Brickworks In A Sweet Spot

This story features BRICKWORKS LIMITED, and other companies. For more info SHARE ANALYSIS: BKW

-Should industrial portfolio be sold?
-Improved pricing power
-Land & development profits to slow
 

By Eva Brocklehurst

Brickworks ((BKW)) is luxuriating in a strong residential construction environment on Australia’s east coast as demand for bricks runs up against capacity, while management also forecasts an increase in earnings from investments in the second half.

The company’s first half earnings were a fair reflection of the driving force in the property and equities markets in Australia, in Citi’s view. With direct participation in industrial property development and an investment in coal miner/equity adviser WH Soul Pattinson ((SOL)), the broker considers the company is in a good position, while a 6.4% return on capital employed remains well short of the weighted average cost of capital (WACC) hurdle and below building material peers.

In terms of capital employed, Citi wonders about Brickworks’ industrial property trust portfolio and whether, given the strong outlook for building products, the company should realise the value in its share of these properties. If that were to be the case, gearing would drop to 8.0% from 15%. Despite expecting an improved outlook over FY15, Citi believes the share price is fair and retains a Neutral rating.

Ongoing strength in housing is flowing through to improved pricing outcomes for the company, expected to play out strongly in the second half. In this respect, management expects second half building product earnings to be significantly higher than the prior corresponding half. Deutsche Bank highlighted this upbeat pricing outlook and the trend in demand for bricks. Brick prices are expected to increase 8-10% in FY15, with demand in Sydney observed as strong as it was before the 2000 Olympics. All available east coast production is now being brought online.

Deutsche Bank currently expects FY15 Australian housing starts of 203,200 units and FY16 starts of 205,600 units, 8.6% and 11.8% above consensus estimates respectively and retains a Buy rating on the stock. The broker does observe that the Bristile Roofing business has lost some market share because of heavy discounting in alternative products, such as BlueScope’s ((BSL)) Colorbond range. Also, growth in building products may be at capacity in Western Australia while the company may have lost some share in Queensland. Nevertheless, renovation of 2-3 storey buildings in Sydney is underpinning brick demand, given historical building codes that demand brick inputs.

First half results were better than Macquarie expected and the broker notes Brickworks is looking to boost output to meet demand. The company is planning to bring plant 2 at Horsley Park back on line, with the re-commissioning expected to cost less than $1.0m. Brickworks expects the market to reach its constraints in terms of capacity by the second half of 2015 and Macquarie suspects the will lengthen the cycle somewhat, providing protection for building products profitability. Meanwhile, high capacity utilisation and a more consolidated market are supporting pricing power.

The main area where first half results beat Macquarie’s estimates was land and development, driven by revaluation profits. While property sales remain in prospect, Macquarie suspects earnings will be under pressure from this source going into FY16. On a prospective basis the stock has de-rated vis-a-vis the ASX100 Industrials, to the bottom of historical levels, but Macquarie does not envisage much in the way of re-rating ahead, especially as land and development profits slow.

Brickworks has two Buy and one Hold rating on FNArena’s database. The consensus target is $15.54, suggesting 10.3% upside to the last share price. This compares with $14.80 ahead of the results. Targets range from $14.55 to $16.82.
 

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