Fletcher Takes A New Road

This story features FLETCHER BUILDING LIMITED. For more info SHARE ANALYSIS: FBU

-Sensible and accretive, brokers maintain
-Improves potential in NZ contract wins
-Diversifies away from manufacturing

By Eva Brocklehurst

Construction conglomerate Fletcher Building ((FBU)) will acquire Higgins Group, New Zealand's third largest road construction and maintenance contractor.

Most brokers consider the acquisition is sound and the move was widely anticipated. The purchase price of NZ$315m was somewhat of a surprise to Morgan Stanley, given press reports were suggesting around NZ$100m back in October.

The acquisition multiple of 7.9 times FY16 earnings is larger than the broker expected, especially given Higgins was previously a private company. Still, Morgan Stanley accepts that in the context of Fletcher Building's enterprise value/earnings multiple of 9.3, the acquisition is adding to value. Applying the company's margins from its heavy building product divisions suggests to the broker there could be as much as NZ$10m in synergies being realised..

Management expects synergy benefits of $2m per annum, which Credit Suisse also considers conservative, given the road contracting and maintenance that Higgins offers should be enhanced by Fletcher's infrastructure business. It could also improve the prospects of Higgins winning the NZ Transport Agency contract.

Credit Suisse still expects, outside of NZ, that operations will continue to under-earn the company's cost of capital and the current stock price implies little long-term earnings growth.

Deutsche Bank believes the acquisition makes sense because of the strategic and complementary nature of the asset. FY16 guidance has been maintained at NZ$650-690m which the broker notes represents 13% growth on the prior year. The Higgins transaction will not be finalised until June 30 so will not be featured in FY16 results.

The proceeds from the sale of Rocla Quarry Products should enable Fletcher to satisfy around two-third of the Higgins acquisition price, brokers assert, without drawing down on its syndicated bank facility. Management also signalled, but without detail, that it remains interested in acquiring an integrated heavy-end Australian asset. Deutsche Bank observes there is one potential asset of this nature for sale, which it does not name.

The company announced a change to its segment reporting, separating the construction and property businesses into two units to reflect the increasing importance of the property division. The heavy and light building products are being combined, and roofing is being moved into the laminates and panels division.

Deutsche Bank observes this is the third change to segment reporting since 2012 and reflects changes to management. The broker also observes that Higgins Group is the only acquisition made since October 2012, when the current CEO commenced with the company. Since then four divestments have occurred, in addition to the closure of the Crane copper tube factory.

Higgins Group has three business divisions: Contracting NZ, Contracting Fiji and aggregates. The Fiji division complements Fletcher Building's existing South Pacific operations. Higgins is already a supplier to Fletcher's construction division for major infrastructure projects.

Higgins, therefore, fills a gap, in Macquarie's view. Road works are a reasonably large part of the construction market in NZ and Fletcher's existing business does not compete in maintenance. Macquarie suspects the company’s lack of presence in roads has been costing it a share of capital works.

Moreover, the acquisition helps the company to diversify away from its manufacturing base which has been losing market share across Australasia. Macquarie believes this situation is occurring because of a deteriorating cost/service position. The broker believes the re-shuffling of the divisions also underpins a desire to significantly increase the company's NZ residential building rate.

One aspect that surprised Macquarie was the importance of the Fijian market to Higgins. Credit Suisse also suspects Fletcher's construction business may provide a platform for Higgins to expand beyond Fiji in the South Pacific.

UBS likes the acquisition, given the natural synergies from vertical integration and the proposition of a combined entity when competing for tenders. The broker estimates Fletcher Building, post acquisition, will have a 45% market share in NZ capital works and 10% in road maintenance/asphalt. The broker believes Fletcher Building is arguably the best value in the building materials sector, once investors become more confident in the earnings projections.

There are four Buy ratings and two Hold on FNArena's database. The dividend yield on consensus FY16 forecasts for Fletcher Building is 5.4% and 5.9% on FY17.
 

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