hold and three Sell ratings on the FNArena database. The consensus target is $3.05, suggesting 13.6% downside to the last share price. Targets range from $1.90 (Merrills) to $4.15 (CS). Boral has four Buy, two Hold and two Sell ratings. The consensus target is $5.85, signalling 2.1% upside to the last share price. The targets range from $5.20 (CIMB and Merrills) to $6.40 (UBS).
 

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