This week the TAMIM Australian Equity Growth Individually Managed Account (IMA) portfolio managers take a look at portfolio holding Boral Limited (BLD.ASX). BLD is an interesting stock exposed to positive thematic of increased housing construction and infrastructure spend in the USA through its existing operations and recent acquisition. Read on to find out why.
Boral is an Australian based building and materials group with operations spanning Australia, Asia and the USA. Boral produces and distributes a broad range of construction materials, including quarry products, cement, fly ash, pre-mix concrete and asphalt; and building products, including clay bricks and pavers, clay and concrete roof tiles, concrete masonry products, timber, plasterboard, and lightweight trim and siding.
Boral is exposed to positive thematic of increased housing construction and infrastructure spend in the USA through its existing operations and recent acquisition of Headwaters Inc and increasing infrastructure spend in Australia, particularly NSW.
Boral has strong market positions in Australia and Asia (through its USG JV) and now the USA. BLD has a competitive advantage in these markets a as result of its scale and product characteristics.
The New Boral
Boral entered a binding agreement to acquire Headwaters Inc. for US$24.25 per share in cash, representing an aggregate EV of cUS$2.6bn. Implied multiple is c10.6x EV/EBITDA for the 12 months ending 30 Sep-2017, reducing to c7.5x incorporating full annual synergies.
BLD has described the deal as being strategically compelling, transformative and better positioning the Group to deliver more sustainable growth and above cost of capital returns through market cycles. We broadly agree that the transaction achieves or can achieve these aims. On the face of it, the transaction:
Combines complementary businesses and more than doubles Boral USA revenues.
Delivers scale, more product offerings, geographic breadth, multi-channel distribution and increased diversification across growing US construction markets
Builds a more balanced portfolio of traditional and light weight products
Post transaction Boral will have three divisions:
The well-established Boral Australia;
the fast-growing USG Boral business in Asia, Australia and the Middle East; and
Boral USA, a now scaled building products and fly ash business with greater geographic reach, more diverse product offerings and stronger growth prospects.
Source: Company filings
Group EBIT of A$211m was up 6% on the pcp and broadly in line with market expectations while adjusted EPS increased 8%. Strong growth was recorded by Boral USA and USG Boral while the Boral Australia result was solid. The dividend of A$12.0cps was ahead of expectations as the company paid above its stated 50-70% payout ratio target reflecting the recent capital raising. Guidance was for Group FY2017 EBIT to be higher than FY2016, despite an adverse cA$6.5m impact of Boral CSR Bricks divestment with each business to record improvement year-on-year. This improvement reflects a combination of stronger pricing and increasing infrastructure work in Australia, improved cost performance in USG Boral (Asia) and ongoing recovery in the USA. With guidance affirmed, and the 2Q stronger than expected, this allayed concerns that BLD was at risk of a downgrade.
Consensus forecasts were upgraded following the result as more brokers factored in earnings from the Headwaters acquisition. Not all brokers have factored the transaction into forecasts making consensus estimates relatively uninformative.
Source: Company filings
Opportunities & Risks
US housing and infrastructure boom - BLD is now more highly leveraged to the US construction cycle. Boral’s US business was previously arguably sub scale and the acquisition improves margins and returns in this business. While the housing recovery is in full swing, US housing is yet to recover to mid-cycle levels which, along with increased infrastructure spending, should provide a favourable backdrop for BLD’s increased US exposure.
Increased Australian infrastructure spend - BLD is leveraged to building activity and in particular on large scale projects. There has been much talk of an infrastructure construction boom in NSW over coming years. While this has been a "it will happen soon" story for a while, the pieces are in place for the upswing to take place. Western Sydney Airport will cost cA$5bn to build and will require A$38bn in ancillary works, WestConnex is a >A$20bn project with A$17bn on project works. The NSW 2016-17 Budget provides for a record capital spend of A$73.3bn in the four years to 2019-20. The Government's commitment in 2016-17 is A$21.8 bn. The opportunity in NSW infrastructure is real and should offset any potential moderation in housing construction activity. Ongoing cost improvement – Management has been transforming BLD over recent years through its Fix, Execute, Transform program. This has significantly improved BLD’s cost base and we believe there are still improvements to be made across the Australian business and through the US acquisition. Management is guiding to cUS$100m of synergies within four years of transaction completion.
Regulatory risks - BLD has raised A$2bn presuming regulatory approval of the transaction. While the deal has received Headwaters shareholder approval, the deal is still subject to sign off by the US regulator (Federal Trade Commission). Management seem confident that the deal will ultimately be approved.
Integration risks - clearly risks exist in integrating such a large acquisition. To mitigate risks, BLD has appointed a dedicated integration management office to support USA leadership team and synergy realisation.
Pricing pressure - building materials is a high fixed cost business and while positively disposed to volume gains, the largest upside can come from pricing gains. Two price increases were put through in FY16 across several products and they seem to have stuck. Increased industrial demand could drive an uplift in prices but a downturn in housing activity could also drive a decline in prices.
Post transaction and integration of the Headwaters business, BLD appears to be trading on 8.1x FY18F EV/EBITDA in line with 15.5x FY18F EPS vs an historical average 15.7x. We believe this is attractive given the strong earnings growth outlook outlined above. It is also trading at a discount to the sector average of 20-26%.
While BLD has performed solidly over recent months, we believe that positive local themes combined with earnings growth out of the US should combine to drive medium term EPS growth and ROIC improvement and therefore a potential re-rating of the stock.
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