Australia | Aug 31 2017
Growth is expected across all Boral's divisions in FY18 as price increases for construction materials are effected in Australia and synergies are derived from the recent acquisition of Headwaters in the US.
-FY18 key to bedding down Headwaters deal, Meridian JV
-Capacity constraints in Australia may be an issue for outer years
-Strong exposure to US construction recovery, particularly in Texas
By Eva Brocklehurst
Volume and price growth prevailed in FY17 for Boral ((BLD)) amidst improvement initiatives and the acquisition of Headwaters in the US. Underlying operating earnings (EBIT) increased 15.6%, which brokers concede was a strong performance. Where they differ is in the extent of optimism regarding the FY18 outlook.
No quantitative guidance is provided but growth is again expected across all the company's divisions in FY18. Price increases in Australia, effective from October, have been announced for concrete, cement and aggregates while a significant increase in earnings from North America is expected, reflecting the Headwaters acquisition.
Ord Minnett considers FY17 a transformational period for the company as it completed the Headwaters deal and formed the Meridian Brick joint venture. The broker believes the earnings outlook is promising, if the company can execute targeted synergies and continue its commercial and operational excellence programs. Yet the broker maintains a Hold rating, given a full valuation and the lack of upside risks to optimistic forecasts.
Deutsche Bank factors in around 20% operating earnings growth in Australia in FY18. Synergies for Headwaters greater than US$100m by year four have been outlined by the company, with US$30-35m in year one (FY18). A positive earnings contribution is expected from the Meridian Brick JV. Plasterboard was one of the disappointing areas for Macquarie. USG Boral missed recently lowered estimates, as China, Indonesia and Thailand revealed declines in earnings.
Australia
Citi observes Australia is about to cycle tougher comparables, given the company has signalled effectively flat operating earnings, amid rising construction activity. Are capacity constraints becoming an issue for Boral Australia earnings in outer years? Citi suspects this may be the case.
Citi believes the $80m in non-cash annual amortisation charges may lead to a revised dividend pay-out policy. The broker points out this item remains a charge on shareholder equity and cannot be excluded for convenience. Moreover, considerable caution in the guidance provided seems to contrast significantly with the number of Australian infrastructure projects in front of the company.
The broker acknowledges the dry weather has continued into FY18 and, if the Australian operations perform as formidably as in the fourth quarter of FY17, then risks to first half earnings may indeed lie to the upside.
Credit Suisse is more confident, calculating underlying operating earnings growth in Boral Australia of 21%. Momentum in FY18 is envisaged underpinned by volume growth, real price growth and operating improvements. Offsetting this will be an increase in energy and diesel costs. As the dust settles from the acquisitions and discontinued businesses, the broker expects investors will renew their focus on the opportunities across the east coast of Australia and in the US.
Macquarie suspects Australia's mix has stabilised and the benefit of growing infrastructure activity is likely to continue to tighten the market. Mix changes have affected pricing volumes at Boral Australia, especially as LNG-related work wound down. The Barangaroo development, now complete, also had good relative economics. Macquarie observes these impacts diminish going forward.
The company has highlighted cost headwinds regarding electricity going into FY18. In FY17 electricity costs were offset by diesel savings but the company is guiding to $15-20m in headwinds in FY18, predominantly from electricity prices.
Macquarie believes it worth noting that electricity spot and forward curve prices have started to moderate. UBS incorporates 10% underlying growth in Boral Australia, ex-property, partly offset by the additional electricity costs.
North America
Macquarie continues to like the investment case and the exposure to Australian infrastructure and US housing at a reasonable price. A supportive market should mitigate the risks involved in the integration of Headwaters and the broker is comfortable with the company's synergy targets. The legacy US business missed the broker's forecasts but this was affected by one-off costs.
Citi downgrades Boral to Sell from Neutral. The broker observes, despite the excellent outcomes in Australia, capital expenditure guidance has stepped up and reality is colliding with overly optimistic expectations. Moreover, the integration of Headwaters is complex and a reliance on exceeding FY18 synergy targets looks premature.
The broker believes the investor tour of the Headwaters operations in September will be critical to establishing confidence regarding the timing and scope of benefits from increased capital expenditure, especially as the heavy lifting done by Boral Australia now appears more constrained in FY18.
Citi observes Cyclone Harvey has created a swathe of rebuilding requirements across Texas and there is potential for the company to increase its earnings ,as the combined Boral and Headwaters entity derives large portions of revenue in Texas. Nevertheless, it may take weeks for affected areas to dry out across the state, which in turn will dampen demand for fly ash.
UBS incorporates US$35m in synergies from Headwaters in FY18. The broker continues to factor in valuation upside and believes a price/earnings ratio of 16.5x, reflecting a -10% discount to the All Industrials, ex-financials, is unwarranted because of the exposure that Headwaters provides to the cyclical recovery in US construction activity. The broker is also attracted to the predictable and counter-cyclical nature of fly ash, which is 40% of Headwaters operating earnings.
UBS believes industry structures are attractive, as Boral is positioned to hold 55-60% of the market, with earnings underpinned by long-term contracts and rising prices from construction materials. The Headwaters building products business combines a niche portfolio of products and an extensive distribution network, which the broker believes compliments the legacy Boral cladding and roofing business.
FNArena's database shows four Buy ratings, two Hold and one Sell (Citi). The consensus target is $6.91, suggesting 5.6% upside to the last share price. Targets range from $5.58 (Morgan Stanley, yet to update on the results) to $7.67 (Deutsche Bank).
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