The swings in Brickworks’ (ASX:BKW) share price over the last 18 months reflects oscillating investor sentiment, driven by the strong performance and long-term attraction of the Property division on the one hand, and on the other, increasing challenging conditions for the Building Products division.
With recent Company commentary continuing to point to ongoing strong conditions for the Property division, are the shares finally ready for a re-rating?
Overview Of Brickworks
Brickworks comprises four divisions:
i. Building Products Australia – comprises three business units: Austral Bricks (67% of divisional revenue), Concrete Products (17% of divisional revenue) and Bristile Roofing (15% of divisional revenue). Around 70% of the division is exposed to detached housing.
ii. Building Products North America – BKW first entered the North America market in 2018 via the acquisition of brickmaker Glen-Gery. The Company recently completed the acquisition of Illinois Brick Company (IBC) for US$51m. IBC is the largest independent brick distributor in the US.
iii. Property – The Company develops surplus land and includes a 50% interest in an Industrial Property Trust JV with the Goodman Group. At the end of FY22, the net value of leased assets held within the JV stood at $1.54b. BKW also has a JV in the BKW Manufacturing Trust, which held a net asset value of $211m as at FY22 and the Company fully owns over 5,000 hectares of operational and surplus land across Australia and North America.
iv. Investments – Represents BKW’s 26.1% shareholding in Washington H Soul Pattinson (ASX: SOL). In turn, SOL also holds a 43.3% interest in BKW.
Key Fundamental Drivers
Scope for Further Gains from Property Revaluations
BKW’s property holdings continue to benefit from a strong industrial market, with the Company expecting to deliver record property earnings in 1H23.
The current focus of development within the Industrial JV Trust is the Oakdale West Estate, in western Sydney. Aside from several facilities that have either been recently completed, or due for completion in 1H23, there is significant additional area for development within the Estate. BKW are experiencing strong demand for this land, with around 69,000m2 of development area to commence construction in the coming months. This includes two facilities totalling 42,000m2 under heads of agreement with blue-chip tenants, and several smaller infill developments.
The significant boost from property revaluations and property development profits in FY22 were one-off in nature, although there remains further upside from its Property division through further development opportunities and ultimately rental income growth as new developments complete. To this end, the Company is seeing significant rental growth across both new developments and lease renewals, which management expects to offset the impact of negative revaluations for industrial assets from higher interest rates. There is the potential for strong rental growth and limited transaction activity to result in slightly positive revaluations in FY23.
Over the longer-term, there is potentially significant upside to BKW’s property income driven by the access to land at low historical cost pricing, in a market where industrial vacancy is running near record lows globally.
Pricing Power for Building Products Business
The strong backlog of work should see relatively resilient earnings in FY23 and is supported by comments in the recent trading update, where the Company noted improvements in both revenue and EBITDA for the Australian and US businesses in 1Q23. However, the outlook for the Building Products business in Australia and the US is challenged by weakening front-end sales in residential activity.
Recent Company comments suggest that labour and trade availability issues, while improving, continue to persist, with BKW still implementing pro-active price increases in response. BKW was able to implement price increases of 8-10% to offset supply chain pressures as well as other inflationary issues (particularly energy), which contributed to EBITDA margin increasing in FY22.
The price increases are important from the viewpoint that they are: i) Required in order to offset a likely substantial increase in gas costs once current agreements for BKW’s Australian operations roll off in December 2024 and ii) Alleviate margin pressure in the US business as a result of the Company continuing to sell a higher proportion of products into the lower-margin residential segment.
Balance Sheet in Strong Position
BKW remains in a strong financial position with gearing at 15%, adequate funding headroom across total facilities of $1,015m and significant flexibility within its existing bank covenants. Further, there is no short-term refinancing risk, with the next debt maturity due in FY24.
The strong balance sheet position is significant from the viewpoint that it enables the Company to self-fund its expansion plans into the UK. In October 2022, BKW entered into a 10-year supply agreement with Brickability, a market leading building products company in the UK. The benefit of the agreement is that the UK presents an attractive expansion opportunity, given that bricks commanding an 85% share in external walling in housing and the UK is experiencing pressure from gas costs. With domestic manufacturing capacity below annual demand of around 3 billion bricks, around 10-20% of UK supply is sourced from imports.
Overall, we take a cautious view on BKW at current levels.
Based on consensus EPS estimates, BKW is currently trading on a 1-year forward P/E multiple of ~12x, which we consider a difficult measure by which to assess BKW’s relative attractiveness or otherwise given: i) The disparate range in consensus estimates and ii) The difficulty in predicting earnings from BKW’s investment in SOL, which accounts for at least ~55% of the group valuation.
While there are factors supporting FY23 earnings for the Building Products division (i.e. a strong pipeline of work from housing activity in Australia, improving non-residential construction activity in the US), the outlook beyond the FY23 period looks uncertain given a rising interest rate environment globally may impact demand for housing and construction work. Although only accounting for ~10% of group valuation, the Building Products division remains a significant earnings driver (accounting for ~23% of group EBIT in FY22) and absorbs a significant chunk of overall invested capital (and therefore management attention).
The past few weeks has seen the stock break above the trend-line that had been in place during the last year. This is a positive sign and it implies that the share price could head higher from here and retest the next line of resistance near $24. It would be a negative sign if the share price were to fall under $22 again.
Michael Gable is managing director of Fairmont Equities.
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