Reliance Worldwide Eyes European Expansion

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This story features RELIANCE WORLDWIDE CORP. LIMITED.
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Reliance Worldwide will acquire PTC fitting manufacturer John Guest and tackle expansion in Europe.

-John Guest acquisition complements company's US business
-Strong wholesale distribution reduces residual US retail risk
-Return-on-capital metrics should gradually improve
 

By Eva Brocklehurst

Reliance Worldwide ((RWC)) has Europe in its sights for expansion and to this end will make a large UK acquisition, John Guest, to provide growth. John Guest products are manufactured within the UK, with distribution facilities across continental Europe in markets such as Germany, France, Italy and Spain.

Brokers consider this acquisition supports the company's existing business in various ways. Europe currently accounts for less than 10% of Reliance Worldwide revenue and the Americas accounts for only 15% of John Guest revenue.

Other benefits include a highly complementary product range, new product segments for Reliance Worldwide and more diverse customer and distribution channels, creating a strong global PTC (push-to-connect) fittings business in both brass and plastic. The deal is highly accretive but the main negative, Morgans observes, is the impact on returns, which drop to 9% in FY20 from 35% in FY17.

The broker also cites execution risks, given the size of the deal, but believes the acquisition is a good fit strategically and the positives outweigh the negatives. If management can execute well there are growth opportunities, as PTC adoption is still very low globally. Morgans upgrades to Add from Hold.

The acquisition makes strategic sense but Deutsche Bank is less comfortable, as it adds further risk to a business that is considered to have too many strategies. Management must now handle another integration and ensure growth across new products, regions and end markets. While the acquisition multiple appears high at 12.4x, after synergies the broker acknowledges this becomes more reasonable at 10.3x. Deutsche Bank upgrades to Hold from Sell.

Bell Potter, not one of the eight stockbrokers monitored daily on the FNArena database, also upgrades the stock, to Buy from Hold, and increases the target to $5.40 from $4.75. Bell Potter expects the initial negative return-on-capital metrics to steadily improve, forecasting returns to fall to 15.2% in FY19 before moving back to 20% over the medium term.

John Guest

John Guest produces plastic PTC plumbing fittings and associated products, servicing the plumbing, heating and industrial markets, and has approximately 1300 employees. The consideration is GBP687.5m. Reliance Worldwide will fund the acquisition with a $1.1bn equity raising and extended debt facility of $750m with existing lenders.

Expansion opportunities in the near term include adapting some of the company's existing products, such as mixing and safety valves, into the John Guest range. US management has previously identified water quality and filtration as attractive markets, and John Guest provides a foothold in this area for Reliance Worldwide.

Of particular attraction for Bell Potter is the strong wholesale distribution model that lowers dependence on sales through US retail channels, in particular Home Depot, where some residual risk lies. The John Guest business generates strong operating earnings (EBITDA) margins of 33%, achieved through a combination of manufacturing and distribution scale, high levels of automation and a relatively higher proportion of PTC fittings as a percentage of overall sales.

Bell Potter suggests integrating John Guest into the Reliance Worldwide business will result in a significant rise in margins, even before cost synergies are realised. The company has estimated synergies in excess of $20m over three years, with the bulk expected to be reached by the end of FY19. The broker suggests margins should improve in FY19 by around 450 basis points. This results in Bell Potter upgrading estimates for earnings per share by 15.7% for FY19 and 19.9% for FY20.

The company expects to retain a 40-60% dividend pay-out and management has reiterated its FY18 underlying operating earnings guidance of $150-155m, ex John Guest and transaction costs.

Morgans increases FY19 underlying earnings estimates by 70% and underpinning this is a full year contribution from John Guest and $15m in synergies, offset by -$10m in one-off integration costs. The broker's FY20 forecasts assumes underlying growth for John Guest of 9%.

FNArena's database shows two Buy ratings and one Hold (Deutsche Bank). The consensus target is $4.87, signalling -8.5% downside to the last share price.

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