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Shares of housebuilders have fallen, possibly prompted by concerns about home prices and margins, potentially triggering weakness in the wider sector. We believe, however, that developers and basic material producers such as Forterra have limited exposure to those drivers and operate under very different dynamics. Their pricing power is underpinned by low inventories and a consolidated sector. The positive demand-supply situation could improve further due to new government housebuilding initiatives.
Forterra’s guidance in its HY results today that FY 2018 results would be “in line” contrasts with this morning’s unscheduled trading update from larger rival Ibstock, warning on 2018 profits, due to production difficulties, needing more spending. We believe that Forterra, the UK’s number two, is reaping the benefits of several plant upgrades since the IPO and more aggressive rationalisation during the last downturn. We have kept our PBT, EPS and DPS estimates unchanged.
Forterra’s AGM statement revealed that poor weather from the ‘Beast from the East’ had delayed production and deliveries during Q1 – in common with the rest of the sector – but predicted the shortfall would be made up during the rest of the year and that the outlook for the year remained in line with its expectations. It also outlined in detail its previously flagged plans to boost capacity by c. 100 million bricks.
Two features stood out in Forterra’s first full year results since its IPO: another significant ‘beat’ on cashflow expectations; and the formal signal that Britain’s second biggest brickmaker was to ‘press the button’ on a new plant, having previously waited until there was clear evidence of sustainable housebuilding demand. We believe the time is right, but that the company will remain measured in its expansion, in keeping with what we believe is its conservative track record.
Next week’s FY 2017E results from Forterra, we envisage, are likely to feature the continuing sector theme of the gap between demand and supply for bricks – an issue highlighted in rival Ibstock’s figures. Latest government data show stocks at almost the same lows as during the “shortages” of 2014, amid new recent highs in imports. Government policies to increase housebuilding supply indicates to us that there is scope for Forterra to move ahead with measured capacity increases.
Chancellor Philip Hammond’s Budget pledged to add 300,000 homes a year, up from 185,000 in 2016. This should support or even strain a favourable supply-demand balance, underpinning pricing of Forterra’s bricks, blocks and specialist products. The Bison deal may bring innovative systems to build homes faster. We have nudged up FY 17E estimates after the November trading update, but suspect the mid-term outlook could improve further, given this positive backdrop.
Strong demand in the newbuild housing market helped towards a good first half result, in terms of meeting our FY 17 EBITDA and another strong cash performance. Although company guidance for the FY is unchanged, we sense there is scope for slight outperformance, since the H1 result represents 53% of our FY estimate. Net debt was c. £10m below our estimates, before the Bison acquisition, which we thought was a positive move
Brick and concrete products manufacturer Forterra has broadened its end markets and added to the group's growth prospects with what we see as the opportunistic £20m acquisition of the trade and assets of Bison Manufacturing from loss-making construction group Laing O'Rourke. Forterra states that it would have cost over £35m to build the business itself on a greenfield site and estimates that the deal will make returns in excess of its cost of capital during 2019. We estimate it will at least break even in 2018.
Strong housebuilding data, encouraging statements from leading housebuilders and the Conservative Manifesto’s pledge to build 1.5 million homes by 2022, reinforce, in our view, the robust tone of Forterra’s AGM statement. This indicated strong brick demand and overall trading in the first four months and, once again, impressive cash flow. Short-, mid- and long-term trends appear encouraging, in our view.
A year to the day after the IPO, Forterra's US private equity owner has placed its entire remaining c. 53% holding at 195p – a 5% discount to yesterday's closing price. The placing was larger than initially proposed yesterday "due to strong investor demand". We believe the market may have viewed the 'overhang' as a concern and this might have partly explained the stock's discount versus larger rival Ibstock (IBST). The shares have reacted positively in early trading, rising to a new high. This comes against what we see as a positive backdrop for suppliers of bricks and other new housing products.
The top three brickmaker’s FY 2016 results announcement gave an upbeat outlook, for at least the first half of the current financial year, driven by “strong” house-building levels and a reduction in the stock overhang among builders’ merchants. It maintained guidance for FY 2017E. We have trimmed back our estimates, which were slightly ahead of consensus, principally to reflect a higher depreciation charge than we had modelled. We continue to believe that Forterra offers long-term growth, fuelled by Government housing policy.
Government aid to boost housebuilding could require at least half a billion more bricks by 2021, we estimate. This reinforces what we see as Forterra’s attractions to investors: a fundamental product, underpinned by long-term demand; a consolidated market; and conservative management. Forterra has, in our view, a particularly attractive risk-reward balance and an undemanding valuation relative to its peer group.
Latest building materials data from the government shows that the level of brick stocks held by manufacturers has fallen for five months and is now 11% below their recent peak in May 2016. Moreover, the more representative YoY rate of increase has narrowed almost every month for a year as manufacturers, particularly Forterra, have trimmed production, while imports have also normalised. This, in our view, could support pricing power and help dispel concerns among some investors about over-stocking by big customers.
Yesterday’s Autumn Statement appears to be: good for 'alternative' housing providers, UK-focused contractors and materials producers; potentially problematic for mainstream housebuilders; and bad news especially for lettings-dominated agents. Chancellor Philip Hammond’s key spending measures included an additional £3.7bn funding to boost new housing volumes and £1.1bn for roads. Shares in estate agents, however, have fallen in response to the threat to ban them from charging fees to tenants.
Brick maker Forterra has issued a reassuring trading update ahead of tomorrow’s investor day, highlighting “encouraging” trends in volume and industry stock levels. We are not changing our P&L estimates but have again trimmed our projected net debt, notwithstanding further modest capex signalled for 2017. The company, in our view, stands to gain from likely government action to boost housebuilding volumes and has continued to demonstrate its operational and financial focus, at a still attractive valuation.
We maintain our headline profit estimates for 2016 - 18 after the brick and building products group unveiled its maiden interim results. We have cut our debt forecasts after better cash flow than the company had anticipated. We believe our target price of 183p looks increasingly conservative, given the strength of cash flow. Despite having risen 50% since its post-Brexit low point, we believe this conservative and cash-focused group represents attractive value at a 2017 yield of 5.8%, P/E of 6.9x and EV/EBITDA of 5.5x.
The first signs that UK brick stocks appear to be declining appear in today’s building materials statistics. Along with (in our view, overdone) Brexit fears, we believe rising stock levels had been one of the reasons for Forterra’s weak share price performance since its April IPO. Although this data is only an early indicator of supply and demand coming more into equilibrium, it adds to our strong Buy case for the UK’s number two brick manufacturer, which appears still undervalued despite bouncing 26% of its 8 July low. Our TP remains 183p.
Forterra, the former Hanson Building Products, should benefit in our view from sustainable long-term growth in housing volumes, underpinned by demand for its unique yellow London Brick range. The shares have fallen 35% since the EU referendum, but we believe the impact of ‘Brexit’ should only be a temporary hiatus. We believe the company is conservatively run, cash generative and agile. At an estimated 2017 P/E of 4.9x, yield of 8.2% and FCF yield of 22.4%, the share price fall looks like a buying opportunity. We initiate with a 183p TP.
