Property, Investments Underpin Brickworks

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

Market fundamentals remain strong for Brickworks but tighter credit has emerged to dent the housing outlook, particularly in NSW and Queensland.

-Fundamentals still supportive of new housing construction over the longer term
-Relying on property and investments to cushion the housing downturn
-Property development in FY19 centred on Oakdale South
 

By Eva Brocklehurst

Brickworks ((BKW)) is battling higher energy costs in its building products segment while property profits continue to exceed expectations. Strong contributions from investments as well as property drove a better than expected FY18 result, albeit buoyed by property sales. Building products benefited from demand on the east coast which was offset by a decline in sales in Western Australia.

Morgans notes an increased dividend continues the company's track record of raising dividends over the longer term. The balance sheet is robust, with gearing at 14.7%. Operating cash flow was up 48% in FY18 from increased earnings, distributions from the property trust and lower tax.

Energy costs are taking some of the cream off the top of building products while the housing market is becoming more challenging. Order books remain solid and east coast conditions are still supportive. Fundamentals such as population growth remain positive for new housing construction over the longer term but brokers note tighter credit conditions have resulted in patchy sales of late, despite a strong order book on the east coast.

Margin pressures from energy costs are building. Macquarie expects the initial guidance for a $20m step up in annual energy costs will be realised. Gas price increases will take effect in January and are expected to have a "significant adverse impact" on earnings, the company acknowledges.

Morgans notes the company's performance in WA has improved on the back of a range of restructuring initiatives. Furthermore, Brickworks has recently secured a new five-year wholesale gas agreement with Santos ((STO)), to start January 1, 2020. This flexible supply is a positive, the broker suggests, as contracted price increases taking affect from January 1, 2019 will have a significant adverse impact.

Meanwhile, Austral Bricks continues to emphasise margin growth through the sale of premium products and Brickworks is continuing to build in the Sydney CBD, with two projects on the drawing board. The cement import terminal is on track and expected to be in full production late in FY19. The next area of focus for further upgrades in NSW is Austral Bricks' Horsley Park plant.

Citi agrees that with FY18 marking the peak in the current housing cycle, the company will be relying on property and investments to cushion the downturn. Tighter bank lending has affected building activity, with the broker noting delays and cancellations and some projects. Brickworks first noticed this in August and envisages housing to fall -10% per annum over the next two years.

Bell Potter also observes conditions continue to vary across the states. The broker increases forecasts for property and investments while maintaining building product earnings estimates. The net result is upgrades of 20.4% and 13.2% for FY19 and FY20 respectively.

Investments

Investment earnings were up 20% and more earnings growth is expected, as thermal coal prices remain high and New Hope Corp ((NHC)) will purchase a further 40% of the Bengalla JV, taking its stake to 80% and boosting coal production across the next two years. Meanwhile, the market value of Brickwork's stake in Soul Pattinson grew to $2.2bn. Soul Pattinson is New Hope's largest shareholder, while Soul Pattinson and Brickworks have cross-shareholdings.

WH Soul Pattinson ((SOL)) now accounts for a large portion of Brickwork's value and, together with the asset base of the property trusts, brokers believe it should provide downside protection to valuations in the event of a housing downturn.

Reflecting on this emphasis, Bell Potter suggests a material decline in the Soul Pattinson share price is the biggest downside risk to the Brickworks valuation. The broker, not one of the eight stockbrokers monitored daily on the FNArena database, retains a Hold rating with a target of $16.

Morgans agrees the pressures on building products should be mitigated by the cross-holding in Soul Pattinson and increased activity in property, yet considers the stock fully valued. Citi also points to the TPG Telecom ((TPM)) merger with Vodafone Australia ((HTA)) as underpinning the company's investments.

Property

In property, development will be centred on Oakdale South (NSW), as three assets are completed during FY19. Property in FY18 was supported by profits from the completion of developments at Rochedale (QLD) and Oakdale Central amid a significant uplift in value following completion of infrastructure works. Property trust distributions increased by 20% while trust assets were up by 9%.

The sale of the Punchbowl (NSW) site along with strong development activity in the trust should support earnings. Significant development activity in the trusts produced strong redevelopment profits in FY18 and brokers expect another strong year as rental income rises. Bell Potter suggests the industrial property trust remains the undervalued part of the business and should deliver solid profits over the next 10 years.

FNArena's database shows four Hold ratings for Brickworks. The consensus target is $15.95, signalling -1.4% downside to the last share price.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms