The share price of Bricksworks (ASX:BKW) recently enjoyed a brief recovery following the release of its interim results for the six months to 31 January 2022 (1H22). The main reason for this appears to be the longer-term upside from BKW’s Property division through further development opportunities.
Our recent research report on the Company sought to identify other potential fundamental drivers for the shares. So, does the recent retreat in the share price present an entry opportunity?
Brickworks comprises four divisions:
i. Building Products Australia – comprises three business units: Austral Bricks (61% of divisional revenue), Concrete Products (23% of divisional revenue) and Bristile Roofing (16% of divisional revenue).
ii. Building Products North America – BKW first entered the North America market in 2018 via the acquisition of brick maker 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 FY21, the total value of leased assets held within the JV stood at $2b.
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. Following the merger of SOL and Milton Corporation (which became effective on 21 September 2021), BKW’s share of the larger WHSP reduced from 39.4% to 26.1%.
The level of residential and commercial construction activity in both Australia and North America is a key driver of volumes/prices/demand for the Company’s Building Products businesses.
Key Fundamental Drivers
Further Upside from Property Division Likely
The Property division reported a strong gain in earnings in 1H22. This was driven by a ~50 basis points compression in cap rates to an average of 3.6%, as well as development profits.
While the significant boost from property revaluations and property development profits are one-off in nature, there remains further upside from its Property division through further development opportunities and ultimately rental income growth as new developments complete.
Strong Underlying Demand for Building Products Australia Division
Despite a difficult start to 2H22 due to persistent heavy rainfall and flooding, underlying demand for building products across Australia remains strong. This is due to a large backlog of detached house construction work still in the pipeline. However, the outlook beyond this timeframe is clouded given the uncertainty around the timing and extent of immigration (along with moderating house price growth and building approvals).
Importantly, there is evidence of operating leverage in the division. Underlying EBIT in 1H22 rose by 66%. This well exceeded the reported sales growth of 6%, as production efficiencies have improved. The Company was also able to implement price increases to offset impacts from cost inflation and supply chain pressures. Depending on the product, prices were raised by up to 10%. This is high by historical measures. It is also worth noting that the Building Products division is relatively immune to current cost pressures owing to contractual cover for key inputs.
Building Products North America Division Remains Challenged
Despite an 84% increase in sales (due to the IBC acquisition which was completed in August 2021), EBIT fell by 70% to $1.1m. Transportation and labour cost pressures adversely impacted earnings and there was a higher portion of sales into the lower-margin residential segment. While these factors were expected to impact earnings, the extent of the impact was much greater than anticipated, as consensus EBIT estimates for the division were ~$6m.
Following the acquisition of IBC, lower-margin detached residential segment now represent ~60-65% of divisional sales. Margin improvement is expected to occur over the medium-to-longer term as the sales mix shifts back toward higher-margin non-residential activity. The order book is now at record levels and growing strongly. This is expected to flow through to increased sales activity from April, across both the residential and higher-margin commercial segments. However, inflationary pressure is expected to continue. Manufacturing cost reductions are anticipated once production volumes normalise. As such, higher earnings from the division are expected in 2H22.
While BKW’s fundamentals are appealing given the longer-term upside from BKW’s Property division, we prefer to remain on the sidelines for now. The extent of the forecast decline in consensus EPS forecasts for FY23/24as well as the difficulty in predicting earnings (as evidenced by the large range in consensus estimates), which is likely due to:
i. Lack of transparency in earnings for the Investments division and uncertainty as to how long SOL can continue to benefit from strong resource-related profit streams. In context, BKW’s investment in SOL accounts for around half of BKW’s overall valuation.
ii. The North American Building Products business, whose earnings are currently minimal despite significant investment, needs a strong non-residential recovery. This is especially given the prospect of rising interest rates in the US.
The rally off the March lows has been very strong, breaking through resistance at $23 and then moving up towards the downtrend line just above $24. We naturally expect it to cool off here. If it can hold onto $23, then it may be setting itself up to edge higher over time. Otherwise a break under $23 could lead to further weakness.
Michael Gable is managing director of Fairmont Equities.
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