Shares in Adelaide Brighton (ASX:ABC) have lost over a third of their value in the last year. There are plenty of reasons to remain pessimistic on the Company. However, there are a couple of signs which indicate it could be worth a second look.
About Adelaide Brighton
Adelaide Brighton manufactures cement, concrete, lime and aggregates in the domestic construction markets. They have leading market positions in three of Australia’s seven regional cement markets. These are namely Western Australia (WA), South Australia (SA) and the Northern Territory (NT).
The Company has two operating segments: The Cement, Lime and Concrete division, which accounts for ~91% of group revenue and the Concrete Products division. ABC has a 31 December balance date and results for the full year to 31 December 2018 (FY18) showed a 3.7% profit decline. This was mainly driven by a considerable slowdown in cement sales in the second half of the year.
Key Factors Driving the Outlook
Following on from the significant decline in cement sales volume in 2H18, the Company expects overall volumes in FY19 to be stable. However across each of the key end markets, this is expected to vary, with infrastructure and non-residential activity expected to offset the downturn in residential (i.e. housing) volumes.
While we consider ABC’s exposure to the non-residential and infrastructure sectors places the Company is a position to offset housing market weakness, the risk to overall volume growth is to the downside. In particular, on a weighted average basis (i.e. taking into account ABC’ relative exposures in each of the end markets), volume may decline by 1-2%, as opposed to the Company’s expectation of an offset. The key variable in this is a worse-than expected decline in housing activity.
Can Price Increases Offset Cost Pressure?
In October 2018, ABC announced price increases for cement, concrete, aggregates and concrete products, effective from 1 April 2019.
Overall, we expect that price increases will only partially offset input cost pressures, with a key risk to price increases being maintained is that ABC has a greater exposure to the residential market, which is expected to suffer the biggest volume decline in FY19.
Ongoing cost pressures point to a further decline in EBIT margin in FY19. The EBIT margin declined from 17.2% in FY17 to 16.3% in FY18. EBIT margin in FY18 was impacted by import costs, regional mix in cement and product mix in aggregates, and accordingly, were below market expectations. In addition to import cost pressure, the Company faces cost risks from the roll-off of gas contracts in late FY19 and early FY20, increasing clinker prices and freight costs.
Potential for Capital Management
Whilst the balance sheet has capacity to fund further acquisitions, the key focus for the Company, in light of the appointment of a new CEO, Mr Nick Miller, is the operational performance of the business for FY19. There is also the articulation of any change in strategy under the new leadership, which is likely to be minimal.
In the absence of any merger & acquisition opportunities, return of capital to shareholders remain an option. To this end, ABC paid a fully franked special dividend of 4.0 cents per share.
Whilst the shares are currently trading at the lower end of its 1-year forward P/E multiple over the last three years, we struggle to see any major catalysts for the shares. ABC’s investment appeal has typically been its attractive yield, strong cashflow and steady business model. While these attributes remain, factors such as: i) Moderating housing approvals and construction activity, ii) Further EBIT margin pressure and iii) Modest and declining earnings growth expectations for FY19 and FY20, respectively warrant a more cautious view.
Having said that, we note that there is potential for corporate appeal from ABC’s major shareholder, the Barro family, currently hold a 43% stake in ABC. The Barro family owns the Barro concrete group, which runs the Pronto concrete business in Melbourne with a range of other operations including 20 concrete plants and 18 quarries. Both ABC and the Barro family have publicly acknowledged that a merger between the businesses is logical, with ABC’s Chairman quoted as saying “it makes a lot of sense for those businesses to be brought together at some point”.
The long term chart for ABC looks ugly. At first glance you would assume it would continue to fall. However, there are tentative signs of the shares finding a low here. We have noticed that the April low was right on the low from December – January. Price action for the last several days is starting to look bullish also. It is still early days as to whether we now have seen a “double bottom” form on the chart. If ABC falls past the recent low near $4.22, then traders should consider getting out very quickly. However, in terms of risk/reward, there might be a trade here for those willing to take on a bit of risk and assume that corporate appeal might lift the shares higher.
Michael Gable is managing director of Fairmont Equities.
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