America Not The Main Game For Brickworks

Small Caps | 1:46 PM

While a weak performance from Brickworks' North American building products division was disappointing, brokers agree the company's property and equity investments are a more important driver.

-Brickworks' North American building products earnings deteriorate more than feared
-Australian building products performed positively
-Stabilisation in property valuations underpins

By Greg Peel

Brickworks ((BKW)) released an earnings update on Tuesday, ahead of its first half earnings result due on March 20. Pre-announcements typically are not good news, Jarden notes.

Shares in the building products, equity and property investment company fell -6.9%, albeit amidst weak general market sentiment. This is not a great time for releasing bad news.

Brickworks revealed a -13% first half decline in North America building products revenues compared to consensus expecting -7% and significantly lower earnings, driven by challenging market conditions and winter weather in key operating regions, on top of market share loss given strong competition in the retail segment.

Plant closures to manage inventories have reduced margins significantly while benefits from plant rationalisation are delayed due to weak markets. Uncertainty on the timing of the market recovery remains.

No doubt on again, off again tariffs and growing US recession fears will not help in the second half.

Brickworks has taken at -$74m impairment on its North American business, or -$55m post-tax, having already taken a post-tax impairment in September last year of -$68.8m.

Fortunately for Brickworks, North American building products is not its sole operating business.

Mixed Bag

As Brickworks' US building materials business softened progressively in the half, the Australian equivalent is performing ahead of consensus with earnings stable despite lower volumes, reflecting the work done by management to rationalise the business in a downturn and positioning it well, UBS suggests, for when volumes turn.

Jarden considers a similar earnings contribution year on year in Australia a positive operational performance, reflecting a strong controllables focus including price hikes, cost-outs and plant rationalisation. Jarden would expect the first half to represent a trough in Building Products Australia earnings, with residential construction activity seemingly "on the turn".

Yet, brokers agree Brickworks' building materials businesses are not the primary drivers of the company's value.

Brickworks offers exposure to Western Sydney industrial property via its trusts managed by property fund manager Goodman Group ((GMG)), and an indirect equity investment portfolio via its cross-ownership with WH Soul Pattinson ((SOL)).

Whilst Jarden remains cautious regarding the core bricks business, with material substitution and higher for longer energy costs providing structural headwinds, operating assets represent only 25% of Brickworks' total asset values.

Property

While Brickworks' Oakdale East development in Sydney's southwest, the company's own design centre showcasing its building products, will contribute some 250ksqm of additional gross lettable area, the first half represents a gap between Oakdale West completion and Oakdale East contribution over the next five years, UBS notes.

As a result, first half development profits are minimal, but total Oakdale East development profit is unchanged and likely to be delivered on a consistent basis across FY26-29. With development income to be minimal, rental income is the primary source of divisional earnings in the first half, Morgans notes.

Across the total property portfolio, Brickworks guided to higher earnings year on year following a significant loss in the first half 2024. Management noted capitalisation rates have stabilised (valuations have stopped falling) and expects no significant change to the value of property trust assets, in line with Macquarie's expectations.

Brickworks' property portfolio underpins its valuation, UBS suggests, at some 50% sum-of-the-parts. Despite industrial rent growth normalising, rental income appreciation remains robust given old lease agreements continue to expire. Previously, this coincided with an increasing cap rate environment, but with the Australian cap rate increase cycle now complete, UBS is positive and sees the risk pendulum now in favour of valuation uplifts rather than any decreases.

Citi agrees the property division is a much bigger driver of Brickworks' value than building products and thus sees the negative share price reaction on the day as being unwarranted.

Morgans, on the other hand, believes the primary driver of value remains Brickworks' $3.1bn interest in WH Soul Pattinson which, ex of net debt, is worth $16 per share on the broker's estimation, but comes with a $6 per share deferred tax liability and would likely trade at an appropriate listed investment company (which is basically what Soul Pattinson is) discount of around -10%.